ASX Weekly Wrap 24/10 - 28/10

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.

Well we certainly got more movements in the markets this week but unfortunately it was not in the direction we had hoped. The market peeled off -146.50 points during the week or -2.70%. Our high was 5,455.7 on Tuesday and our low was 5,261.40 today. The market started the week off relatively flat with the market keen to digest CPI data out on Wednesday. Once that data was released the selling only proceeded to get more aggressive and has continued that theme for the rest of the week.

As stated above the most important, and really only piece, of data to drop this week was the Australian third quarter CPI figures. The headline number was lot stronger than forecast. It came in at +0.7% for the quarter on quarter versus a forecast of +0.5%. Year on year was also higher than expected with a +1.3% print. Core inflation, which strips out large one off items, came in right on forecast of +0.4%.

This continues the theme I have been speaking about for a few weeks now that the global trend is turning and that it seems as if inflation, and hence rates, have bottomed and that the figures are starting to turn up. For me this also signals the confirmation of the bottom of the Australian cash rate cycle as well. Obviously this mean eventually the next rate move for the RBA will be up. Generally higher rates are negative for equity markets as all indicators to which earnings performance are measured by rise plus the fact that that debt becomes more expensive. Also eventually the returns gap possibly made by other investment classes compared to equities starts to narrow and because equities are seen as a riskier asset class a move is made out of these into others.

Now I need to be clear here. This is not something that will play out tomorrow and that will cause our market to collapse. This is something that will play out of the coming years, but because markets are always looking forward this is something they start to factor in now. I wouldn’t expect any consideration of the RBA raising rates to happen until late next year or even into 2018 but the market will account for the possibility now.

NAB came out with its full year results on Thursday which were generally well received. Their cash earnings were +4% to $6.48billion, however statutory net profit was off some 94.4% to $352mill as NAB wrote off the CYBG demerger and the sale of 80% of its life business. Costs were down 2% and Tier 1 Capital ratio was up 7bp to 9.80%. This is significant as they are only required by regulation to have an 8.75-9.25% ratio. Again this further strengthens the view the big banks will not have go to market for more capital any time soon. NAB was able to maintain its final dividend at 99cps but its payout ratio now sits at 88% which unsustainable. Historically it has sat in that mid-70s range so you would either need a lift in earnings to get it back down or a cut in dividends. The later seems more likely going forward.

On the negative side interest margins declined 2bp as a result of the low rate environment and increased competition. Bad debts also rose 7% to $800mill, but remain well under control. Finally revenue only rose +3.7% excluding significant items.

Overall it was a solid report and further enhanced the view that the decrease in bank earnings has probably bottomed out and there is no further need for capital. Growing earnings is still tough and will be for the foreseeable future but they should be able to still pay a 6%+ yield and be a relatively safe, low risk investment. I reiterate that the big 4 are all worth entry at this point as long term holds. On current earnings NAB is trading at 11.5x PE and yields 7.1%.

Macquarie Group (MQG) also reported their half yearly earnings this morning in what was also a fairly solid, but expected report. Net profit came in at $1.05bill, down 2% on 1H last year but up 6% on the last half. Operating income was also down 2% on 1H but up 8% on last half at $5.2bill. The first half dividend is $1.90 (45% franked) which is up on last year’s $1.60 in the same period. Tier 1 capital ratio was at 10.4% which MQG says is a $3.7bill surplus to regulatory requirements. Their annuity style business net profit contribution was down 15% on the same period but up 36% on the last half.

What can we take away from this MQG report? I think the biggest takeaway is reliability and consistency of earnings. MQG has transformed itself from a volatile earner relying heavily on international markets to that which 70% of earnings now is derived from its annuity style business. This provides stability and a predictability in their earnings. One that should fill investors with confidence. So whilst you won’t get huge lifts in earnings year on year, MQG’s earnings are a lot safer. On their current earnings MQG is trading 12-13x pe and has a yield of 5.3%. I like MQG and what they bring to the table, however I do think they will pull back to that $72-$73 mark based on the above chart. I will wait until then for another entry point.

Just rounding out the banks ANZ announced today that it would write down a further $268mill in charges in its upcoming financials due for release next Thursday. This takes the grand total to $360mill. The latest write downs relate to the way it values its derivative instruments ($168mill) and some restructuring costs ($100mill). The market did not like this as it wasn’t really expected and the stock was down 1.5% on the back of it.

Wesfarmers (WES) had a quarterly update out on Wednesday and it wasn’t pretty reading. It seems some of what has hindered Woolies earnings over the last few years are having an impact with WES as well. First quarter sales dropped for Coles by 0.3% on year as competition continues to increase. This mainly stems from the convenience store division as overall food & liquor sales were up just under 3.0%. Their Liquor division also is struggling to get a foot hold as WOW Dan Murphy’s brand dominates the market. Bunnings continues to power on lifting sales by 7.4%. Kmart sales also rose strongly by 11.2% but Targets fell a whopping 17.1% as the company refocuses the company to be more in-line with Kmart. They have stopped having big toy sales as they reduce inventory as the average stock is held for 6 months plus then customers often have length laybys on these as well. Higher inventories and stock that doesn’t move quickly are often bad for the balance sheet of retailers. Finally Officeworks sales were up strongly as well by 7.5%.

The market did not like this at all focusing on new sales pressure on Coles and the restructuring of Target. The stock has been sold down this week from the mid-$45 range to now around $40.20. One has to imagine if the Target brand will be dissolved all together and just swallow up into K-mart. There would seem to be some self-cannibalization in trying to structure Target the same as K-mart. Most target stores could easily be sold off or converted to K-mart.

WES also made a quick note regarding its Coal division. It said EBIT would break even this half as opposed to the $310mill loss it saw in 16. This is a result of higher metallurgical coal prices and increased production.

Not much excitement in the commodity prices or resources sector this week apart from Iron Ore. Iron Ore has continued its gradual rise from mid $50s to sit above $63 a ton at the moment. This saw healthy weeks for the likes of BHP & RIO but mostly for FMG. As suggested last week FMG was poised to break to the upside and it did this week. It now sits at $5.50+ and looks set to continue its rise. I would expect BHP & RIO to soon upgrade earnings forecasts or at least come in at the high end of current forecasts. We have seen significant rises in Met Coal, Thermal Coal and Iron ore in the last few weeks. This will only add to their bottom line. The AUD is also helping the cause staying fairly stable trading in that 74-77c range against the USD. If the US do decide to raise rates though in December and into next year we could see the AUD fall further which further enhances BHP, RIO & FMG’s earnings potential.

As I mentioned last week, it was an important week for the XJO technically this week. We broke that upward trend line (red) and didn’t snap back above it. This mean 5,225 is our new target (green line) as this should act as the neckline. It has been resistance before and acted as support twice since then (blue circles). We need to hold this and bounce off it before consolidating and starting a new trend. If we can’t hold this then we could possibly see 5,000 again or even 4,850.

I thought we had enough strength last week to hold our upward trend and continue on our merry way but I feel that strong CPI number was the last dash which sent us through. Traditionally the markets are very strong in Nov/Dec, but I feel my previous target of 5,700 will not be reached now, barring some miracle. The bottom of that upward trend will now act as resistance on any move upwards. November is also traditionally the worst month for banks, as most go ex-dividend so money comes out of the market as investor move onto the next yield play.

I can see strength coming from the Resources (gold & iron ore) sector, Industrials and Health. I believe there is probably another week of downward movement to play out before our next direction is decided so it may pay to sit tight.

I know I haven’t had many individual stocks I am focusing on of late, but most of the others I have mentioned in the past still are on my entry list. I haven’t had any stocks scream out to me in the last few weeks hence the lack of mentions. Sometimes it’s better to sit on your hands and conserve capital than jump into a stock just for the sake of it. I am happy to discuss any stocks previously mentioned, in your portfolio or others you just want some general advice on. Feel free to give me a call or shoot me an email.

A quiet start to the week next week before a load of data is dumped on us in the latter half. Markets will be very quiet on Monday and Tuesday as most Victorians will be out of the office for the Melbourne Cup. The RBA makes a cash rate decision on Tuesday which is expected to be a non-event. We then have our services PMI and trade balance out next Thursday. On Friday night the US has its own trade balance out + employment figures. On Wednesday CSR releases its own earnings and then on Thursday we have ANZ plus BT Financial release theirs. Of course tonight we have Q3 GDP figures out for the US which are expected to be a bit soft. Any sign of strength will almost mean a rate rise is a certainty.

A quiet weekend for me personally. The NBA is back, which I am very happy with. I’ll see if I can sneak in a few cheeky games without the wife noticing. The AFL fixture was released during the week and Crows fans should be happy with it. I don’t see it as difficult as this years, especially the start. We also got 5 Friday night games, 4 of which, are at the Adelaide Oval. Bring on 2017 I say. Hope you all enjoy your weekend and take advantage of this beautiful weather. Will speak with you next week. Go Crows!

heath@hlminvestments.com.au

0413 799 315

PO Box 6014

BURTON SA 5110

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.