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Weekly market update - 14th of February 2019

Written and accurate as at: Feb 14, 2019 Current Stats & Facts

The market maintained its rally through last week, adding another +3.5% (S&P/ASX 300) as more sanguine sentiment reigned on the outlook for US rates, global growth, and the hope of a trade deal between China and the US – or at least a deferral of for the next round of tariffs. Financials (+6.6%) led the way following the release of the Royal Commission’s recommendations, while A-REITs gained +3.7% and Resources +1.0%. While we seem to have shifted from a stance of fear to optimism in a few weeks, we remain mindful that we are in an environment of elevated macro uncertainty with some signs of a softer growth outlook and, as such, would not be surprised if the market moved into a consolidation phase as we shift into reporting season.

On the macro front US 10 year Treasuries fell to 2.63%, while Australian 10 year bonds rallied to 2.2%. The latter reflects recognition of a slowing economy and the RBA shifting from a bias towards tightening to a more neutral position, with its updated forecasts on Friday catching up to the consensus view of a softer outlook.

Little shifted in the commodity markets, as the Chinese New Year holiday saw a drop in trading. Oil softened a percent, while iron ore crept a little higher and remains above US$90 a tonne. The last time the iron ore price was at these levels the AUD was at parity with the USD; today, with the AUD at 70c, the tailwind to Australian miners is even stronger. A strong oil price continues to propel Fortescue Metals (FMG, +3.4%), which enjoys the additional benefit of a narrowing discount for its poorer-grade ore as Vale production comes under pressure. On the flip side, BlueScope Steel (BSL, -4.2%) was among the weakest stocks as higher iron ore eats into its margin.

As expected, the Royal Commission did not ultimately recommend any extension of responsible lending requirements, relieving some risk to growth from tighter credit. The Commission’s recommendations called for some change in the wealth industry, although it stopped short of advocating an end to vertical integration. There were also some new proposals for the regulatory regime. The most significant outcome for the banks was the statement of shortcomings of National Australia Bank’s (NAB, +4.0%) senior management, which has ultimately led to the departure of both the CEO and Chairman. The key question regarding NAB is whether new management will look to scale back on the bank’s investment strategy and possibly take a haircut on the dividend to rebase expectations. We see uncertainty to persist here for a period.

Even as the Royal Commission overhang disappears, we still see a challenging environment for banks. Commonwealth Bank’s (CBA, +7.2%) half yearly report demonstrated the pressure facing banks, driven by weaker margins on their mortgage book. Revenue growth is limited as mortgage competition remains robust and the appetite for repricing remains limited. Meanwhile higher overnight indexed swap (OIS) spreads have led to sustained higher funding costs, putting further pressure on margins. NAB’s trading update demonstrated that the key issue lies in retail mortgages, as trends in SME lending remain reasonable.

Elsewhere among the financials, Westpac (WBC) added +9.0% and ANZ (ANZ) +7.9%. NAB’s erstwhile UK arm CYBG (CYB, +10.9%) produced a better quarterly report than many expected following their surprise margin downgrade in late 2018. Management upgraded their margin outlook, while also providing further detail on the cost synergies to come from the merger with Virgin Money. Consensus earnings were upgraded, although Brexit remains a near-term overhang. Fund manager Janus Henderson (JHG, +8.3%) delivered an average result, but no worse than the market expected, and has been helped by the market’s recovery in recent weeks.

As the market expected, a softer housing market and execution issues with its US flyash strategy saw Boral (BLD, -2.8%) downgrade earnings guidance, although they went harder than the market expected.  REA Group’s (REA, -1.9%) result revealed the impact of a softer housing environment and fewer listings in Australia. Nine Entertainment (NEC, -4.0%) also underperformed as the market remains concerned over the outlook for advertising. There is no doubt that the ad market has been weak, with the banks having stopped advertising and unlikely to start again until after the election.  At the same time NEC continues to win key rating battles, with Married at First Sight winning the battle against Seven’s My Kitchen Rules…

Viva Energy (VEA, +22.4%), which distributes Shell fuel in Australia, soared on the back of a deal which saw it purchase the right to set the retail fuel margin at the Coles-operated petrol stations, which had been previously set by Coles management. This will result in a meaningful earnings uplift for VEA, as well as allowing it to drop the fuel price – currently at a material premium to the market – in order to win back some market share. Elsewhere, James Hardie’s (JHX, +9.3%) result was in line with expectations but gave more confidence in the outlook as the US housing market shows some signs of improvement and input costs seem to be rolling over. At the same time, the new CEO has reaffirmed his commitment to the market’s existing strategy to regain share in the US market. While execution risk remains, the market found reassurance in this consistent approach to strategy.

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