ASX200 is up 1.49% for the week and tested the 6600 index level as global markets rebounded on hopes of a resolution to the ongoing trade tariff negotiations between the US and China (and Mexico…).
Somewhat more relevant is any news from central banks with The Federal Reserve, Bank of England and Bank of Japan all set to meet as well as the European Central Bank gathering for a forum in Portugal (tough life being an ECB member). With market movements largely focused on central bankers reluctance to cut interest rates in an attempt to stimulate growth.
With all this attention on central bankers, it makes me wonder if anyone actually likes investing in companies any more? Are we all just slaves to the latest ‘hot stocks’, the latest profitless company that’s generating 30% qoq revenue growth? Is it all just propped up on the fact that the ‘cost’ of capital has never been lower so if you can build a dominant market position, you can be profitable later?
Of course, there’s nothing wrong with buying a company on its future profits, provided the probability of those profits realising is not over-stated or over-estimated.
My argument is pretty simple; you can’t rate cut your way to growth after you’ve already rate cut your way to growth and it didn’t really work.
The data we’ve seen out of the US is weak. Employment numbers last week were well below expectations and the market has become excited because the chance of a rate cut has increased. Go figure. MS tell me that bond markets now expect the Fed to cut rates by 86bp over the next 12 months.
Here in Australia, we just had our first rate cut. Chances are, we’ll have another in either July or August as unemployment (5.2%, now trending up) and more importantly in my view, under-utilisation (13.7%, equal highest since Jun-18) remain elevated. It looks like unemployment will rise for the next year or so.
Despite much of the post-election property hype (which personally, I think will fade) the consumer segment is still battling. A nice little wrap from UBS below:
But what’s it all mean for markets? Well, the bulls (like Citi strategist Tony Brennan… who I think is pretty smart) will argue that: “As lower interest rates improve earnings prospects for cyclical sectors, multiples typically also re-rate, generally from a relatively low point, while they de-rate for defensive sectors, often from a high point, as the premium for stable earnings falls.”
The premise being that slowdowns in economic growth and the subsequent rate cuts are reasonably predictable, and as a result, defensives are overbought while cyclicals are ignored. However, things have historically picked up. I’d suspect mainly as a result of the AUD adjusting and Australia importing more and more growth from other developed economies – most recently China – as our goods and services become cheaper for foreigners.
I’m not so bullish.
While the idea that cash rate down means cyclicals up looks pretty on the chart above, the scale matters. The x-axis is years, and the returns are indexed to 100 in 2002. It is volatile enough to show a trend, maybe a discernable trend? I don’t think so.
Further, while the rate cuts are now primarily expected and priced, I think the longevity of this low growth, low inflation era has been repeatedly and consistently underestimated. It was only six months ago that we were panicked by rising interest rates, a hawkish Fed and a bond market sell-off that spooked everyone into one of the worst quarters of returns ever. US 10y bonds vs the S&P500 below.
All of a sudden, the Fed gets dovish on the back of weaker than expected data and equity markets scream higher while bond markets continue to price weaker and weaker inflation outlook. This doesn’t make a lot of sense…
Growth is slowing, earnings growth is peaking, and recession risks are rising so we need to reduce interest rates to stimulate inflation OR;
Growth isn’t as bad as the bond markets think, earnings are going higher, and the Fed has it wrong.
You can probably guess I’m going to bet on scenario one, using smaller positions in a few selected quality, offshore earning cyclicals as my ‘hedge’.
I think Australia has a recession coming. I think we’ve already got a household recession; we just haven’t had the lethal mix of a weak consumer and a weak housing/building market ‘come together’ yet… give it 6-12 months.
What has defensive earnings?
Usually, you’d say property (as rents are somewhat sticky), but there’s been a lot of asset revaluation going on and a fair bit of equity raised in the A-REIT sector which makes me wary.
You’d also look to those infrastructure asset stocks like Transurban (TCL), Sydney (SYD), Atlas Arteria (ALX) and Spark (SKI) etc. Sydney Airport (SYD) for me as I’d bet my life that Sydney is going to be a tourist destination until long after I’m dead and if you make it cheaper (lower AUD) that only makes it more attractive.
I also think a lot of the SaaS businesses look defensive in a non-typical way. Stuff like Adobe (ADBE) and Microsoft (MSFT) – core business tools that you can’t turn off.
You can roll the dice on a few of the domestic consumer staples companies though I’d probably avoid as I think they lose on price and people are likely to switch (I think) when under pressure (those not shopping at Aldi, make the change to save money.) I’d probably rather ride the oil price with Woodside (WPL) and back in high-quality assets with tier one talent operating them.
Healthcare is traditionally a defensive sector (COH over CSL at the moment for me), as is digital infrastructure (in large-cap data centres I like Interxion (INXN) over stuff like NextDC (NXT).
If you want to hide, you’d probably think about some floating rate notes (hybrids) or a bond manager who’s not afraid of a bit of duration. There’s a few ETF’s around you can buy as well which give you the same sort of exposure.
Movers & Shakers
Nano’s catching a bid after a big write up in the AFR calling it the next Cochlear – a bit rich in my opinion. Bingo shorters getting a bit worried and covering whilst the rest is a bit of a mixed bag… lots of foreign currency earners.
Challenger proved you can’t sell 3% investment products to older people forever, as annuity sales continued to slow, resulting in a profit guidance reduction. AGL pulled its bid for Vocus – probably a good move.
and Afterpay… oh this was delightful last week.
So here’s how it played out:
Thur 6 June: Business Update – lots of BS and slipped in on the last page this beauty…
Well, because for many years, Afterpay didn’t follow the AML/CTF rules of third-party verification (I’ve been screaming this from the rooftops since the IPO!)
How do we know this?
Well, remember when your teenager could buy alcohol on Afterpay?
See, if they’d bother to ID them before lending them $300, they’d know not to let them make that purchase. APT also potentially allowed a lot of money laundering occur on their ‘platform’ because of this neglectful and frankly, greed driven decision (credit checks cost money).
Anyway, on Tuesday 11th, after the above ‘business update’, APT announce a $300m capital raise and $100m equity sell-down by the founders. Interesting timing…
AND THEN… the cherry on top, on the 13th they announced they’d received an AUSTRAC notice requiring them to be subjected to an external audit. The results of which will be available to shareholders just 13 days after the founders’ escrow period ends on their locked-up shares. Does anyone want to bet they sell more shares?
I couldn’t make this sh*t up — Afterpay $10 by New Year.
Oh, and Zip (Z1P) have been compliant and third party verifying since day 1 when Larry & Peter negotiated a real pointy deal with Veda to high-volume, fast, credit checks.
Have a good week,