The amusing mis-pricing of Australian shares

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From Morgan Stanley today:

Newsflow and data for the ASX 200 is peaking over the next month. So with commodity linked earnings rolling, industrial outlooks being recalibrated and fiscal and monetary intentions updated, we look into the upcoming noise and break out what matters for markets.

A Big Few Weeks for Markets: A run of shortened working weeks are now over and with the onset of May,a raft of potentially market moving information will also appear. Resource quarterlies are already impacting aggregate EPSg levels, industrial earnings will be updated as the 3Q conference circuit starts in earnest, monetary policy will once again be compared with the US Fed setup and the Federal budget may once again (finally) be worthy of ordering in Pizza to assist dissemination of what looms as a key plank in the re-election platform for the incumbent government.

Resources Earnings Tapering– Should you be OW? The quarterly Resources production updates have already commenced and mixed updates on volumes and costs have seen MS estimates downgraded across a number of stocks. The end of the upgrade cycle has led to some meaningful relative underperformance across March and April for ASX Resources (-4.9%). Our conviction around OW portfolio positioning is linked to both the attractive balance sheet and FCF metrics at both forecast (retracing) and spot commodity outlooks as well as what should ultimately be favorable demand backdrop as global growth coordinates and continues to accelerate.

Industrials Earnings in need of a Big 2H: Trading updates will start to flood in for Industrial companies across various conferences and investor days. In 1HF17 the EPS growth rate for Industrials ex Banks was negative 1.7%. The full year fiscal 2017 consensus estimate is positive 4.6% growth. Taking into account seasonality of earnings the 2HF17 run rate of growth needs to be solid double digit to meet expectations. Our view is that the industrial cycle is facingheadwinds from a past peak housing cycle, fatigued consumer and continued real cost pressures (Australia Macro+: Macro Matters: Industrial Earnings – Negative Jaws Looming (06 Apr 2017). The cracks seen in the recent WES update (Wesfarmers: Are Cracks Emerging? (27 Apr 2017)) and recent CCL downgrade (Coca-Cola Amatil: The Earnings Cloud… (23 Apr 2017))give credence to such caution in our view.

Banks – Volume vs Price: Bank earnings season kicks off and whilst our team sees results as being of acceptable quality and well within expectations, the valuations are asking for more in the outlook (see ANZ Bank:Looking for Upgrades (27 Apr 2017) and Nat Aust Bank: Priced to Deliver,25 Apr 2017). Investors have rewarded the Big 4’s oligopolistic pricing power with the sector outperforming the ASX 200 this CYTD by +2.5%. And whilst the re pricing initiatives have stabilized both earnings and insulated near term dividends – the tightening cycle and now further focus from Macro Pru 2 puts downward pressure on system growth. Our banks team recently cut total housing loan growth to sub 4.5% in FY18e and FY19e for the majors (Australia Banks: Mortgages: A New Age, 19 Apr 2017) and we add this to business credit growth of 3-5% depending on which Bank you look at – system growth looks to be sub 5% for a while. The macro read thru is one of a looming disconnect and potential growth disappointment to consensus.

Detecting a Fiscal Pulse? The upcomingFederal Budget on May 9 is looming as potentially a Pizza worthy event. The last two budgets have been lack lustre in terms of new policy and have remained anchored to failed passage of a near decade of “return to surplus” targeting initiatives. The recent speech by Treasurer regarding the segmentation of debt between “Good” infrastructure linked debt and “Bad” opex spend (link to Treasurer Scott Morrison’s Speech) open the door to a new narrative (and initiatives) from this year’s budget. Today’s press speculation of real fiscal intent to build the second Sydney airport and linked infrastructure (refer to AFR article (27 Apr 2017)) means that (warranted) skepticism around a fiscal boost could be countered by hard evidence and calibrated quickly as a much needed offset to the domestic cycle headwinds presenting.

Building Pressure on the Currency: The next RBA meeting will again allow investors to compare and contrast the local outlook for official rates and that of the US Fed path (which is now 60%+ price for a June hike). The market continues to price a more hawkish RBA than Fed beyond the next 12 months, but we think this misses the fact that a 3% cash rate is equivalent to ~6.25% pre-GFC given world-leadinghousehold leverage. We believe the looming growth disappointments and a swing to negative rate differentials will pressure the AUD lower over 2018. Our Global FX Strategy team has AUD/USD forecast at 0.67.

We’ve played this song before. All through 2014/15 I warned that iron ore was going to fall far lower than anyone expected and thus the capital values for miners and any other firms exposed to Australian income was too high. So it turned out.

Now we have the ASX200 back at those early 2015 levels and everyone is again pricing an endless flow of iron ore riches just as the bottom falls out of the bulk commodity market. Both iron ore and coking coal are going to halve over the next twelve months barring further Chinese stimulus (of which there is no sign, on the contrary) and that means the terms of trade will collapse by roughly one quarter to new lows.

Morgan Stanley is exactly right to be cautious on the market, they’re just not bearish enough on miners and the dollar. The idea that the RBA will be hiking faster than the Fed a few years out is a joke as China moves post-growth.

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About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.