Postcard from London

by Raymond Chan

Latte with Ray wrote this article at Hathrow Airport, awaiting flight back to Sydney. We spent a week here visiting our UK clients.

Our thoughts on Europe Financial Markets … The European Economy remains weak. The financial markets here are having ongoing issues. Over past two weeks, we had Deustche Bank stock price reaching record low, Commerzbank (2nd largest German bank) cutting 9,600 jobs (or 20% of workforce) and ING trimming another 5,000 jobs. When we talked to our contacts over here, they were all looking for job opportunities either in Asia and Australia.

It's not just a "Deutsche Bank specific" issue … On Deustche Bank, an insto client commented that the situation is definitely much worse than what the mkt is pricing in right now. Everybody is relying on State support for a rescue plan but the German govt is bounded by the EU bail-in law which restrict direct intervention. [EU regulations prevents European Bank Bailout by ECB & other Central Banks, unless a risk of “very extraordinary” systemic stress.] The announcement by Commerzbank last week highlighted that it may not be a Deutsche Bank specific problem. Most likely will see more asset sales and even deep discount rights issue. But UK banks taking over iconic German bank seems quite far-fetched at this moment given Brexit and national pride. Like all previous bailouts, we need to see much worse mkt movement before a solution would come up. Expect more volatilities over the next few months.

Brexit … As you know, Brexit introduces uncertainty to UK economy. This week, the GBP reached new 31 years low against USD. Well, it’s definitely great for Inbound Tourists and Overseas Property Buyers here given the 20% “currency” discount. However, this does not help business confidence. We think this week’s Henderson taking over Janus Capital is interesting. Henderson was a spin off out of AMP Capital now dual-listed in UK and Australia. Under the proposed takeover, if successful, we will see Henderson to de-list from UK and move its primary listing to US. We can’t help but feel the Brexit may have something to do with the proposal.

What does it mean for our Australian Portfolio? Europe is a significant economy and one of biggest trading partners to China. In turn, China is Australia’s biggest trading partner. With economy going soft here, Latte with Ray maintains that the ECB will have no choice but maintain its easing bias (despite some “European experts” here calling for ECB QE tapering). In US, it’s without doubt the FED is now pushing back the tightening timetable. This week, our new RBA governor Phillip Lowe holds rate at 1.5% and still easing. In this low interest rate and low growth environment, we think infrastructure assets are “core portfolio holdings”. Having said that, while we like the infrastructure stocks as an asset class, we don’t agree on the current pricings. Even after recent price correction, the PE on infrastructure stocks remains elevated.

Among the infrastructure stocks, Latte with Ray prefers TCL (already a Core Portfolio holdings), SYD (we see 2nd Sydney airport announcement as upcoming catalyst) and Magellan Infrastructure Fund MICH (ETF listed on ASX). We would love to top up TCL below $10.00 and buy into SYD below $6.00. We expect both TCL & SYD can generate growing dividend returns over next few years. On Magellan Infrastructure Fund, the ETF offers us global diversification in infrastructure assets and more importantly “AUD hedged” return.

When to buy? We don’t think we have seen the bottom of infrastructure stock correction yet, it’s likely to see further selling pressure when the market starts talking up the prospect of Fed rate December hike. As you know, the performance of infrastructure stocks are negatively correlatd with 10 year US (and Aussie) bond yield. The higher the bond yields, the less attractive the infrastructure stocks are going to be. However, in our opinion, price weakness will present us with the opportunity to buy. We expect both TCL & SYD to generate growing dividend returns for Long Term Investors.
 

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