Markets, and a tale of two floats

Bond indicators, Telstra and Medibank

Robert Gottliebsen

Markets, and a tale of two floats

Sometimes fate plays a cruel trick. On June 30 our shares fell, which not only curbs superannuation results for 2016-17 but, for superannuation funds facing higher taxes, the starting point is lower – that is, the Australian Tax Office will collect more revenue.

But to more serious matters. Whenever I see a big share market move the first thing I do is look at the bond market. It is usually a better indicator of what is really happening.

And so it was this week when Wall Street fell heavily — a fall that would have been much greater but for the fact that bank stocks gained after the Federal Reserve approved bank plans to raise dividend payouts and share buy backs as a result of good news in the annual stress testing.

The trend to higher rates

As well as the share exodus, investors were selling bonds and pushing up yields, which is a clear sign that the market expects higher interest rates when the US economy is showing signs of slowing.

In Europe, the markets are also predicting higher rates. And once a world trend develops, we don’t miss out. And the likelihood of our rates edging up was increased by this week’s revelation that the Australian labour market continues to show signs of improvement. The number of Australian jobs increased by a further 1.6 per cent in the three months to May and have almost reached their February 2011 peak.

And anecdotal evidence shows that the rise is continuing, particularly in Victoria and South Australia. Even WA is doing better.  This will eventually translate into higher wages, but more importantly it will curb any suggestion of a rate cut and put rate rises on the agenda to compound the international pressure. But given the strength of the Australian dollar; the depressed level of consumer confidence and our over-leveraged housing market, it is hard to see big rates rises.

And there is one more factor that long-term investors have to factor into our market. You can never be certain who will win the election – particularly one that might be delayed as far as 2019.

Telstra’s network issues

This week the major global story has been about the dangers that companies face from hackers and rogue software. It has become a business risk that will increase and, from time to time, affect profits of corporations.

But an even greater issue is the need for companies to be right on top of their technology in this environment, and nothing illustrates that better than two government floats – Telstra and Medibank.

In the case of Telstra the controversial CEO import Sol Trujillo absolutely nailed it when it came to technology. He set up a magnificent mobile network that was far away better than any of his rivals, and that enabled his successor David Thodey to ramp up Telstra’s share in the mobile market which underpinned the company. Since then Optus has invested in a better network, and Vodafone is heading in a similar direction. At the same time Telstra, has not spent enough money on its base network and it is starting to have breakdowns.

These would normally be disasters, but the Telstra rural mobile network is way above anyone else and means that any person or business moving in rural areas needs to use a Telstra mobile even through it costs more.

So, at a time when upgrading is required overall, suddenly in the mobile sector Telstra is under attack from lower prices by Optus and Vodafone. At the moment Telstra is holding the price line, but the gap between Optus and Vodafone prices and Telstra prices is widening and that is unsustainable. Telstra has its fingers crossed that Optus and Vodafone will restore prices as 2017 proceeds, but I doubt it. They need extra market share and the only place to get it is from Telstra.

During the week I had a call from a Telstra person pointing out that one of my appliances had finished its Telstra contract. I laughed. They are looking to lock me into the current prices and I mentioned to the sales person that it might be better for me to wait a bit longer as Telstra will need to meet the market. None of this is good for Telstra profit growth. Telstra is becoming an income stock.

Medibank’s technology health scare

All those who took up Medibank shares in the float are making money, so they are relatively happy. The group is fortunate to have Craig Drummond as its CEO. But when he came into the business he found a Medibank whose technology was breaking down. Volleys of customers were having difficulty in managing the system, and the complaint levels reached enormous proportions.

Bupa saw its chance and now has a slightly bigger share of the market than Medibank, which has slipped back alarmingly. On the plus side, the industry ombudsman’s record of complaints shows a very sharp fall, so clearly Drummond is fixing the technical problems.

The company should never have been allowed to get into the position that Drummond discovered, but it looks like it is coming through.

It seems that one of the obscure statistics that boosts the level of Medicare profits is private hospital operations. For some time they have been rising at a 4.4 per cent clip, which boosts claims for private insurers like Medibank. But, more recently, that growth rate has declined to 3.8 per cent, which will boost Medibank profits.

Of course, the decline needs to be a permanent change, but I doubt it given our ageing population. However, it is possible that the decline in health insurance is being reflected in lower operations. That would be bad for Medibank, but the decline in operations will certainly help in the short term.

Longer term I believe our total hospital network including private hospitals should change the way they operate, and need to introduce equipment such as iPads and avoid the enormous paper war they are currently engaged in.

When it had 40 per cent of the market Medibank was in a unique position to drive that change, but now it is much harder. It is going to take a politician of real substance to get the hospitals to change and lower their costs.

But when that happens it will be a huge boost for private insurers, because the costs of each claim will be slashed. However, the vested interests that love the current system will be hard to beat.

This Week

Shane Oliver, AMP

Investment markets and key developments over the past week

Global share markets had a rough ride over the last week as somewhat more hawkish comments from central banks weighed and pushed bond yields higher. This was particularly the case in Europe. US, European and Japanese shares fell but Chinese shares managed solid gains. Meanwhile, commodity prices rose solidly from oversold and under loved levels - particularly oil and iron ore. Reflecting higher commodity prices and a weaker $US, the $A bounced back to around $US0.77 although it’s worth noting that it’s been stuck between $US0.72 and $US0.78 for more than a year now. Despite the weakness in US and European shares, Australian shares managed a small rise over the last week helped by a rebound in commodity prices and inflows into super funds ahead of limits affecting some members starting July. July is normally a strong month for Australian shares although the pull forward of super flows in June could be a drag this July.

Taper tantrum 2.0 - some more hawkish noises from central banks, but don't get too excited. Central bankers from the Fed, the ECB, the Bank of England and the Bank of Canada all sounded a bit more hawkish over the last week, with the last three signalling an eventual end to ultra easy monetary policy. But there are several points to note in relation to this:

First, the shift in the tone of central bank commentary - notably at the ECB, Bank of Canada and Bank of England - in large part just matches the improvement seen in growth and the receding risks of deflation so should be seen as good news. But with underlying inflationary pressures remaining weak, global monetary policy remains a long way from anything approaching being tight and this is likely to remain the case for some time.

Second, Fed Chair Yellen is just reiterating her long stated comments that it’s appropriate for the Fed to gradually remove monetary accommodation providing the US economy continues to improve. However, while she does not appear to be too concerned about inflation running below target because the labour market is so tight, others at the Fed have expressed concern about the inflation undershoot and so an even slower pace of Fed hikes (eg not hiking in September and waiting till December) remains a high risk. There is nothing in what Yellen has said pointing to a faster tightening.

Third, while several Fed officials (Yellen, Fischer and Williams) referred to strength in the US share market/asset prices its noteworthy that Yellen referred to the ongoing debate about shares looking a bit expensive on absolute measures (like PE's) but maybe not so on a relative basis (if low bond yields are allowed for). What does seem clear though is that at the current point the Fed does not see the share market as a constraint on raising rates. Obviously if it has a sharp fall on the back of growth worries this would be different.

Fourth, ECB President Draghi is clearly (and rightly) becoming more upbeat with the threat of deflation receding and "political winds...becoming tailwinds" (presumably a reference to President Macron's pro-reform and pro-Europe election victory in France in particular). And why wouldn't he with Eurozone economic confidence at its highest in nearly a decade.

As such he is right to warn policy will need to adjust once inflation rises. But at this stage there is still little evidence of much of a tick up in underlying inflation and political risk around Italy will likely slow Draghi from moving too quickly. Our view remains that the ECB will announce a 2018 taper to its quantitative easing program later this year but that rate hikes are a while away. And the Bank of Japan remains years away from any easy money exit.

More broadly we have been concerned for some time that global shares are vulnerable to a correction. As we have seen over the last week, worries about central bank tightening have provided a potential trigger. But as we have seen with the Fed since it first started the process of monetary tightening with taper talk four years ago, monetary tightening is likely to remain very gradual and conditional on further economic improvement. A share market correction yes - just like we saw with the 2013 taper tantrum -  but we are a long way from the sort of tight monetary policy that could bring the bull market in shares to an end.

The rally in bonds this year had arguably gone a bit too far - things weren't that bad - and positioning had become excessively long and complacent leaving them vulnerable to a rebound in yield that we are now seeing. However, with inflationary pressures remaining weak and monetary tightening likely to remain gradual (and non-existent in many countries including Australia for some time) the uptrend in bond yields is likely to remain gradual too.

Delay in the US Senate vote on healthcare reform by a week or so is unlikely to be fatal. The delay looks to be more about allowing time for Republican Senators to discuss changes to the bill. Recall that healthcare reform was also thought dead in the House earlier this year when a vote on it was cancelled - only to see it pass a month or so later. Since Republicans and President Trump agree on reforming Obamacare and tax reform (tax cuts) our view remains that it will be passed clearing the way for the latter.

Eight rate hikes over the next two years from the RBA? Don't come the raw prawn with me...in other words I doubt it. Former RBA board member John Edwards comment that if the RBA forecasts - for growth to pick up above 3 per cent and inflation to be around 2.5 per cent by mid-2019 - come to fruition then the RBA "will want the cash rate to be 3.5 per cent at least by end 2019" coming on the back of more talk of monetary tightening globally over the last week have naturally sparked a bit of interest. However, it’s doubtful this will happen. First, even if the RBA forecasts are correct it’s likely that the rise in household debt ratios means the neutral rate of interest (appropriate for an environment of 3 per cent growth and 2.5 per cent inflation) has fallen to maybe 2.5-3 per cent. A 2 per cent rise in mortgage rates on top of the rate hikes for investors and interest only borrowers already announced would mean a 50 per cent plus rise in interest servicing costs relative to household income from late last year and likely cause a significant slowing in consumer spending and risk a rapid decline in home prices in Sydney and Melbourne. And the RBA knows this (and so won't be that extreme). Second, the RBA only forecasts underlying inflation around 2 per cent, ie the low end of its target range, out to the end of 2018, making it hard to justify much in the way of rate hikes for the next 18 months. Third, eight rate hikes would likely push the $A higher damaging our competitiveness and services exports like tourism and higher education when we still need to see strong growth in them. Finally, the risks to the RBA's growth and inflation forecasts are likely on the downside. Our view remains that rates are on hold ahead of a rate hike maybe in 2019.

Major global economic events and implications

US data was somewhat mixed over the last week. Durable goods orders and new home sales were softish but consumer confidence saw an unexpected rise (to around its highest since the early 2000), home prices continue to rise, inventory levels rose more than expected in May, unemployment claims remain ultra low and March quarter GDP growth was revised up slightly to 1.4 per cent annualised due to a stronger consumer.

Meanwhile, major banks in the US were cleared by the Fed to pay out hefty dividends and undertake buybacks following recent stress tests indicating capital levels at banks are healthy. The post GFC US bank capital rebuild is now complete and the tide is turning against heavy handed regulation of them.

In Europe, economic confidence rose to its highest in a decade driven by both consumer and business confidence pointing to stronger economic growth. Similarly, the German IFO business conditions index was stronger than expected reaching a post-reunification high.

Japanese data for May showed strong jobs vacancies to applicant’s data (aided by a falling population), strong growth in industrial production on an annual basis and less negative household spending but core inflation still stuck around zero. With core inflation well below the Bank of Japan's 2 per cent target, no change to BoJ ultra easy money is in sight.

China's official business conditions PMIs surprisingly improved in June, suggesting that the recent slowing in growth may have come to an end. In fact, I just got back from China and it looks as frantic as ever.

Australian economic events and implications

Australian data was light on with only second order releases. Credit growth remains moderate with weak personal and business lending and some moderation in property investor lending as recent APRA measures hit. Continued solid growth in jobs vacancies over the three months to May according to ABS data adds to confidence that employment growth will remain solid in the months ahead. Meanwhile, population growth picked up to 1.6 per cent in 2016 from 1.4 per cent in 2015 confirming that underlying demand for housing remains strong and helping underpin potential growth in the economy. About 60 per cent of the increase was due to net immigration and Victoria remained the fastest growing state with a 2.4 per cent population gain in 2016. WA and NT were near the weakest.

Dr Shane Oliver is head of investment strategy and chief economist, AMP Capital

Next Week

Craig James, CommSec

Reserve Bank Board meets; “Top Shelf” indicators return

A busy week lies ahead. The Reserve Bank Board meets and key economic indicators will be released in Australia. Overseas, purchasing manager survey results dominate with payrolls data to be issued in the US.

In Australia, the week kicks off on Monday with CoreLogic issuing its closely-watched home value index for June. And it seems that Sydney and Melbourne prices have kicked again. Based on current data, home prices may have lifted by 1.5 per cent in June after recording a seasonal decline of 1.1 per cent in May.

Also on Monday the Performance of Manufacturing index is issued with building approvals and the ANZ survey of job advertisements.

The manufacturing sector is relatively healthy at present with the latest gauge from Australian Industry Group showing that activity eased modestly in May from 15-year highs.

The building approvals data from the Australian Bureau of Statistics (ABS) can be volatile from month to month. But it is the best early gauge of future construction, so the figures are analysed closely. Approvals have peaked but are not showing signs of slumping. Underlying demand for homes remains solid.

The ANZ job advertisement series hit fresh six-year highs in May, and has lifted in four of the last five months. Job ads tend to lead employment by around 5-6 months so the outlook for the job market remains healthy.

On Tuesday, the Reserve Bank meets to decide interest rate settings. Meanwhile retail trade data is issued by the ABS while ANZ and Roy Morgan publish the usual weekly consumer confidence figures.

The Reserve Bank won’t be touching the official cash rate. In fact, many economists believe the Reserve Bank could stay on the sidelines for the best part of another year.

The retail trade data should prove interesting. Survey and anecdotal evidence suggest that consumers are spending more, especially on services as opposed to traditional purchases like clothes and shoes.

On Thursday, the ABS releases the May data on international trade – in other words, the monthly export and import figures. The main complication with interpreting the results at present is the impact of Cyclone Debbie in disrupting coal and some agricultural exports. But in an underlying sense, healthy trade surpluses are being recorded.

Overseas: US jobs data in focus

It is a holiday-shortened week in the US with the Independence Day holiday celebrated on July 4. And no doubt many Americans will be keen to take an extra day of leave on the Monday, which could make for quiet times on financial markets early in the week. The data release of note is the non-farm payrolls figures to be released on Friday.

The week begins on Monday in the US with data on construction spending and new vehicle sales to be released as well as the ISM manufacturing index. Economists expect that vehicle sales rose by 1.4 per cent in June to a 16.9 million seasonally adjusted annual rate. And the manufacturing gauge is tipped to be flat at 55.0 – still well ahead of the 50 reading that divides expansion from contraction.

After a holiday on Tuesday, there are a spattering of indicators on the US menu for Wednesday. Data on factory orders is released with the ISM New York index.

In the US on Thursday the ISM services index is released together with the Challenger job layoffs series, ADP employment data, international trade figures and weekly data on claims for unemployment insurance.

Arguably the ISM services index is of most importance with economists tipping a modest fall from 56.9 to a still very healthy reading of 56.6 in June. The other indicator of note is the ADP jobs data, which can provide guidance on the official employment figures on Friday. Economists tip a 178,000 lift in private sector jobs.

And on Friday in the US, the influential non-farm payrolls data is issued. Economists expect that job creation lifted from 138,000 to 183,000 in June. While unemployment is seen as unchanged at 4.3 per cent, average hourly earnings (wages) may have grown by 0.3 per cent. If wages and jobs fail to lift as expected, further doubt will be thrown on the need – or the likelihood – of the Federal Reserve lifting rates again in 2017.

In China, the key dates for economic indicators are Monday and Wednesday. On Monday, the Caixin purchasing manager’s survey for manufacturing is released. And on Wednesday the equivalent gauge for the services sector will be released.

Financial markets

Over 2016/17 the All Ordinaries index has tracked a range of just over 844 points – from almost 5,140 points to just over 5,980 points. At face value the range sounds significant – that is, before we put it in the context of history. The differential between highs and lows is 16.4 per cent, marking it as the least volatile year in 16 years.

The average differential for the All Ords over the period is actually just below 27 per cent, so it is clear that the share market has been generally well behaved.

Another way to look at volatility is the number of daily moves either above or below 1 per cent. Over the past year there have been 31 days where the share market has risen or fallen by 1 per cent in a day – the lowest result in 12 years.

Craig James is chief economist at CommSec.

Readings & Viewings

Rupert Murdoch has been out of the news recently, but now’s he’s back in it. The story is around his $15 billion takeover play for broadcaster Sky, which regulators believe will give the media mogul too much power.

Now, some were predicting this takeover deal could have ended up in the shredder. Not so. This well-known stationery business is set for a windfall, and it has nothing to do with end of the financial year sales.

Donald Trump was also back in the news late this week over his Twitter attacks against two US television presenters. What didn’t get a lot of pick-up was his attack on Amazon founder Jeff Bezos. It was to do whether Amazon is paying its fair share of taxes? Trump apparently doesn’t think so.

Staying in the tax field, the UK's accountancy watchdog says it has begun an investigation into the auditing of BT’s financial statements.

Who is the most cautious CEO in the tech world? To find the answer, IBM ran the numbers through its supercomputer Watson.

Outside of the tech area, Warren Buffett is also regarded as a cautious man. But he’s banking on big returns as he continues to move up the share register of a major multinational bank.

Staying on banking, the US housing market was shaken to its foundations during the GFC. But what happened back then is clearly being forgotten by some as McMansions make a comeback. No doubt bank lenders will be taking notice.

The Federal Reserve has approved plans from the 34 largest US banks to use extra capital for stock buybacks, dividends and other purposes beyond being a cushion against catastrophe.

Elsewhere, hedge fund Third Point sets its activist sights on Nestlé.

Tradeweb is to be main offshore trading platform for China 'Bond Connect'.

If you’re planning to invest in any form of retail IPO, it’s vital to consider the perceived Amazon effect, as this company has discovered.

A landmark ruling against Google in Canada could have far-reaching legal implications around the world.

AngloGold Ashanti could cut up to 8500 jobs at its unprofitable South African mines.

Also from Africa, Natural Resource Governance Institute, has described Nigeria’s $2.4 billion Excess Crude Account as one of the most poorly governed sovereign wealth funds in the world.

Australia has joined the lithium-ion battery race with plans to develop two “gigafactories” in Queensland and the Northern Territory.

Related Articles