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Weekly market update - 23rd of September 2019

Written and accurate as at: Sep 23, 2019 Current Stats & Facts

The broader environment helped our market to a positive second consecutive week by gaining almost one per cent.  The oil price surged in response to drone attacks upon the Abqaiq and Khurais oil facilities in Saudi Arabia’s east, which disrupted around 5% of global oil supply. Brent crude rose from US$60 to as high as US$69 a barrel, before settling at around US$65 by week’s end, a gain of 8%. This saw the Energy sector (+3.1%) post the best gains for the week.

Bonds also rallied during the week, with US 10 year Treasury yields falling from 1.90% to 1.75%. This meant we saw a reversal of the usual relationship between the oil price and bond yields. Typically, oil and bonds are positively correlated – in the sense that a rising oil price generally implies improved demand, a better outlook, and lower bond prices. However in this instance, the supply-side shock – and its geopolitical associations – saw oil and bond prices rise in concert.

This defensively-minded rally in bonds was exacerbated by worries over volatility in US short-term money markets. The Fed has been required to inject liquidity into the overnight lending (or ‘repo’ markets) to address a shortage in short-term funding and keep overnight interest rates in check.

Key issues include a relative lack of deposits in the US financial system, as people have shifted into short-term Treasury instruments to improve their return. Central banks around the world have also shifted out of the traditional system to make use of the Fed’s foreign repo programme. There is also a seasonal element, as companies draw down on their balances as tax bills become due. The net effect has been a lack of liquidity in the overnight funding market – and a spike in rates to as high as 10%. Some are pointing to repo market issues prior to the GFC and assuming this portends a similar episode. However, we think that the multitude of moving parts and contributing factors makes it difficult to draw such a simple conclusion. Nevertheless, this has added to expectations that the Fed will have to cut rates faster than first thought in order to inject more money into the system – hence the fall in bond yields.

Nevertheless, this combination of macro issues stopped the previous week’s ‘anti-momentum’ rotation in its tracks. While the logic of this rotation remains, given the high valuations in parts of the market and diminishing earnings risk of some ‘value’ parts of the market, these recent developments may mean that bond-sensitive growth and defensive yield stocks may hold up better than people might have thought.

BlueScope Steel (BSL, -5.2%) was the weakest stock in the S&P/ASX 100. While this was in part due to softer steel margin spreads in the US, BSL also remains acutely sensitive to the state of Sino-American trade. While there was little in the way of news-flow here last week, some chose to read deeper meaning into the cancellation of a Chinese trade delegation visit to mid-Western farms. At this point, most think that a comprehensive trade deal is unlikely before the next US Presidential election in November 2020. December 15, 2019, looms as the next key date when a further round of tariffs are threatened and include a wide range of consumer goods, which is likely to have a greater impact upon consumer sentiment.

A2 Milk (A2M, -4.1%) held a series of investor strategy sessions in Shanghai last week. Under its new CEO A2M plans to diversify its product base and distribution away from infant formula and the daigou channels that have dominated their growth in recent years. Examples include a shift to more traditional distribution – via ‘mother and baby’ stores in China - and moves into new product areas such as coffee creamer in the US. While the sessions were short on detail, it is clear that the uncertainties and risks will be higher, that sales and marketing costs will increase, and that current margins are unlikely to hold. This could see some stock price pressure in the coming halves. It is also an example of the risks to the ratings of some highly-valued growth companies as they shift into more capital-intensive phases of growth.

Packaging company Amcor (AMC, -3.5%) fell in response to oil, which is a key input into its plastic resin. Pepsi – a key AMC client in North America – also announced that they would look to reduce their use of virgin (non-recycled) plastic by 35% by 2025. While AMC fell on the news, there are parallels here with AMC’s own pledge to have all packaging either recyclable or reusable by 2025.

The oil price rise also weighed on Qantas (QAN, -3.0%). QAN’s oil price exposure is already 100% hedged for FY20 and 40% hedged for FY21. Along with Virgin Australia (VAH), QAN has the highest level of hedging among any airline globally, leaving it the least exposed to oil price volatility.  

Elsewhere Ramsay Health Care (RHC, -1.9%) saw a large block trade as the Ramsay Foundation sold down its stake for funding. The stock had already begun to recover by week’s end.   

The week’s winners were largely macro driven. Gold miners enjoyed the dual support of falling bond yields and heightened tensions in the Middle East. Northern Star (NST, +8.7%) was the best performer in the S&P/ASX 100, followed by Newcrest (NCM, +7.3%) and Evolution Mining (EVN, +5.1%). The oil-sensitives also did well: contractor Worley Parsons (WOR) was up 6.5%, while Santos (STO) rose +5.4% and Oil Search (OSH) +4.8%.

James Hardie (JHX, +5.2%) updated investors on its North American strategy, where a reorganisation of its account management is showing signs of traction in regaining lost market share in building products.

Outside of this, growth stocks did well as bond yields fell, with Wisetech (WTC) +3.9%, Afterpay Touch (APT) +3.5% and Seek (SEK) +2.9%. Defensive yield stocks such as Transurban (TCL, +1.9%) and Atlas Arteria (ALX, +1.7%) also outperformed.

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