By Raymond Chan

Latte with Ray wrote this article at Heathrow Airport, awaiting a flight back to Sydney. 

Our thoughts on Europe's financial markets

The European economy remains weak. The financial markets here are having ongoing issues. Over past two weeks, we had Deutsche Bank's stock price reaching a record low, Commerzbank (the second largest German bank) cutting 9,600 jobs (or 20% of the 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 or Australia. 

It's not just Deutsche Bank

On Deutsche Bank, an institutional client commented that the situation is definitely much worse than what the market is pricing in right now.

Everybody is relying on State support for a rescue plan, but the German government is bounded by the EU's bail-in law which restricts direct intervention. [EU regulations prevent European bank bailouts by the ECB and 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 the 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 market movement before a solution would come up. Expect more volatility over the next few months. 

Brexit

As you know, Brexit introduces uncertainty to the UK economy. This week, the GBP reached new 31-year low against the 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 the Henderson takeover of Janus Capital is interesting. Henderson was a spin off from AMP Capital - now dual-listed in the UK and Australia. Under the proposed takeover, if successful, we will see Henderson to de-list from UK and move its primary listing to the US. We can’t help but feel that 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 the economy going soft, Latte with Ray maintains that the ECB will have no choice but to maintain its easing bias (despite some “European experts” here calling for ECB QE tapering). In the US, it’s without doubt the Fed is now pushing back the tightening timetable. Our new RBA governor Philip Lowe held rates at 1.5%.

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 second Sydney airport announcement as an upcoming catalyst) and Magellan Infrastructure Fund MICH (ETF-listed on the ASX). We would love to top up TCL below $10.00, and buy into SYD below $6.00. We expect that both TCL and SYD can generate growing dividend returns over next few years. On the Magellan Infrastructure Fund, the ETF offers us global diversification in infrastructure assets, and more importantly, “AUD hedged” returns. 

When to buy?

We don’t think we have seen the bottom of the infrastructure stock correction yet. It’s likely to see further selling pressure when the market starts talking up the prospect of a Fed rate December hike.

As you know, the performance of infrastructure stocks are negatively correlated with 10-year US and Aussie bond yields. 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 and SYD to generate growing dividend returns for long term investors. 

Disclaimer – Morgans Financial Limited (Morgans)

This report is provided for general information purposes only and is not intended as an offer to enter into any transaction.  This information contained in it is not necessarily complete and its accuracy cannot be guaranteed.  We have prepared this presentation without consideration of the investment objectives, financial situation or particular needs of any individual investor.