ASX Market Update 13th February 2023
Global Market Commentar
*Chart: S&P500 as at 10/02/23
Equity markets have extended the rally they started 2023 with, albeit with a pause over the last week. A sense of hawkishness has crept into markets even if it is only slight. A strong jobs report in the US, a week ago (+500k), saw markets pull back and retreat from their dovish stance. Locally the RBA went moderately more hawkish in their statement compared to December after they raised rates by 25bps on Tuesday. I can see a further 2% downside on the SPX to that 3980 range to test our uptrend and breakout from the downtrend we experienced all of 2022.
Despite this I feel the Fed gave off a very dovish tone when they spoke last week, it just seems most of this was already baked into markets. I think three key statements summed this up perfectly. The first being Powell acknowledged deflation is present and should continue into 2023. He only sees only two more hikes (likely 50bps overall) before a pause and that he stressed they didn’t want to overtighten. I feel the markets ran with these on the day as confirmation of what it already has priced in. Lowe, on the other hand, doubled down on the threat of high inflation being entrenched in our economy, threat of spiraling wages and the fact there were more rises to come.
However, I do believe Lowe has told the markets what they need to hear at the moment rather than what he truly believes. Australian 10yr bond yields had sunken below 3.30% before Tuesday, undoing a lot of the work that the RBA still needs them to do. This is an easing of monetary conditions, which is a threat of leading to above trend growth and hence demand lead inflation. After the RBA meeting these bonds rallied 40bps back above 3.70% and hence a tightening of conditions once again.
The above chart backs this up as the RBA themselves don’t believe inflation to be entrenched or demand lead. The above shows the RBA believe 80%+ of inflation, above their 2.5% target, has been caused by supply or foreign shocks. Despite this the terminal rate here in Australia has moved up from 3.80% to 4.10%.
I am still of the belief a March hike will be the last for a while, but I doubt we see cuts this year and rates remain higher for longer. Despite a lot of prices starting to come down globally, we are yet to see most of it here in Australia due to the lag we live with. This is putting pressure on Australian households and will eat into discretionary spending. The RBA hardly wants to add to this prematurely with an over aggressive rate hiking cycle. Remember rate hikes have a much more immediate impact here in Australia vs the US. Here most households are exposed to variable rates and thus as soon as the RBA hikes, we get that dreaded letter that our mortgage repayments will be rising within 6 weeks. In the US most are on fixed term rates for the life of their mortgages and thus tightening takes longer to trickle down.
I am still in the camp we experience a material slowdown in economic activity here in Australia, but not a recession. Discretionary spending will be challenged this year and I still have stocks exposed to apparel, department stores and most durable goods on an avoid for now. Housing construction & increase in foreign tourism will help boost other retailers and service providers.
S&P/ASX 200
*Chart: S&P/ASX 200 as of 10/02/23
The XJO was weaker by 1.65% this week with its first fall in six weeks. As the US comes to the tail end of their Q4 earnings reporting season we have just started our half yearly reporting season. To date only 18 companies have reported but we have a massive week ahead with some of the big hitters such as JBH, CSL, WES, FMG, CBA, ASX, NCM, TLS announcing earnings.
In the short term I can see further downside in the index to around the 7,300 level but maintaining our longer term upward trend. I have seen earnings forecast from +3% to +7% lately for FY23 locally which would have us around the 14x forward earnings mark, slightly on the cheaper side of fair. If commodities can maintain their uptick and energy bounces, then we should see a revision upwards here.
I feel the main thing we are focused on with earnings season is cost controls. Have input prices started to abate or is it too soon yet? My gut feel is we won’t see any material downside to appear in reports until full year announcements in August. Energy & labor costs have remained on the higher side of things here in Australia despite falling overseas. These will come down dramatically as they start to filter through here and higher skilled immigration flows through.
Again, are companies still passing these price rises onto consumers or are they taking on some of them eating into margins. Their cashflow positions will tell the story here. Also, outside of resources/energy will dividends continue to rise and how healthy are those cash positions? These will all be important facets of the earnings season in the weeks ahead.
However, a lot of focus is given to the overall indexes these days and for many investors that doesn’t mean much. Afterall, we are stock pickers and portfolio managers, so it really does come down to the quality we have in those portfolios rather than an index level. I am confident in the exposure we have moving forward it remains resilient with consistent earnings growth.
Energy
*Chart WTI Crude Oil as at 10/02/23
Energy prices across the board have taken a hammering for the better part of 8 months. Fears of a supply shortage due to the Russian sanctions fail to materialize and as I expressed some time ago, the Russian invasion of Ukraine did not pull supply from the market it simple changed supply chains and who was buying oil off whom. For instance, China has been buying cheap oil off the Russians all this time and filling their domestic oil reserves ready for re-opening. OPEC+ nations have also been buying cheap Russian oil/gas to feed their domestic markets whilst selling their own product into world markets at a premium.
So where to for oil and energy? It’s my belief in the short term we could see some further downside in the price of oil & gas. I believe we are amid an energy glut as China recently was rejecting gas shipments and burning some off domestically. The EU have had a very mild winter and not used anywhere near as much gas as per usual. The latest data I saw had EU reserves at around 70% of capacity where on average they would be down to 57%. I will acknowledge the sideways consolidation we are seeing in oil prices so we may have seen the bottom, but I wouldn’t be surprised to see one final flush and have WTI crude with a six handle. Confirmation of a US/EU recession could be the catalyst for this.
Longer term, in 2024 and beyond, I feel we do see $100 oil again. I will note Morgan Stanley sees oil at $110bl again by Q4 23, which I believe is too optimistic. A lot of that is on the premise of the China re-open but I don’t feel that is as bullish for oil prices as everyone hopes as per the above.
As the above chart shows, according to the latest data Chinese oil reserves, both commercial and in SPR, are well above that in the US. Initially as China re-opens, and Russia doesn’t discount their production as much, China will call upon those reserves. It also has more freedom on its SPR use than the US and can use it to manipulate prices, like they did in 2021. In 2H23 I do expect an acceleration of oil prices as the China story gets more momentum and we should have a better idea on the state of the US/EU economy.
Morgan Stanley puts Chinese daily demand at just above 14mbld but expect it to climb back to trend of around 16.5mbld by year end. This is a catalyst for upside price but will take some time to show up in markets and to make a dent in inventories.
I am happy to hold energy stocks such as Woodside (WDS) here if I’m already in. They have weathered the downturn in energy prices well I just feel there will be ‘that moment’ when we see a flush to higher lows that we can add to our positions. I am keen on energy service providers such as Worley (WOR) here as prices for their services are climbing and they are in extremely short supply. Trading at around 16-17x FY24 earnings is a little expensive but given the structural deficiency we have entered in the energy sector longer term I am happy to pay that.
Again just to summarize in the short term, next six months, I am bearish energy after that I can see a very bullish scenario again for oil & gas.
Alumina/Aluminium
*Chart AWC as at 13/02/23
I have spoken at length about the Chinese re-open and how bullish that is for commodities overall. I have also expressed my bullishness for copper and how I believe it’s the number one resource to have exposure to moving forward. Well, I want to add another to that list and that is Alumina/Aluminium. Alumina is produced from bauxite, which is then converted into Aluminium. Now aluminium is used in practically everything from transportation, construction and electrical to cans, foils, and kitchen utensils. Its one of the most used materials on earth. Now due to slowing demand in China last year and high energy costs in the EU production of these metals were both curbed. Demand for it will rise by 3% in China according to Goldmans. They also see aluminium prices moving from the current $US2,500t to $3,100t this year and $3,750 longer term. These are all very bullish factors for alumina/aluminium producers on the ASX. Below are some ways to get exposure to this sector on our market.
Alumina (AWC $1.55)- The ASX’s largest Alumina producer who also has the benefit of mining a lot of bauxite feed stock for its operations. Suffered from high energy costs at its Spanish operations last year and practically across the globe. Energy costs represent 20-40% of all costs for these types of operations so you can see why they ate into margins over the last 18 months. Earnings don’t look too good for FY23 but FY24 should be a lot better, especially if prices continue to climb.
South32 (S32 $4.55)- A lot of crossovers in S32 as I also listed it as one of my favourites for copper exposure. Around 35% of S32 EBITDA is derived from its Alumina/Aluminium production. This gives us decent exposure to both materials. S32 only trades at 9x forward earnings with a forecast yield of 5% so a much better fundamental outlook than AWC. UBS recently upgraded their price target for S32 to $5.70 well above current prices. S32 remains one of my favourites in the material sector.
Alpha HPA (A4N $0.65)- A4N is a higher risk, speculative pick at only a approx. $500mill market cap. A4N aren’t into the production of Alumina or Aluminium but up the value chain with high end Alumina products. Their main products are in high purity aluminium salts (Sulfate, Nitrate) and soon high purity Aluminas (HPAs). These specialist materials are very highly sought after and in very short supply. They are mostly used in lithium-ion batteries, LED lighting & semi-conductors. The last two are what really get me excited as the globe transitions from old school fluorescent lighting and into LEDs, especially mini-LEDs that can be found in electronics like mobile phones and smart watches. Of course, semi-conductors will continue to gain momentum as everything we own will soon enough have a chip inserted into it. Stage 1 production of the salts has commenced with stage 2 HPAs to follow in the next couple of years.
And there we have it for another ‘ASX Market Update’. I hope you all took something out of it. Markets have certainly started the year a lot better than we did in 2022 and on the back of historical data probabilities suggest it should continue for the rest of the year.
It was an emotional start to the year at the end of January as our youngest son began school for the first time. He has taken to it better than we could have expected and loves going to find his big brother at recess and lunch for a play. He’s adjusted well and making new friends every day. The house is just so quiet now even with a 3-month-old. Its going to take some adjusting to not having the boys at home. I hope you are all keeping well and staying safe. I look forward to speaking with you all soon. Have a good one. Go Crows!
heath@hlminvestments.com.au
0413 799 315
Important Notice
Any advice in this article should be considered General Advice only and does not consider your personal needs and objectives or your financial circumstances. You should therefore consider these matters yourself before deciding whether the advice is appropriate to you and whether you should act upon it. I am happy to assist you in this process. To do so, I will need to collect personal and financial details from you before providing my recommendations. Please note the author may own shares in the companies mentioned in the above blog.
