Category: Countries & Regions

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The circus in Washington | Bob Doll

We don’t want to make light of the mounting troubles the president faces, but we are more focused on metrics such as consumer and business confidence levels as signs of how much the political turmoil will negatively affect financial markets.

Bob Doll, Nuveen Investments – Weekly Commentary

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East to West: US rallies, China falls

The S&P 500 is testing its January high at 2870. A rising Trend Index indicates buying pressure. Follow-through is likely to test resistance at 3000.

S&P 500

A monthly chart of the NASDAQ 100 illustrates tech stock strength, with a rally from 4500 to 7500 in just two years. Breakout above medium-term resistance at 7500 is more likely, offering a target of 8000, while a correction would test support at 7000. Breakout from the triangle pattern on the Trend Index would indicate index direction.

Nasdaq 100

Canada’s TSX 60 index is also advancing. A rising Trend Index suggests buying pressure. Retracement that respects support at 960 is likely and would signal another advance, with a target of 1040.

TSX 60

China paints the opposite picture, with the Shanghai Composite Index testing long-term support at 2700. Trend Index peaks below zero warn of selling pressure and breach of support would offer a long-term target of the 2014 low at 2000.

Shanghai Composite Index

Hong Kong’s Hang Seng Index broke support at 28,000/28,500 offering a long-term target of 25,000.

Hang Seng Index

South Korea’s Seoul Composite Index found support above 2200. Retracement to test new resistance at 2350 is likely. A lot depends on progress in peace negotiations with North Korea.

Seoul Composite Index

Japan’s Nikkei 225 is consolidating between 23,000 and 24,000 suggesting uncertainty over fallout from a threatened US-China trade war.

Nikkei 225

India is more on the periphery of current trade disputes, with the Nifty continuing its advance toward a target of 12,000.

Nifty

In Europe, Dow Jones Euro Stoxx 600 continues to reflect uncertainty, with long-term consolidation below 400. Breakout would signal a fresh advance but don’t hold your breath. It could take a while.

Dow Jones Euro Stoxx 600

The Footsie is retracing to test support at 7500 but respect is likely and would offer a target of 8000.

FTSE 100

North America clearly leads the global recovery, while Asia lags. Europe is sandwiched in the middle, with potential loss of trade in the East and West if a trade war erupts.

Thucydides once wrote “When one great power threatens to displace another, war is almost always the result.” In his day it was Athens and Sparta but in the modern era, war between great powers, with mutually assured destruction (MAD), is most unlikely. What we are witnessing is negotiation to define rules for peaceful coexistence in the 21st century. A lack of clear rules increases the risk of miscalculation and rapid escalation to a hard conflict.

Absent the willingness to use military force, the country with the greatest economic power is in the strongest position to set the rules.

War is a matter not so much of arms as of money.

~ Thucydides (460 – 400 B.C.)

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ASX 200 hurt by banks, miners and politics

After a false break above 8100 the ASX 300 Banks index completed a bull trap with reversal below 7900. Expect a test of primary support at 7300.

ASX 300 Banks Index

Resources stocks continued their correction, with the ASX 300 Metals & Mining index finding short-term support at 3600. Follow-through is likely and would test primary support at 3400, with fears of a US-China trade war undermining commodity prices.

ASX 300 Metals & Mining

The ASX 200 retreated below its new support level at 6300. Political upheaval may have contributed but penetration of the rising trendline would warn of a correction (already signaled by bearish Divergence on the Trend Index).

ASX 200

I remain wary of banks because of higher funding costs, falling credit growth and rising default risk and cautious on Australian stocks, holding over 30% cash in the Australian Growth portfolio.

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Support for the Yuan lifts Gold

China’s PBOC stepped in with belated support for the Yuan, holding the line at 14.5 US cents.

CNY/USD

The Dollar retreated, with the Dollar Index testing support at 95. Respect of support would confirm another advance, with a long-term target of 103 — if central banks like the Fed and PBOC don’t intervene.

Dollar Index

Gold rallied as the Dollar weakened, testing resistance at $1200/ounce. Respect of the descending trendline would warn of another decline with a long-term target of the 2015 low at $1050/ounce.

Spot Gold in USD

The Australian Dollar also rallied, reducing the benefit to local gold miners.

Australian Dollar/USD

The All Ordinaries Gold Index (XGD) continues its downward path, with a long-term target of 4000/4100.

All Ordinaries Gold Index

China is conserving its capital account as best it can, after losing $1 trillion in foreign reserves supporting the Yuan in 2015 – 2016.

China: Foreign Reserves excluding Gold

But failure to support its currency is sure to antagonize the Trump administration and elicit further trade tariffs.

….Trade is drying up and China is stuck with debt it can’t repay or rollover easily. This marks the end of China’s Cinderella growth story, and the beginning of a period of economic slowdown and potential social unrest.

~ Jim Rickards at Daily Reckoning

If that’s the case, expect the Dollar to strengthen and further gold weakness.

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APN Outdoor (APO) – Sell

Stock: APN Outdoor
Symbol: APO
Exchange: ASX
Financial Year-end: 31 December
Latest price: $6.70
Date: August 24, 2018

Sector: Consumer Cyclical
Industry: Marketing Services
Investment Theme: Structural Trends

APO is positioned to benefit from the rise of technology, with fast-growing revenues from digital billboard advertising.

Company Profile

APN Outdoor is a leading outdoor advertising company with 28% market share in Australia and 30% in New Zealand.

Competitors & Markets

APO will rank second behind the combined 50% market share of oOhmedia and Adshel if their proposed merger goes ahead.

APO is active in billboards (55% of total revenue), transit (26%), airports (11%) and rail (8%). Digital advertising grew 18% in FY18 and contributes 42% of total revenue, with 134 large format digital panels across Australia & New Zealand. Non-digital advertising declined 5% due to loss of the Melbourne Yarra trams contract (won by JCDecaux).

Outdoor advertising sites are secured by 5- to 10-year leasehold contracts and may be subject to competitive bidding on renewal of larger sites.

Financial performance

Revenue Growth

Revenue growth slowed to 4% in HY18, compared to an average of 6.7% over the previous two years.

Revenue and EPS

Earnings per share (right-hand scale) declined slightly from FY16.

Margins

EPS decline is a result of tighter margins.

EBT Margins

Cash Flow

Cash flows declined relative to net income as APO invested in digital displays.

Net Income & Free Cash Flow % of Revenue

Dividends

APO declared fully franked dividends of 7 cents (H1 FY18) and 12.5 cents (H2 FY17), amounting to a 2.9% dividend yield.

EPS and Dividends

Capital structure

APO uses debt to fund new digital billboards, maintaining a net debt to equity ratio of 35%. This could render it vulnerable in an economic down-turn.

Net Cash/(Debt) % of Equity

Weaknesses

Outdoor advertising revenues can be volatile over the economic cycle.

Recent management changes leave APO with new leadership after the retirement of CEO Richard Herring (having led the group since 2004) in September 2017 and CFO Wayne Castle in January 2018.

Takeover Offer

French outdoor advertising giant JCDecaux tabled a AUD 6.70 per share cash offer in June 2018, to acquire 100% of APO. The offer was recommended by the APO Board of Directors and is likely to go to a shareholder vote in October 2018.

The Australian Competition and Consumer Commission’s (ACCC) cleared the proposed acquisition on August 23 but the deal still remains subject to a number of conditions, including approval of APN Outdoor shareholders, court approval, the Foreign Investment Review Board (FIRB) and the New Zealand Overseas Investment Office (OIO) approval, and the satisfaction or waiver of certain other conditions outlined in the Scheme Implementation Agreement lodged with the ASX on 26 June 2018.

APO is expected to declare a fully franked special dividend of up to $0.30 per share just before the takeover. The AUD 6.70 offer per share would be reduced by the cash amount of the dividend but shareholders would benefit from up to $0.13 per share in franking credits.

Valuation

With expected annual revenue and earnings growth of 7%, APO is projected to deliver low annual returns of 6%, or 7.6% after franking credits.

Technical Analysis

APO broke resistance at $6.00 after the JCDecaux offer. Twiggs Momentum (50-week) and Trend Index (50-week) recovered to positive territory but remain weak.

Twiggs Momentum & Trend Index

Conclusion

Sell at $6.70. Prospects of 13 cents in franking credits are not sufficient incentive to hang on to APO.
[**Note added 26/08/18: Clarification is required regarding the upcoming dividend of 7 cents plus 3 cents franking credit. Sellers prior to the ex date of September 5th will forego the dividend. Sellers after the ex date are likely to receive a price, probably 7 cents lower. They may wish to wait until September 5th for the benefit of the 3 cents franking credit but need to weigh this against the increased uncertainty.]

Disclosure

Staff of The Patient Investor may directly or indirectly own shares in the above company.

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S&P 500 volatility falls

The Philadelphia Fed Leading Index at 1.42 for June 2018 maintains a healthy margin above the 1% level that would warn of a potential slow-down.

Philadelphia Fed Leading Index

The picture reinforces a steeply-climbing Freight Transportation Index, indicating strong economic activity.

Freight Transportation Index

Concerns that the economy may over-heat, spiking inflation, are not reflected in strong growth in average hourly earnings. The Fed has done a good job of containing money supply growth, with growth in the broad money supply (MZM plus time deposits) closely tracking nominal GDP.

Nominal GDP and Money Supply Growth

Credit and money supply expansion at faster rates than nominal GDP have in the past flagged an overheating economy and higher inflation, leading to a recession when the Fed attempts to curb inflation.

We are in stage 3 of a bull market but there are few signs that the economy will slow or earnings will fall.

The S&P 500 respected its new support level at 2800, confirming an advance to 3000. Declining Twiggs Volatility (21-day) signals that market risk is low and we can expect business as usual.

S&P 500

The NASDAQ 100 continues to warn of a correction, with bearish divergence on Twiggs Money Flow. This is secondary in nature, because of the indicator’s position relative to the zero line, but could test support at 7000.

Nasdaq 100

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China threatened by loss of US trade

The threat of a US-China trade war has rattled investors, with the Shanghai Composite Index breaking primary support at 2700 to signal another decline. Trend Index peaks below zero warn of strong selling pressure. Long-term target is the 2012 to 2014 lows at 2000.

Shanghai Composite Index

Hong Kong’s Hang Seng Index is also under the pump, breaking support at 28,000 to warn of another decline.

Hang Seng Index

Copper prices, a good barometer of the Chinese economy, are also falling. Breach of $6,000 offers a target of $5,500/tonne.

Copper S1

The Yuan has fallen almost 10 percent, testing support at 14.5 US cents. Failure of the PBOC to support the Yuan (by selling some of their $3 trillion of foreign reserves) may cushion the economic impact in the short-term but only invites further escalation from the Trump administration.

Chinese Yuan/USD

There is no easy way out. Trump clearly has the upper hand in trade negotiations.

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ASX 200 breakout

Strong earnings reports and continued interest in major banks lifted the ASX 200. Rising Trend Index troughs signal buying pressure. Breakout above 6300 offers a short-term target of 6500.

ASX 200

The ASX 300 Banks index followed through above 8100, indicating another rally with a medium-term target of 8500 (long-term 8750).

ASX 300 Banks Index

But the ASX 300 Metals & Mining index broke support at 3750, warning of a test of primary support at 3400. Fears of a US-China trade war are likely to undermine commodity prices.

ASX 300 Metals & Mining

I am also wary of banks because of higher funding costs, falling credit growth and rising default risk .

So the primary trend on the ASX 200 is up but I remain cautious, holding over 30% cash in the Australian Growth portfolio.

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S&P 500 earnings surge

Of companies in the S&P 500 index, 90.2% have reported their results for the quarter. According to S&P Dow Jones Indices:

  • Sales growth at 11.0% year-on-year (Y/Y) is close to a potential record.
  • The earnings beat rate of 78% is also historically high, compared to an average of 67%.
  • Operating margins are at a record 11.58%, compared to an average of 8.08% over the last 20 years.

Forward earnings estimates are climbing, driving the forward Price-Earnings ratio to a more comfortable 17.6 compared to its March 2015 high of 23.9.

S&P 500 Forward Earnings Estimates

Valuations based on historic earnings remain high, but P/E multiples have fallen to 22.02 from 24.16 in the last quarter. The long-term chart below compares the index price to previous highest annual EPS, to eliminate distortions caused by sudden falls in earnings.

S&P 500 Price-earnings based on Maximum Previous Earnngs

The current earnings multiple is still significantly higher than the 18.86 reached prior to the 1929 Wall Street crash and 18.69 in October 1987. But high valuations don’t cause market crashes. Sudden falls in earnings do. And there is little sign of that at present.

The S&P 500 is retracing for another test of its new support level at 2800. Respect would signal an advance to 3000. Declining Money Flow warns of selling pressure but this appears secondary in nature, with the indicator still well above the zero line.

S&P 500

The Nasdaq 100 also warns of a correction, with bearish divergence on Twiggs Money Flow. Again this appears secondary in nature because of the indicator’s position relative to the zero line. Expect a test of support at 7000.

Nasdaq 100

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ASX 200 buying pressure

The ASX 300 Metals & Mining index continues to test support at 3750. Breach of support and the rising trendline would warn of a correction to 3400.

ASX 300 Metals & Mining

The ASX 300 Banks index recovered above 8000, the false break suggesting another rally, targeting 8500.

ASX 300 Banks Index

I remain wary of banks, however, because of higher funding costs, falling credit growth and rising default risk .

The ASX 200 continues to test resistance at 6300. Rising Twiggs Money Flow troughs signal buying pressure. Breakout above 6300 would present a short-term target of 6500.

ASX 200

The primary trend is upward but economic indicators and the potential impact of a US-China trade war make me cautious. I hold more than 30% cash in the Australian Growth portfolio.

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