From Jonathan Bayes, Chief Investment Officer, Partners Wealth Group.
So much to cover this week, with a large focus on the economy and the ‘bigger picture’ so to speak.
Now first, can I say, I don’t try to be deliberately negative or cynical.
Whilst its certainly an innate bias of mine, I am not going out of my way to be so.
So, when I speak to my concerns for the local economy in the years to come, these concerns stem from a genuine appraisal of the facts as I see them.
Furthermore, I think there is merit in focusing on risks locally for the purposes of risk mitigation since so much of Australia’s domestic superannuation pool continues to reside in the local share-market.
Investors would do well to hold some cynicism given such a substantial exposure.
Using that as a preface, this week was interesting.
Two year high on the Australian Dollar unhelpful
The Australian Dollar soared to a 2-year high of 80.99c against the US dollar, and press reports spoke optimistically about a rebound in wages growth citing rather innocuous remarks from both the RBA Governor Philip Lowe and the Treasurer Scott Morrison.
Australia’s short term money markets even moved to price in a rise in local RBA cash rates in the coming year, for the first time in 6 years.
No interest rate rise ahead despite what you might be reading
But to be super clear, the prospect of a rise in Australian interest rates in the coming year is extremely low in my opinion. Nigh on minimal.
And the reasons are several.
Firstly, domestic economic activity is barely getting out of second gear as evidenced by the June quarter accounts released this week which showed GDP rising a paltry +1.8% in the past year.
Sure, business confidence is surging, employment has improved a little (at least there is some full-time jobs growth in 2017 unlike 2016 which was the year of the part-time worker), and infrastructure spending is hitting its straps. But on the other side of the ledger, Australian households remain deeply levered and unwilling or unable to loosen the purse strings (as evidenced by this week’s disappointing retail sales figure).
More interestingly, residential construction activity is just starting to soften up as evidenced by the significant fall in this month’s Australian Industry Group survey on new apartment construction orders.
The economy is mixed, not strong, and the rapid rise in the Australian Dollar through 80c is doing more harm than good to our prospects of improved growth in 2018.
In fact, the rise in the AUD from the low 70s to the low 80’s year-to-date is seen as being the equivalent of perhaps 3 x 0.25% RBA interest rate hikes in terms of its impact on the local economy.
The rising AUD puts pressure on our domestic productivity, and acts as a drag on local growth.
In truth, the higher AUD (supposedly on account of our economic rebound) is actually more likely to work against the RBA raising interest rates anytime soon, confounding the optimism of some pundits seen in the media this week.
But all is not lost
Whilst my outlook for the local economy remains indifferent, it doesn’t mean that opportunities aren’t emerging.
For example, the rising Australian Dollar is making it ever more attractive to local investors to raise their holdings to international share-markets.
Secondly, the rising AUD has begun to contribute to underperformance from several high-quality stocks who earn significant revenues from foreign markets.
We think this emerging underperformance from the likes of Sonic Healthcare (SHL), BT Investment Management (BTT) and Mantra Group (MTR) should be watched.
SHL has underperformed -13% since we took some profits at $24 in June, but remains a cracking company and cash-flow generator.
Elsewhere, the market remains bifurcated between the ‘growers’ – stocks with awesome earnings stories like A2 Milk (A2M), BWX (BWX) & Costa Group (CGC) for example – and the fallen, with stocks like Telstra (TLS), Healthscope (HSO), Regis Healthcare (REG) springing to mind.
Telstra (TLS) – broker upgrade this week
TLS was upgraded by Credit Suisse to BUY this week, and they make a good point.
At $3.70 currently, the stock is pricing in a fully-franked dividend yield for at least the next 4-years, but more probably longer.
With Australian 5-year bond yields back at only 2.15%, the yield is pretty attractive.
More so, the underlying valuation of TLS is now looking pretty reasonable too.
CS suggest TLS is sitting on about 17x trough earnings when stripping away all NBN payments, but make the point that this arguably overvalues TLS since the company’s depreciation charge is significantly higher than its likely cash capital expenditures.
TLS on a trough cash P/E ratio is actually on around 14x which is rather compelling, particularly when you consider the prospect of improved earnings in the early 2020’s as 5G services begin rolling out.
Anyways, we have persisted with TLS to our detriment, but still feel like the stock will see $4.00+ as the year winds down.
Other interesting situations
Beyond TLS, the likes of HSO, REG and MTR all look particularly interesting.
Whilst certainly not making excuses for a couple of poor share calls, value is still very much on the outer in terms of ‘style’, but that doesn’t mean there isn’t merit in ‘value’ in some pockets of the share-market.
HSO has been sent to the naughty corner following its disappointing 2018 guidance, but at $1.62 I feel the stock is a steal for the medium-term investor.
It now sits on 16x (same as the market), but with a heap of growth potential in its expanding portfolio and arguably a likely turn in government policy to alleviate the ongoing decline in private health insurance.
MTR and REG equally look compelling for the medium-term investor, and reflect similar multiples to HSO.
A new name on the horizon is BT Investment Management (BTT), and we are monitoring the situation there with interest.
In the big cap names, Commonwealth Bank (CBA) has given back all of its premium to the sector and now offers a near 6% fully-franked dividend yield.
We won’t be recommending the share unless it gets super cheap such is the ‘over-ownership’ amongst retail investors, and our concerns for Australian housing into 2018 remain, but we can surely acknowledge much of the premium valuation in CBA has now unwound, and investors will likely be drawn to the share should it trade to $70 or so in the weeks ahead.
CBA has underperformed the market by over -9% in the wake of the AUSTRAC headlines and now sits at a near 5-year relative low to the ASX200.
So there are definitely things about.
We remain overweight cash locally, and well placed to act should opportunities present themselves.
We could be looking to spend some of that cash in the weeks ahead, so stay tuned.
For more information on the above please contact your Partners Wealth Group advisor directly or on 1800 333 143.