Market Matters Afternoon Report Friday 5th August 2016

Afternoon Report 05/08/2016

Market Matters Afternoon Report Friday 5th August 2016

Good Afternoon everyone

Market Data

What Mattered Today

A bit of a yawn of a session really as the market looks ahead for the non-farm payrolls print in the US tonight. Resources were better than banks, Telstra (TLS) was lower, Energy stocks were up with Origin (ORG) the best of the majors adding +3.11%. Suncorp (SUN) broke $13.50 on the upside and rallied as high $13.69 before a soft close; it was up +1.43% on the session to $13.49.

Suncorp Group (SUN) Daily Chart

A range of +/-29pts. 5483 low, 5512 high and a close at 5497; up +21pts or +0.39%...

ASX 200 Intraday Chart

In the U.S tonight, the consensus is for +180k jobs to have been created in July with the unemployment rate to drop to 4.80%. Importantly, watch for signs of wage growth with average hourly earnings expected to tick up by 0.20%. Last week saw the Employment Cost Index in the US show wages are growing at 2.3% - which is important when considering the outlook for US interest rates. A better print tonight will see expectations for a December hike firm up.

Last night we had the Bank of England (BoE) cut interest rates by 25 bps and reintroduced QE as part of a package of measures aimed at supporting growth. The Pound dropped but only by about -1.7%. Governor Carney said that he is not a fan of negative interest rates but that additional easing may be adopted before year end. The BoE shifted its inflation targeting horizon from 18-24 months to the longer term, implying it will tolerate further GBP weakness. Although currency weakness is a negative for stocks like Henderson (HGG) and Clydesdale (CYB), decisive action by the BoE to ensure the UK avoids recession is more important. Henderson was up +1.46% today.

Henderson Group (HGG) Daily Chart

The RBA minutes were out today, and the AUD rallied - settling at 76.58 around 4.20pm…Technically, the AUD is testing the upside of its recent trading range and is threating to breakout. The RBA seems likely to sit on their hands for the remainder of the year which is supportive of the currency.

Australian Dollar Daily Chart

The other interesting aspect of the release was commentary on the oversupply of units in some parts of the country – a trend we’ve been discussing for some time now….

"There are some concerns about the concentration of new supply in areas such as some parts of inner-city Melbourne and Brisbane. Downward pressure on prices from large increases in supply relative to demand for apartments in some areas could increase the risk of off-the-plan purchases failing to settle."

"Despite the substantial increase in supply in recent years, vacancy rates in Sydney, Melbourne, and Brisbane have only risen a little, to be around their long-run average levels," it said.

"That said, rent inflation in these cities has been declining, and has also been a little weaker than suggested by its historical relationship with the vacancy rate." (AFR)

Emerging Markets have been a discussion point for us lately, and we used their likely strength as a precursor to allocate capital towards resource stocks a few months ago. We’re now seeing mainstream media catch onto the theme with the AFR this afternoon putting a positive spin on the outlook for economies in that space and the stocks that have a high correlation to it.

For those that missed it, here is what we wrote a week or so ago…

We have South 32 (S32) in the portfolio now and in the last few months, we’ve also had Fortescue (FMG) and Regis Resources (RRL). Clearly, resources are back in favour, and we’re seeing money flow into the miners on the back of rejuvenated optimism. To be clear, we like the sector and will continue to look for opportunities to increase our exposure to it in the short term. We’ve written a lot about resources and their high correlation to emerging markets; we like emerging markets thus we like resources and vice versa. The main reason is simply that both resources & emerging markets have already undergone deep adjustment caused by external forces (capital flow/supply/demand etc. ) and are now coming out the other side. Compare that to what we see in developed economies where that adjustment simply has not happened, and it’s easy to be more optimistic on emerging market growth.

For example, (and as highlighted in a recent strategy piece by Morgan Stanley) Emerging Markets have had to adapt to an environment of collapsing commodity prices, USD strength and a tightening in financial conditions which spurred substantial capital outflows the sharp depreciation in EM currencies, accelerating inflation and a tightening in domestic monetary policy. When economies/stocks/sectors or even individuals stare down the abys, we often see major structural changes emerge that sets a better foundation for whatever happens in the future.

Looking at resource companies, they too have had to deal with an environment of weak demand, collapsing commodity prices, USD strength (which puts pressure on commodity prices), highly geared balance sheets in many instances and to top things off, a market that has been fixated with yield in a low interest rate environment which has forced dividends to stay unsustainably high until recently (think BHP + RIO’s progressive dividend policy).

In that hostile environment, miners have been forced to reduce CapEx, strip every conceivable cost from their business, de-lever their balance sheets and operate as efficiently as they possibly could. In short, the tough period has been a massive wake-up call for the sector (as was the case with many emerging markets). We now have a better-operating environment, and we’re seeing miners generating significant free cash flow (FCF) courtesy of commodity and currency tailwinds since early 2016. The sector is now remarkably unleveraged, with >60% of major mining companies (S&P200) having NO debt and net cash, and of the companies that are indebted – BHP, RIO, NCM, FMG, AWC, WHC, IGO – all have identifiable and plausible pathways to retire debt. Interestingly, recent moves in commodity prices have underpinned significant FCF (FMG could be debt free in ~2 -3 years at current spot iron ore price) could reduce this list to just 2-3 names within a couple of years.

Since then, we’ve bought Independence Group (IGO) around $3.80 and we’ve taken profits on South32 (S32) after it made a false break over $2.

Independence Group (IGO) Daily Chart

Sectors Today

Source; Bloomberg

ASX 200 Movers

Reporting next week

NPAT = net profit after tax (consensus numbers)
EPS = earnings per share (consensus numbers)
DPS = dividend per share (consensus numbers)

Select Economic Data – Today; Stuff that really Matters in Green

US employment data key tonight!

What Matters Overseas

FUTURES are higher….

Watch out for the Weekend Report on Sunday Morning

Regards,
The Market Matters Team
Level 12 28-34 O'Connell St
Sydney NSW 2000

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