The Australian equity market has bounced strongly from the lows in mid-February (up 12%), including jumping over 8% since 11 April. The recent RBA official interest rate cut has supported equities, which still appear attractive on a yield basis.
While it is positive to see an improvement in investor sentiment, we are cautious about the rapid recovery, particularly when it comes to the valuations of certain securities. Without any dramatic alteration in earnings expectations, the prices of many investments have risen to levels above what we determine to be their fair value. In contrast, however, there are a large number of stocks that have not participated in the recent rally, and represent attractive fundamental value.
As has been the case since the beginning of calendar 2016, we believe that the current volatility presents an opportunity for investors to be nimble and take advantage of the opportunities on offer.
Defensive investments with consistent long term yields have been the major beneficiaries of that latest rally. Many of these investments are now trading above what we consider to be fair value, and are consequently prone to a potential short-term sell-off.
The futures market is currently implying a strong chance of another cut to interest rates within the next three months and some, including Commonwealth Bank, are suggesting there will be two cuts by the end of the year. There is also a 25% probability being placed on a cut as soon as June.
The expectation for cuts is being driven by the premise that the RBA’s mandate is to maintain inflation within its 2-3% target range and with current softness in the global economy the RBA’s own current prediction (as set out in their recent Statement of Monetary Policy) is that inflation will remain at or below the bottom end of that range for the entire forecast period ahead.
Listed Hybrid Recovery
The listed hybrids market rallied across the board in April and early May, with particular investor interest appearing for longer dated securities. We believe there are two reasons for this:
- the equity markets have bounced back somewhat following a very nervous start to the new year. Having been sold off by almost 10% in the first two months of 2016, the ASX 200 is 3% higher than where it was on 1 January; and
- yields in the bond markets continued to fall as expectations of further RBA rate cuts took hold. This proved to be an accurate assessment as the RBA lowered its official cash rate by 0.25% to 1.75% on 3rd May.
It is important to remember that hybrid securities are part bonds/part equities and they will track both markets to varying extents. When equites and bonds rally, it is expected that hybrids will follow suit.
With cash rates now below 2.0% and the 10 year Government Bond rate at an all-time low of 2.2%, investors - especially retirees - are finding it increasingly difficult to find attractive yields from (relatively) safe assets.
Consequently we have seen a considerable amount of interest in the longer dated hybrid securities issued by the four major banks – securities such as ANZPF, WBCPE, CBAPD and NABPC. In addition, hybrids issued by some of the second tier financial institutions such as Bank of Queensland and Challenger have also rallied significantly in the past 4-6 weeks.
Westpac have today announced a new hybrid issue (to be listed as WBCPG) which will in part be used to redeem the maturing capital security - WCTPA. The quoted margin over bank bills is 4.9 – 5.1%, which implies a yield to maturity of approximately 7.0% (inclusive of franking credits). This would appear to be “fair value” based on where other Westpac hybrids and those issued by ANZ, CBA and NAB are currently trading. We will conduct a more detailed review of these securities prior to their issue date.
News in Review
- US retail sales data showed a strong rise of 1.3% in April from a month earlier. The data also highlighted a shift from department stores (where sales fell 1.7% over 12 months) towards online sales (where sales grew by more than 10% over the past year).
- The US reported an increase in job openings in March to the second-highest level seen since 2000. The quits rate was steady at 2.1% and continues to suggest stronger wage growth lies ahead. The initial claims, however, rose sharply for a second week in a row to 294,000, the highest level since February last year.
- China reported that its CPI fell 0.2% mom in April, leaving the annual inflation rate steady at 2.3% year on year (in line with consensus estimates). Food prices were the largest contributors to consumer inflation, rising 7.4% in April compared to the same period a year ago. On the producer side, producer prices declined for a 50th consecutive month, as the extended slump in PPI quells fears about the deflationary pressure on the PPI that has been dragging on corporate profits.
- Chinese industrial output rose 6.0% year-over-year in April, compared with 6.8% growth in March and below the median forecast of 6.6% growth. Retail sales also grew by a less-than-expected 10.1% in April compared with a year earlier, slowing from March’s 10.5% year-over-year rise.
- Hong Kong experienced negative GDP growth in the quarter to March, with economic growth contracting by 0.4% as property prices continued to fall and property sales fell to a 25 year low.
- As widely expected, the Bank of England left its policy rate unchanged at 0.5% following its latest meeting. The Inflation Report saw the Bank cut its economic growth forecast by one or two tenths each year. The central bank’s view on inflation was little changed, noting that inflation remains well below its 2% target, largely due to falls in energy and food prices which are "expected to fade over the next year". However, inflation may increase in the near term thanks to the fall in GBP and the rise in the oil price. The path of policy normalisation will largely be contingent upon the EU membership referendum.
- The RBA's May rate cut appears to have had a significant impact on consumer confidence. The Westpac consumer sentiment index rose an impressive 8.5% month on month in May to its highest level since January 2014. The index is now back to an above-average reading, with respondents signalling greater optimism about the outlook for the economy and a greater willingness to spend on major household items.
- Crude benchmarks rallied at least 3% over the week, boosting the West Texas Intermediate price (the US benchmark) back to a 2016 high of over $46 per barrel, the rise attributed to a sharp decline in US crude output and a decline in crude stockpiles.
- Boston Federal Reserve’s Eric Rosengren maintained his recent hawkish rhetoric claiming, ““The market remains too pessimistic about the fundamental strength of the U.S. economy, and the likelihood of removing monetary accommodation is higher than is currently priced into financial markets based on current data”.
- Japan’s Labour Survey revealed a 1.4% year on year rise in the per-capita total cash earnings, a 0.4% rise in the scheduled base pay and 2.2% employment growth in March.
- Apple will invest $1 billion in Chinese ride hailing app Didi Chuxing, the Beijing company said Friday as it vies with bitter US-based rival Uber for market share in China.
- Berkshire Hathaway has emerged as an investor in Apple, purchasing $1 billion worth of the tech giant’s stock in the last quarter.
- Brazil's federal court ratified a settlement reached with the country's authorities over a deadly dam spill. Under the agreement reached in March, Samarco - an equal joint venture between BHP and Brazil's Vale - will pay up to $US2.3 billion ($A3.08 billion) over six years. It will also set up a fund for restoration work and to provide compensation for damages caused by the tailings dam spill.
- Fairfax Media has flagged an end to weekday print editions of The Sydney Morning Herald and The Age in the face of falling advertising revenue. Chief executive Greg Hywood said the masthead newspapers - which have been in print since 1831 and 1854 respectively - could become weekend-only, as those editions generate the majority of their advertising revenue.
- Telstra plans to return at least 1.5 billion Australian dollars (US$1.1 billion) to shareholders, using the proceeds of its sale of Autohome Inc. shares. Telstra said Monday it plans to start a capital management program in the first half of the 2017 financial year, and will provide details at its full-year results presentation on Aug. 11. The return of capital would be in addition to Telstra's ordinary dividend.
- Crown Resorts has reduced its exposure to the weakening Macau gambling market, cutting its stake in its Macau joint-venture, Melco Crown Entertainment (MCE). Investors have welcomed the move, with analysts saying proceeds generated from the sale of part of Crown's MCE holding will ease its debt and help it fund big projects in Sydney, Melbourne and Perth.