Category: Australia & NZ

Posted on

Is the ASX over-priced?

On the weekend I discussed how earnings for the S&P 500 have grown by roughly 6.0% over the last three decades but the growth rate should rise as stock buybacks have averaged just over 3.0% a year since 2011. In an ideal world the growth rate would lift to close to 9.0% p.a. if buybacks continue at the present rate. Add a 2.0% dividend yield and we have an expected annual return close to 11.0%.

Forward Price Earnings Ratio for S&P 500

I conducted a similar exercise for the ASX using data supplied by marketindex.com.au.

The first noticeable difference is that earnings for the ASX All Ordinaries Index grew at a slower pace. Earnings since 1980 grew at an average compound annual growth rate of 4.4%, while dividends grew at a much higher rate of 6.3%.

Forward Price Earnings Ratio for S&P 500

How is that possible?

Well the dividend payout ratio increased from the low forties to the high seventies. An average of just over 60%.

With a current payout ratio of 77% (Feb 2017), there is little room to increase the payout ratio any further. I expect dividend growth to match earnings growth (4.4% p.a.) for the foreseeable future.

Buybacks are not a major feature on the ASX, where investors favor dividends because of the franking credits. The dividend yield is higher, at just over 4.0%, for the same reason.

So the expected average return on the All Ordinaries Index should be no higher than 8.4% p.a. (the sum of dividend yield and expected growth) compared to an expected return of close to 11.0% for the S&P 500. That is, if buybacks are effective in lifting the earnings growth rate.

Obviously one has to factor in expected changes in the (AUDUSD) exchange rate, but that is a substantial difference for offshore investors. Local investors are also taking into account franking credits which benefit could amount to an additional 1.4% p.a.. But that still leaves a grossed-up return just shy of 10 percent (9.8% p.a.).

I would have expected a larger risk premium for a smaller exchange with strong commodity exposure.

Posted on

RBA stuck

Great slide from the NAB budget presentation:

RBA Interest Rates in a Cleft Stick

The RBA is in a cleft stick:

  • Raising interest rates would increase mortgage stress and threaten stability of the banking system.
  • Lowering interest rates would aggravate the housing bubble, creating a bigger threat in years to come.

The underlying problem is record high household debt to income levels. Housing affordability is merely a symptom.

There are only two possible solutions:

  1. Raise incomes; or
  2. Reduce debt levels.

Both have negative consequences.

Raising incomes would primarily take place through higher inflation. This would generate more demand for debt to buy inflation-hedge assets, so would have to be linked to strong macroprudential (e.g. lower maximum LVRs for housing) to prevent this. A positive offshoot would be a weaker Dollar, strengthening local industry. The big negative would be the restrictive monetary policy needed to slow inflation when the job is done, with a likely recession.

Shrinking debt levels without raising interest rates is difficult but macroprudential policies would help. Also policies that penalize banks for offshore borrowings. The big negative would be falling housing prices as investors try to liquidate some of their investments and the consequent threat to banking stability. The slow-down in new construction would also threaten an economy-wide down-turn.

Of the two, I would favor the former option as having less risk. But there is a third option: wait in the hope that something will turn up. That is the line of least resistance and therefore the most likely course government will take.

Posted on

ASX 200 bearish consolidation

The big banks fell sharply on news of a new levy on bank liabilities in the latest budget. At this stage the ASX 300 Banks Index merely shows a secondary reaction. Breach of 8500, however, would signal a primary trend reversal, offering a medium-term target of 8000*.

ASX 300 Banks

* Target: 8500 – ( 9000 – 8500 ) = 8000

Resources stocks compensated, with the ASX 300 Metals & Mining Index rallying to test resistance at 2850/2900. Breakout is unlikely given the weak lead from iron ore. Reversal below 2700 remains likely and would strengthen the bear signal for resources.

ASX 300 Metals & Mining

Iron ore formed a bearish consolidation above support at $60. Breach would offer a short-term target of $50*.

Iron ore

* Target: 60 – ( 70 – 60 ) = 50

Selling of the Aussie Dollar continues, with a medium-term test of primary support at 71.50/72.00 now likely.

Aussie Dollar

Consolidation of the ASX 200 above support at 5800 is a bearish pattern. Breach would signal a correction to test primary support at 5600*. Twiggs Money Flow still indicates long-term buying pressure and only a fall below zero would warn of a reversal.

ASX 200

* Target medium-term: 5800 – ( 6000 – 5800 ) = 5600

Posted on

2 More Warning Signs for the ASX

The recent Iron ore rally has faded and the commodity is again testing support at $60. Twiggs Momentum (13-week) below zero indicates a primary down-trend.

Iron ore

The ASX 300 Metals & Mining Index broke support at 2850, warning of a down-trend. A Twiggs Money Flow peak below zero flags strong selling pressure.

ASX 300 Metals & Mining

Falling ore prices will place strong downward pressure on the ASX and the Aussie Dollar.

Aussie Dollar

ASX 300 Banks Index retreated below 9000. Declining Twiggs Money Flow indicates medium-term selling pressure. Follow-through below 8900, or Twiggs Money Flow below zero, would warn of a correction.

ASX 300 Banks

The large red engulfing candle on the weekly ASX 200 chart also warns of a (secondary) reversal. Breach of support at 5800 would signal a correction. Twiggs Money Flow still shows long-term buying pressure and only a fall below zero would warn of a market top (primary trend reversal).

ASX 200

* Target medium-term: 5800 + ( 5800 – 5600 ) = 6000

Posted on

‘Be careful what you wish for’: RBA could cause Aussie rout

From Myriam Robin at the Sydney Morning Herald:

The yield differential between 10-year US and Australian government bonds has shrunk to less than 30 basis points, the tightest in about 15 years, as the US engages in monetary tightening while the RBA appears set to keep rates steady at 1.5 per cent.

….This should be a serious concern for Australian policymakers, TD Securities’ chief Asia-Pacific macro strategist Annette Beacher told The Australian Financial Review, as many foreign investors are primarily attracted to the high-yield status of the local currency.

The Aussie Dollar has attracted investors over the last decade primarily because good fortune in avoiding a post-GFC recession enhanced Australia’s reputation as a stable economy. But the Aussie is still a commodity currency prone to boom-bust cycles. Dodging the 2008/2009 bullet was more a matter of luck than of skillful management of the economy. Without China’s massive post-GFC stimulus the Australian economy would have been smashed — along with the housing bubble — and the big four banks would have gone to the wall (or more likely been rescued by a government bailout). And the Aussie would be trading close to 50 cents, which ironically, despite the massive shock, may have put the economy in a stronger (and more realistic) position than it is today.

Source: ‘Be careful what you wish for’: RBA could cause Aussie rout

Posted on

ASX 200 advance slows as iron ore falls

Iron ore found support at $60.

Iron ore

The ASX 300 Metals & Mining Index has taken some encouragement from the rally, with support at 2850. But bear rallies are normally short in duration and reverse sharply.

ASX 300 Metals & Mining

The ASX 200 advance has slowed after the recent sell-off in the resources sector. But rising Twiggs Money Flow still signals buying pressure and another attempt at 6000 seems likely.

ASX 200

* Target medium-term: 5800 + ( 5800 – 5600 ) = 6000

ASX 300 Banks, the largest sector in the broad index, is consolidating above its new support level at 9000. Declining Twiggs Money Flow warns of medium-term selling pressure. Reversal below 8900 is unlikely but would warn of a correction.

ASX 300 Banks

Bank exposure to residential mortgages is the Achilles heel of the Australian economy and APRA is likely to keep the pressure on banks to raise lending standards and increase capital reserves, which would lower return on equity.

Posted on

Federal budget 2017: The next boom is under way – before another bust

From Michael Pascoe:

A Caterpillar and Komatsu cavalry is arriving just in time to save the next two federal budgets from the effects of slowing residential building approvals, solving one of Treasurer Scott Morrison’s fiscal dilemmas. National spending on transport infrastructure is in the process of soaring 73 per cent from last financial year to 2018-19, according to industry research company Macromonitor.

Spending on road and rail hit a cyclical low of about $19 billion in 2015-16. In constant dollars, the cycle is expected to peak at $33 billion in 2018-19. That spending would more than cover a 10 per cent decline from last year’s $63 billion worth of new residential building….

Increased infrastructure spending is welcome but former RBA governor’s comments on setting up a proper process of infrastructure planning and selection [see link below] highlight the negative boom-bust mentality of government focused on the election cycle.

Source: Federal budget 2017: The next boom is under way – before another bust

Posted on

IMF predicts Australian GDP rise but iron ore drops

From Latika Bourke at Sydney Morning Herald:

Australian economy to boom as unemployment drops, IMF

…The IMF predicts Australia’s economy will grow by 3.1 per cent in 2017 and 3 per cent in 2018. This is better than the most recent forecast by the Australian Treasury and released by the Australian government in December last year, which predicted GDP would “pick up to 2¾ per cent in 2017-18 as the detraction from mining investment eases.”

Broad projections like those of the IMF offer little comfort. The very next headline warns of falling iron ore prices:

From Timothy Moore at The Age:

Spot iron ore extends retreat, sliding another 4.6pc

The spot price of iron ore now has fallen one-third from its February peak, as the slide into a bear market turns into an accelerating rout.

At its Tuesday fix, ore with 62 per cent iron content slid $US3.05, or 4.6 per cent, to $US63.20 a tonne, according to Metal Bulletin. The price has tumbled more than 20 per cent so far this month….

Breach of the rising trendline warns that spot iron ore is likely to test primary support at 50. Reversal of 13-week Twiggs Momentum below zero warns of a primary down-trend.

Iron Ore Spot Price

Falling resources stocks are dragging the ASX 200 lower. The up-trend is still intact but expect strong resistance at 6000. Reversal below 5680 would signal reversal to a down-trend.

ASX 200

Posted on

Falling iron ore weighs on Resources stocks

Iron ore broke support at 70. Follow-through below the rising trendline would warn that the up-trend is weakening.

Iron Ore

Australian resources stocks, represented here by the ASX 300 Metals & Mining Index [$XMM], reflect strong selling pressure with a bearish divergence on Twiggs Money Flow. Follow-through below 2850 would warn of a (primary) reversal.

ASX 300 Metals & Mining Index

Posted on

Australia: Financial Stability | RBA

Extract from the latest Financial Stability Review by the RBA:

….In Australia, vulnerabilities related to household debt and the housing market more generally have increased, though the nature of the risks differs across the country. Household indebtedness has continued to rise and some riskier types of borrowing, such as interest-only lending, remain prevalent. Investor activity and housing price growth have picked up strongly in Sydney and Melbourne. A large pipeline of new supply is weighing on apartment prices and rents in Brisbane, while housing market conditions remain weak in Perth. Nonetheless, indicators of household financial stress currently remain contained and low interest rates are supporting households’ ability to service their debt and build repayment buffers.

The Council of Financial Regulators (CFR) has been monitoring and evaluating the risks to household balance sheets, focusing in particular on interest-only and high loan-to-valuation lending, investor credit growth and lending standards. In an environment of heightened risks, the Australian Prudential Regulation Authority (APRA) has recently taken additional supervisory measures to reinforce sound residential mortgage lending practices. The Australian Securities and Investments Commission has also announced further steps to ensure that interest-only loans are appropriate for borrowers’ circumstances and that remediation can be provided to borrowers who suffer financial distress as a consequence of past poor lending practices. The CFR will continue to monitor developments carefully and consider further measures if necessary.

Conditions in non-residential commercial property markets have continued to strengthen in Melbourne and Sydney, while in Brisbane and Perth high vacancy rates and declining rents remain a challenge. Vulnerabilities in other non-financial businesses generally appear low. Listed corporations’ profits are in line with their average of recent years and indicators of stress among businesses are well contained, with the exception of regions with large exposures to the mining sector. For many mining businesses conditions have improved as higher commodity prices have contributed to increased earnings, though the outlook for commodity prices remains uncertain.

Australian banks remain well placed to manage these various challenges. Profitability has moderated in recent years but remains high by international standards and asset performance is strong. Australian banks have continued to reduce exposures to low-return assets and are building more resilient liquidity structures, partly in response to regulatory requirements. Capital
ratios have risen substantially in recent years and are expected to increase further once APRA finalises its framework to ensure that banks are ‘unquestionably strong.’

Risks within the non-bank financial sector are manageable. At this stage, the shadow banking sector poses only limited risk to financial stability due to its small share of the financial system and minimal linkages with the regulated sector, though the regulators are monitoring this sector carefully. Similarly, financial stability risks stemming from the superannuation sector remain low.

While the insurance sector continues to face a range of challenges, profitability has increased of late and the sector remains well capitalised.

International regulatory efforts have continued to focus on core post-crisis reforms, such as addressing ‘too big to fail’, as well as new areas, such as the asset management industry and financial technology. While the goal of completing the Basel III reforms by end 2016 was not met, discussions are ongoing to try to finalise an agreement soon. Domestically, APRA is continuing its focus on the risk culture in prudentially regulated institutions and will review compensation policies and practices to ensure these are prudent.

Reading between the lines:

  • household debt is too high
  • apartments are in over-supply and prices are falling
  • we have to maintain record-low interest rates to support the housing bubble
  • APRA is “taking steps” to slow debt growth but also has to be careful not to upset the housing bubble
  • the Basel committee has been dragging its feet on new regulatory guidelines and we cannot afford to wait any longer

Source: RBA Financial Stability Review PDF (2.4Mb)

Powered by WordPress / WordPress Maintenance Service By Website Helper