Kreston market update week ending Friday 13th August 2010

Kreston ANZ

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Kreston Dormers

Kreston Dormers Financial Services Pty Ltd

The ASX 200 broke its 5 week positive trend with a sharp -3.2% reversal of the recent 6.7% rise since early July. All sectors were down with a -3.7% fall from the Banks the biggest negative.

After the positive company reporting season in the US, news of a slowing US economy took centre stage and pushed markets lower. Volumes were high over the wee so the sell off was broad based and the S&P 500 fell below its 200 day moving average which is a key measure technical trader use to predict trends. This suggests further volatility.

We hit 4,300 on the ASX 200 twice since mid May and each time the market has recovered to 4,600. Gradual rises have preceded sharp falls in what seems to be emerging as a trading range.

	Index	Change	%
All Ordinaries	4,433	-143	-3.1
S&P / ASX 200	4,411	-144	-3.2
Property Index	848	-27	-3.1
Utilities Index	4,166	-62	-1.5
Financials Index	4,253	-162	-3.7
Materials Index	12,043	-247	-2.0
Energy Index	14,588	-406	-2.7

Bank Term Deposit rose in the 1 and 3 year tenors. The rising competition for deposits is beginning to show up in bank profit results.

Term	Rate %	Change in rate
3 months	5.65	0.00
6 months	5.90	0.00
12 months	6.21	0.20
3 Years	7.00	0.20
5 years	6.95	0.00

Overseas markets broke the upward trend that commenced in early July. The US S&P 500 was down sharply -3.7% while the UK FTSE fell -1.8%. In Asia, Hong Kong's Hang Seng fell -1.8% and Japan's Nikkei put in the worst performance down -4.5%.

CBA, NAB, Stockland and Telstra amongst others reported this week with mixed results.

Due to the number of companies covered in this report, we have not included a Feature Section.

Australian News

The Australian half yearly reporting season kicked off in earnest. Results have ranged from strong to disappointing while management forecasts have been consistently cautious.

National Australia Bank (NAB)

Highlights of the solid trading result were:

• Cash earnings of $1.1bn for the 3rd quarter in line with the first two quarters of 2010.
• Stable revenue and margins despite increased pricing competition (that NAB started).
• Lending growth was up but not by much.
• Asset quality was still reasonable with bad debts of $510M lower than the previous quarters.

Management is expecting the long awaited rise in business credit growth to occur in 2011. While the top end of town (large corporates) are generally tracking well, small and medium sized businesses have not participated in the buoyant conditions.

NAB's lending is heavily biased toward business lending and NAB needs small and medium business conditions to improve before we will see a strong rise in the share price.

NAB's share price fell on the day of its update due to:

• the increased likelihood of their bid for AXA being successful,
• caution on short term credit growth, and
• lack of positive surprises in the result.

Commonwealth Bank (CBA)

The full year result was generally in line with market expectations although a slowing trend is becoming apparent:

• Cash NPAT rose 42% to $6,101m.
• Earnings per share rose by 21% to 360.3c.
• 2nd half impairment expenses were significantly lower.
• The negative in the numbers was 4% lower net interest income (interest received less interest paid) as the banks compete for deposits.
• The positive surprise was that the final dividend was increased to 170 cents fully franked from 120 cents previously.

Similar to the NAB, CBA warned of slowing lending in the latter part of the half leading up to June 2010. At that time, share markets were down and interest rates were rising so the weakness is not entirely unexpected.

CBA management expects the 2nd half to December 2010 to be soft while the first part of 2011 to be 'hopefully' stronger. CBA's share price fell by 3% on the day of the announcement on the back of comments on slowing short term growth and this flowed through to other bank share prices.

In summary in the banking sector we can expect:

• Slower growth until consumer confidence picks up (which it actually did in June) and business confidence to rise (which fell in July).
• Rising home loan rates as banks pay increased interest on offshore borrowings (around 50% of the banks funding comes from offshore).
• Continuing political comment on the size of banks profits.

Telstra (TLS)

Telstra reported a disappointing $3.88 billion profit which was a 4.7% fall from the previous year. The result included a $168 million write-down of the Hong Kong based mobile phone company CSL. TLS is suffering from migration from fixed lines to mobile phone and rising price competition.

Telstra did say they are attracting more customers but not whether this is resulting in more sales/revenues. Management stated that their number one priority is to retain and attract new customers.

Having recently compared their broadband and phone offering to their competitors, I must say Telstra has some work to do on their pricing. The service and performance of their voice and internet products are good but too highly priced. I am waiting for Telstra's prices to drop before comparing again.

The company has forecast 'flattish' revenue for the 2011 financial year, but it expects a high single digit percentage fall in earnings before interest, tax, depreciation and amortisation. There are some real challenges for Telstra 'going forward'.

Stockland (SGP)

Listed Property Trust and developer Stockland reported a 10% increase in underlying profits with residential property business up 16%. Like the banks, the company warned of softening housing market conditions due to interest rate rises although they are seeing commercial property values stabilising. Guidance for 2010/11 was somewhat cautious as the company expected earnings in 2010/11 to rise 7%.

Bradken (BKN)

Mining and rail equipment manufacturer Bradken delivered a healthy full year 2010 result of $70.4 million which was up 10% on previous year's profit. The second half EBITDA of $167.0 million was up 36% on the first half which bodes well for next year's results. Rail was the standout performer. Management forecasts were upbeat with a 15% to 20% rise in EBITDA expected.

Other companies reported mainly solid results

Other companies that have reported solid results were Coca Cola Amatil (CCL) Transurban (TCL), Bunnings Warehouse Trust (BWP) and even Myer (MYR). James Hardie (JHX) joined Telstra as the other 'shocker' result this week.

Economic Data : Housing Finance and Unemployment

Housing finance was down 2.4% in June which supports the comments from the banks on recent the slowing in activity. The concern was that construction lending fell 5.9% in June. We need more houses and lower prices rather than fewer houses and eventually higher prices.

Based on this data and unemployment data below, we expect the RBA to hold off on interest rate rises for the next few months which should stabilise housing construction.

Australian unemployment rate increased 0.2% to 5.3 per cent in July. At the same time there was a rise in the participation rate (% of people employed) by 0.2% to 65.5%.

In their media release the ABS reported 'the number of people employed increased by 23,500 people to 11.236 million, seasonally adjusted, in July. The rise in employment was driven by a rise in part-time employment, up 27,700 people to 3.369 million, which was slightly offset by a fall in full-time employment, down 4,200 people to 7.866 million.'

The positive side of the numbers is that we were approaching 'full employment' which could have put pressure on inflation through expectations of higher wages. Also there are more people working and more people wanting to work despite the rise in unemployment. When viewed from the perspective of the overall economy, the data had some positives as long as employment stays strong.

There are probably some underlying trends there. Discouraged unemployed registering for work? Are retirees going back to work? Are people staying in work longer? Putting aside any personal impact, it is good for the economy due to lower social security needs and government health funding. That is a huge challenge for our economy over the next 20 to 30 years.

Overseas News

Overseas news was negative this week although the negatives were actually in many ways expected. The theme was slowing US and Chinese economies.

The US economy is slowing

The US Federal Reserve (The Fed) stated this week that 'The pace of economic recovery is likely to be more modest in the near term than had been anticipated'. That is Fed speak for "The economy is slowing".

In response, the Fed will suspend the unwinding of its quantitative easing program by continuing their buying of mortgage backed bonds to maintain liquidity and thus lower interest rates.

When a government buys bonds from the market it means there is more cash in private sector hands. This cash then finds its ways to lender or investors. As there is more money to lend or to invest in other assets, then lenders will lend at lower rates and/or investors will pay more for other assets (in the case of interest bearing assets the rise in price may equate to lower interest rate being paid for the security purchased e.g. bonds).

Also the Fed has a bigger balance sheet i.e. it owns more assets (bonds) but it must 'fund' these purchases with a liability on their balance sheet. This is a 'book' entry and doesn't need to be funded by cash or capital raising. Thus the balance sheet of the bank and economy grows – sometimes called 'printing money'. What unfortunately has been happening to date is that, the Fed buys the bonds from the banks and the banks have not been lending the money but have simply been depositing it back with the Fed. The Fed is responding by cutting interest rates it is paying on these deposits to 0%, thus encouraging these banks to lend. It is a complicated game.

Despite the expectation already in place that the economy was slowing, markets sold off heavily this week on the back of the Fed comments. The downbeat Fed comments made investors wonder whether things are worse than expected and the relatively minor response by the Fed meant those same investors questioned whether that would be enough.

A deterioration in the US trade surplus also added to concerns that the previous quarter growth of 2.4% was actually much lower and will be adjusted down to as low as 1% to 1.5%.

What is required now is for data to start showing a slowed US economy but an economy that has at least stabilised at that lower growth rate. For example, the last reported GDP growth rate was 2.4% for the US. If future data suggests it had slowed to say 1.9% and then stabilised, that would be the first step in the market becoming less volatile.

China is slowing due to government tightening

Adding to the negative sentiment from US economic news, China's annual factory output growth slowed to 13.4% in July from 13.7% in June but was slightly above most forecasts. Year-to-date growth in investment in fixed assets such as flats and factories in urban areas slowed to (still very high) 24.9% from 25.5%.

Chinese inflation quickened to 3.3 percent in July, the fastest in 21 months, boosted by rising food costs.

Again the news of a slowing economy was pretty much expected. However, the market has sold off on the question 'How far will China (and the US) slow?'