From Jonathan Bayes, Investment Consultant, Bentleys Wealth Advisors.
This week, it feels like the penny is beginning to drop.
This week, it feels like domestic Australian investors are beginning to pay attention to the long unfolding secular shifts in the Australian economy and in the resultant impact that is set to be felt on local portfolio’s.
Australian shares again underperformed the global peer group by around 1-2% depending on which market you compared it to.
Australian shares have now underperformed the international indices by 5-6% year-to-date.
What’s interesting about all of this is that it is occurring even without assistance from the Australian Dollar, which is up +3.5% since January 1st.
The implication? That it’s a dearth of domestic Australian share-market opportunity that is driving this creeping underperformance.
And this is but the start.
This week we saw the banks and miners both suffering – two sectors that I have mentioned ad infinitum contribute 40% of ASX200 value.
The retail sector continued to fall as well, and is now down -20% year-to-date.
Oh, and it’s not because of Amazon despite what the papers tell you.
It’s because Australia’s retail sales are running at their slowest rate in 3-years and because household cash-flows are fast constricting.
Within the consumer discretionary space, Australia’s two largest auto retailers both profit-warned this week, blaming a cautious consumer for the disappointing year-to-date 2017 car sales.
Banks were rocked a little with the S&P credit downgrade to many of Australia’s second-line banking institutions this week. The ratings agency went with a formal cut from A- to BBB+ to the likes of Bendigo Bank (BEN) and Bank of Queensland (BOQ), a move that will again raise borrowing costs for all of the institutions affected.
In the miners, iron ore inventories continued to climb and iron ore prices are now at their lowest level in 6-months.
But they have more to fall.
Bank dividends – NAB & Westpac set to cut.
I did some work myself this week on the major Australian banks, specifically insofar as their abilities to maintain the currently generous dividend payout ratios on offer.
And the outlook here is mixed.
Australia’s banks, like many of our major corporates, have run inflated dividend payout ratios in the years post the GFC.
The high payout ratios worked well in an environment of low interest rates and shareholders have done well both in terms of the dividends paid, and the resulting performance of the underlying shares themselves.
However, in recent years the banks have been forced to accrue greater capital to conform with more stringent global banking regulation, and this month they were further blindsided by the impost of the governments $6bn+ Major Bank Levy which will likely take around 3% from sector earnings.
Payout ratios are now looking increasingly high and vulnerable.
National Australia Bank (NAB) looks most at risk of a 10% dividend cut given the forecast of a flat $1.98 in annual 2017 dividend implies an 80%+ payout ratio, well above its targeted 70-75% ratio.
Westpac (WBC) are the next highest and will be paying out near 80% in 2017 if they too deliver on the market forecasts of $1.88.
Commonwealth Bank (CBA) look least at risk with a payout ratio nearer 75%, but note that even this number is well above the 60-65% payout ratio that ANZ Bank (ANZ) set when they rebased their dividend by over 10% in early 2016.
The pips are squeaking on the dividend front even with housing still at its highs.
So, let’s take this a step further.
Right now the big 4 banks write-off a little more than $4bn in bad & doubtful debts a year.
Over the GFC the banks wrote off $20bn in an 18-month period, give or take a billion dollars or two, which is 3x the current level of charge-offs.
Back then it was less a housing issue, and much more a commercial property, margin loan and personal loan issue.
If housing starts to roll-back, which I am thoroughly sure of, and we begin to see more housing investors come under pressure from higher interest charges and tighter borrowing standards, then Australia’s banks will surely be forced to take higher charges.
A simple doubling of bank debts will take off near enough to 10% from banking sector profits.
And at that point, the dividends get cut again.
Using NAB as an example, its dividend could conceivably go from $1.98 currently to $1.60-1.70 – a 20% cut ultimately.
AGAIN, NONE OF THIS IS SAID TO SCARE.
IT IS SAID TO MAKE A GENUINE AND PRAGMATIC POINT THAT MANY DOMESTIC AUSTRALIAN INVESTORS CONTINUE TO IGNORE.
There is a place for Australian banks in portfolio’s.
They are solid institutions and they still pay out sound dividend income.
But bear no false expectation that the banks aren’t set to do it a lot tougher in the coming years, they are, and that means you want to be casting a wider net for your ‘growth’ exposures.
In fact, as a guide, whilst Australia’s banking sector has idled away to be down -3% year-to-date, Korea’s index is up +17%, Taiwan is +10%, NASDAQ is +15%, Hong Kong is +15% and European markets are +10%.
Our model portfolios are currently significantly underweight in the domestic banks, even when including our Macquarie Bank (MQG) overweight.
Woolworths (WOW) – directors are buying
We were encouraged to see that several of WOW directors had been buying shares in the stock earlier this month.
Well over $600,000 in shares were purchased, which is not small change, and hopefully augers well for further share price upside in the coming months.
The next news we should expect to hear from WOW is from the ACCC who will rule in July on the sale of WOW’s service station portfolio to BP.
That’s it for this week.
Have a great weekend.
Overseas this week we had a few things to take note of.
In the technology space, Japan’s Softbank (9984) took a surprise 5% stake in the leading graphics chip designer NVIDIA (NVDA).
The noteworthiness of this if you will, is that NVDA shares are already up 200% in the past 12 months and now have a market value of $80bn. Further, that Softbank have decided to pay up for this stake is doubly interesting since the Japanese group surprised everyone early last year by acquiring leading chip-maker ARM Holdings of the UK for a whopping US$32bn.
Softbank are notable for their prescient views on emerging technological trends, and their founder Masayoshi Son is widely seen as a visionary in the vein of Steve Jobs, Elon Musk and Jeff Bezos.
The $4bn bet on NVDA isn’t huge by Softbank’s standards but is notable in that it comes at a time when the semi-conductor has run red-hot for months now, with many questioning whether it is time for as pullback.
This bet certainly points to a view that the explosion in internet connectivity has a long way still to run.
In Hong Kong this week we saw the local monetary authority order a new round of tightening measures for the property sector. Much like Australia and indeed the rest of the world, Hong Kong property has been on a tear, fueled by low interest rates and Chinese buying.
For more information on the above please contact Bentleys Wealth Advisors directly or on 02 9220 0700. This information is general in nature and is provided by Bentleys Wealth Advisors. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.
From Jonathan Bayes, Investment Consultant, Bentleys Wealth Advisors.