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A tapering sort of year

‘Tapering’ was the mot-du-jour as 2014 began with the US Federal Reserve introducing the world to the art of unwinding its massive program of quantitative easing. At the same time, the Chinese government was reaffirming its target of 7.5% economic growth. Commodity prices weren’t especially on the radar with iron ore hovering around US$135/t and oil sitting above US$100 per barrel.

The instigation of QE tapering by the Fed was in response to the recovery of the US economy and while it wasn’t a smooth reaction by the US stock market, the Dow Jones did begin to reflect the signal. Until the Santa Claus rally kicked in late this week, the Dow had climbed a modest 4.0% from the beginning of the year but could now finish with a flourish thanks to some positive commentary from Fed Chairman Janet Yellen.

The broader S&P500 Index has fared better rising around 12% so far this year while the Nasdaq is up around 14%.

2014 ytd performance

As with nearly all economies trying to recover from the GFC, the race to the bottom in the currency markets was a common theme. Unfortunately for Australia, the local currency was buoyed by the stubbornly high terms of trade from the resources investment boom and the Aussie dollar began the year at 0.8920 against the USD. So far this year it has belatedly fallen towards 0.8200 against the USD with the Reserve Bank openly hoping for it to continue towards 0.75.

Australia’s relatively overvalued currency and pervasive high dividend yielding stocks were like a flame to a moth as international money chased the attractive yield.

Politically it has been a mixed year as well with the Coalition’s first year in government marked by an obstinate posse of rogue senators blocking and badgering the legislative agenda. The Carbon Tax and the Mining Tax have been expunged but other key policies have been well and truly foiled. The Budget deficit has pushed out to more than $40 billion – a persistent problem.

IPO fever

Early in the year, Medibank Private was slated to be sold by the government and Chinese ecommerce site Alibaba also signalled its intention to list later in the year. Both companies were among a big rush of new stocks hitting the market as private equity firms and corporates looked for ways of tapping into the large amounts of cash sitting on the sidelines.

Not all that glitters is worth investing in, however, and it was a case of buyer beware. King Digital Entertainment cashed in on the popularity of its Candy Crush game with its listing valuing the company at US$7.6 billion. But the stock has proved to be a one-hit wonder so far and has slipped 27% since listing leaving a bad taste.

In Australia, the range of IPO outcomes was quite diverse. Patent attorneys Spruson & Ferguson listed as IPH and watched its stock zoom from the $2.10 listing price to $3.40, a gain of over 60%. At the other extreme, Victorian education provider Vocation enjoyed a successful debut but blew up spectacularly when it lost a large chunk of its business due to some dodgy course management.

Of the larger floats, Healthscope attracted huge attention and after a slow start, has settled into the market enjoying a PE rating in the twenties piggy-backing on the success of its nearest competitor, Ramsay Healthcare.

The Medibank Private listing was far less generous to investors as the government swept most of the value into its own coffers leaving little stock for investors small and large, local or overseas. The sheer size of the company ensured its entry into various indexes thus creating more demand and supporting the share price as a consequence.

In Australia, more than $20 billion of new floats were added to the market this year and more are expected in 2015.

Media meltdown

Another story that has yet to play out is the demise of the Ten Network. While relatively small in dollar terms, it has a number of interesting angles.

The rise of advertising on the internet has seen online ad spending in 2013 reach 31.5% of the $12 billion Australian market, just shy of commercial television at 32%. It seems that 2014 will be the crossover point for online advertising to become the largest sector.

Network Ten has seen its revenue dry up even more quickly due to a lack of watchable content. Ten’s news and current affairs director at the time, Peter Meakin, said the broadcaster’s revenue was “down the toilet” and “ratings were less than auspicious”. Ten responded by axing some local programs and making lots of people redundant but it hasn’t solved the core problem.

The most curious aspect has been the involvement of several of Australia’s richest people who seem to have cooked their investment in the network. After buying stakes at levels around $1.50 per share, Gina Rinehart, Lachlan Murdoch, and James Packer are trying to figure out how to salvage what’s left of the situation while a trade sale is being negotiated.

It does to some extent depend on whether the government is prepared to change more of the silly rules that cover the highly-protected media sector. If and when it does, there should be more mergers and acquisitions across the sector as content costs continue to rise and revenue shrinks.

May 14 provided one of the lowlights of the year as besties James Packer and David Gyngell engaged in a spot of WWF in the streets of Bondi. It hasn’t been confirmed if the biffo was designed to sell a few more newspapers for Rupert but the headlines were priceless.

The NT News pondered “Why I’ve Got a Packer Up My Clacker” while stablemates The Daily Telegraph and the Courier Mail pitched in with “Packer Whacker” and “James Whacker” respectively.

packer clacker

 

It’s not clear if the pair have kissed and made up, but Gyngell’s Nine Entertainment Co. has certainly improved its ratings performance if not the share price this year.

James Packer probably should still be on Santa’s naughty list but he’s being punished sufficiently by a 24% spanking of the Crown Resorts share price.

Flight horror

The year will also be remembered for two particular Malaysian Airlines flights each for different reasons. Coincidentally, both aircraft were Boeing 777s.

Back in June, the International Air Transport Association reported that in 2013 there was 29 million flights with western built jet aircraft with the loss of just 12 hulls.

The March disappearance of flight MH370 (227 people aboard) from Kuala Lumpur to China has confounded everyone and the debris has not been found. The MH17 flight that was shot down (298 people killed) over Ukraine in July and has had far greater implications given the alleged involvement of the Russian government.

The sanctions imposed by western countries on Russia as a consequence has also coincided with a steep and economically significant fall in global oil prices.

Another day, another oil price crisis

As the global oil price fell from well above US$100 per barrel to under US$60 per barrel, the dynamics of world economic growth have also shifted.

Lower oil prices are bad news for OPEC which has exacerbated the situation by refusing to cut its own production. Conversely, the boom in US shale oil and gas production to a significant level has provided a boon to the US economy with far-reaching consequences for raw material costs for industry, lower transport costs, and geopolitically by reducing reliance on imported energy. This change will be a real game changer for global economics for a long time to come.

The lower oil price has affected Australia’s oil and gas sector just as the country is surging towards becoming the world’s largest producer of LNG by 2020, according to the Bureau of Resource Energy and Economics.

But despite the Brent oil price being 45% below its level a year ago, Woodside Petroleum is just 8% lower, Oil Search 12% lower and Santos is 49% lower. Santos has reduced its capital expenditure by 25% amidst calls to strengthen its balance sheet and had its credit rating downgraded.

A lower oil price has a positive effect for heavy users, and no-one was perhaps more relieved than embattled Qantas CEO Alan Joyce. Qantas’s fuel bill last year was close to $4.5 billion, substantially more than it spent on wages.

Now that Qantas and Virgin have stopped piling on new capacity, the prospect of turning a profit in the current financial year looks realistic. That will be a turnaround of gigantic proportions given the $646 million pretax loss reported by the company last year. But don’t underestimate the ability of the airline industry to stuff it all up again.

Safe as houses

The Financial Services Inquiry led by former Commonwealth Bank boss David Murray was, among other things, aimed at ensuring Australia’s financially important institutions were carrying enough capital to withstand potential future crises.

The banks are already well capitalised based on international measures but will likely need to raise more capital next year.

The major retail banks in Australia all have large exposures to residential housing which has seen prices continue to surge ahead in Sydney and Melbourne. The median price of a house in Sydney popped through the $1 million mark during the year according to RP Data leaving many first home buyers and renters aghast. But elsewhere, the situation looks less onerous leaving the banks to claim that there is no housing bubble in Australia.

Rising housing wealth has not led to households spending more money on discretionary items in preference to reducing debt balances.

Much of the boom in Sydney and Melbourne house sales has been attributed to investors rather than owner-occupiers leading some critics to point towards the generous tax concessions on investment property as a distortion to the housing market.

In aggregate, the four banks produced annual net profits of $28.6 billion in 2014 while putting $21.7 billion of fully franked dividends back into investors’ pockets.

Owning bank shares was once again a winning strategy this year but only thanks to the average 8.5% fully franked dividend yield and also because other sectors performed so badly.

More and more iron ore

As night follows day, an Australian resources boom is always followed by some form of bust and that was exemplified by the price of iron ore this year.

It’s worth remembering that Chinese production of crude steel reached an all-time high of 843 million tonnes in July. The east coast blast furnaces were being fed with high quality Australian iron ore and metallurgical coal.

But iron ore businesses require massive scale from the mines through to the railways and port infrastructure. BHP, RIO, and Fortescue Metals were spending billions of dollars to ramp up production that has ultimately flooded the world market and precipitated the price plunge. Having spent the money, the companies must now reap the cash flow from the volumes being produced, regardless of the price effect.

Luckily for BHP and RIO, they are easily the lowest cost producers of iron ore so while they do feel the pain of lower prices, it is not at the expense of profits albeit at reduced margins. FMG is less fortunate but will survive the crunch perhaps unlike some of the smaller producers.

Even the government is now assuming the iron ore price will be US$60 per tonne for the next two years.

2015?

As we head into a new calendar year, the popular calls are for the Australian dollar to go lower as well as interest rates while unemployment nudges higher and the economy fumbles through a period of sub-normal growth.

The government is wrestling with a Budget monster while the RBA is jostling with market opinion that has a one-way bet on interest rates.

Commodity prices have taken the wind out of the economy’s sails and consumers are like possums in the headlights.

That’s not a great platform for the equity market to launch from but it won’t prevent some sectors and stocks outperforming others as telecommunications and healthcare did in 2014. A big part of the trick, as usual, is avoiding the landmine stocks like Vocation.

Watch out for more IPOs and bank capital raisings, the spinco from BHP (whatever it is eventually called), and perhaps even a takeover or three.

Other bits and pieces in 2014

Germany beat Argentina 1-0 in a nerve-wracking World Cup final in July after humiliating the Brazilians 7-1 in their semi-final.

Scotland the brave generously said “nae” to independence believing they would take the “great” out of Great Britain. The Scots immediately also decided to allow women folk to become members at the home of golf, the Royal and Ancient Golf Club at St Andrews.

Apple launched its iPhone 6 and 6-plus with larger screens to compete with Samsung. First weekend sales of the new devices shot through 10 million units amidst the usual smokescreen of marketing promotion and hype and controlled inventory release.

In a sign of the times, a Chinese insurance company bought the famed New York hotel, the Waldorf Astoria for $1.95 billion or approximately $1.4 million per room key.

Obituaries
• Shirley Temple, February, age 85
• Paul Ramsay (2 May)
• Robin Williams (63) 12 August
• Gough Whitlam, aged 98, 21 October
• Oscar de la Renta, 82, 21 October
• Melbourne Cup horses Admire Rakti and Araldo

And a final quiet word of hope that next year will be free of events such as in Sydney this week.

All the best for the holiday season and a rewarding 2015.

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