January 2015 Review & Comments
Written by Tony Gray   
Wednesday, 18 February 2015 08:51

It has been a rollercoaster for a range of global and local sectors in recent months.

As well publicised, iron ore and oil prices have fallen very sharply.  For us, the surprise has been more the degree and rapidity of the falls.  By way of example, forecasts as far back as 2010 were predicting supply and demand for iron ore balancing out by 2014 – and for prices of circa $80 per tonne (the price today is ~US$64 per tonne). 

As most portfolios have very low exposure to mining, energy and related service sector exposures, the falls have not been a great concern.  In terms of opportunity, most of the stocks that have fallen sharply involve a higher degree of risk.  For many stocks, if the main commodity they sell stays down in price, or falls further, then they will be unable to meet debt repayment commitments.  If prices rebound modestly, then that balance sheet risk retreats and share prices could advance significantly.

Ultra low interest rates also increase the likelihood of corporate activity (i.e. takeovers).

The nature of these opportunities is more suited to the trader or aggressive investor, so my intention is to not broadly raise these with investors – but I’m happy to discuss for those interested or who feel we are ignoring the opportunity.

There are of course some ‘blue chip’ stocks well down in price.  There has been a rebound through later January and early February and we now have an idea of the ranges established.  We are interested in stocks such as BHP Billiton and Origin Energy at the lower end of the 3 month price range.  ALS Limited (ALQ) also offers cyclical recovery potential and has done a very good job of growing their chemical analysis business globally – while the mineral and energy divisions are understandably under pressure, the Life Sciences (Food and Pharma) grew to become the largest division by profit in the 3rd quarter and the Industrial division is holding steady. 

We are more optimistic on the medium term outlook for oil prices, since more expensive shale supply is likely to drop-out of production and see moderate price rises.  We can already see this with sharp reductions in North American drilling activity.

Aside from commodity stocks, the other major factors at work relate to interest rates and exchange rates.

The falling $A has seen the value of international assets rise nicely and also benefited local companies who export or have overseas operations.  Many of these stocks are in the ‘non-core’ category and still represent decent opportunities – often with still attractive income yields.

The Reserve Bank decision this week to cut the overnight cash rate to 2.25% was understandable given 10 year Commonwealth Government Bonds are trading on an implied yield of just 2.7%.  The guidance that further cuts may occur in the near-term was a bit of a surprise and really put a rocket under yield related stocks.

Make no mistake, many stocks are rising in price only due to lower interest rates.  Underlying earnings may be little changed, but share prices are much higher.  A classic example is Telstra.  Four years ago the dividend was 28 cents per annum and the share price ~$3.00.  The dividend for the last year totalled 29.5 cents and the share price is ~$6.65 (placing the company on a yield of 4.4% fully franked).

Still, with all asset classes over-valued relative to historical norms, to a degree we are forced to keep dancing while the music plays.  We do have the advantage of observing the US sharemarket as that economy progressed through an ultra-low interest rate cycle.  US 10 year government bond yields are down to 1.7% and fuelled a 6 year bull market in shares and commercial property.  There is a decent chance that US interest rates begin rising in 2015 and how that impacts share prices will help guide decisions for local assets.

We are finding Australian listed property distinctly unattractive.  Gearing levels are rising, corporate activity increasing and premiums to asset backing expanding.  We’re not selling at this point, since we believe the chase for yield may well result in further price gains – and with the same dilemma as everyone else – what else is there to purchase to replace the income!

First half reporting season for Australian companies is underway and fingers crossed there will not be downgrades justifying a sell decision.  I’m confident we will uncover more opportunities and my focus this month is on reviewing portfolios – but don’t be shy in contacting me first.

Best wishes

 

 

A.W. (Tony) Gray BCom, LLB, Dip FP, GDipAppFin, CFP, FFin

Principal, TG Financial

Please treat the above comments as General Advice or general information, with no action to occur until we have considered with reference to your financial position, needs and goals.


 

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