Australian Market Commentary
The Australian bond market (as measured by the Bloomberg AusBond Composite 0+ Yr Index) returned 0.86% over the month. The yield curve flattened slightly as 3-year government bond yields ended the month down 12 basis points (bps) to 0.50% while 10-year government bond yields were down 13 bps to 0.82%. Short-term bank bill rates ended the month lower. The 1-month rate was down 1 bp to 0.79%, the 3-month rate was down 7 bps to 0.81% while the 6-month rate was down 9 bps to 0.81%. The Australian dollar again fell sharply, closing the month at USD 0.65.
The cash rate remained unchanged during February at a record low of 0.75%. The RBA acknowledged the uncertainty being created by the coronavirus and reiterated that they would ease monetary policy further if needed “to support sustainable growth in the economy, full employment and the achievement of the inflation target over time”.
Domestic economic data releases were mixed in February. Employment rose by 13,500 positions in January which exceeded expectations. The unemployment rate jumped to 5.3% from 5.1%. The NAB Survey of Business Conditions was steady in January at +3 points and business confidence remained negative at -1. December retail sales were lower than expected, falling 0.5%. National CoreLogic dwelling prices continued to post gains, rising 1.0% in February.
Australian Market Outlook
Thus far in 2020, markets have been increasingly dominated by growing fears regarding the impact of the coronavirus as it spreads globally. Prior to this, there had been high hopes for global growth in 2020, following signs in late 2019 that global industrial production had bottomed, and fundamental data in China had also shown improvement. Given the uncertainties posed by the coronavirus, the improvements in Chinese data will have been short-lived, with some predicting negative Q1 GDP due to the effects of the coronavirus. However we remain hopeful regarding the overall global growth outlook given the willingness of central banks to maintain liquidity in times of crisis. While the virus is dominating headlines now, it will eventually dissipate. Looking further out, eyes will also be on the US this year, with the presidential election taking place in November and the field for the Democratic presidential nomination narrowing.
Domestically, the Australian economy has been growing below-trend, with sustained low income growth impacting household consumption. Despite strong employment growth, unemployment has hovered around the low 5% mark in recent months as labour force participation has increased to all-time highs. Economic growth is expected to take a hit in the near term from the bushfires and the coronavirus but we believe growth down the track should remain supported by the record low level of interest rates and turnaround in the housing market.
Speaking of central bank willingness to act in times of crisis, the RBA delivered a 0.25% rate cut on 3 March, in response to the coronavirus, taking the cash rate to a new record low of 0.50%. The RBA noted that the virus outbreak is having a significant impact on the economy, especially the education and travel sectors. With Q1 GDP expected to take a hit, the RBA decided it was appropriate to ease policy in order to support the economy. Whether the RBA has acted too early or whether these actions will have the desired effect remains to be seen. As with everything about this coronavirus outbreak, only time will tell. Once the coronavirus is contained, we believe the foundations for a rebound in growth are in place, including low rates, a lower exchange rate and expected recovery in construction and household consumption.
Credit Commentary
The credit markets in February were severely hit in the last week as concerns about the coronavirus pushed spreads substantially wider. The US CDX widened by 16 bps, the European iTraxx by 18 bps and domestically the Australian iTraxx widened by 15 bps.
Results for the A-REITs were overall solid with SCA Property Group and Dexus at the stronger end while the diversified trusts such as Mirvac, Stockland and GPT having more mixed 1H20 results. Other issuers such as BWP Trust and Vicinity Centres reported reasonable results but Vicinity warned about potential slowdown due to the coronavirus.
Results from Commonwealth Bank, National Australia Bank, Suncorp, Macquarie and Bendigo were all solid, suggesting a robust financial sector. As an exception, AMP reported results that missed expectations and was heavy on 1H19 impairments costs. QBE reported mostly strong results. Of relevance to the RMBS market, its LMI business is improving in quality but diminishing in size. Mortgage insurer Genworth Australia reported positively but faces the same headwinds as QBE LMI.
Wesfarmers and Woolworths reported overall positive results with complications due to divestments. Victorian Power Networks (which covers CitiPower and Powercor) reported strong results, Downer reported a weak but not unexpected half year result. Telstra reported 1H20 earnings down on the pcp but in line with expectations and guidance. AGL recorded an overall positive financial and operational result for 1H20. Qantas reported relatively flat performance and forecast an Australian dollar (AUD) 100-150 million impact from the coronavirus. Sydney Airport reported a strong FY19 underlying result that defied flat passenger growth, with net operating receipts increasing 5.4%, but they elected not to provide guidance for the FY dividend at this point given the uncertainty due to the coronavirus. Lendlease reported a reasonable but not resounding result given the restructuring it is currently undergoing. Aurizon and Transurban both recorded solid results for 1H20 and a healthy balance sheet.
Offshore, BNP beat street expectations in a strong final quarter performance. ING, on the other hand, produced a mixed set of results below expectations, while HSBC announced a scale-back of its European investment banking activities. Ford produced a 4Q earnings miss against recently downgraded expectations while GM (equity +1%) reported a sharp fall in 4Q earnings reflecting the impact of last autumn’s (fall’s) strike but presented sound margins and a relatively upbeat view incoming models for 2020. Caterpillar produced 4Q results that beat expectations, but downgraded FY20 forecasts to be well below 2019. Apple announcement that it wouldn’t hit revenue guidance for the March. AB InBev reported its full year earnings below expectations.
Caltex reported a challenged FY19 result. The ongoing potential take-over by either Alimentation Couche Tard or EG Group puts extra pressure on credit and Moody’s placed the issuer on negative watch given the lower ratings of the potential acquirers.
In other ratings news, Amcor was downgraded to BBB from BBB+ by Fitch, reflective of slower than expected deleveraging. The outlook is stable. Nissan Motor Co Ltd was downgraded to Baa1 from A3 by Moody’s due to weak profitability, negative free cash flow and ongoing challenges in respect of the Renault relationship. The outlook is negative.
Australian Prime Property Fund Retail was downgraded to A- from A+ by Standard and Poors (S&P) due to recent sales reducing the fund’s scale and diversity. Suncorp’s ratings have been moved to positive outlook by S&P after the sale of the capital intensive life business, and supported by the stronger capital position of the bank.
Domestic corporate supply was AUD 5 billion, including two non-financial corporate issues from Toyota and GPT. Securitised markets saw three issues totalling AUD 1.9 billion: one prime RMBS issue from Columbus Capital, one personal loan securitisation and a refinancing of a Puma deal.
Credit Outlook
After the credit spread widening in the last week of February, credit at current spreads seems more attractively priced but nervousness suggests a much more volatile environment. The allocation to credit can, however, be more weighted towards shorter-dated credit which is less sensitive to spread movements.
Supply has been strong this past year but may be more challenged until markets settle. Although non-financial issuers have been increasing in number and size, issuance is still biased towards financials. Domestic non-financial supply is often less abundant and is always uncertain given many Australian investment-grade issuers tend to be lowly geared and so require less debt. In addition, the bank loan market remains attractive for shorter maturities and offshore markets offer competitive pricing for sizable long-term debt issues. Given the possibility of further weakness of spreads, caution needs to be applied especially when investing in lower-rated or longer-dated credits. High-yield spreads offshore appear reasonably tight and are vulnerable to widening; as such, the extent of compensation for taking exposure to lower-rated credit is less compelling.
Domestic and offshore financials tend to be the most common issuers in the Australian market and can offer value. However, for offshore issuers, caution must be applied due to the complexity of the variations in treatment of capital requirements with varying rules on TLAC (total loss-absorbing capacity). Accordingly, domestic major banks offer a simpler value proposition due to their liquidity while some of the smaller local ADIs provide a solid spread with conservative management. On the non-financial side, the lack of supply has resulted in many deals being expensive, but stable sectors such as the utilities and quality REITs remain more attractive sectors. Securitised product remains another area of value, given solid spreads and in many cases superior credit quality.
