ASX Weekly Wrap 27/05 - 31/05

This will be a real short wrap this week as most of the headlines dominating markets is macro related. As I have mentioned before this is a real quiet time leading into the EOFY for corporate news on the ASX. The XJO finished off weaker last week by 59.10 points or 0.92%. Our high was 6,464.60 on Monday and our low was 6,362.20 on Friday.

Again trade tensions between the US & China weighed on markets as Trump declared the US were ‘not ready’ to make a deal with China. This was then exaggerated later in the week when trump declared a 5% tariff to place on all goods coming in from Mexico by June 10th unless they stopped illegal human migration into the US and drug trafficking, or at least made an attempt to. The Mexico tariff won’t have much impact but of course it’s a worry for markets of possible things to come. In positive news Trump visited Japan and they are expected to sign a new trade agreement soon after Japan’s upcoming elections.

The XJO is now trading in a much defined up trend. It looked a bit ugly the week before the election and looked like we could perhaps break down to 6,100. However the surprise Liberal win really boosted our markets and we have basically out performed all markets across the globe recently. For example the US was -6.58% in May whilst we enjoyed a +1.1% rally. I have spoken to you all about a possible divergence between the US and Australia occurring over the short term as we look to outperform. The XJO is really telling us it expects that the earnings cycle has bottomed here and things will only improve vs the US where earnings may have topped out for a little while with some downside risk. For us we look like heading towards the top of that channel again around the 6,550 mark.

Short & Sharp

· The RBA cut our official cash rate by 25bps to 1.25% on Tuesday in a move that was wildly expected and priced into markets. Most of the focus was what RBA Chair Lowe had to say afterwards. Basically he confirmed rates would be cut at least one more time this year to a 1% level and left the door open to further measures if needed.

· Australia’s Q1 GDP figures were released on Wednesday and they were very soft, as expected. Our QoQ came in at +0.4%, slightly below forecast, and our YoY rate came in at +1.8%. This is our slowest pace of growth since the GFC. However given the election and stimulus to come I would expect this is possibly our lows. Q4 may also be soft, but I think you will find Q1 & Q2 of 19/20 will be very solid. If you remember back in 2016 after our last election we actually printed a negative quarter of -0.1% Q3 2016). The next quarter we produced a +1.0% rate of growth. It is obvious an election has an impact on the way we spend here in Australia, especially when we expect the possibility of a change of Government. Business and consumers put spending and investment decisions on hold until there is more clarity.

· Our Trade Surplus for April came in strong again despite missing forecasts. The surplus is at $4.871bill vs $5.1bill expected and $4.949bill in March. It missed expectations due to stronger than expected import numbers of +3%, -2% in March, which in its own way is a good thing. As we don’t manufacture many good ourselves a lot of our demand has to be sourced from overseas. This points to an increase in demand for April. If we do receive 2-3 more rate cuts and the AUD subsequently falls I would expect the surpluses to grow from here yet again. The better than Government forecast surpluses are a windfall for the economy that gives the Government surplus funds, via taxation, not accounted for it can then go spend and stimulate our economy moving forward.

· Rare Earth Element (REE) stocks outperformed last week as China signaled it may ban the exports of REE from China to the US in retaliation to measures the US have used in the trade war. Since the US imports 80% of its REE from China this would be a big problem for them and means they have to source REE from other countries, such as Australia. Stocks such a Lynas (LYC) are +54% for May due to this + the takeover attempt by WES at $2.25. This is unlikely to happen as the stock now trades at approx. $2.70. Others stocks to benefit include ARU, PEK & ALK which have all had big moves to the upside.

· Costa Group (CGC) $3.65- Fruit & Veg producer CGC released an earnings update to the market which was not well received. It now expected NPAT to be in the range of $57-$66mill after last year’s profit of $56.6mill. It had previously forecast a 30% rise in NPAT but several one off factors have hindered this. The stock was smashed by 27% on the back of this. CGC is now about 50% off its highs and after reading many reports about the reasons behind these downgrades I really like the stock here and am looking for an entry. Issues such as a fruit fly, rare berry condition, higher water rights + others have all impacted CGC bottom line at once. CGC is taking measures to help overcome these issues and we shouldn’t see a repeat in 19/20. Previously management have been very conservative with earnings thus they could still beat their own forecasts moving forward.

· Link Holdings (LNK) $5.60- LNK also put out an earnings update that saw the stock punished hard. It cited that underlying NPAT would be in the range of $195-$205mill FY18/19 after recording a $206mill profit last year. It said the cause for the guidance was due to the conditions in the EU, in particular Brexit that had impacted its business. LNK is not one I follow closely but have noticed many analysts believe it has been sold down too hard on the back of this. It may be a good play in the future if Brexit does not look like going ahead.

Before I wind up this week’s wrap I wanted to talk to you all about a macro theory I have surrounding global cash rates & inflation. I spoke about this on twitter yesterday (@heathmoss83), but feel it has some legs and could explain our economic environment moving forward. What we have seen for a while now is very low inflation, and hence very low cash rates on a global scale. Now I believe that moving forward that cash rates will continue to average down, and I’ll tell you why. As the world has become more global and competitive over the last decade it has forced efficiencies in markets. By this I mean as most companies are now competing on a global scale they have had to look for more efficient ways to produce their goods and services and compete with global counterparts. This has been aided by the internet, advancement of technology and free trade. Now as we all know more competition means lower prices, and lower prices means lower inflation and lower inflation means lower cash rates. Companies are becoming more and more efficient at producing their goods & services forcing prices down. This has been happening for decades. Take a look at the car industry. Only 30-40 years ago a lot of manufacturing and assembly was done by hand. Moving forward to today we have production lines that are mostly automated. And in real terms car prices have not moved. In the last 5 years alone car prices are down almost 10% here in Australia due to expensive cars made by Holdens & Ford leaving the country in favour of their cheaper counterparts in Asia. Also think about how we consume our entertainment now. Back in the day we used to have to go to the movies for $20-$30 or rent a video/dvd for $6-$10 to watch what we wanted. Now we have streaming services such as Netflix, Stan, Kayo, Foxtel, Amazon that give us a movie store full of options to watch for $10-$15 a month. This has forced cinemas to decrease their prices to as low as $10 per movie now and upgrade the viewing experience (better chairs, image, sound etc.) to compete. Now these are two very simple examples, but thousands more can be found in society today.

I believe there are two main reasons this has all occurred. The first is due to the rapid advancement in technology in the last couple of decades from the use the use of the internet, AI, automation/robotics and the rise of tech giants like Google, Amazon & Facebook. The next element that contributed to this is the GFC. The GFC forced companies to cut back and find better ways of producing products and services at lower costs in order to lower prices for consumers. This was, of course, due to the cut back in spending during the GFC as a result of job losses. Its times like these that companies often take stock and reassess at how they do things that brings about these efficiencies.

The second element surrounding this theory comes in the form of debt. As a society, and a capitalist system, we have gorged on debt. The growth of debt has outpaced that of wages for a few decades now. This now means that small incremental movements in the cash rate have a much larger impact on consumers back pocket than they had in the past. Take a 2% rise in the cash rate on a $400k home loan, which is today’s average in Australia. This would add $8,000 per annum in interest costs to that loan. Now a 2% rise in rates back in the early 90s when the average loan was about $71k would only add approx. $1400 to interest costs per annum for the owner. Thus as you can see the impact for the same rise in rates has a much larger impact on today’s consumer than it did 30 years ago. As well all know the reason rates are increased are to curb inflation by restricting demand.

What does this mean moving forward? I feel we are unlikely to see a cash rate above 5% in our lifetimes as we possibly see decades of lower inflation. Core inflation may peak at 3%. The next credit bust (aka GFC) will dwarf the last and take longer to recover from. In contrast economic booms will last much longer as debt remains cheaper for longer and ultimately debt fuels economic growth. Hence I feel there are many more good times ahead, but it will ultimately end in tears and for a lot of us left in the fetal position again.

Before parting I will say Oil used to be the great leveler and real big push behind inflation as it was involved in so many levels of the supply chain. However even now that is under pressure as we find more efficient and cost effective ways of extracting oil + also move to other technology such as electric vehicles and drones (for logistics) that will have a huge impact on our use of the black gold.

Personally is been a tough week or so with the two boys being sick with colds. We also took them for vaccines last week, which is heartbreaking. Both obviously cried when they got the shot and it just tears you up seeing their sad little faces as a result. However it is going to benefit them in the long run and nothing a bit of chocolate can’t fix. We also started looking at schools to send our eldest to, which is another bitter sweet moment for us as parents. On one hand it’s great to think about them growing up and the new adventure they will embark on in school. On the other they are growing up and not the little boys they once were and a bit closer to leaving home. I’m not ready for this just yet ha ha. Anyway have a great week everyone, what’s left of it, and stay safe. I look forward to speaking with you all soon. 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.