Changing its tune: Beijing’s blues depress Aussie dollar, commodities

China’s monthly trade data yesterday provided a timely reminder of the fragile global growth outlook.

China’s monthly trade data yesterday provided a timely reminder of the fragile global growth outlook, weighing on commodity prices, resources companies and the Australian dollar.

If not for a fall in bond yields which triggered a slight recovery in some of the “bond proxies” that have suffered from a sharp rise in bond yields in the past two months, yesterday’s fall in the Australian sharemarket would have been a bit worse.

With resources-sector heavyweights BHP Billiton and Rio Tinto down almost 3 per cent — falls that were magnified by Citi cutting its rating on both miners to “sell” — and recent gains in the major banks apparently running out of steam before their reports this month, Australia’s benchmark S&P/ASX 200 index hit a two-week low of 5420.8. It closed down 0.7 per cent at 5435.5.

After rising almost 6 per cent in the past four weeks — a period in which 10-year bond yields jumped to four-month highs amid rising expectations of a US interest rate hike and diminished expectations of further policy stimulus elsewhere — it’s no wonder the localmarket suffered its biggest one-day fall in five weeks yesterday.

To be sure, consensus estimates for one-year forward earnings per share have crept up by 1.5 per cent since mid-September, extending a recovery in earnings expectations since April as commodity prices surprised on the upside.

WTI crude oil has jumped 20 per cent in the past four weeks and coking coal surged above $US200 a tonne, driving contract prices up 117 per cent in three months. Combined with gains in iron ore and base metals, the jump in oil and coal prices explains the earnings upgrades and share prices gains in resources producers.

But even with the sustained rise in earnings estimates over the past six months, Australia’s sharemarket remains expensive and vulnerable to any rise in bond yields, higher volatility or growth shocks that might emerge.

While it’s some way below a late August peak of 16.8 times, the one-year forward PE ratio of the market is still a fairly lofty at about 16 times versus a 10-year average of 13.7. Hence the recent concern about the back up in ultra-low bond yields that have validated higher-than-normal sharemarket valuations despite tepid global economic growth.

As Citi’s Clarke Wilkins notes, BHP and Rio have rallied strongly on the back of higher bulk commodities — the key driver of performance within the sector for the year to date — but his firm expects prices to pull back significantly from late 2016 as demand cools and supply responds.

“With share prices largely reflecting spot valuations it suggests that the market has become more efficient at pricing this in, which creates downside risk should bulk prices roll over in late-2016 and 2017, as we expect,” Wilkins says.

But while Citi’s downgrades on the miners and China’s trade data set the cat among the pigeons yesterday, Wilkins conceded that “there is perhaps more upside on an earnings basis should spot prices hold” as valuations for both BHP Billiton and Rio Tinto are “certainly not demanding”.

Indeed, many still feel that further upgrades of resources-sector earnings are possible while spot prices remain buoyant. As Bell Potter’s Richard Coppleson wrote yesterday, the trade data could be an early sign that the recent recovery in China’s economic activity is losing momentum. But he cautioned against reading too much into a single data point given the volatility of the trade figures.

“We could see a period of short-term weakness, but watch the lows — if they are higher lows — then they won’t be down for long,” Coppleson says.