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Weekly market update - 15th of January 2019

Written and accurate as at: Jan 15, 2019 Current Stats & Facts

The local market has started the year on a brighter note, up +2.3% ytd. There is a sense that the prevailing attitude to the two key drivers of recent volatility – Fed policy and US-China trade negotiations – has turned more positive in the last fortnight, helping the market bounce from what looked like oversold levels in late December.

While the Fed has not changed its outlook for rate increases, Chair Powell made some comments suggesting that the Board is mindful of the equity market in considering its stance. This explicit acknowledgement of market fears has assuaged some near term concerns over the pace of rate hikes, however we would caution against getting overly excited. Having experienced the “Fed put” under Greenspan and Bernanke, Powell’s statement raises the risk that we have shifted to a “Fed call”, in that it may see excessive market strength as the opportunity to continue on a path of more aggressive rate hikes. The Fed’s potential to act as an upside cap on equities was reinforced by Powell’s remarks on financial market excess and bursting asset bubbles as the key driver of recent crises, rather than inflation.  Nevertheless, the slight change in the Fed’s tone has calmed some of the fears of late 2018.

On trade, there is a view that President Trump has backed himself into a corner in threatening to impose 25% tariffs on Chinese imports if no deal is agreed by the March deadline. Such a sanction would cause damage to the US economy, providing strong motivation to get a deal done.

The market’s more positive mood is good news. However a degree of caution is warranted; Risk remains and investors must walk carefully in coming weeks. Any disappointment around the Fed or trade could see the market re-test recent lows. At the same time people, possibly fixated on the Fed and trade, may be understating the weaker data coming out of the European economy. Chinese data is softening too – and this will be a focal point of the upcoming US earnings season given Apple’s recent downgrade due to weaker demand.

It is also important to look at which stocks have led the rebound. The outperformance of bond sensitives (REITs +3.3%, Utilities +4.6%) is understandable as US 10 year Treasury yields have fallen back below 3%. Some recovery in the oil price also explains good gains in the Energy sector (+6.9%). However caution remains over the rebound in growth names, exemplified by the +3.9% return from Technology, led by last year’s darlings such as Wisetech Global (WTC, +13.2%) and Afterpay Touch (APT +9.1%). Growth stock de-rating has been driven by an end to a sustained period of excess liquidity, as QE comes to an end and credit growth has slowed; impling greater volatility and also casts doubt on the sustainability of a growth stock re-rating.

Nevertheless, the Australian market looks reasonably valued at ~14x next-12-month (NTM) P/E, sandwiched between the US market at 16x and Europe at 12x. The latter demonstrates the risk to the Australian market if growth starts to soften. At this point the domestic economy remains okay, supported by growth in jobs, in wages, and by the boost to discretionary budgets from lower fuel and utility prices. It is important to keep a weather eye on the US, where there have been some sharp negative earnings revisions, albeit concentrated on auto and oil-sensitives. The broader economy remains reasonable at this point.

In stocks news, agricultural producer Costa Group (CGC, -37.5%) has endured a tough start to the year. Management downgraded earnings on disappointing volumes for avocados, berries and tomatoes pointing to softer demand, although higher supply of key products and some substitution may also be playing a role. The market has de-rated the stock beyond the 10-15% hit to earnings, reflecting in part its previously high rating for an ag stock. CGC is in a growth phase, investing in new production to reduce geographical and seasonal risk, and has a material degree of capital tied up and not earning as a result. 

Elsewhere in the consumer space, Metcash (MTS, -4.5%) softened on some concerns over falling market share. In stark contrast, third-party analysis and data at this point suggests that, if anything, the independent supermarkets are making gains in share. JB Hi-Fi (JBH, -2.5%) was also weaker, with a poor Christmas for Macy’s in the US and some soft data for smaller domestic clothing stores prompting broader fears on consumer strength.  Again, in contrast, most consumer electronics retailers around the world are suggesting that at this stage, it was a reasonable Christmas.

Sydney Airport (SYD, -1.8%) bucked the broader trend of bond-sensitive outperformance, as data suggests that incoming Chinese tourism has slowed in recent months.  Chinese tourism has been running at 10%+ growth per annum for the past few years, so a deceleration to mid-to-high single digit growth would not be surprising. This is an important trend to watch, given the compounding effect that Chinese tourism has on other parts of the economy. Housing also remains a key trend to watch; REA Group (REA, -2.4%) has been weak ytd on softer volumes and prices in Sydney, in particular. Real indicators of the sector’s health won’t be available until after the summer holiday period has ended in February or March. Any signs of a moderation in pricing declines are likely to be well received – while an acceleration in weakness is another source of potential market risk.

As discussed, the best performers ytd have been drawn from energy, bond-sensitives and the growth sectors. The oil and gas producers such as Origin (ORG, +8.0%), Santos (STO, +6.6%), Oil Search (OSH, +6.3%) and Woodside (WPL, +6.2%) have all enjoyed some relief from the pressures of late 2018 as the oil price has responded to some shut-downs in the US Permian basin and a cut to Saudi oil production. REITs such as Goodman Group (GMG, +7.0%) and Unibail (URW, +7.3%) have also outperformed on lower bond yields. Outside of the tech stocks already listed, growth names in the health care sector such as CSL (CSL, +5.4%) and Cochlear (COH, +6.1%) have done well, as has gaming stock Aristocrat (ALL, +6.5%).

The iron ore price has held steady, supporting Fortescue Metals (FMG, +9.3%), while BlueScope Steel (BSL, +11.1%) has also outperformed within the commodity complex.

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