ASX Market Update 21st June 2021

ASX200 (XJO)

· The XJO closed the week with a 56.60 point or 0.77% gain. Our high for the week was 7,406.20 on Wednesday and the low was 7,312.30 on Tuesday.

· This marks the fifth straight week of gains for the XJO and a strong 11.87% gain for 2021 thus far.

· We saw a record close on the XJO on Wednesday of 7,386.20, with an intraday record high of 7,406.20 on the same day.

Market Commentary

The XJO has continued to outperform in the last month topping new highs several times, driven mainly by the banks and resources stocks. Our market continues to be cum-upgrade whereby we have had many companies release trading updates for the fourth quarter upgrading their FY20/21 earnings. This then sees analysts and research houses lift their forecasts and price targets for stocks and the market then plays catch up. We are seeing this across numerous sectors except for Australian tech which seems to be a laggard and still suffering from lockdowns. This is all on the back of an extremely strong economy and the fact we have remained mostly open for the last 12 months.

This week we saw jobs figures for May which made me look twice as I could not believe what I was reading. For the month we saw 115k jobs added, of which 97,500 were full time positions. Hours worked grew 25mill+, the participation rate grew to 66.2% and the unemployment rate fell to 5.1% from 5.5%. These were extraordinary strong numbers and unexpected by most. However, if you have been tracking the ANZ Job Ads data, which sit at 12-month highs, you can start to understand the strength. Add in record high figures for hiring intentions, capacity utilization & spending intentions from the NAB business survey it also supports the figures we saw.

The previous week we had Q1 Australian GDP figures released which also saw a beat on forecasts. The figures came in at +1.1%y/y and +1.8%q/q vs the +0.6% and +1.5% forecast. Our economy is now larger than it was before the covid pandemic, and we are only one of four nations to be in this position.

From Job Keeper & Seeker keeping people in jobs, with incomes and in constant communication with employers during the tough March to June months last year. To the business payments, first home buyer grants + building grants, credit rules relaxation, home loan holiday’s, industrial relations law reforms & the new landlord/renters structure it really set up Australia to survive and come out of this pandemic in a stronger position than before. Federal & State Governments must be commended on the support measures plus getting them out there quickly as it saved the economy from complete Armageddon. We are the envy of the world and for incredibly good reason.

Looking to the US and what is dominating most market headlines these days are the inflation figures we are seeing flow through in their economy. For April they saw +4.2% headline & +3.0% core CPI figures and in May we saw +5.0% & +3.8% respectively. These are extremely high numbers and figures we have not seen since the early 80s. The Fed is still shrugging these off as transitory and at this point bond markets tend to believe that as well. The US 10yr Treasury yield has dropped from 1.75% to 1.44% currently over the last couple of months despite some sharp increasing along the way.

To confuse matters further we woke up to the Fed’s monthly meeting on Thursday morning with a more hawkish tone. Whilst rates were kept on hold more than expected Fed members had moved their dot plots higher as to where they expect rates to be over the next few years. At this point there is a 70% chance of at least one rate hike by 2024, but the market is reading the changing tone by the Fed telling them this could increase to possibly two or three rate hikes by then. Whilst the Fed member dot plots are not a forecast and hardly reliable it feeds that higher rates and inflation machine we have been hearing about in the last few months. To add to this the Fed has upgraded their CPI forecasts for 2021/22 as well.

Locally I really feel for the head of the RBA Philip Lowe. He no sooner had given a speech on Thursday morning reiterating the RBA’s message that we will see no rate hikes until 2024 at the earliest, when they expect full employment and rising wages, only for our May Job’s figures to come in and exceed forecasts by some margin. It is now expected that the RBA will have to shift focus slightly as we will more than likely hit their targets well before 2024. At this stage it looks like the yield curve control (YCC) program will not roll over to the Nov 2024 set and will be abolished, but another lot of QE will be dispersed. Possibly as much as $100bill+. Therefore we rallied hard to start the week after the RBA minutes dropped on Tuesday as obviously QE is bullish for equities.

The reaction to this week’s events in the USD, as per the DXY index above, has been a strong move higher. If rates are indeed expected to go higher sooner than expected this is bullish for the USD. However, to me this looks like it could be a typical short squeeze as well. Short USD was one of the most popular trades over the last 12 months and if there is even a sniff of this possibly going the other way it will see shorters scramble for the exits. This helps the RBA somewhat as if there is sustained upward pressure on the USD it does most of the work for them and keeps the AUD lower. This means they could possibly have a more hawkish tone and not see the AUD run away. It is hard to say if this USD move is sustained or not. I am still of the belief we see downward pressure on it again in the second half of the year when eventually an infrastructure stimulus bill is passed. Also, economic data in the US has not been as strong as we have seen here of late. It has been more mixed, and they do face some structural headwinds in their labor market.

So how do we sum all this up and relate it back to equities, and how do we play it? From my perspective the longer-term picture stays the same. We will see sustained higher inflation (i.e., 2.5-3% core), remain in a secular commodities bull market, higher rates and real yields & see above median growth in company earnings for the next 2-3 years. Thus, for us we remain focused on resources, financials, discretionary spending, and industrial sectors with a US Tech slant as well. We look to go underweight Australian tech, health care and high growth companies with high debt levels.

In the shorter term expect the market to focus in on Fed meetings and CPI data releases very closely. They will be hanging on every word and data point. This means we could see heightened volatility over the coming months as the USD and yields dominate markets. Remember that higher yields and inflation are generally negative for equities as earnings multiples get revised down, but in the longer-term rising earnings will still see stock prices move up. In fact, we could see a market go sideways for a period whilst earnings still rise and thus bringing PEs down. It does not have to mean markets go backwards to factor in lower multiples.

Commodities

It’s been an extremely rough week for commodity prices especially in copper and Gold. To start the week, we had China declare that they were encouraging producers to source local materials rather than from international commodity markets + they also said they were going to release some copper, zinc, and aluminum from strategic reserves. As to how much and for how long we can only guess. Then, as we saw above, the USD rallied hard putting further downward pressure on commodity prices. Remember most commodities are priced in USD, so a higher USD makes them more expensive to purchase in other currencies.

The copper chart above illustrates the tough week it had. Technically it has pulled back to test the last breakout point and back to the longer-term trend (green) at around $US4.15. Copper worries me the least over the longer term and I am encouraged by the current price action. The fundamentals are extremely strong for copper moving forward as demand will outstrip supply by some margin in the years ahead. This pull back allows you to buy the dips in producers such as Oz Minerals (OZL), Copper Mountain (C6C) and Sandfire Resources (SFR) over the coming weeks. It will also give you better opportunities in explorers and developers such as New World Resources (NWC), Eagle Mountain (EM2), AuKing (AKN), Redbank Cooper (RCP) and Noronex (NRX). Also keep an eye out for the 29 Metals IPO due to list later this year. The founder of Oxiana, now Oz Minerals, Owen Hegarty is involved in the company and they do have some quality assets.

Gold has also had it rough this week as markets are forecasting higher yields it tends to lead to selling in the precious metal. We saw gold drop over 2.5% this week on the back of the yield forecasts and higher USD. It is hard to recommend Gold over the shorter term in what will be volatile times for the precious metals. Thus, it is an avoid for me at this time until things settle down fundamentally and we get some better shape on the charts technically.

Oil has bucked the trend and continues to grind higher. After selling off towards $70bl on the back of the USD move it has almost regained all its losses. I like oil and energy overall in the bigger picture. There is no doubt there is a large shift towards greener transportation, via electric vehicles, and infrastructure as the globe tries to hit emission targets over the next few decades. So, whilst overall that is negative for Oil in the very longer term, in the short term it is providing an opportunity. Due to the shift in focus, and legislative changes, it means there is an underinvestment in oil projects and exploration despite our heavy reliance on it. Gaining debt for projects is a lot harder these days as financials remain under pressure to not fund environmentally bad projects. Biden has also limited possible oil supply in the US with the revoking of the US/Canada pipeline and banning of exploration and drilling on public land within the US. In fact JP Morgan have forecast that at this point there is a $600bill deficit in oil supply investment to meet demand by 2030. To me this means the oil price is going a lot higher and I have heard some analysts suggest $125bl by 2024, which I think is a reasonable target.

Most of Australia’s listed energy companies such as Santos (STO), Woodside Petroleum (WPL) & Beach Petroleum (BPT) produce mostly LNG, but also have oil side to their business. Plus, there is a correlation there between the LNG & Oil prices thus they should move together. Of the bigger producers I like BPT the best as it is seeming best value at current prices.

Karoon Energy (KAR) & Oil Search (OSH) will give you better exposure to oil as KAR starts to ramp up production of its Brazilian oil assets and OSH looks to develop a major oil project in Alaska. Both are also setting up for technical breakouts to the upside.

Another way to play the Oil sector would be to invest in Worley (WOR) whos engineering division does most of its work in the Oil & Gas sector.

In the speculative end of the market Carnarvon Petroleum (CV) looks to be a solid prospect looking to develop its first oil production by 2023. It is a long road ahead and there will be a few capital raisings along the way but if oil prices continue to surge then the CVN evaluation should as well.

Earnings season is around the corner so I think my next update will concentrate on what to expect there and how we should position ourselves for what should be a positive period. I am also keen to revisit the lithium/battery sector again and discuss a few prospects there. However, I will wrap up this week’s update here and now.

As colder weather sets in, we have had the cold virus sweep through the house, however I am yet to catch it. It is hard watching the kids battle it as it does take a toll on their little bodies. At the same time though they are resilient and managed to keep smiles on their faces for most of the time. Its great to see some decent rain here in SA as well. Its something we have been begging for, for some time. I have enjoyed watching the Crows still even though results have been mixed. Have seen some strong performances from us this year with the wins over Melbourne, Geelong, and the comeback vs the Saints sticking out. The future looks promising! Have a great week all and please stay safe. Let us hope the markets remain kind to us. Go Crows!

heath@hlminvestments.com.au

0413 799 315

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.