ASX Weekly Wrap 29/10 - 02/11

The XJO had its best week in two years last week as the XJO rose 184.00 points or 3.24%. This was on the back of those large 4%+ losses we saw the week beforehand, thus we were able to make up some ground again. Optimism returned to global markets after both Trump & the Chinese leader made positive comments regarding where trade negotiations were at between the two nations. Our low for the week was 5,665.20 on Monday and the high was 5,877.20 on Thursday.

*Chart courtesy of Pete Wargent

We have a few bank earnings to cover this week so I will rip through what economic data we have. First up was Australia’s trade balance, which came in much better than expected. We posted a $3.017bill surplus vs $1.7bill expected for September. August’s figure of $1.6bill was also revised upwards to $2.342 as well. Again it was bulk commodities that did most of the heavy lifting with Coal, iron Ore & LNG production levels and prices remaining strong. We are also now almost in surplus within the services sector as well, providing another boost. A lower AUD is also helping our cause as well. Imports rose 1.9% whilst exports rose 3.7% for September. Our trade balance has been a real positive for us in 2018 and really has helped support the economy. We are exporting more raw materials than ever before and with a lower AUD our services (education, tourism etc.) are looking a lot more attractive for Asian consumers. This will help us print another solid GDP figure for the third quarter despite some softness in other areas.

The second data point I want to look at today is US Jobs for October which also came in well above forecast. The US economy added 250,000 jobs vs the 190,000 expected. The unemployment rate stayed flat at 3.7% with the participation rate rising to 62.9%, from 62.7%. The big talking point came from wages which came in with a +3.1% read vs +2.8% last month. This was the strongest lift in wages since June 2009. It has taken a while to get going, and for an unemployment rate to be near record lows, but wages are starting to gain some momentum in the US. It also shows we shouldn’t feel so bad here with unemployment at 5% and wages at 2% growth. It took a long time for US wages to gain traction even though they were considered fully employed. The market sold off on the back of this as bond yields rose. Again a stronger than expected US economy does raise fears about more rate increases. Overall though, even if rates are going up, people are employed, wages are rising, people spend that money and company earnings continue to be strong. This is bullish in the longer term for equity markets.

Yesterday we had the results of the US mid-term election filter through during the day and as the markets expected the Republicans retained the senate, but lost the house. This saw US markets rise as much as 2% last night as no surprises were thrown in and the Republicans actually fared better in the house than expected. What this means for Trump is any policies he wishes to implement, outside of executive orders, he will have to negotiate with the Democrats to get them through. This may limit policy he can implement, but he has already said he is more than willing to work with the Democrats moving forward. This probably means we don’t see the $10trill Infrastructure plan come to pass, but doesn’t mean we don’t see a watered down version of it. Infrastructure through the middle of the US is in very poor condition and does need fixing regardless. Overall it is still positive for global markets as it still provides Trump with plenty of options.

We had three of our largest banks report their earnings last week and the first I will be covering is ANZ. Below is a summary of some of the key financials from their report.

As you can see it was a soft result for ANZ with cash profit falling 5% on last year’s numbers. ROE also fell but they were able to maintain their dividend of 160cps (100% Franked) for the full year. In positive news their payout ratio was only 61% (based on pre-abnormal net profit) vs 82% the last couple of years. This means that ANZ has lots of room to maintain their current dividend should earnings continue to deteriorate. Other important stats to take from the report not shown above was their net interest margin which fell 7bps to 1.82%, showing sign of further pressures of the low rate environment and increased costs of overseas funding. ANZ’s credit quality continued to improve with its total provision charge falling 42% to $688mill on last year’s $1.199bill figure. Also 90+ day delinquencies for owner occupier loans sat around 0.80% and 0.90% for investors. The investor delinquencies have risen from 0.40% in 2015 to that current figure but owner occupier have maintained that rate for some time.

Finally a big concern for our banks in the coming years were the conversion of interest only loans to principle and interest (P&I). During the 2013-2016 period a lot of investment loans were created on an interest only (IO) basis and most of these tend to have 5 year terms. The worry was when 2020/21 rolled around there would be a large wall of interest only loans to convert to higher P&I repayments that the owners could not afford or even be approved for on the basis on tighter lending standards. This seems to have been mitigated somewhat with a large sum of early conversions in the last two years. For ANZ of $46bill in IO to P&I loan conversions over the last two years $18bill of them have been early conversions. In fact the percentage of IO only loans overall, in the Australian financial sector, has fallen from 39% of all loans to 28.8% in the last 15 months. This is a very healthy sign for our banking system and how robust it is. Now this could be a case of both customers and banks being proactive in converting these loans whilst house prices were higher, but I have also heard of banks offering lower rates to these customers that make the P&I repayment lower than the IO.

In summary the story is much the same. Very tough conditions for banks at the moment with credit growth below trend and house prices falling. Not to mention low interest rate environments and increased costs of funding. However balance sheet quality is improving with delinquencies remaining low and risks moving forward decreasing. I remain underweight Australian banks simply because the risk is to the downside for earnings. I do like ANZ, longer term, and it is my top pick in the banks with a more conservative portfolio. It also is trading 11.7x current and 11.2x FY19 forward earnings. A 6.10% fully franked yield is also very attractive.

Next up is National Australia Bank (NAB), who also released their full year earnings last week. Again a quick summary of NAB’s results are below.

The story with NAB is similar to ANZ with one-off restructuring and remediation costs cutting into their cash earnings which fell 14%. Excluding these one off events cash earnings were only down 2%, which isn’t a bad result given the environment. Like ANZ their ROE took a hit, but they maintained their dividends. NAB’s payout ratio is on the high end of the scale at 88% and I can’t see them going above 90%, thus if earnings weren’t to improve in the next 12 months and fall back then we could see a dividend cut by NAB to keep it in check. Asset sales help boost their CET1 ratio, which rose 14bps to 10.2%. This is below the required 10.5% required by APRA in 2020, but they do have time on their side. We may see them issue a few Hybrids to help lift the ratio above 10.5% if earnings aren’t going to pick up.

We have seen NAB also improve its balance sheet by reducing the amount of IO loans on its books. Back in Mar-17 this sat at 32.1% of all loans written. As of this year’s full report it sits at 24.5% as a wave of early conversions also occurred at NAB. Of the $46bill of loans converted from IO to P&I since 1H16, $13.4bill of them have been early conversions. Once again this shows the responsible and prudent nature of Australian banks.

NAB is trading on a slightly more expensive multiple than ANZ of 12.3x, and it did go ex-dividend today, so you have missed out on that. NAB is on a yield of 7.9%, which to me says the market is expecting a dividend cut in the near future. As I pointed out earlier their payout ratio is quite high so I would not be surprised to see it happen. Whilst their loan book is improving I don’t think it is of the same quality as ANZ. My preference is for ANZ over NAB at current levels. Also if you buy ANZ before the 12th November you also pick up a handy 80cps dividend.

The last bank to cover today is Macquarie Group (MQG). It has been a darling of the market for the last 24 months and has outperformed our big four banks by some margin. Once again MQG went with a theme of under promise and over deliver and once again beat forecasts set by themselves and the market. Below is a summary of their first half results.

MQG saw a 5% lift in earnings over the same period last year, but it was flat when compared to the 2H18. The annuity style business saw a 10% lift on 2H18 but a 29% fall when compared to the same time last year. This is because the 1H18 benefitted from performance fees and invested related income. The capital markets side of the business did most of the heavy lifting this half seeing a 6% rise on 2H18 but also an impressive 95% lift on 1H18. This was put down to increased client activity and more trading opportunities presented by the markets. Operating income increased 8% to $5.803bill compared to the same time last year and +6% on 2H18. Both the dividend ($2.15ps) and EPS ($3.88ps) also rose in line with earnings at 5%. I will note their payout ratio was only 56%, which is lower than the 60-80% range MQG have flagged. We may see a bigger than expected final dividend to bring that back into range in 2019. Assets under management also improved by 11%, which is important for MQG as it increases their net fee base moving forward.

Looking forward MQG has stated that it expects FY19 earnings to be 10% up on FY18 overall. Hence we know from recent results that is a conservative forecast. They do mention the impacts of financial markets on the results, but one would think more volatility like we have seen recently would benefit MQG due to increased trading activity and opportunities for clients in their capital markets division. Their annuity division looks after itself and is steady as she goes. It also makes up 70% of their earnings so makes MQG base earnings very reliable.

If we assume MQG hits its target and lifts earnings by 10%, that would see full year EPS of around $8.34ps, which means MQG is trading on a PE of 14.6x here with a forecasted dividend yield of 4.8% (45% fully franked). I used a full year dividend of $5.84 which is a 70% payout ratio. This is around the payout ratio MQG has given the last two years. This is an attractive valuation, in my mind, for a company that has consistently outperformed and with 70% of its earnings in a very stable sector. Not to mention the USD exposure and the fact 67% of earnings come from overseas. I see a lot of value in MQG for longer term investors.

As I mentioned last week the XJO has bounced perfectly off the longer term trend line (red circle) and in my opinion looks headed towards that shorter term trend line we broke below a few weeks ago (purple arrow). From there I feel we consolidate before we break the current downtrend and make our next move higher. Whilst my forecast of 6,400-6,600 by the end of the year does seem a way off now I still believe we hit that mark easily, although a couple of months later.

I am the strong belief we see very bullish global equity markets in 2019 and here’s why. Since World War 2 we have had 18 midterm elections. In the 12 months post those elections we have seen the S&P 500 rise 100% of the time. The average return in that time is 17%!!! (source: Market Matters 08/11/18) The third year of a president’s term is usual the best and this is what we are entering into with Trump in 2019. Funnily enough the second year, 2018 with Trump, is usually the worst. Given how equity friendly Trump’s policies are I can see the US, and Global equity markets, having a ripping 2019. So how can we get the best exposure to this event and take full advantage of it? I have listed some possibilities below:

GGUS: This is a Betashares geared US S&P 500 ETF. It is internally geared (around 50-65%) and buys exposure to the top 500 companies listed in the US by market cap. It’s very simple and listed on the ASX. Management costs are a little high at 0.80% per annum but you are paying for that international exposure + gearing.

NDQ: This is another Betashares ETF which gives you exposure to the Nasdaq 100 index. If US markets are going to rally hard, you can bet a lot of the high beta growth stocks will do so as well. This will give you exposure to the likes of Apple, Microsoft, Google, Amazon etc. This has a 0.48% management fee.

IEM: This is an iShares ETF that gives you exposure to the MSCI Emerging Markets (China, Mexico, India, Indonesia etc). EM have been hit hard the last few months and we are at lows we haven’t seen since January 2016 in markets such as China. Once again if the US markets and economy continue to do well eventually EM will be dragged up. Also talks between China & US should ramp up and I am of the opinion we see a trade agree in Q1 2019. This has a management fee of 0.69%

ASIA: Another Betashares ETF which gives you exposure to the 50 largest tech companies in Asia. This means it contains companies like Alibaba, Bidu, Tencent, JD.com among others. Chinese Tech stocks are extremely undervalued when compared to their peers on the NASDAQ. I believe this gap will be closed over the next 12 months. Management costs are 0.67%.

Australian Stocks: I have been encouraging a lot of you to take advantage of the 10% fall in the XJO the last week or so and accumulate quality companies. If the US is to rally hard over the next 12 months we are very likely to follow suite. You could weight these investments towards companies with high exposure to the US economy, but overall a rising tide lifts all ships, so most quality companies should do well.

The above is what I feel can give you best exposure to global and local equity markets and the highest return possible. Of course not all of the above suggestions are appropriate for all investors and should be taken as General Advice only. Please speak to me or your financial advisor before making any decisions on anything above and whether or not it meets your financial objectives, goals and circumstances.

Well as we close in on 3,000 words I think I have bored you all enough for one week. I do apologise for how late this week’s newsletter has come out but I wanted to wait for the mid-term elections to finish, just in case there were some surprises. Next week’s wrap will cover the WBC earnings + CBA quarterly update among other goodies. I hope you all have a wonderful and safe week. Speak to you all soon. 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 take into account 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.