ASX Market Update 6th April 2023
Global Market Commentary
Chart: S&P 500 as at 05/04/23
Before we delve into the most recent events of global equity markets, I wanted to clear up a few house keeping matters. I am going to try and keep my newsletters a bit shorter and punchier moving forward. Usually, these things end up being 3k+ words with large walls of text that I am sure bores a few. However, I think if I can keep things short & sweet, I can pump these out more regularly.
The last couple of weeks has seen a relief rally (+6% for the SPX) across most global equity markets. After the collapse of SVB & Signature Banks we saw quick action by the Fed to sure up and build confidence in their banking system. After the initial volatility died down and credit markets tightened right up we have started to see things ease across the market. Even after an initial build up on the Fed balance sheet we have even seen that start to wind back.
Chart courtesy of @TheTranscript_ on Twitter
Concerns still remain about the US regional banking system and what could be lurking underneath. First Republic Bank & Charles Schwab are feared to be the next dominos to fall or at least need major capital injections. However, as you can see from the chart above SVB & Signature banks are real outliers in the system. At this stage this looks like systematic problem that has been solved with a systematic solution and limited contagion. This is not what breaks financial markets, but it has brought something else to the surface.
Chart courtesy of Bloomberg
Commercial real estate (CRE) in the US is becoming a large concern for a few reasons. The chart above depicts office vacancy rates at all time highs. People have not come back to the office full time since the pandemic and there are a lot of empty cubicles. This is leaving a lot of real estate firms holding the bag as valuations plummet. Normally they may be able to ride this out but by 2025 there is $432bill of CRE that needs to be refinanced, $270bill this year. This means a lot of loans that roll over into much higher rates and are paying much higher repayments. We have already started to see the impact of this with $160bill that has come due this year, $30bill is past due and has not been refinanced. If we start to see large defaults on these loans this then leaves the providers of the credit holding the bag with CRE properties that need a fire sale at valuations that may not cover the initial loans. Also, I will give you one guess as to what sector holds the most exposure to CRE loans………
Chart courtesy of Bloomberg
You guessed it…….. its Regional Banks. As this chart depicts, they have up to 70% of all CRE loans in the US on what are already suspect balance sheets. Hence if defaults start to rise in this sector then we could see a few more of these institutions blow up and cause a major contagion event. The chances of another GFC type event are still slim in my opinion but its this situation that I feel could spark it. In 2008 it was residential property that blew it all up, this time around it could be CRE. At best though the strains on the sector will see loan growth retrace, which impacts construction which, as I have said in earlier updates, has a major impact on the jobs markets and economy.
Chart Courtesy of @FactSet on Twitter
I am still of the strong belief the US enters at least a shallow recession in Q2/Q3 this year. Jobs are about to start being lost in a big way in the coming months spurred on by their construction sector which will then impact consumer spending, which is the crotch of the US economy. The above situation in CRE could be the difference between it being a mild recession or a deep and nasty one.
Question is have the US markets priced any of this in? At a forward PE of around 17x which is below 5 & 10 year averages you could argue a mild recession has been. But anything worse and there is significant downside to earnings and thus it has not been priced in. An earnings recession is already underway with Q4 22 earnings -5% and Q1 earnings forecast to be -6%. Analysts’ downgrades are also running at twice the rate they normally would in this situation so at least the situation is being acknowledged. However, if you forecast earnings to come off 15% and the market to trade at 15x forward earnings that gives us an index level of around 2,950. We are currently at 4,100. That gives us a possible 28% downside if the worst were to occur. Thus for me the US market is expensive at current levels and I feel during the next two quarters there will be an excellent entry point to that market.
The upcoming Q1 23 earnings season, which starts next week with the banks, is likely to give us more clarity surrounding future earnings expectations and guidance.
S&P/ASX 200
Chart: S&P/ASX 200 as at 05/04/23
The XJO has also seen a nice recovery over the last two weeks breaking our seven week losing streak with a strong 3% gain last week. Whilst our banking system is secure and earnings still growing, although modestly, we do have our own headwinds ahead. Consumer spending is about to nose dive and we have a mortgage cliff in the second half of the year with hundreds of billions of fixed rate loans rolling over to much higher rates. This will obviously see defaults rise but more important be a demand suck for the economy as household budgets become strained.
Luckily the RBA saw these headwinds this week and decided to pause rate hikes. I mentioned last year I feel they would pause by the end of Q1 and this has played out nicely. I also believe that they are now done hiking in this cycle and will be cutting maybe as soon as Q4 this year. We have also seen fixed rates coming down at the banks with MQG the latest today cutting 30bps from their fixed rate loans. This will assist our mortgage cliff in the second half of the year as those rates should keep coming down as rate expectations ease.
Our own banks start reporting in a few weeks with BOQ (20/4), NAB (4/5), MQG (5/5), ANZ (5/5) and WBC (8/5) reporting, which we will watch to see if delinquencies start climbing and/or if future impairments are to be made. If CBA is anything to go by then as long as loan growth doesn’t nosedive, and arrears stay in check then profits will be healthy. Expanding NIMs arising from current variable loans seeing rate increases and then the wave of fixed rate mortgages rolling over to much higher rates for the rest of the year will benefit earnings moving forward. CBA saw a 13bps drag on NIM from declining loan growth but +39bps from rising rates. They also had 90+ day arrears at 0.43% which is well below Dec-19 when they were at 0.91%. Our banks, outside of CBA, are not expensive mostly trading at 10-12x forward earnings on low book values.
Locally our market still remains on the cheaper side of the ledger at 14x forward earnings and a 4.5% forecast yield. However, FY24 & 25 are currently forecasted to see little to no earnings growth. Again, I reiterate it’s a stock pickers market and investing in quality companies is more important than ever. I have a long list of these companies I am happy to discuss on a personal level. I have also been allocating a lot more money into bonds, via ETFs, which will help safeguard portfolios if markets do peel off, reduce volatility and should outperform equities in the next 12 months if bond yields continue to fall. My favourite bond ETFs are:
· Betashares Australian Government Bond ETF (AGVT)
· Betashares US Treasury Bond 20+ YR ETF (GGOV)
· Global X US Treasury Bond ETF (USTB)
· Vaneck Australian Subordinated Debt ETF (SUBD)
It just depends on what regions exposure you want, duration, currency hedges or type of debt. I am favoring long duration at the moment as it should see the best outperformance moving forward with the largest bond price recoveries.
In wrapping up I am genuinely concerned about global equity markets, in particular the US, for the next 6 months as markets remain precariously poised. I haven’t felt like this way for a while. As always if something were to happen it will only provide us with opportunity to buy quality companies at cheaper valuations.
A much punchier update this week at a mere 1800 words or so. I feel we can get slightly punchier and keep it under 1500. I’m really looking forward to the Easter long weekend. Its one of my favourite holiday periods as markets are shut and I can spend quality time with my family. We had the boys teacher/parent interviews today and I have to say I couldn’t be more proud of them. We got glowing reviews and feedback for them both which just warms the heart. It also reassures you as a parent that we must be doing something right. Our daughter is growing up so fast now as she turned 5 months old this week. She is such a happy and smiley baby and causes us little stress at all. Also, how about them Crows on the weekend? Love beating the other mob across town. It gave me hope that there is something for us this season despite a rough start. I hope you all have a wonderful Easter break and if you are travelling, please drive carefully & of course everyone needs to stay safe. Markets are shut for Good Friday and Monday so I will speak to you all next week. 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.
