The Monday Report

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This story features ENERGY RESOURCES OF AUSTRALIA LIMITED, and other companies.
For more info SHARE ANALYSIS: ERA

By Greg Peel

The Yield Factor

The ASX200 enjoyed a solid rally last Tuesday, bumped around for a couple of days and then tanked again on Friday thanks to a weak lead form Wall Street. The index ended the week slightly lower than where it began.

It could have been much worse, with the index falling like a stone from the open on Friday to be down over -80 points late morning to hit a low of 5676, having seen 5788 on the Tuesday. Then lo and behold, in came the bargain hunters on Friday afternoon to take us back to a close of 5703. We’ve seen plenty of volatility of late, but no break-out from the 5680-5800 range.

Fundamental to Friday’s fall was the drop in the WTI oil price. Having appeared to be pushing back towards the US$50/bbl mark on the assumption prices in the forties will force US rig shutdowns, a weekly US inventory build had oil high-tailing it once more. And the news didn’t get any better last night. The week before, two US rigs shut down, suggesting maybe the line in the sand had been reached. Last week, seven extra rigs fired up.

The local energy sector led the fall on Friday in losing -2.1%. Thereafter, all sectors posted losses ranging from -0.6% for consumer staples to -2.0% for healthcare. The only exception was materials, which managed to hold its ground on stronger metal prices. Yield-paying sectors were among the hardest hit, including the banks (-1.0%).

Rising global yields are clearly an issue for investors in the Australian market – a market once popular with local and offshore investors for paying high yields in a low interest rate environment. As global yields rise, that attraction fades. And in amongst it all we have the enigma that is the banks.

Banks should, all things being equal, rise in value on rising rates. Indeed, on odd days when US rates rise and US bank stocks rise, local bank shares are bought up as well. But rising rates threaten Australia’s perilous household debt situation at a time the housing market is beginning to cool, and rising rates undermine the value of the 5-6% yields local banks are currently paying.

As a result the banks have been bouncing backwards and forwards all year, and thus, too, has the index.

Wall Street bounced back on Friday night thanks to a strong jobs number, but oil fell further. The SPI futures closed up 10 points, balancing those inputs. One day we’re going to break out of the current range, and at this stage it looks like it might take the upcoming US earnings season to make a difference, or maybe we have to wait until the local result season next month.

The Jobs Debate

The US added 222,000 jobs in June, well above expectations of a 180,000 gain. April and May numbers were also revised higher. The unemployment rate ticked up to 4.4% from 4.3% but this can be attributed to an increase in participation.

As a result, the Dow closed up 94 points or 0.4% and the S&P rose 0.6% to 2425 as the Nasdaq jumped 1.0%.

Wall Street also assumed there would be no change to the Fed’s intention to again raise its funds rate this year. The US ten-year yield gained another 2 basis point to 2.39% and the US dollar index rose 0.2% to 96.00. But underlying the strong jobs numbers was wages growth of only 0.2% when 0.3% was expected, leaving annual growth at a below-trend 2.5%.

The strong US labour market is fundamental to the Fed’s tightening bias, which includes not just rate rises but a tapering of its balance sheet. The assumption here is that rising jobs numbers will lead to rising wage inflation, thus forcing the need for higher rates. Yet there remains no sign of wage inflation.

The break-down of the June non-farm payroll result showed most of the growth was in lower paid areas such as healthcare and hospitality, and not in higher paying industries – just as is the case in Australia at present. This is clearly at least one reason why jobs growth is not firing up wages. The question is then being asked: Could the Fed kill off the modest US economic recovery if it makes its moves on the wrong assumption?

Either way, global rates are rising and that is good for US banks, which do not pay the sort of yields Australian banks hand out. A flat US yield curve ensures thirty-year priced mortgage rates remain benign. Thus US banks benefit from better net interest margins without associated risk.

The US financial sector thus continued to rise on Friday night while elsewhere, influence came from the current “swinging” sectors. The oil price has turned south again so energy is once again being sold. Otherwise, Big Tech will have a run of bad days on “overvaluation” calls before shooting back up again, as was the case on Friday night, on strong economic data.

Wall Street is, therefore, also largely stuck in a range, waiting for something to happen in Washington that doesn’t involve nuking North Korea. The difference between the US and Australian markets is that the top end of that range is all-time highs.

Commodities

The US Energy Information Agency confirmed on Friday night that US weekly crude inventories had risen. But it was the seven new rigs coming on line, when it had appeared the tide had finally turned, that really spooked the oil market. West Texas crude fell -US97c to or -2% to US$44.36/bbl.

The combination of a stronger greenback, rising US and global rates but a lack of any sign of inflation is proving too much for gold. It fell -US$12.40 to US$1212.20/oz.

Having had a solid run of late, lead fell -3% in London. Nickel fell -2%.

Iron ore rose US80c to US$62.10/t.

The Aussie rose 0.2% to US$0.7602.

The SPI Overnight closed up 10 points on Saturday morning.

The Week Ahead

The US economic week begins slowly before hotting up on Friday. The Fed Beige Book is out on Wednesday and the PPI on Thursday. Friday sees retail sales, industrial production, the CPI and consumer sentiment.

China will post inflation numbers today and trade numbers on Thursday.

In Australia we’ll see housing finance numbers tomorrow along with the monthly NAB business confidence survey, followed on Wednesday by the Westpac consumer confidence survey.

In the stock market, the June quarter production & sales report season kicks off this week for the resource sectors. Wednesday sees Energy Resources of Australia ((ERA)) reporting followed by Whitehaven Coal ((WHC)) on Thursday.

Rudi will appear on Sky Business on Tuesday morning, via Skype, to discuss broker calls at around 11.15am. On Thursday he'll be interviewed by Peter Switzer between 7-8pm and on Friday he'll repeat the Skype experience, probably around 11.30am.
 

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