Latte with Ray – Postcard from London

Raymond Chan

We spent a week here visiting our UK clients. The European Economy remains weak, and the financial markets here are having ongoing issues. Over past two weeks, we had Deutsche Bank stock price reaching record low, Commerzbank (2nd largest German bank) cutting 9,600 jobs (or 20% of workforce) and ING trimming another 5,000 jobs. When we talked to our contacts over here, they were all looking for job opportunities either in Asia and Australia ... What does it mean for our Australian Investors?

It's not just a "Deutsche Bank specific" issue … On Deutsche Bank, an institutional client commented that the situation is definitely much worse than what the market is pricing in right now. Everybody is relying on State support for a rescue plan, but the German govt is bounded by the EU bail-in law which restricts direct intervention. [EU regulations prevents European Bank Bailout by ECB & other Central Banks unless a risk of “very extraordinary” systemic stress.] The announcement by Commerzbank highlighted that it might not be a Deutsche Bank specific problem. Most likely will see more asset sales and even deep discount rights issue. But UK banks taking over iconic German bank seems quite far-fetched at this moment given Brexit and national pride. Like all previous bailouts, we need to see much worse market movement before a solution would come up. Expect more volatilities over the next few months.

Brexit … As you know, Brexit introduces uncertainty to UK economy. Last week, the GBP reached new 31 years low against USD. Well, it’s definitely great for Inbound Tourists and Overseas Property Buyers here given the 20% “currency” discount. However, this does not help business confidence. We think Henderson's takeover of Janus Capital is interesting. Henderson was a spin off out of AMP Capital now dual-listed in UK and Australia. Under the proposed takeover, if successful, we will see Henderson to de-list from the UK and move its primary listing to the US. We can’t help but feel the Brexit may have something to do with the proposal.

What does it mean for our Australian Portfolio? Europe is a significant economy and one of biggest trading partners to China. In turn, China is Australia’s biggest trading partner. With the economy going soft here, Latte with Ray maintains that the ECB will have no choice but maintain its easing bias (despite some “European experts” here calling for ECB QE tapering). In the US, it’s, without doubt, the FED is now pushing back the tightening timetable. Last week, our new RBA governor Phillip Lowe held rate at 1.5% and still easing. In this low-interest rate and low growth environment, we think infrastructure assets are “core portfolio holdings.” Having said that, while we like the infrastructure stocks as an asset class, we don’t agree on the current pricings. Even after recent price correction, the PE on infrastructure stocks remains elevated.

Among the infrastructure stocks, Latte with Ray prefers TCL (recent quarterly traffic numbers look fine), SYD (we see 2nd Sydney airport announcement as the upcoming catalyst) and Magellan Infrastructure Fund MICH (ETF listed on ASX). We would love to buy TCL below $10.00 and SYD below $6.00. We expect both TCL & SYD can generate growing cash flow (and dividends) over next few years. On Magellan Infrastructure Fund, the ETF offers us global diversification in infrastructure assets and more importantly “AUD hedged” return.

When to buy? We don’t think we have seen the bottom of infrastructure stock correction yet; it’s likely to see further selling pressure when the market starts talking up the prospect of Fed rate December hike. As you know, the performance of infrastructure stocks is negatively correlated with ten years US (and Aussie) bond yield. The higher the bond yields, the less attractive the infrastructure stocks are going to be. However, in our opinion, price weakness will present us with the opportunity to buy.

This article is contributed by Raymond Chan, Managing Partner, Morgans Financial Limited - Sydney Hunter Street


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