The ASX200 this week posted its best performance for the year, and catapulted the index to its highest level since the GFC.
Bank stocks led the charge, snapping out of their 2018 decline and rising over +4%.
But before you pop the champagne it’s worth understanding why we moved the way we did this week, and in large part it’s down to knock on effects associated with regional share-market weakness, particularly in China.
Australia a shining light, but likely short-lived
Australia had a good week, that can’t be denied. In fact, the Aussie banks were well due a bounce having underperformed the broader index by -7% year-to-date, but the best explanation for the surge in banks, other large-cap Australian shares such as Wesfarmers (WES), CSL (CSL) and Woolworths (WOW) is that regional fund managers were busily hoovering up their Australian holdings to re-balance portfolios away from China and north Asia.
This week Asian equities were notably week, with Chinese, Hong Kong and Korean share-market indices all down between -2% and -5%. Concerns in China around issues of credit quality and slowing economic growth in particular has seen the Shanghai Composite fall to its lowest level in 2 years this week.
Strength in the US-dollar is a key factor in market concerns relating to an economic slowdown in emerging markets such as China, and this week key trends in both the Chinese and global emerging market indices broke long-term trend support, indicating a broadening in market caution towards these markets.
This matters for Australian investors because Australia is the second-largest market by weight in the important Asia Ex-Japan share-market benchmark with a weight of around 17%, about a half of Hong Kong/China’s 37% weight, and just ahead of Korea at 14%. If fund managers benchmarked to this index (and there are a lot) are bailing out of the major HK/China markets as they are, and they have to put their money somewhere else post-haste, Australia’s substantially underperforming market and major bank stocks are understandably a pretty great place to hide.
But to be really clear, this is a rally in Australia born of technical buying, not a fundamental turn in the fortunes of our major banks. Whilst they have come back a long way, the outlook for earnings remains really pretty ordinary. For reasons I have outlined many times before, the Aussie banks face the prospect of absent loan growth, tighter regulation, increased competition and rising funding costs, and all of this before we speculate on the fate of housing.
In fact, if China is indeed looking wobbly on economic growth, and on this I have to say it’s far from certain, Australia’s economy could well see some of the recent wind sucked from its sails given China comprises a substantial 40% of all exports shipped.
The banks are going nowhere and this rally will peter out potentially as soon as today.
In fact, precisely the way the Australian rally that came out of nowhere in early May petered out instantly, the same is more than likely to occur again here as early as next week.
For all of those of you holding too many banks (still), and there are lots of investors in this camp, this rally provides a good chance to top-slice holdings next week to provide cash for better growth opportunities as the year progresses.
ANZ is up 10% from its lows in the space of a week.
The bull-market continues in the much-loved stocks
This surge in buying of Australian shares this week has further propelled many ‘favourites’ to fresh highs. CSL (CSL), Cochlear (COH), SEEK (SEK), REA Group (REA), Costa Group (CGC), A2 Milk (A2M) etc etc are all powering ahead to be 30-35-40x next year’s earnings numbers, and prone to ever more risk the higher they go.
REA has not seen upgrades for 2 years and new-listings have unsurprisingly turned negative, but the stock this week powered to new highs at $93 and to a valuation of 35x 2019. To be honest, I thought REA was expensive at $60, so what on earth do I know, other than to say that when earnings start getting downgraded, which is surely soon on this stock, the de-rating will be swift and harsh.
WES and WOW have each rallied beyond our target prices for precisely no reason other than that other stocks and markets have been doing poorly. I highlighted this in reference to the banks above. If that’s a good reason to keep holding on, then go for it, but valuations on WOW are now at peak, and WES is rapidly moving back to 20x earnings despite an absence of earnings growth too.
In all of these stocks it is simply a case of musical chairs, and the game is fun until such time as the music stops.
Global liquidity continues to be removed from global financial markets and economies, and at some point, sooner than later, the frog in the pot of boiling water realizes too late that he is boiling.
Telstra (TLS) – what a pain in the neck
The analyst day came with major headlines on job losses, but in the end the main outcome was a pretty significant re-basing lower in forward estimates for TLS underlying earnings, despite intentions to escalate cost out by $1bn to $2.5bn.
2019 core operating cash-flows were forecast to be $6.8-7.6bn before NBN associated one-off payments, implying a fall of 10-20% on 2018 figures. Much of the erosion in profitability comes from the decision to strategically reset the mobile division by streamlining its pricing plans and competing more aggressively to maintain market share against heightened competition from both Optus, Vodafone and the new network being built by TPG due for launch in 2020.
Alongside the wider group restructure TLS announced plans to split its infrastructure assets away from the operating business, and the potential for a de-merger of these assets post completion of the NBN rollout. This is a welcome move, and though quite long-dated, does offer up the potential for a re-gearing of this asset which should be to the benefit of shareholders.
I keep coming back to the underlying cash-flows of TLS and its balance sheet structure, and thinking through the idea of $7bn in underlying operating cashflows, less $4bn of capital expenditures and perhaps another $1-1.2bn in associated interest and tax charges. That gives you $1.8bn to $2bn in underlying cash earnings in 2020 against a market cap of $31.5bn currently, or 15x earnings – which doesn’t seem cheap. But this ignores the value of NBN cash payments which are still surely $10bn+ or more, which implies a market value of TLS closer to the low $20bn, and hence making the P/E on the stock closer to 10x.
I have been way too persistent here, I’m not happy that’s the case, but I do think the stock is closer to a BUY here, and based on the numbers above, I wouldn’t be surprised to see activity emerge from an activist shareholder in the months ahead should the share price remain in this range.
Have a great week.
Friday 10am values
|S&P / ASX 200||6232||+215||+3.6%|
|Property Trust Index||1440||+41||+2.9%|
Thursday Closing Values
|U.S. S&P 500||2750||-32||-1.2%|
Key Dates: Australian Companies
|Mon 25th June||Div Pay Date – NABPB, SUNPE, SUNPF, SUNPG
|Tue 26th June||N/A
|Wed 27th June||Div Pay Date – ANZPG, ANZPH, NABPA, NABPE
|Thu 28th June||Div Ex Date – WBCPG
|Fri 22nd June||Div EX Date – WBCPF, WBCPH
22nd June 2018, 1pm