Australian stocks recover as Trump fuels optimism

The ASX recovered from below 6000 as Donald Trump fuelled US optimism, while inflation data cut rate hike prospects.

Ahead of Donald Trump’s address, Wall Street had its biggest decline since May. Pic: AP

Australian shares recovered from a fall below 6000 points as Donald Trump’s State of the Union address fuelled optimism about the US economy and below-target inflation data in Australia reduced expectations that the Reserve Bank will start to lift official interest rates this year.

However, the bounce in the Australian share market was mostly driven by a fall in domestic bond yields, which will be hard to sustain as strengthening economic growth and lessening central bank bond buying puts upward pressure on bond yields globally.

After initially turning negative from a weak Wall Street lead, the S & P/ASX 200 share index closed up 0.2 per cent at 6037.7, while the Australian dollar eased off US81c and the 10-year Commonwealth Government bond yield fell 5 basis points to 2.81 per cent.

Wall Street’s Dow Jones industrial average had its biggest decline since May, losing 1.4 per cent, hit by hefty losses in health care and technology companies.

However US futures turned positive during President Trump’s address and were pointing to a 0.3 per cent opening rise in the Dow Jones.

Locally, with December-quarter inflation rising 1.9 per cent year-on-year versus a consensus estimate of 2.0 per cent, the market-implied chance of an official interest rate increase in July fell to 27 per cent from 42 per cent a day earlier, according to Bloomberg data.

A S X 200 and The dollar

“The inflation data confirms that underlying pricing pressures in the Australian economy are still weak as the economy is still running below potential, competition in numerous remains intense and the rise in the Australian dollar is helping to keep imported price growth low,” said AMP Capital’s head of investment strategy and chief economist, Shane Oliver.

“Continuing low inflation means that there is little chance of an imminent RBA interest rate hike.”

But while real estate, health care, utilities, infrastructure and telecommunications shares led gains as bond yields fell, the economic growth-sensitive resources stocks went backwards, with BHP Billiton and Rio Tinto, Woodside Petroleum and Fortescue Metals all hitting four-week lows.

With Goldman Sachs warning of large month-end selling by US pension funds to rebalance their portfolios after a massive outperformance from US equities versus bonds in January, Wall Street could stumble again despite Mr Trump’s call for $US1.5 trillion in US infrastructure spending.

And while the rise in global bond yields has not been an impediment for the overall stock market so far, investors should tread warily in stocks at the top of the “Bondcano”, according to Credit Suisse Australia equity strategist Hasan Tevfik.

“The Bondcano has erupted once again and 2018 has so far been a poor year for the fixed income market,” Mr Tevfik said. “We continue to think we have seen the low in bond yields this cycle, if not for much longer, and the more recent supply-demand outlook helps confirm our view.

“Big buyers of government bonds, central banks, are now dropping away. Meanwhile, big sellers of government bonds — the US government — are set to issue at a faster pace.”

Indeed, the supply-demand backdrop for the global bond markets continues to deteriorate.

This month the Federal Reserve doubled the pace at which it is shrinking its balance sheet of US Treasuries and the European Central Bank halved the pace at which it is purchasing bonds. Meanwhile, the US government has just passed a tax plan that promises to boost bond supply.

A 30-basis point rise in the yield of the 10-year US Treasury bond has resulted in a total return drawdown of 2.3 per cent, making the worst January since 2009, according to Credit Suisse.

In Australia, the rise in bond yields has been more moderate, with a gain of only 21 basis points — equating to a 1.3 per cent drawdown — though it has so far been the weakest January for Aussie bond investors since 2012.

“We think rising bond yields from low levels has signalled continued recovery and an accommodative cost of capital. Rising bond yields from high levels are likely to be more of a headwind as it will be consistent with tight liquidity. Right now, bad for bonds is good for equities,” Mr Tevfik said.

Benchmark 10-year US Treasury bond yields are up 140 basis points since they hit a record low in mid-2016 higher, while equivalent Australian bond yields are up about 100 basis points, even though inflation remains below target and the RBA is in no hurry to lift official interest rates here.

Credit Suisse expects the 10-year US Treasury yield to hit 2.9 per cent this year but Mr Tevfik says the risk of an “overshoot” looms large. In that environment, stocks that have struggled the most from the 18-month surge in bond yields — gold producers, and companies with excessively high price-to-earnings multiples, high-dividend payout ratios or poor growth outlooks — are vulnerable.

“These stocks are at the very top of the Bondcano and include Northern Star, Sydney Airport, BWP Trust and Ramsay,” Mr Tevfik said. “Rather we think investors should consider those stocks at the bottom of the Bondcano. They have outperformed when bond yields have pushed higher and include BlueScope, BHP, Computershare and Macquarie Group.”