NEWS + VIEWS – 9/08/2024
MARKETS
Share markets experienced significant volatility this week. The sell-off in the US quickly flowed through to other markets with investors still on edge.
The domestic profit reporting season, which kicked off last week, should give some direction to local investors. Companies with some bad news to disclose will often ‘confess’ over the few weeks prior to the reporting season. There were few confessions, which could be a positive indicator for upcoming company results.
TO CUT OR NOT TO CUT – THAT IS THE QUESTION
Bond markets are still expecting a rate cut before the end of the year despite Reserve Bank of Australia (RBA) Governor Michelle Bullock stating that ‘near-term’ interest rate cuts were not on the cards. In fact, she stated that the recent Board meeting had only discussed steady rates or a lift.
Bond traders are discounting the RBA comments and point to the ‘trimmed mean’ inflation rate in June easing from 4% to 3.9% (refer chart below). Furthermore, falling rates overseas will provide scope for rate cuts although inflation rates are lower in major economies than in Australia.
One thing is clear is that State and Federal Government spending is boosting inflation and working against interest rate cuts.
There are always winners and losers. Higher rates are feeding directly into returns for investors. For example, the fixed component of hybrid security returns is reviewed quarterly and tied directly to the official RBA cash rate.
Term deposits are less directly linked to RBA rates but follow sooner or later (sooner when rates are falling and later if they are rising). Macquarie’s 12-month term deposit rate has been reduced to 4.85% from 5.10% over the past month or so, which suggests that Macquarie is betting on market interest rate cut expectations being realised.
SHARE MARKETS ALL OVER THE PLACE
Markets were spooked on Friday when US non-farm jobs added in July were well below expectations (114,000 vs 170,000). Unemployment also rose to 4.3% from 4.1%. Investors quickly swapped to sell-off mode as fears of a recession took hold. The sentiment flowed through to domestic markets. The Japanese market was hit particularly hard (see below) falling 17.5% over Friday and Monday.
Source: IRESS
The CBOE Volatility Index (VIX), sometimes called the fear index, charts the expected volatility of the US share market over the next three months. The chart below shows that it spiked from below 20 on Thursday to a very high 47 on Monday as investors fled share markets.
Source: IRESS
Markets reversed direction on Tuesday night when the US ISM Purchasing Managers Index (PMI) showed a rebound into positive territory suggesting that the US was not moving into recession.
Share markets had a lot of optimism built into prices and are up some 20% since last October’s lows. The S&P 500 Price/Earnings ratio (P/E) is still trading above 20 times and above long-term averages. Any sense that company earnings would not ‘catch up’ with inflated prices was bound to start a sell-off. Also, after strong gains, investors seemed to be looking for a reason to take profits.
As usual, no one can tell whether we have seen the end of this pullback. However, a period of weakness is probably healthy for share markets. As long as company earnings continue to grow, then investors will back the market. The positive impact of falling interest rates, at least offshore, should also provide a boost in profits for companies and some comfort for investors.
Domestically, the current profit reporting season will have strong bearing on at least individual companies.
COMPANY NEWS
Rio Tinto (RIO) focussed on copper growth
RIO last week reported a first half underlying net profit of US$5.8 billion, in line with expectations and driven by its copper and aluminium divisions. The declared dividend of A$2.70 per share represented a payout ratio of 50%, in line with company practice.
RIO derives most of its profits from iron ore but is increasingly focussed on copper growth that will come from existing projects, mainly the underground Oyu Tolgoi mine in Mongolia but also ventures with Codelco in Chile and First Quantum in Peru. CEO Jakob Stausholm may consider a large acquisition, but it would have to provide value that is hard to find amid a copper market that is running hot.
Woodside Energy (WDS) on the acquisition trail
Last week, WDS signed a $US1.2 billion deal to buy LNG developer Tellurian and its U.S. Gulf Coast Driftwood project. This week it announced the $3.7 billion purchase of OCI’s clean ammonium plant in the US with only a 10% return. Ammonium production is a ‘new’ field for WDS.
Also this week, the Western Australian Environmental Protection Authority (EPA) said it expects to release its recommendations on WDS’ Browse gas project in 2025, after a newspaper reported that the project might be knocked back by the EPA. WDS will continue negotiating for approval.
Like other energy and mining companies, WDS seems to be struggling with the investment settings in Australia. Industrial relations changes, uncompetitive tax settings, government intervention in supply, environmental requirements and ‘lawfare’ must be taking their toll on decisions to invest in Australia. It is interesting to note that WDS’s last two announcements relate to investments offshore. BHP has warned of a deteriorating investment environment in Australia and their last acquisition was in South America (not to mention the failed bid for offshore based Anglo American). The company has also stated it will not make further investments in Queensland.
Commodities have been a major driver of Australia’s wealth over many decades. Governments need to be part of attracting investment, not driving it offshore.
Gerard O’Shaughnessy
P 0423 771 330
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