(TUESDAY 14TH JUNE - 08.22 - JAMES GERRISH)...The US market was sold off sharply on Friday with the DOW JONES off -175 pts while overnight the index added +1pt in a mixed session of trade. Looking at the sectors on the S&P, financials were up +1% while telcos and healthcare were also higher. The main drags were energy and basic materials and this followed some sizeable losses in the commodity space. Crude was down -2.4%, Copper fell -0.5%, gold was off $15 to $1514 and softs were pretty much all weaker on the CRB. After taking into consideration the 2 sessions, the FUTURES market is down an aggregate -34pts.
Looking at the CRB Index (below) we suggested last week that we'd be concerned if the Index fell below support which is highlighted on the chart. We'll be tracking this level throughout the week and with a swag of economic data out of China today (inflation the key), we could see this level tested.
Another important indicator we'll track this week is the Volatility Index (VIX). The trigger point I'm looking for here is a break up above 20 which signals increasing fear in the US options market - ultimately a negative for the market.
So if we see a break of support in the commodity markets, coupled with a breakout in the VIX, we'll reassess our original call of holding a min 30% cash in portfolio's and may suggest to increase liquidity.
CHINA
The Chinese market has remained above technical support as shown below however its ultimately a bearish technical set up with lower highs - this would trigger a sell in that market on a break below 2660.
There is a host of Chinese data out at midday today with CPI, PPI, Industrial Production, Retail Sales and fixed investment. The main one dictating markets will be CPI with the market expecting inflation of 5.5% YoY up from 5.3% last month and above the targeted 4% upper limit. PPI is also important as it gives greater insight into future inflation pressures derived from higher input costs. This came in at 6.8% last month.
If inflation comes in higher than expected, this will be a negative for the market particularly commodities given it increases pressure on China to tighten policy further. This could erode growth which dictates demand for commodities. I think we've actually seen some concern priced into raw material prices over the last 2 sessions as shown in the CRB Index above. On the flip side, a number below consensus I think we'll see commodities + commodity producers bid higher short term.
One of the main concerns in the market at the moment is that China will have a hard rather than soft landing. We got data out last week that showed a reduction in lending (more than expected) but that's what Chinese officials were hoping to achieve. The Reserve Requirement Ratio (RRR) has been ticked up to 21% reducing liquidity and the potential for asset bubbles.
MARKET CONFIDENCE
Domestic + international economic data has been weak and this has lead to a sharp erosion in confidence. Confidence is actually going to be a common theme at the start of this week with NAB's business survey today (11.30) while we get Westpac's consumer confidence survey out tomorrow (10:30).
Confidence is a very fragile thing at the moment and unfortunately, the negative bias will continue until we see a change in trend of data releases. This may happen today, next week or next month and until such a time, its probably worth taking a fairly cautious stance.
The wind back of QE2 is another aspect that's knocking confidence. Because we're in uncharted waters, the market can't draw on past experience to come up with an assessment of what it might mean going forward. The only thing we're basing it on is the market reaction when QE1 was wound up -which was negative.
From a technical standpoint, the local market is right on support - and at the bottom of its trading range.
BUYING GROWTH
With concern about the outlook for commodities and a slowing of global growth expectations, its worthwhile looking elsewhere for growth. One area that we touched on recently was IT.
For this reason we're adding Vocus Communications Limited (VOC) to the Emerging Growth Portfolio. Vocus is a telecommunications provider with three key services.
1. International Internet connectivity
2. Data centre services
3. And dark fibre networks.
This puts Vocus in a great position to capitalise on continued growth in internet traffic and data volumes, the increasing trend of outsourcing IT requirements and the developing market in cloud computing. (we saw Apple launch the iCloud last week).
It is certainly an emerging growth stock with a highly scalable business model leveraged to the increasing use of the internet. To put this into context, Australian Internet Traffic (volme of data downloads) increased 49% over CY10 while Cisco has forecast Asia Pacific internet traffic to increase by a CAGR of 35% through 2014.
Looking at its current financials, the company raised money in March of this year and has cash of circa $10 million. Forecast EBITDA of $13.1 million for 2011 up from $8.1 million last year. This comes on the back of a 78% rise in revenues YoY, while they're generating Return on Equity of greater than 30%.
We've been waiting for some type of correction in the stock before adding to the portfolio and this has now occurred. The stock is off 10% from recent highs and looks attractive.
Current price of $2.47.
AUSTRALIAN DUAL LISTED STOCKS
In New York, News Corp fell by US$0.10 to US$16.96, equivalent to A$16.00, A$0.30 below its last close on the ASX.
ResMed rose by US$0.02 to US$30.59, equivalent to A$2.89, A$0.02 below its last close on the ASX.
In London, Rio Tinto rose 1.5 pence to £41.06, A$0.02 higher in Australian currency terms.
BHP-Billiton rose 0.5 pence to £22.8, A$0.01 higher in Australian currency terms.
Henderson Group Plc remain unchanged at £1.40.
