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Weekly market update - 4th of February 2019

Written and accurate as at: Feb 04, 2019 Current Stats & Facts

Australian equities were strong in January. The rebound from the last few days of 2018 extended into the new year and ultimately into a 3.9% gain in the S&P/ASX 300 Acc index. Gains were underpinned by a shift in sentiment on two of the key issues which weighed on markets in Q4 2018 – US Fed policy and Chinese economic growth.

In the US, there has been a material shift in rhetoric from the Fed, its now more dovish stance suggesting it is not as deaf to market feedback as many feared. We are still facing an environment of reduced liquidity, however investors are now less concerned that a sharp liquidity crunch could drive a more sustained correction.

On the other side of the Pacific, China has continued to unveil piecemeal stimulus measures in response to a decelerating economy. Among the most recent is the provision of credit backstops in the form of credit default swaps (CDS) which effectively address some bank concerns and encourage lending. This serves as a reminder that Beijing does have several levers it can pull to maintain reasonable economic growth, without having to resort to the relatively blunt tool of property stimulus. That said, the trade dispute remains simmering and is still a source of risk.

While the Australian mining sector is ultimately driven by Chinese demand, it was developments in Brazil which saw a 22% increase in iron ore in January. A disastrous collapse in a tailings dam has seen Vale announce that it will close ~40m tonnes of production, equating to about 10% of its annual production. Beyond the short-term squeeze in iron ore markets, this could have more profound consequences as mines around the world review tailing dams constructed along the same lines as the one which failed so tragically at Corrego de Feijao.

A collapsing oil price also weighed on markets in late 2018 and here, too, we have seen a recovery, with the price up 17% as OPEC cuts begin to bite and fears of a major global slowdown recede. Oil companies form a significant part of global corporate credit markets and an improvement in the oil price has relieved some pressure here and seen corporate credit spreads narrow, signalling more confidence.

In sum, an improvement in sentiment on these key issues has been reflected in better equity prices. In a domestic context, uncertainty persists around the outlook for bank lending and the potential for a credit slowdown to drag on the economy. This week’s recommendations from the Royal Commission are likely to provide more direction.

Management downgrades saw several companies fail to participate in January’s recovery. Costa Group (CGC, -25.5%) was among the market’s worst performers, with softer revenues highlighting some supply-side pressures. Both Challenger (CGF, -23.7%) and AMP (AMP, -7.8%) also made pre-reporting season confessions as new CEOs sought to rebase expectations. Last week ResMed (RMD, -17.9%) saw a decent quarterly result go unrewarded as the market focused on uncertainties over the outlook for several of its recent acquisitions.

While a stronger oil price weighed on Qantas (QAN, -6.0%), it was also hit by a large earnings downgrade from Air New Zealand as the market assumed a read-through to the flying kangaroo. Here, it is important to focus on the essential driver of QAN’s turnaround – the industry discipline which has seen no material domestic capacity added for the last 3-4 years, resulting in less need for ticket discounting. The New Zealand domestic market, in contrast, has been growing capacity at ~5% per annum, while demand has not kept pace. Beyond this, the kiwi carrier had headwinds from a strong NZD and engine issues on some planes which led to groundings – again, neither issue is relevant to QAN. 

Fortescue Metals (FMG, +24.8%) led the market’s January charge, benefiting from both the iron ore price gain and a narrowing of the discount for its lower-grade product. This trend has been in place for the last few months, however it is likely to be sustained further as Vale reduces production – the Brazilian miner has traditionally done a good job of blending ore to achieve grades which squeezed out FMG’s product. Elsewhere midcap resource stocks such as Whitehaven Coal (WHC, +14.6%) and Iluka Resources (+14.2%) also did well. A 5% gain in the copper price indicated the broad strength in commodities in a more supportive environment, beyond the specific event in iron ore. The LNG stocks such as Santos (STO, +18.1%) rallied along with the oil price.

Strong performance from Afterpay Touch (APT, +28.3%), Wisetech (WTC, +20.4%) and A2 Milk (A2M, +17.1%) shows that appetite for smaller growth stocks remains undiminished, ready to resurface at any signs of better market sentiment. 

TPG Telecom’s (TPM, +8.5%) announcement that they would no longer build their 5G telecom network – regardless of whether the ACCC approves their tie-up with Vodafone – also saw a bounce in Telstra (TLS, +9.1%). There were also suggestions that a Labor Federal government would write down the value of NBN Co, allowing it to cut wholesale prices to resellers such as TLS, which would result in more competition and less reliance on 5G mobile. With plenty of speculation over the implications of a change in government for banks, wealth management, and insurance – Telstra stands among Australia’s largest companies as one of the few which might at least not ‘lose’ under a shift to a Labor government.

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