Waiting for a Bottom in These Aussie Stocks

Waiting for a Bottom in These Aussie Stocks

In today’s Money Morning…the silver lining as resources fall…pressure off the RBA…individual stocks can shine, even when the market is grinding sideways…don’t get burned trying to catch the absolute bottom in a falling stock…and more…

Aussie stocks fell nearly 1% yesterday, and the selling looks set to continue today. The Dow Jones index fell 0.55% overnight while the S&P500 was down 0.3%.

The biggest move came in iron ore and base metals, and that will lead to ongoing selling in the resources sector today. The iron ore price declined another 4.6% overnight, and now trades around US$63/tonne, well off the peak reached in February.

But this is hardly a surprise. As the iron ore price traded near US$90/tonne, not many thought it was sustainable. In fact, most forecasts had the iron ore price coming back into the US$50s.

And here we are…or at least we’re getting close.

Base metals and oil prices fell too. But let’s keep things in perspective. The ASX 200 is trading around 5,800 points. It recently hit a near two year high at 5,950 points.

As far as corrections go, this one is minor. It may gather speed, or it may fizzle out pretty quickly. But it’s certainly nothing to be worried about. Corrections happen. That’s how the market works.

Depending on how you look at it, the air coming out of the iron ore tyres right now is a silver lining for Australia. From a short term perspective, anyway.

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Well, a lower iron ore price means lower national income growth for Australia. That takes some pressure off the dollar and gives the Reserve Bank more reason to sit on its hands and do nothing about interest rates.

As I’ve explained previously, the biggest risk to Australia’s debt-addled economy is higher interest rates. The biggest risk to higher interest rates are surging commodity prices. So now that you’re seeing commodities undergoing a correction, there is less inflationary pressure building in the economy, and the Reserve Bank can twiddle its thumbs for many months to come.

That’s the glass half full scenario. The glass half empty outlook says that China is slowing again. It says that the Trump ‘reflation’ trade is unwinding, and deflation will again become the main concern.

US Treasuries and gold are both pointing to this outcome. The question is how long will these respective rallies last?

Have a look at a chart of the US 10 year bond yield, below. At 2.18%, it’s at the lowest point since November last year.

Source: Optuma

Click to enlarge

But the retreat in yields over the past month has been dramatic. I don’t think it has much longer to go…you’ll likely see a rebound within days.

Also, note the moving averages (blue and red lines on the chart) still indicate a healthy trend. But for it to remain so, you want to see yields bounce back above 2.3% soon.

Falling bond yields are good for gold, as it indicates lower growth expectations and therefore a slower pace of interest rate rises. This is why the gold price has been strong in the past month, too. Take a look at the chart below…

Source: Optuma

Click to enlarge

Gold is now approaching US$1,300 an ounce. But it is heavily ‘overbought’. That’s a technical way of saying a pullback is due. So don’t be surprised if you see a retreat in bond yields and a sell-off in gold unfold over the next week, as fears about everything (war with North Korea, Syria, stock and house price bubbles, etc) subside.

In short, I’m saying this is nothing more than a correction for stocks in general. Right now, the ‘fear trade’ is working. Things like gold, bonds and safe harbour currencies like the Japanese yen are doing well. But I don’t think it will last.

That doesn’t mean stocks will soon return to making new highs. We might see a period of extended sideways moves, with not much going on in the major indices.

A market of stocks

But you’ll continue to see action at the individual stock level. One sector that is in the throes of change right now is the telco sector. Yesterday, Telstra [ASX:TLS] closed at $4 per share, its lowest point since October 2012.

It’s not just Telstra. All stocks in the sector are under severe share price pressure. The source of this pressure is the ongoing rollout of the National Broadband Network. As more people sign up to the new network, it squeezes existing players’ margins.

That leaves the mobile phone sector as one of the most profitable for the telcos…and certainly for Telstra. This is why TPG [ASX:TPM] wants to build its own mobile network. It wants some of the action.

So in addition to margin pressure across broadband, you’ll soon see it in mobiles too. Which is why Telstra’s share price looks like this…

Source: Optuma

Click to enlarge

But it’s now hugely oversold and due for a bounce. The bargain hunters are about to move in.

If you believe the earnings and dividend forecasts for FY17, Telstra looks attractive, trading on a yield of 7.8%. But the concern is what the earnings will be after TPG comes into the market with a cut price offering.

As someone who is on a Telstra mobile plan, I know their offer is expensive and very stingy when it comes to data. But hey, I lost my phone last year and didn’t have the luxury of being able to shop around.

The point is, if another network comes in (TPG expects to build coverage of 80%) and provides a good service at a lower price, it will absolutely hit Telstra.

Telstra has benefitted for years from having the best and most comprehensive mobile network. That has allowed them to charge premium prices and earn attractive profit margins.

Now this competitive advantage is under attack. Which is why the share price is back where it was four and a half years ago.

Is Telstra good value now? Maybe. But who knows how the market will look in a few years’ time?

I’d prefer to wait for Telstra’s share price to find a bottom, rather than try and pick a bottom myself. Given the recent share price damage, that could take many months to play out.

Regards,

Greg Canavan,
Editor, Money Morning

Greg Canavan

Greg Canavan

Greg Canavan is a Feature Editor at Money Morning and Head of Research at Port Phillip Publishing.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

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