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Weekly market update - 10th of December 2018

Written and accurate as at: Dec 10, 2018 Current Stats & Facts

The Australian market enjoyed a small gain last week which masked significant rotation in a macro-driven week. It was again the usual suspects in the line-up; trade, rates and oil.

The sense that the pace of Fed rate hikes would decelerate in 2019 saw US 10 year Treasury yields fall almost 20bps to just above 2.8%, a substantial shift from where we were a few months ago. Bond-sensitives in the Australian market rallied in response with the S&P/ASX 300 AREIT index gaining 4.5%.  US job claims data came in slightly higher than expected, which some have pounced on as proof of a deteriorating US economy. At this point several key economists stated they are not expecting to see a major near-term downturn in the US economy. While the data was slightly softer than expected, most believe this is not necessarily a bad thing; labour is already tight in the US and further pressure there would only encourage more rate hikes. Nevertheless, the market is expressing some suspicion here at the moment which, alongside uncertainty over trade and Chinese growth, continues to weigh on cyclicals in the equity market.

The relief at Xi and Trump’s decision to postpone tariff increases has proved short-lived, with uncertainty over what was actually agreed compounded by the arrest of Huawei’s CFO in Canada at America’s behest. This is a reminder that trade friction will continue to be a material risk over coming months and is likely to remain a headwind for the cyclical sectors.

On the oil front, OPEC’s decision to cut production is likely to stabilise the oil price. However this cut in supply will take some time to feed through the complex and comes in a season which typically sees inventory expansion – as a result, consensus feels it would be unlikely to see a significant tightening in the oil market.

Wealth manager IOOF (IFL) fell -33.3% as APRA moved to disqualify its senior executives. The immediate implication for IFL is unclear and it also raises some doubt over its purchase of ANZ’s (ANZ) wealth arm. The one near certainty is that we are in an environment of high and increasing regulatory activity, which in turn raises questions over the ultimate structure of the financial industry in the next few years. There are plenty of cheap financials; but investors should remain mindful that there is also plenty of exogenous risk. In terms of ANZ, should the deal fall through it is unlikely to have a material effect on its earnings. A retention of the wealth arm would come with some capital impost, however ANZ has substantial excess capital and is likely to be able to absorb the impact with little problem.

Elsewhere in financials the looming UK parliamentary vote on Prime Minister May’s Brexit proposal weighed on CYBG (CYB, -8.0%). The list of potential outcomes and implications of Tuesday’s vote is long. However it is notable that Parliament’s Remainders and “soft” Brexiteers have combined to pass the requirement that if the vote fails then nothing can happen without recourse to the parliament, which reduces the chance of a default to a “hard” Brexit. At a company level, CYB’s executives were in Australia last week, reinforcing their message of continued cost synergies with Virgin Money and the opportunity to gain further market share as the UK’s larger banks are forced by regulatory change to shed customers. International fund manager Janus Henderson (JHG, -7.3%) was also among the week’s underperformers, joining the increasingly large cohort of cheap financials.

High profile tech company Afterpay Touch (APT, -12.0%) continued to bounce around, with some caution over the scale of the regulatory risk it faces in Australia as well as the competitive pressure it will meet as it expands into the US. Several other growth stocks such as Aristocrat (ALL, -5.1%) were also weak.

The market was disappointed with Metcash’s (MTS, -11.9%) result, despite a material improvement in underlying sales comps in its supermarkets business. While the liquor and hardware divisions continue to perform well, the market is focused on the IGA segment; the worry is that sales trends are declining, and management are running out of areas to save costs and support earnings.  The sales decline has slowed materially and is now driven by broader grocery deflation rather than competitive pressure, while some believe that there is further to go in terms of cost savings. MTS is on 10-11x NTM P/E, with a strong balance sheet, roughly 6% yield and continues to buy back stock.

Nine Entertainment (NEC, -4.6%) also sold off despite reasonably positive underlying news, as the market focused on negative data in terms of TV ad growth – which was complicated by the timing of the NRL grand final – rather than management’s upgraded synergy targets from the deal to merge with Fairfax (FXJ).

Adelaide Brighton (ABC, -10.2%) is part of the cyclical bucket which is cheap, but which may find it hard to re-rate in the current macro environment. Management downgraded earnings last week, compounding existing market concerns over the effect of a slowing housing cycle, notwithstanding that ABC’s exposure to cement means that it is less sensitive to housing than many suppose.

Origin Energy (ORG, +7.1%) enjoyed some rare respite from what has been a tough few months, following a well-received investor day which detailed cost-out initiatives. Power companies continue to face a challenging environment as they have to manage the margin pressure of balancing energy previously contracted at elevated levels against the crimped retail prices they can charge today. This lag effect worked in their favour for a period, but has now swung about. At the same time, the structural declines in prices for renewable energy is likely to see reduced price points right across the complex, highlighting the longer term issues facing the sector.

Elsewhere, bond sensitives in property (Scentre Group (SCG, +6.7%), Goodman Group (GMG, +6.9%)) and in infrastructure (Transurban (TCL, +4.1%), Sydney Airport (SYD, +4.4%)) bounced on the fall in bond yields. Defensives such as Telstra (TLS, +5.1%) were rewarded, while BlueScope Steel (BSL, +7.0%) was one of the few cyclicals to outperform as it topped up its buy back programme.


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