Crispin Murray: what’s driving Australian equities this week

Pendal's Head of Equities, Crispin Murray

Here’s what’s driving Australian equities this week according to Pendal’s head of equities Crispin Murray (pictured above). Reported by portfolio specialist Chris Adams.

SYDNEY’S LOCKDOWN dominated local news last week, but the S&P/ASX 300 fell only 0.5%.

The takeover bid for Sydney Airport (SYD) reminded us of the abundant liquidity — and propensity among long-term investors to look through Covid-related earnings issues, supporting market sentiment. 

At a global macro level we saw bonds rally for the first four days of last week. This reinforces the narrative that we are through peak growth and the delta variant is exacerbating a global slowdown.

Sentiment reversed on Friday, perhaps suggesting that sentiment had turned too negative. We expect more sentiment swings through the northern summer as we wait for data on the economy and the effect of the Delta variant.

There are signs of a potential stimulatory shift in Chinese policy. This could be a positive development that supports resources in coming months.

Outlook for Covid and vaccines

The Sydney outbreak has taken a turn for the worse, breaking containment lines. We are now looking at a far longer period of restrictions.

While Covid remains contained to Greater Sydney the economic impact will be material, though not severe for the broader domestic economy.

Growth in new case numbers is tracking worse than Victoria’s second wave last year. On the plus side tightened lockdown measures, higher testing numbers and the ability of contact tracers to identify exposure sites should help. But the higher transmissibility of the Delta variant is an offsetting factor. 

The Delta variant is now dominant in the US, prompting further scrutiny. At this point it appears cases will start to rise materially. The key variable is what this means for hospitalisations. Until we have greater visibility the market may continue to worry about the potential for restrictions to return.

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The UK continues to run the gauntlet on new cases. So far a surge in infections has not translated into hospitalisations.

There is a growing debate about the effectiveness of vaccines and the need for boosters. Early studies on Delta indicated the mRNA vaccines were very effective — well into the 80% range in preventing Covid.

But data from Israel is concerning. It indicates the effectiveness of Pfizer in preventing Delta infections is in the mid-60% range. This is from a larger sample set than previous studies.

This could be due to the fact that Israelis had their injections four-to-five months earlier, which may suggest waning immunity and a lower efficacy in preventing infection.

The vaccines are still highly effective against severe infections. But this shows why a debate over the need for booster shots is gaining impetus.  

Economic outlook

We have had a series of weaker data points for the first time in months. US unemployment, PMI data, unemployment claims and vehicle sales have all softened and money supply growth has slowed.

Much of this can be explained by holidays, shortages of certain products or labour and some hot weather. But it is a trend that needs to be watched. Along with the increasing prevalence of the Delta strain this has triggered a further flattening of the yield curve on concerns for near-term economic growth.

We need to bear in mind the link between market price action and policy.

There is a view that if inflation and growth expectations soften sufficiently – and the yield curve flattens below 100bps – we could see the Fed delay tapering. This moderating factor suggests we may be near the end of the recent rally in bonds, although a move higher is unlikely in the next few months.

In China the State Council signalled a shift in policy to be more supportive of growth. A cut in the reserve requirement ratio (RRR) for banks followed, which can help credit growth.

This is most likely in response to weak consumption. But China faces a similar challenge to Australia: low levels of immunity and a reliance on vaccines that may have limited effectiveness against the Delta strain. This could force the Chinese to maintain restrictions for longer.

Beijing’s move to prop up growth via traditional investment-related stimulus would be supportive of commodities.

Meanwhile the European Central Bank announced its policy framework.

The ECB is taking a less activist approach to inflation than the Fed. They will tolerate an overshoot of inflation targets, but won’t actively try to generate inflation. The wash-out is no real shift in Europe’s more conservative approach.

Markets

Bond yields fell for much of last week on concerns over the economic outlook, before reversing on Friday.

As a result the US 10-year Treasury yield fell only 6 bps to 1.36%. The Australian equivalent fell 12 bps to end at the same yield.

Brent crude fell 2.7% despite the lack of a deal between OPEC and its partners on increasing supply. Concerns over growth — coupled with speculation that OPEC’s cohesion may be waning — are probably at play.

Most sectors in the S&P/ASX 300 fell last week, though the index was propped up by the bid for Sydney Airport (SYD, +33.4%). Otherwise there was a relatively small spread across sectors, with growth lagging after a good run.

The bid for SYD by a consortium of pension funds was last week’s big news. The offer of $8.25 per share was a 40% premium. It values the stock at 25x EBITDA based on post-Covid FY23 earnings, versus a historical trading range of 18-21x. 

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This represents an enterprise value of $30 billion versus the previous peak of $29 billion. We see this as a very competitive bid in the wake of an uncertain rate of recovery in international travel and the impact of the Western Sydney Airport. There may be a higher offer to follow, but the increase is likely to be small. The bid is conditional on board approval and Unisuper agreeing to roll its 15% holding into the venture.

Tabcorp (TAH, -8.1%) announced a plan to demerge its Lotteries and Keno business by June 2022, effectively rejecting offers for its wagering business. The stock’s fall reflects the high cost of the demerger – a $225 million to $275 million one-off and $40 million ongoing.

Crown (CW, -7.8%) delivered a market update that was softer than expected. Market attention remains fixed on the Victorian Royal Commission, which has now ended and will report in October. The risk of losing its licence – as well as the potential impact on revenue from upgraded compliance procedures – will have an impact on valuations from potential bidders.

Ramsay Health Care (RHC, +0.7%) raised its bid for UK-listed private hospital group Spire. This is unlikely to change the minds of big shareholders who hold a blocking stake to prevent the deal. This leaves the company back where it started, but in a bit of strategic bind, which is reflected in the price.

A2 Milk (A2M, +10.4%) has rebounded on signs of an improvement in volume and pricing in China’s infant formula market. We remain wary. China’s low birth-rate will likely result in lower demand, while local providers continue to gain market share.

Viva Energy (VEA, +5.9%) delivered a well-received update. EBITDA was well ahead of consensus and the non-refining business is back to its previous peak profit level, despite a decline in the aviation business. This demonstrates the industry structure is helping support margins, while the company is also controlling costs. Government moves to protect refining have also removed a great deal of uncertainty. 

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