ASX Weekly Wrap 03/10 - 07/10

Welcome to the ASX Weekly Wrap. A weekly email that will be sent out to clients, and also made available on my website, with a brief description of the events that moved the local markets during the week and also what I am watching on an individual stock level. Feel free to provide feedback and alert me to any topics that you may want covered.

In what was another lackluster week for the XJO we saw little movement either side of where we finished last week. We ended the week just +31.5 points up or +0.58%. It wasn’t through the lack of Bullish data either that we didn’t move as almost all the data that came out this week for Australia, and abroad, was on the positive side. The only explanation we can draw from this is everyone is sitting on their hands waiting for the Jobs numbers out of the US tonight which will almost confirm if they raise rates in December or not. Our high was 5,492.10 on Monday and our low was 5,439.80 on Wednesday. A very tight range of 52.3 points for the week.

I’m going to keep the wrap up of the data brief as I want to talk to you about Bonds and why they are so important at the moment. Monday was a very quiet day as we saw half of Australia on a public holiday. Whilst the markets are open and brokers like myself are in front of the screens there are not many calls coming through as I assume most people are not even aware the markets are open.

On Tuesday we had the RBA meet and decide upon our cash rate. As expected they left it on hold at record lows of 1.50%. As I have said in previous week’s wraps I believe this is the bottom of our rate cycle and the next move for rates will be up. On Wednesday we saw our retails sale released which also came in higher than expected at +0.4%. Forecast was for a +0.2% move. Finally on Thursday we saw Australia’s trade balance, for August, released which came in at a $2.01billion deficit. This was much smaller than the anticipated $2.3billion forecast. It was also smaller than the $2.121bill in July. There is some suggestions going around if the price of coal continues to rise then we could see the trade deficit wiped off in a matter of months. Markets didn’t really react to any data at all this week, because as I suspect all eyes are on the Jobs numbers in the US tonight.

At an individual stock level news was also very quiet this week. The big 4 banks all met with the House of Representatives economic committee to be questioned over fees, scandals, rates etc. Most are skeptical on these meetings and believe they are a waste of time. They did get some comments from the banks suggesting they could have handled certain scandals better, have more focus towards customers and even some admitted that rates on credit cards may be too high. I can see a banking tribunal being created out of this to handle customer grievances and compensation claims. What else comes from this remains to be seen, but I feel it’s a step in the right direction.

Bradken (BKN) received a takeover offer from Japanese company Hitachi Construction of $3.25 per share. This was a significant premium to the last traded price in BKN and consequentially they rose 31% on the back of this. As a shareholder you would have to feel a little upset if this were to go through. It was only a few years ago that BKN received a much higher takeover offer that was quickly rejected by the board. Since then the stock has continued to struggle. The financial services firm Henderson Group (HGG) also moved up sharply on the back of some M&A activity. HGG revealed that they would be merging with US company Janus Capital Group, delisting from the UK and dual listing in the US and Australia as Janus Henderson Global Investors plc. This is expected to wrap up in Q2 of 2017. The market reacted positively to this and the shares rose 11% on the back of it.

Bank of Queensland (BOQ) released its full year results yesterday in what was a fairly weak report. Headlines numbers were: Revenue +3% to $1,117mill, Profit +6% to $338mill and a dividend of 38cps, which was flat. More importantly though were its net interest margins. These numbers came in at 1.94% vs an expectation of 1.96%. More concerning were its second half margins which were only 1.90%. Obviously they are feeling the pinch of a competitive low rate market in Australia. BOQ is not a stock I am focusing on and feel much comfortable investing in one of the big four over them.

The selloff in debt laden, high yielding, interest rate sensitive stocks such as property trusts, TCL , SYD, APA etc. continued this week as the threat of higher rates in the US increased. This is negative for such stocks as it makes debt more expensive for them and as a result it can impact on earnings. TCL already has started to make moves to help ease this burden announcing that it will be paying off some debt owing in 2017 and 2019. They have secured more funding to do this but at secured fixed rates that are lower than the loans they are paying out. These will also relate to what I will talk about later in regards to the issue of rising Bond yields.

Finally in the commodity markets we saw some big moves in Gold and Oil this week. Gold has plummeted to roughly $US1250 ounce after breaking important support on a technical basis. Gold was trading above $US1300 an ounce at the end of last week so it has been a large move. As a result Aussie gold miners took big hits this week and were some of the worst performing stocks. On the flip side WTI Oil rose above $50 a barrel for the first time since April and on the back of OPECs planned cuts in production from last week. This saw the Australian energy sector outperform the market this week as the likes of WPL, OSH, STO, ORG etc. all surged. The thought is that oil could head as high as $55-$60 in this move. However you would have to think OPEC would need to cut more in order to get the price going any higher than that as the world still has a glut of oil.

Technically I could almost post the same chart I did last week for the XJO as not much has changed. We still sit in that upward channel and look headed for 5,700. There looks to be some exhaustion in this current upwards move so we could see a small pull back of 100 points or so before our next move up.

This week instead of focusing on specific stocks I wanted to discuss the situation surrounding Bond Yields in the US, and domestically, and why we should be taking notice of their movements and the implications for our share market.

Over the last few months there has been a changing mindset as to how economies around the world are going to stimulate growth. Since the GFC the central banks have done most of the heavy lifting with cuts to cash rates and the use of Quantitative Easing (QE). However, of late, there has been a changing rhetoric to this problem. It is being realized, certainly by the IMF, but also central banks around the world that lower rates are no longer doing the job and in fact negative rates could be hindering growth. Monetary policy is no longer as effective as it once was in stimulating growth; this includes QE. In fact it has been heard that the EU will begin to taper their QE very soon and it could be completely gone within the next 8-9 months.

Where do they go from here then? Well it’s now being put forward that Governments need to stimulate economies via fiscal stimulus i.e. spending. Since the GFC the common theme has been for Governments to reign in and cut spending. The thinking around this is changing. The most common way Governments can fiscally stimulate this is either by building infrastructure or lowering taxes. Governments would borrow money via issuing bonds to create this fiscal stimulus. This fiscal stimulus should create inflation which will then lead to higher interest rates.

Hence we have a situation now where bonds are being sold off and their yields are rising in anticipation of a change in thinking by central banks and governments and that eventually interest rates will being going back up again.

This is negative for stocks as at the moment we have situation where a 10 year Treasury bond from the US will only return 1.74% per annum in yield. This is compared to stocks where indexes are close to record highs and the returns are much higher. For example in Australia the XJO has averaged around 8% return per annum. This includes dividends plus capital. Due to this disparity price to earnings ratios for shares have ballooned out and are trading at well above historical averages. Now if the yields on bonds continue to increase and close that returns gap Bonds then start looking more attractive and because shares and bonds are fighting for the same investment money, the money flow will start to turn towards bonds. Especially since bonds are seen as a far less risky investment than shares. Hence whilst bond yields are low shares look cheap but if bond yields start rising then they are less attractive.

It also means if interest rates are going up then debt becomes more expensive. This has a twofold effect. The first is debt a company can borrow at and expand their business is more expensive. This can then eat into margins and reduces earnings capability. It’s also negative for investors who use debt to invest. It also becomes more expensive for them to do so making the risk/reward scenario less favorable for them and makes it more likely for them to reduce their investment or not go ahead with it at all.

This is just something we should be aware of and keep an eye on going forward. The shift will not happen overnight and for rates to go up it will play out over a number of years. The markets are always looking forward though so both Bond and equity markets will move in anticipation of this. I hope this makes a bit of sense. I could have gone a lot deeper down the rabbit hole but decided against it in fear of you falling asleep or just getting completely lost.

Quieter week next week in terms of data. We do have the highly anticipated jobs numbers out in the US tonight. I believe that will be about 11pm ACST. These figures likely determine where markets go next week. They will be particularly focused on wage growth as well. I feel this is a far more important stat now than the actual jobs numbers as the US is almost at full employment. Outside of those figures we have Consumer confidence out locally on Wednesday and Business confidence out Tuesday. China’s markets will re-open again after their week off also.

We had a real taste of spring this week with much warmer weather to finish it off. I’m off to the Barossa tomorrow to taste some of the best it has to offer. Quiet weekend sports wise. No footy but NBL and A-League return so I will have something to watch. Keep well everyone and have a wonderful weekend. Go Crows!

- Heath Moss

heath@hlminvestments.com.au

0413799315

Important Notice

Any advice in this article should be considered General Advice only and does not take into account your personal needs and objectives or your financial circumstances. You should therefore consider these matters yourself before deciding whether the advice is appropriate to you and whether you should act upon it. I am happy to assist you in this process. To do so, I will need to collect personal and financial details from you before providing my recommendations. Please note the author may own shares in the companies mentioned in the above blog.