From Jonathan Bayes, Chief Investment Officer, Partners Wealth Group.
There wasn’t much to trouble the scorers this week, with activity muted by the US Thanksgiving holiday.
Our market idled away, posting small gains, but in all there was little new to mention beyond a few AGM remarks.
The RBA Governor Philip Lowe spoke this week about Australia’s continued excess employment capacity, and gave rather strong guidance that interest rates locally were unlikely in need of a near term adjustment’.
We reiterate the view that local interest rates will remain stuck at 1.5% until at least the middle of next year, maybe longer.
Interestingly, the local bond market continues to rally on this benign outlook and rather momentously Australian 2-year government bond yields fell below those of the US for the first time since the early 2000’s.
Falling bond yields relative to the rest of the world is one of several reasons we remain convinced of further weakness in the AUD, but would highlight near term political uncertainty as a real wildcard in the weeks leading into Christmas.
The December 16th Bennelong by-election really is quite a big deal, and though the incumbent John Alexander should retain the seat given his substantial majority at the last election, Labor’s decision to foist Kristina Keneally into competition for the seat means the outcome is far from assured.
Income options for a low return-world
We sent a note out to everybody again yesterday with some ideas for income generation given the collapsing rate of return on cash, term deposits and bond yields.
We highlighted two funds from Smarter Money Investments, the Active Cash fund targeting RBA+1-2% (2.5-3.5%), and the Higher Income fund targeting RBA+1.5-3% (3-4.5%) as viable alternatives to low-returning cash and fixed income.
Importantly on these funds the manager is deliberately seeking to take as little ‘duration risk’ as possible, minimizing the prospect of capital losses should the bond market sell-off.
In laymen’s terms, interest rate ‘duration’ simply explains the time it takes for a bond to return all of its capital and interest. The longer the duration, the greater the sensitivity the bond has to interest rate moves.
Over the past decade, in Australia and across the world, there has been massive bond issuance by corporates and governments alike aimed at taking advantage of these historically low interest rates.
The bonds issued have had increasingly longer maturity dates – why wouldn’t you try and lock in this low cost debt for as long as possible – and though this is terrific for the borrowers, it actually creates greater risk for the bond-holders.
Australian bond duration is now at a record 5 years, having been only a shade over 3 years in 2009, and this simply means bond investors today have greater risk to moves in interest rates.
We like that the Smarter Money funds are deliberately targeted at low duration investments as a means to mitigating this risk.
We also flagged in that note other sources of income, including the PRIME Defensive Income Separately Managed Account (SMA) and the PRIME Diversified Income SMA, but also the recent recommendations for the AMP Wholesale Australian Property Fund and the MCP Master Income Trust (MXT).
I would encourage you to talk to your advisor if you have lazy cash in your portfolio.
In an otherwise quiet week, China saw a rather dramatic 3% sell-off on Thursday, with markets concerned about the continued rise in local Chinese bond yields.
Share-markets in China are up +25% year-to-date, buoyed by ongoing reforms aimed to diffusing the massive debt pile-up that has occurred in China over the past decade, and for the most part have ignored the steady climb in domestic government bond yields.
However, with 10-year Chinese government bond yields breaching 4% this week (up from 3% at the start of 2017), investors are starting to concern themselves about the threat of rising refinancing costs on China’s semi-government and corporate borrowers.
Interestingly bond yields continue to rise in the face of what actually seems to be a slowing economy, with government officials re-affirming this week that there will be no let up in recent housing sector curbs that have caused Chinese residential housing sales to fall into negative territory year-on-year.
The last time this happened was late 2013, early 2014, and it signaled the start of a major multi-year collapse in iron ore prices.
Certainly again, I fail to see how iron ore prices can remain at current levels for too much longer, but I know I am a broken (and wrong) record here for now.
Domestic Share One-liners
AMCOR (AMC) was upgraded to BUY this week by JP Morgan which we liked the look of.
AMC is just a terrific medium-term grower, with great cash-flow, and a great exposure to a falling AUD in 2018 we think.
Woolworths (WOW), Sonic Healthcare (SHL) and QUBE (QUB) had their AGM’s this week (amongst others), and all sounded reasonably comfortable with the outlook for 2018.
We hope we might see a final resolution to WOW’s intended sale of its service station network to BP before Christmas, and this might provide the market with some modest prospect of a special dividend or buyback in 2018.
SHL confirmed that the first 4 months of trading was in-line with its guidance for 6-8% cashflow growth in 2018.
Whilst SHL is not a major part of portfolios anymore, we love the company, and would relish the chance to add it again should the right price arise.
At $21.60 today it is mid-ground between where we sold out at $24, and where we would like to buy it again at $20.
QUB spoke of similar operating conditions to 2017, which was largely in line with analyst forecasts, but we would note encouragingly that its stevedoring competitor DP World this week raised its container surcharges for the second time this year at key eastern seaboard docks.
This greater price discipline on the docks is awesome news for QUB and its Patrick subsidiary. I have seen some analysts suggest that were QUB to follow suit with a raised surcharge, this could add 10% to earnings.
Finally this week, it was interesting to see a couple of insider share sales in one or two of the best performing stocks this year, with the CEO of Corporate Travel (CTD) selling $25m of stock, and the founder of Costa Group (CGC) also selling down a significant $112m worth of stock.
Both CGC and CTD have had stellar runs this year, and both share sales are by founders/senior management, which probably gives reason for caution in the near term.
For more information on the above please contact your Partners Wealth Group advisor directly or on 1800 333 143.