Is it the season to be jolly?
It’s beginning to feel a lot like Christmas. Joy is in the air for investors; globally, financial repression has seen an exhaustive list of equity returns from more than 20 countries show positive returns through the past year, almost without exception, for the second year in a row. November saw a few exceptions, however, with the Australian equity market among them, losing amidst a world where asset prices were generally still climbing. In contrast to global equity markets, the strong performance in fixed interest markets in 2012, has been followed by losses through 2013, in all bar high yield markets; in turn, the equity yield trade that was dominant through 2012 has also been more muted through this year.
The extended equity market rally continues to be the great rerating. Sales and earnings growth remains rare, with each decelerating successively through the past three years. Five years on, though, global ZIRP (zero interest rate policy) and QE may have stimulated asset prices, but the outstanding question remains at what cost. Simply put, debt to GDP ratios continue to rise around the world, which will continue to supress secular demand at a country level (and hence sales at a corporate level). Being able to raise prices whilst increasing unit sales is hence as rare as it is valuable for a corporate in this environment, which is why the James Hardie share price rose 15% the day it reported that very combination during November. Whilst no longer a fundamentally cheap stock Hardies is prone to further upside surprise on these fronts, and remains among the very best managed companies in our market.
Political decisions continue to affect market returns at a micro level as well as through monetary policy. Graincorp’s shareholders were looking to convert some of their raw product into the finest of gins when the new Commonwealth Treasurer invoked the national interest in disallowing a takeover offer by Archer Daniels Midland. Chorus shareholder’s, ourselves included, were also gnashing teeth at regulator vagaries, with the NZ Commerce Commissioner determining that wholesale broadband prices in NZ should be cut by 23%, mostly by having regard to prices in Denmark and Sweden. The worst performing non-resource related equity in the ASX200 through the past year – Echo Entertainment Group – has also had its relative performance more driven by regulatory change than operational factors. Governments remain resource constrained, and avoiding increasing levels of taxation and/or related regulatory risk, will be a key factor determining relative performance of equity portfolios.
The price of physical gold has been monstered as the risk of deflation mounts. The twin pillars of the enormous amount of fixed asset investment made through the past decade – global steel and cement capacity, for example, has each more than doubled during this time, whilst demand growth has been less than half of that added capacity - and the impact of demographics upon demand, has instructed our view that deflation is a far more likely prospect than inflation, through the medium to longer term. Eighty percent of mature economies now have inflation rates sub 2%, the highest proportion since the GFC. Of the 30 worst performing stocks in the ASX200 through the past year, all of them are resource stocks or mining service companies; and the worst of this motley lot have been the gold stocks. Whilst fiat currencies have continued to be debased through quantitative easing, gold has not offered the safe harbour we had anticipated. This trend only continued apace through November, with the portfolio’s position in Newcrest continuing to accordingly suffer. Newcrest’s balance sheet is poor, with excessive levels of debt. In the circumstances, it was ironic that the Newcrest Board asked us to carefully consider our intent to vote against resolutions at their AGM for fear of jeopardising that Board’s “… financial skill and experience …”. No prizes for guessing how we voted.
The raft of initial public offerings in recent weeks has been a return to the halcyon days in terms of number of issues, if not yet dollars. Quality has been mixed; with some better run companies, in poor industries, priced at what we have felt to be full multiples, especially when the vendor has been financial owners. We have not invested in any of these offers, and will be intrigued to see how many fare once they are more seasoned as equity market investments, say in two to three years time. We suspect the ghosts of Repco and Myer may feature in many of those comparisons.
We increased our holding in Orica through recent times, both before and after its 2013 result which was released in November. Notwithstanding a volatile share price, Orica has an amazingly stable earnings history, with earnings before interest and tax within 10% of A$1bn each year since 2006. In that time, a large amount of investment – almost A$6bn – has been made as well, for ostensibly little return. We do not anticipate any material return to be made on this new investment henceforth; but, equally, do not anticipate further material downside to earnings, either. We find it hard to objectively disagree with anything the new CEO has implemented since assuming the role a little more than a year ago; focusing upon improving the return on the existing asset suite, by holding prices, improving productivity and reducing capex. We now await the global duopolist in the Ammonium Nitrate space – Incitec Pivot – to copy Orica’s lead, and begin to focus on return on assets, rather than just asset growth.
For two years in a row now, equity market performance has been very strong – double digits – in the face of slowing revenue and earnings growth. We doubt a trifecta in performance is in the offing for Australia, especially as earnings growth will again be anemic and less than expectations, especially for many domestic cyclicals. The Australian equity market has notably underperformed many others this year, and the currency has also corrected.
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