Category: Australia & NZ

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Bailout time

Boeing has applied to the Federal government for a $60 billion bailout. The troubled aircraft manufacturer is in need of rescuing but has indulged in $54.9 billion of stock buybacks in support of its stock price.

Former UN ambassador and ex-South Carolina governor, Nikki Halley resigned from Boeing’s board, saying that she opposes federal support for Boeing. Smart political move. Public anger is growing.

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Many corporations used stock buybacks to boost earnings per share after earnings growth slowed in 2014/15. Boeing was no exception.

Stock Buybacks and LT Debt

The company had a reputation for engineering fine aircraft but in recent years that focus has shifted to financial engineering and cost-cutting to boost earnings per share. Free cash flow was squandered on stock buybacks, dividends and executive bonuses. No reserves were accumulated for a rainy day.

Well, a rainy day finally arrived in 2018. The Boeing 737 MAX airliner, which began service in 2017, was involved in two fatal accidents, Lion Air on October 29, 2018, and Ethiopian Airlines on March 10, 2019, caused by a malfunction of the aircraft’s new MCAS automated control system. The aircraft was grounded by airline authorities around the world and Boeing suspended production in December 2019. After a software bug was discovered in January, the return to service was delayed. Despite an outstanding issue over non-compliant wiring bundles the FAA has indicated that they expect the 737 Max to return to service in the second half of 2020.

The company had to raise almost $10 billion in bonds to help it weather the setback. CEO Dennis Muilenburg was ousted in late 2019 but still walked away with a golden parachute of up to $50 million.

A hit from the 2020 Coronavirus outbreak has put the company into difficulties, with the stock getting pounded. Boeing has been forced to apply for a government bailout.

Stock Buybacks and LT Debt

The company is a strategic asset of the United States and should be protected.

But rewarding bad behavior would promote moral hazard on a wide scale. To give management and stockholders a free ride would encourage risk-taking by other companies — with the expectation that they will be bailed out if something goes wrong.

Support the company but hurt the stockholders

Management and existing stockholders need to feel the pain.

Offer support in the form of $60 billion of convertible bonds or preference shares, ranking behind creditors but ahead of stockholders. Conversion into ordinary shares should be in 10 years time but at the current stock price of $100. Stockholders and management awards will take a huge hit,  while taxpayers can look forward to a sizeable gain when the company recovers.

Support should be non-voting (bonds or prefs) to keep political interference to a minimum.

Buybacks

Preventing future buybacks is a completely separate issue that should be addressed on a national basis and not by placing restrictions on individual companies. For the record, we are against buybacks because they can be used to artificially support stock prices. Companies that need to return capital to stockholders should declare a special dividend.

Avoid a Domino-effect

There are a string of companies lining up with bailout requests. It is important to put emotions aside and save those that are still viable businesses and not just strategic assets like Boeing. Millions of jobs are at stake. And disruption to credit markets could have a Lehman-like domino effect.

Just ensure that it is on terms that favor the taxpayer, so that stockholders will think twice about future profligacy.

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ASX catches a virus

It’s not a pretty sight. The ASX 200 fell close to 10% in a single week. The severity of the fall suggests that sellers are committed and buyers are scarce. Breach of support at 6400 is highly likely and would offer a target of 5400 (a 25% draw-down).

ASX 200

A V-shaped recovery is unlikely.

The ASX 300 Metals & Mining index broke primary support at 4100, completing a double-top reversal with a target of 3400.

ASX 300 Metals & Mining

The Aussie Dollar is also getting smashed, headed for a target of 64 cents after breaking support at 67.

AUDUSD

The ASX 300 Banks index is headed for a test of 7250/7300. Breach is likely and would offer a test of 6750.

ASX 300 Banks

Our conclusion hasn’t changed from last week:

Threats continue to outweigh opportunities in our view and we retain a bearish view on the global and domestic economies. Our focus remains on defensive and contra-cyclical (gold) stocks.

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ASX 200 retracement likely

A short candle with a tall shadow on the ASX 200 weekly chart warns of short-term selling pressure. Expect retracement to test the new support level at 6800.

ASX 200

Weakness has been driven by the Resources sector, with a gravestone candle on the ASX 300 Metals & Mining index warning of selling pressure at resistance at 4800 and a likely reversal to test support at 4450.

ASX 300 Metals & Mining

A short candle on the ASX 300 Banks index warns of increased short-term selling pressure. Respect of the descending trendline would signal another decline; breach of support at 7250 would confirm. Penetration of the trendline is less likely but would suggest that a bottom is forming.

ASX 300 Banks

We continue to hold a bearish view on the domestic economy but recognize that the temporary tailwind from resources (iron ore) may partly alleviate this. IT and Healthcare sectors are, in our view, over-priced and we maintain our focus on defensive and contra-cyclical (gold) stocks.

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ASX 200 lifted by resources

The ASX 200 is advancing towards its medium-term target of 7200 after breaking resistance at 6800. A high trend index trough signals buying pressure.

ASX 200

Primary driver of the advance is Resources. Signing of phase one of the US-China trade deal lifted iron ore, which is  testing resistance at 95. Consolidation at/below 95 is likely, however, given that the mid-2019 peak was caused by supply disruption in Brazil.

Iron Ore

The ASX 300 Metals & Mining index is headed for a test of resistance at 4800.

ASX 300 Metals & Mining

Financials are weak, but the ASX 300 Banks index found support at 7250. Respect of the descending trendline would warn of another decline, with a short-term target of 7000. Penetration of the trendline is less likely but would warn that a bottom is forming.

ASX 300 Banks

The ASX 200 REITs index is testing resistance at 1680, reflecting the investor demand for yield.

ASX 200 REITs

A weakening Australian Dollar may lift exports slightly but reflects concerns over the phase one US-China trade deal and the impact substantive purchase commitments made by China will have on other energy and commodity suppliers. Breach of 68.50 would offer a short-term target of 67 US cents.

AUDUSD

We continue to hold a bearish view on the domestic economy but recognize that the tailwind from resources may partly alleviate this. IT and Healthcare sectors are, in our view, over-priced and we maintain our focus on defensive and contra-cyclical (gold) stocks.

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ASX Leading Sectors

The ASX 200 broke resistance at 6800, signaling a fresh advance. Expect retracement to test the new support level. Respect would strengthen the bull signal, confirming a fresh advance.

ASX 200 Quarterly

At the same time, fundamentals are distinctly bearish, with falling retail sales and dwindling GDP growth. So, what sectors are driving the index?

A comparison of the ASX 200 sector indices shows that the advance is led by Healthcare and Information Technology sectors, while the laggards are Financials, Utilities and Telecommunications.

ASX Sector Comparison

Top performers in Healthcare (with forward price-earnings ratio where available) are:

  • Polynovo (PNV) – negative eps
  • Clinuvel (CUV) – 79
  • Pro Medicus (PME) – 137
  • Nanosonics (NAN) – 158
  • Resmed (RMD) – 55
  • CSL (CSL) – 49
  • Fisher & Paykel Health (FPH) – 55

ASX 200 Healthcare Top Performers

In Information Technology, top performers are:

  • Afterpay (APT) – negative eps (forward pe 476)
  • Nearmap (NEA) – negative eps
  • Bravura (BVS) – 37
  • Appen (APX) – 58
  • Xero (XRO) – 5998 (forward pe 270)
  • Altium (ALU) – 63

ASX 200 Information Technology Top Performers

The graph below compares PE Ratios on the y-axis to required Annual Growth in earnings on the x-axis. The curve plots the compound annual growth (CAGR) required for a 20-year income stream to deliver a 12.5% return on investment.

PE Ratio compared to Expected Growth

What this illustrates is that PE Ratios above 50 should be treated with caution as they assume the ability to maintain high CAGR in earnings (e.g. above 20%) for long periods. Even when growing off a low base that can be difficult to achieve.

Bottom line: many stocks in these sectors (Healthcare and IT) are highly-priced and vulnerable to strong draw-downs.

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Australia: Bearish apart from mining

Household disposable income lifted in response to the recent tax cuts but households remain risk-averse, with consumption still falling and extra income going straight to debt repayment — reflected by a jump in the Saving ratio below.
Australia Household Saving

Housing prices are recovering despite high levels of mortgage stress in the outer suburbs but building approvals for new housing continue to fall. Construction expenditure is likely to follow.

Australia Building Approvals

GDP growth is falling, while corporate profits (% of GDP) remain in the doldrums apart from the mining sector.

Australia Corporate Profits

Low household disposable income and corporate profit growth in turn lead to low business investment (% of GDP).

Australia Business Investment

Low investment leads to low job creation. Job vacancies and job ads both warn of declining employment growth.

Australia Job Ads

Cyclical employment growth is expected to slow in line with the fall in the Leading Indicator over the past year.

Australia Leading Employment Indicator

We maintain a bearish outlook for the Australian economy, though Mining continues to surprise to the upside.

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ASX 200 breakout

The ASX 200 broke resistance at 6800, signaling a fresh advance. Expect retracement to test the new support level; respect would strengthen the bull signal.

ASX 200

Primary driver of the advance is resources. Talk of an imminent phase 1 US-China trade deal lifted iron ore, which is now testing resistance at 95. Expect retracement to test primary support at 80 but respect would confirm that a base has formed.

Iron Ore

The ASX 300 Metals & Mining index is advancing in step with iron ore prices, with a short-term target of 4800.

ASX 300 Metals & Mining

Financials remain weak, with the ASX 300 Banks index ranging in a bearish narrow band between 7200 and 7500. Respect of the descending trendline would warn of another decline, with a short-term target of 7000.

ASX 300 Banks

The ASX 200 REITs index recovered after a false break below 1580, with a short-term target of 1680.

ASX 200 REITs

We maintain a focus on defensive and contra-cyclical (gold) sectors because of our bearish outlook for the Australian and global economy.

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ASX 200 hesitant because of banks

Financials are still weak. The ASX 300 Banks rally appears short-lived, posting a red candle for the week. Expect another test of support at 7200; breach would test primary support at 6750.

ASX 300 Banks

The ASX 200 REITs index recovered above support at 1600. False breaks on both the bull and bear side indicate hesitancy but declining peaks on the Trend Index warn of long-term selling pressure.

ASX 200 REITs

The ASX 300 Metals & Mining index is more bullish, having broken resistance at 4450. Expect retracement to test the new support level; respect would confirm the target of 4800.

ASX 300 Metals & Mining

Talk of an imminent trade deal lifted iron ore above previous support at 90. Expect another test of primary support at 80, but respect would confirm that a base is forming above 80.

Iron Ore

A bearish financial sector is holding the ASX 200 back. Follow-through above recent weekly highs would signal another advance, while reversal below 6600 would test primary support at 6400. Further consolidation between 6400 and 6800 is just as likely given the gradual decline on the Trend Index.

ASX 200

We are avoiding highly-priced growth stocks and focusing on defensive and contra-cyclical sectors because of our bearish outlook for the Australian and global economies.

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ASX 200 hesitant

The resources sector is strengthening.

The ASX 300 Metals & Mining index broke resistance at 4450, suggesting another advance. Buoyed by rising iron ore prices, the breakout offers a target of 4800.

ASX 300 Metals & Mining

Talk of an imminent trade deal lifted iron ore above previous support at 90. Expect another test of primary support at 80, but respect would confirm that a base has formed above 80.

Iron Ore

Financials, on the other hand, are still weak.

The ASX 300 Banks index continues in a down-trend. Expect retracement to test resistance at 7600 but reversal seems unlikely at this stage. Respect of resistance would confirm a target of 6800.

ASX 300 Banks

The ASX 200 REITs index broke support at 1600 after a false break through 1650. Typical of a bull trap, expect a decline to test support at 1500.

ASX 200 REITs

A bearish outlook for banks is keeping the ASX 200 hesitant. The daily chart shows narrow consolidation below resistance at 6750; a bullish sign. Breakout is likely but the Trend Index below zero warns that buyers are cautious.

ASX 200

We maintain low exposure to Australian equities, with a focus on defensive and contra-cyclical stocks, because of our bearish outlook.

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Banks drag on ASX 200

Banks are plagued by fears of large AUSTRAC penalties for breaches of anti money-laundering and counter-terrorism regulations. Commonwealth have paid a $700 million fine, Westpac have already been charged, NAB alerted investors of potential liabilities in their annual report, while ANZ says there are no signs of transgressions.

In other problem areas, mortgage stress continues to rise, with Martin North (Digital Finance Analytics) estimating that 32.5% of households are now in mortgage stress “based on an assessment of their cash flow.” Worst hit are fringe suburbs, where the rate is as high as 60%.

Elsewhere, RBNZ eased their calls for major banks to increase Common Equity Tier 1 Capital (CET1) to 13.5%, with a further 2.5% comprising other forms of capital such as hybrids and convertible preference shares, and relaxed the phase-in from 5 to 7 years. But the changes will still $13.8 billion in additional capital, according to the big four banks. APRA, by comparison, requires a CET1 ratio of 10.5%.

The ASX 300 Banks index continues to trend lower, with declining peaks on the Trend Index warning of selling pressure. Expect retracement to test resistance at 7600; respect would confirm the  target of 6800.

ASX 300 Banks

The ASX 200 REITs index is again testing support at 1600 after a false break above 1650. Breach of support remains unlikely, with financial markets searching for yield, but would offer a target of 1500.

ASX 200 REITs

Iron ore has made a bear market rally to test resistance at 90. Respect of resistance is likely and would warn of another decline.

Iron Ore

A Trend Index peak near zero on the ASX 300 Metals & Mining index warns of another test of support at 4100 (neckline of a large head-and-shoulders reversal pattern). Breach would offer a target of 3400, while respect of support would indicate that a base is forming.

ASX 300 Metals & Mining

Declining banks are dragging the ASX 200 lower and another test of support at 6400 is likely. A resources sector reversal would increase the chance of top forming on the broad index

ASX 200

We maintain low exposure to Australian equities, with a focus on defensive and contra-cyclical stocks, because of our bearish outlook.

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