While the move may be positive for asset prices in the short term, the key question is will the move do enough to achieve the aims of the RBA (and every other central bank). Will it encourage business to borrow and invest in growth?
Low interest rates have assisted individuals to borrow to invest in real estate, and had been supportive of asset prices across most markets. There have been concerns about the level of private indebtedness, which the recent rate cut will partially assist. However, corporates in Australia are particularly cautious when it comes to making commitments for investment. Balance Sheets remain conservative and major initiatives are often coming from technology which has a lower capital outlay than investment in hard assets.
The reporting season, which started this week, will provide investors with a barometer of the climate of listed business. Most analysts are expecting that earnings growth will be poor across most sectors. We anticipate that stronger growth will come from the small to mid-cap companies, as the large companies are finding it tough to generate double digit growth.
Taking a contrarian view, we believe that the potential exists for the reporting season to provide some positive surprises. The impact of the lower interest rates, consistent Australian dollar, improving commodity prices, steady wages and an era of cost consciousness could combine to provide results above expectations. Very often, when everyone has downgraded their forecasts, outperformance occurs.
One sector of the market that has been maligned for some time is the banking sector. This morning we received yet another report from a broker highlighting the risks that they see in the banking sector. Over the last 3 years, we have lost count of the number of similar reports we have seen. While we recognise that Australian banks have experienced a golden era over the last 20 years, we also believe reports of their demise are overstated. The banks are an important component of our economy, and are beneficiaries of the steady employment, low interest rate environment that we are living through. They have also been able to improve the quality of their Balance Sheets through the issue of cheap funding.
While we do not expect the banks to grow earnings by 10% or more, we anticipate that profit growth of 4 - 5% is achievable. Combined with yields of 5.5 - 7.0%, fully franked, a total theoretical annual return of 9.5 - 12% (or 12 - 15% on an after-tax basis), the investment case for banks at the current levels seems compelling.
We would not be surprised to see the share prices of the banks improve markedly over the next 3 - 6 months.
News in Review
- The Reserve Bank of Australia cut the official cash rate by 0.25% to 1.50%. With inflation tracking below the RBA target range of 2 – 3%, the RBA has used the rate cut to continue to support domestic demand.
- The US Federal Reserve decided to keep interest rates on hold, with the target of 0.25% to 0.50% set to remain until the September 2016 meeting. The Federal Open Market Committee's statement on the decision noted that the US labour market has strengthened since June and inflation continues to run below the central bank's target of 2%.
- The US economy grew at an annual rate of 1.2% in the three months to June; far below the forecast 2.6%.
- The European Commission’s Economic Sentiment Index, Europe’s leading barometer of consumer and business confidence, rose 0.2 points to 104.6 in July for 19-member Eurozone. The improvement echoes the resilience seen in other post-Brexit European economic data. Companies in the all-important services sector showed increased optimism regarding the state of the industry.
- The Eurozone economic growth halved in the quarter to June to 0.3%, in line with expectations. France, the second largest economy in the zone had no growth in the quarter.
- In its first estimate since the Brexit vote, the UK economy grew 0.6% in the second quarter of 2016 following a 0.4% rise in Q1. The June quarter's GDP expansion was helped by a 2.1% increase in industrial production, the sector's strongest quarterly performance since 1999.
- The European Banking Authority released its results of the bank stress tests, saying only a small number of banks would struggle to ride out the hypothetical severe economic downturn.
- The ABS reported that Australia’s terms of trade from the June quarter rose for the first time in two years following a 1% fall in import prices and a 1.4% rise in export prices. The key driver of the rise was attributed to higher oil and iron ore prices over the quarter. When the terms of trade increases, Australia is accumulating more money from exports than it is spending on imports.
- The ABS also reported that inflation figures for the June quarter have revealed the consumer price index increased by just 1% over the past year, the lowest annual inflation figure in Australia since June 1999. Continued low levels inflation levels will increase the likelihood of further rate cuts.
- Japanese Prime Minister Shinzo Abe unveiled a surprisingly large 28 trillion yen ($267 billion) stimulus package to invigorate the economy and pursue its 2% inflation target. Recently, the government downgraded its growth forecast for 2016 to 0.9% to 1.7%.
- Oil prices tumbled to the $40 per barrel low seen in April as surging supplies once again expose the chronic global glut and threatens to perpetuate the energy price slump for another year.
- Rio Tinto has approved further development at the Silvergrass iron ore mine in Pilbara, WA. The company has announced that it will spend a further $338 million on the brownfields site, which it expects to have a return on investment in excess of 100%, and a pay-back of only 3 years.
- BHP Billiton will record a provision of between $1.46 billion and $1.73 billion for the Samarco dam disaster when it reports full-year financial results next month.
- Westpac and Commonwealth Bank are the frontrunners to win Australia's biggest single banking contract- to supply all banking services to the NSW government.
- The A2 Milk Company's long-running claim that its A2 protein-only product helps consumers "feel better" and lessen digestive discomfort is set to be tested in court for the first time.
- Qantas signed marketing and promotion deals worth almost $40 million with the NSW and Queensland governments to promote the states around the world.