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Weekly market update - 4th of March 2019

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

Another week of gains capped a strong month for Australian equities, with the S&P/ASX 300 up +0.4% to finish +6.0% ahead in February. Financials gained +1.4% for the week, A-REITs +0.4%, while Resources gave up -1.1%.

The implications of Vale’s tailings dam tragedy dominated the macro. Reduced production has seen tighter iron ore markets and a sharp reduction in the discount for lower grade 58-fines ore – such as that mainly produced by Fortsecue Mining (FMG) – below 63-fines. The issue continues to escalate, with the Vale board bowing to government pressure and standing down its executive and installing temporary management. Ultimately, as much as 70m tonnes could be withdrawn from the seaborne market in the near term, from a total Brazilian production of ~440m tonnes. Iron ore futures are currently trading at ~US$85 a tonne, but there is an expectation that this tightness could shift this into the US$90 range. Most consensus mid-to-long term forecasts have iron ore at US$60-$65, implying material upgrades for the miners.

We saw the last few results of the season, with both Bluescope Steel’s (BSL, +9.5%) and QBE Insurance’s (QBE, +9.4%) being particularly well received. BSL’s result was, if anything, slightly behind expectations, however management did a good job in addressing market concerns over the outlook for steel margins and the fundamental case for the additional capacity that BSL plans to add in the US in coming years. QBE is enjoying the tailwind of mid-single digit price increases and has seen a material improvement in operating performance in recent halves. However the company needs to deliver a strong ‘hockey stick’ second half to meet the full year guidance. We see further margin pressure coming through and, with consensus expectations currently at the top end of the guidance range, see some scope for disappointment here.

The market also responded well to the improved trends in both Australia in France in Ramsay Health Care’s (RHC, +6.7%) result. In Australia, there are signs of a pick-up in higher margin elective procedures – such as knee and hip replacements – following a period in which people were tending to defer to-essential procedures. In France, the regulatory pricing environment saw some improvement for the first time in a decade. RHC ended up +14.2% for the month.

Retail fuel networks Caltex Australia (CTX, +0.7%) and Viva Energy (VEA, +3.0%) – which distributes Shell-branded fuel – both reported. CTX’s result did not contain any surprises, having been largely preannounced. Management responded to calls for the liberation of franking credits via an off-market buy back; CTX has one of the highest ratios of franking credits to market cap in the market. VEA had already enjoyed a strong run into its result following the deal that gave them control of the retail fuel margin at the Coles petrol stations and, like CTX, produced no surprises on reporting day. It was one of February’s strongest performers, up +31.0%. Both have battled with the headwind of low refining margins, which should see some seasonal improvement as northern hemisphere refiners shut down for maintenance as they move into Spring.

There was a marked rotation away from defensives in February, towards cyclicals and the unloved as some of the macro fears receded. Financials outperformed, up +9.1% (S&P/ASX 300 Financials), with the banks outperforming despite lacklustre updates as the overhang from the Royal Commission disappeared. ANZ (ANZ) was the strongest of the Big 4, up +11.9% for the month. Resources (S&P/ASX 300 Resources) were up +6.9% as cyclicals shifted back in to favour. The S&P/ASX 300 AREIT sector underperformed, up +1.9% given the combination of its more defensive characteristics and the pressure on both the retail and residential housing sub-sectors. This was exemplified by the fall in Westfield Unibail Rodamco (URW, -7.1%) – with its exposure to European retail – and Stockland Group (SGP, -7.4%) which owns both residential and retail assets. Gold stocks such as Evolution Mining (EVN, -9.1%) and Newcrest (NCM, -0.1%) lagged as investor confidence improved.

At a stock level, Cochlear (COH, -11.9%) was among the notable underperformers, as a highly-rated growth stock not delivering on expectations. Dominos Pizza (DMP, -8.0%) and Treasury Wine Estates (TWE, -3.0%) are two other market favourites which are finding it hard to meet expectations. The Australian domestic demand for DMP seems to be slipping, perhaps in response to the greater choice offered by online food delivery companies. TWE hit its numbers, which had been preannounced, but the low conversion of reported earnings into cash disappointed the market.

The regional banks Bank of Queensland (BOQ, -11.4%) and Bendigo and Adelaide Bank (BEN, -8.5%) also lost ground on the view that they are doing it even tougher than their larger peers in an environment of muted revenue growth. Reporting season revealed that supermarkets, too, are in a challenging environment. Both Coles (COL, -9.4%) and Woolworths (WOW, -0.9%) are facing issues from higher costs coming through and the top line not moving as much as required to offset the margin pressure.

While the banks outperformed in February, some of the diversified financials did even better. IOOF (IFL, +36.9%) was among the market’s best, enjoying a relief rebound – and short squeeze – as some of the market’s fears around the Royal Commission went unrealised. Fund managers Magellan (MFG, +25.0%) and Janus Henderson (JHG, +17.5%) bounced along with equity market sentiment. In insurance, QBE’s strong final week saw it up 15.1% for the month.

Nine Entertainment (NEC, +17.2%) is no doubt seeing a reduction in bank and government advertising which  has seen weaker free-to-air (FTA) television advertising revenues, we think the market had over-stated the risk. At the same time, its February result demonstrated the strong growth coming through in areas such as Nine Now which, while still smaller than FTA, has been able to offset some of the pressure here.

Elsewhere, A2 Milk (A2M, +14.0%) continued to be among the market’s best – although there is caution over how much of their market share gains are driven by underlying demand versus an inventory build. A regulatory inquiry into Afterpay Touch (APT, +15.9%) did not throw up a roadblock to its model. James Hardie (JHX, +15.1%) was also among the months’ best as its results came in a little better than the market’s expectation.

It has been a strong start to the year: the S&P/ASX 300 is up over 10% - but it is unlikely that the market will continue to maintain this pace. We would not be surprised to see a more subdued period. That said, it is important to note that of the four key concerns influencing markets in the last six months, three have now settled down, for now:

1.  US Fed Policy mistake. The Fed’s pause on rate hikes has calmed fears here and is a reminder that it cannot be assumed that, just because a risk is materialising, governments and regulators will walk blindly into it. There are considerable vested interests in avoiding a slowdown and, while authorities can be slow to respond, this has demonstrated that they are not deaf to the market feedback loop.
2.  Chinese growth. Likewise, Chinese authorities have responded to slowing growth with stimulus measures which seems to be gaining some traction.
3.  US/China trade. Again, while the risks remain present, the market is gaining confidence that we are moving towards some sort of resolution.
4.  Australian domestic economy. This is the one area which has not seen an improvement in sentiment in recent months. There is little doubt that a slowing housing market is having knock on effects in some areas of the economy. However, at an aggregate level reporting season suggested that companies are not seeing a material step down in activity, but there is some volatility in demand and this is one area which demands continued scrutiny.

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