USD-Earning Australian Stocks & Australian Consumer Confidence

  • Returned 7% for the quarter (vs. ASX200 Accumulation Index falling 1.6%), taking performance over the past year to 27.6%
  • Volatility remains very subdued and incremental US economic data is significantly weaker than the Fed would have expected
  • Recent weakness in USD may begin to cause problems for a number of Australian companies that derive a large part of their earnings from the US

Will USD-earners finally underperform?

  • Between September 2014 and September 2015, AUD suffered a rapid decline from US$0.93 to US$0.70
    • Consensus wisdom at the time was that the collapse in the AUD was only getting started and an ultimate trading band of US$0.50 to US$0.60 beckoned
  • Outperformance of USD earners over the past 18 months has been dramatic and has far outstripped the actual decline in the AUD/USD
  • This divergence is even more stark when you look at the relative performance of those USD earners versus the ASX200 in aggregate
  • Initial phase of outperformance can be logically explained by the appreciation of the USD during the corresponding period; however, it is more difficult to rationalize the acceleration of this outperformance after September 2015
  • AUD has recently reversed course and rallied from 70c to 79c by July 2017
  • While it’s true that some specific USD earners have enjoyed a stellar period of EPS upgrades and subsequently share price moves, it’s difficult to argue that all 17 USD-earning stocks in the ASX100 have enjoyed such a purple patch in their operating performance
  • Many of these companies are undoubtedly high-quality businesses with strong management teams but we struggle to find compelling value in most of these stocks
  • Given the recent AUD strength, we believe some of these stocks may struggle to continue their outperformance – importantly, recent weakness in USD has been a global phenomenon with most USD cross rates behaving similarly
    • This has been triggered by Yellen’s more dovish comments, along with President Trump’s difficulty enacting his intended stimulatory fiscal policy

Consumer Confidence

  • At face value, Australian consumers have never had it better – combination of low unemployment, very strong house price growth, low petrol prices and large cuts in the RBA’s cash rate would ordinarily encourage a surge in retail sales and consumer confidence
  • However, there have been some subtle differences in this recent cycle that have negated much of this consumer tailwind
  • Consistent strength in Australia’s employment trends has belied a marked deceleration in wages growth – wages growth has collapsed from its historical range of 3-4% p.a. to its current rate of 1.9% p.a.
    • Real wage growth in Australia is non-existent which places pressure on household budgets, given household expenditure is skewed more heavily to items like education, healthcare, and utilities, which continue to increase at considerably higher rates than 2%
  • While RBA’s official cash rate has fallen from 7.25% to 1.5% over the past 9 years, consumers have not enjoyed the full benefit of this fall
    • Banks have been under pressure from APRA to significantly increase the amount of capital held on their balance sheets to de-risk the sector in the event of a downturn
    • Given this higher capital charge and the banks’ collective desire not to see their ROE collapse, banks have had no option but to re-price their loans higher
    • Current standard variable interest rates on a mortgage are broadly comparable with 2009 when the official cash rate was 3% (not today’s 1.5%)
  • APRA has been intent on tightening the amount of lending for investment properties (by capping each bank’s growth at 10% and enforcing a 30% limit on interest only loans)
    • Result of these moves has been a very large offset against the RBA’s rate cuts, to the point where monetary conditions have barely eased over the past 4 years, despite the drop in the official RBA cash rate
  • Believe consumers are not doing as well as the high-level data may suggest – we maintain a degree of caution when evaluating sectors with a high reliance on the strength of the Australian consumer
    • Imminent arrival of Amazon will pose another significant challenge that will be difficult for many retailers to address

wage growth

L1 Capital Overview

  • Global investment manager with offices in Melbourne, New York and London – established in 2007 and owned by its senior staff, led by founders Raphael Lamm & Mark Landau
  • Since inception, L1 Capital Australian Equities Fund has been the best performing large cap, long only fund in Australia, outperforming the S&P/ASX200 Accumulation Index by 7.3% p.a. (gross)

L1 Capital Long Short Fund Quarterly Report (June 2017)

Image Source: Factset, Datastream

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