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Weekly market update - 11th of June 2019

Written and accurate as at: Jun 11, 2019 Current Stats & Facts

The local bourse gained +0.7% last week. This was driven largely by the rate-sensitives and the banks in the wake of the RBA’s well-flagged cut in the cash rate target by 25bps to 1.25% - a historic low.

It was a relatively tight week in terms of the dispersion of returns for the S&P/ASX 100. Lendlease (LLC) was the weakest stock, down -8.6% on reports of another cost blow-out in its Engineering division, this time for the Melbourne Metro rail project.

A2 Milk (A2M, -7.1%) also underperformed as a recently-released plan from China’s National and Development Reform Commission (NDRC) flagged a potential threat to its infant formula sales. The plan calls for an increase in the proportion of Chinese-produced formula to 60% of the market, from just under 50% today. It also outlined increased regulation of cross-border e-commerce sales. This news also hit A2M’s small-cap peers and highlights the geopolitical risk to this sector. Chinese regulation and policy can be opaque – a fact which is sometimes not reflected in the valuations of this high-growth sector.

Listed property stocks jumped in response to the RBA’s move. The S&P/ASX 300 AREIT index gained +3.5%, on the view that lower cash rates will prompt a shift into defensive high-yield equities to meet their income needs. Goodman Group (GMG, +6.6%) was the best performing stocks in the ASX 100, while Charter Hall Group (CHC, +5.8%) and GPT Group (GPT, +5.0%) also ran well.

Infrastructure outperformed on the same trend, led by the country’s largest gas infrastructure business APA Group (APA, +6.5%). Spark Infrastructure (SKI, +3.9%), Atlas Arteria (ALX, +3.0%), Sydney Airport (SUD, +2.6%) and Transurban (+2.4%) all outperformed.

Elsewhere, the banks gained +1.8% in aggregate. The regionals did best: Bank of Queensland (BOQ) was up +2.7% and Bendigo & Adelaide Bank (BEN)+2.4%. Westpac (WBC, +2.0%) led the majors, followed by Commonwealth Bank (CBA, +1.9%), ANZ (ANZ, +1.8%) and National Australia Bank (NAB, +1.6%).

While the RBA’s rate cut is seen as limiting the downside risk from housing, which is ultimately good for the banks, it also results in more pressure on margins and earnings for the core mortgage businesses. The banks’ outperformance suggests that the market was focused on the former narrative. Offshore funding spreads have been easier for the banks in recent months, which has helped allow the banks to pass on all of the cut (CBA, NAB) or most of it (ANZ, WBC) without attracting widespread earnings downgrades. The consensus expectation is for the RBA to cut again; if they do, the banks will be under pressure to pass the cut on, which is likely to have a negative impact on earnings. The issue is compounded by the reluctance of most banks to cut deposit rates and risk losing flows – and the fact that it becomes progressively harder to cut rates anyway given their already low absolute levels.

The key takeaway is that while sentiment on banks has no doubt improved, many investors remain cautious on their ability to sustain outperformance given the pressure on revenue, margins, costs and earnings. Valuations remain cheap by some measures, but look less compelling once earnings pressure is factored into the equation.

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