A VIEW FROM THE TOP END

Markets:

Earnings season, continued vaccine roll outs, a commodity super cycle and a stimulus deal in the US approaches, it has been a busy two weeks for our update to cover. Diving in we have seen markets react positively to profit announcements as the SP500, Nasdaq and ASX have returned 5.23%, 4.36% and 3.02% respectively for the period. Cheap interest rates are continuing to fuel asset prices, and it is not unique to just equities. Real assets like residential property are climbing with low-cost capital available. Banks here in Australia are seeing queues for mortgage approvals blow out to 30days+ and auction clearance rates are 10% higher than they were pre-pandemic last year. The past few weeks we have been asked frequently how long the music can keep playing at this party, and our standard answer is that rally’s do not die, they are murdered by the central bank. With that thought in mind, the Reserve Bank of Australia governor said at the beginning of the month that the cash rate is not expected to rise until 2024 at the earliest. Get up and dance some more.

Framework Series: Commodity “Super Cycle”:

From an economic standpoint Australia is a farm, a mine, an educator, and an LNG terminal. When we built our framework, we decided to lean into these domestic growth stories. That can be seen in our portfolio construction. During the last six months our portfolios have tilted towards technology as well as resources as we play the Covid recovery story that kickstarted a new economic cycle. That is why when we see economic research quoting a “commodity supercycle” we begin to smile. As investors in the domestic market, we keep our finger on the pulse of the resource sector in Australia and have a game plan centred around copper, and base metals to catch the commodity jetstream.

We like to use google trends to track the use of search words in real time as a proxy for investor interest. You can see that its not the first time that the “commodity supercycle” has been mentioned nor will it be the last.

Now when you start talking about commodities, you need to talk first about China. China is trying to reshuffle their economy to point more inwardly and concentrate on domestic consumer products, as the United States did post WW2, but this reorganisation takes time. Covid is here now, and the Chinese economy needed stimulus to get back on track. The quickest way to reflate the economy was through the construction industry, and that sector runs on easy loans. That is why it is not surprising to find a relationship between commodity prices (iron ore in this case) and credit expansion above zero percent. When credit expands it, iron ore prices follow closely behind…and credit has expanded A LOT since the pandemic began.

With the whole globe adding unprecedented stimulus to their economies in an effort to provide a boost financially post pandemic, we are swimming with the current in the commodity space. However, this is not a story limited to iron ore, natural gas, coal, copper, zinc, nickel, and oil. Australia has an amazing pedigree as a mining nation, and diversification into battery inputs and other industrial materials is occurring. These markets have measurable catalysts behind them now as technology improvements occur, and the world diversifies supply chains away from China. Australia is set to benefit as supply from our shores is low cost, high quality, and a stable alternative for rare earths, and industrial minerals.

One of the stories that we are following that is not being driven by battery technology is the emergence of a high-quality Kaolin-Halloysite area in South Australia. Kaolin-Halloysite is a mineral that is used in several products as a “cheap” filler in paper and ceramics (at $300+ USD per tonne!). What is interesting about the material found in SA, is the shape at the microscopic level. In this region the material is deposited in tubular form compared to traditional flakes. The tube structure gives the material interesting properties that are beneficial as an additive for spray on concrete that increase strength and reduce density. These properties make the Kaolin-Halloysite finds in the Eyre Peninsula particularly interesting to the concrete industry in quantities that can build mining giants.

It is early stages for Australia’s high-grade Kaolin-Halloysite area, but the benefits are there to pursue the finds. High quality resource regions tend to be the gifts that keep on giving. The Gwhar oil field in Saudi Arabia has produced since the 1940s, the Pilbara in WA produces nearly 20% of the world’s iron ore and was discovered in the 1960’s, Kalgoorlie has been mining gold for over 100yrs and is still going strong. The image of a ghost town with a mined out mine is not necessarily the reality for these world class deposits. Technology improves, prices increase making higher strip ratios worth the cost of production and development takes advantage of existing infrastructure. Time will tell with Kaolin-Halloysite in South Australia, but traditional sources of the material are dwindling, and we could be looking at a boom scenario as demand outstrips supply.

Updating our checklist:

• Valuation: In times of recession price to earnings ratios (P/Efwd) will blow out above historic averages, as profit margins collapse. We saw this phenomenon during the global financial crisis (GFC). As profit margins begin to increase again the ratios will begin to revert to the mean. We are seeing glimpses of that the last two months. The ASX200 P/Efwd is now below 20x at 19.7x and the S&P 500 has its P/Efwd at 22.9x, down from an end of calendar year high of 27.0x. The market still looks “rich”, but the valuation is going in the right direction with stronger corporate profit.


• Global PMIs: We will get new PMI data in time for our next newsletter, but we would like to talk quickly about savings rates. Right now the household savings rate has skyrocketed in Australia (and other developed nations). This is important as it could represent pent up demand for goods and services. As the economy continues to improve, we could see these savings enter the economy and add fuel to the recovery.





• Downgrades on guidance: Earnings season continues, and it has been all about the surprises. Companies have really pulled it out of the bag in Q4/HY1 as the highest number of companies exceeded analysts’ earnings and sales expectations. Most of the companies that were brave enough to provide guidance, guided higher. Again, the ratio of upward to downward guidance is at record high.




• Infection rates to slow globally: Melbourne is the latest Australian city to experience a snap lockdown, and Domino’s shares rose on the news. We are not even joking. Even with lockdowns still occurring around the globe, the narrative has shifted to vaccine roll out. Australia will begin their program beginning in March, whereas we see continued momentum in the US’s plan. This week Moderna and Pfizer announced that they have an additional 500million vaccines available, which will see the American population theoretically covered by the end of July. If you follow our resurfaced vaccine tracker you will see that the American industrial machine has steamed ahead as their vaccination rate has now climbed into the “herd immunity by xmas” window. With the latest announcement we expect this vaccination rate to continue to increase as it has been hampered only by supply. The US and UK are both on track to have their populations at herd immunity by October.
  
  TFM Vaccine Tracker




• Monetary and Fiscal stimulus announcements globally: We can tell you that US stimulus of $1.9tr USD is getting closer, China continues to expand credit and Europe is still stimulating. In Australia we can see the benefits of Job keeper have charged profits across broad sectors of the economy. With the program set to expire at the end of March there will be pressure on the Australian government to either taper and extend the program or deal with the consequences of a cliff edge drop.

With low rates here for the foreseeable future, asset prices in equities and real estate continue to have momentum behind their prices. At this early point in a new business cycle, it is a great time to invest in your future. We continue to stress that if you find yourself with extra capital it is an excellent time to speak to one of our advisors. They are trained to assess your financial position, and help you design a plan to meet your financial goals. The best day to plant a tree is always yesterday and that goes double for sorting your financial situation. Till next time take care and we will be in touch in two weeks.

Regards,