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Overnight we saw Brent fall 3.14%, while WTI dropped 5.15%. Both have declined over 50% since the August high. Iron ore delivery into Qingdao recorded another record low on Monday at US$61.20 a tonne.
It did recover yesterday, adding $1.18 to US$63.38 a tonne but, at that price, most mid-sized and junior miners are trading underwater on an all-in cash cost basis. Despite this, the ASX remains on a tear – even after the small consolidation over the past two days.
There are some interesting market fundamentals in the current market that need to be taken into account:
- The material space has added 11% in the past three weeks, mostly due to the big miners. The kick here is the USD and the fact both RIO and BHP have a yield above the current ASX 200 net dividend yield.
- Since mid-January, the ASX has added over 9% in value and reached a six-year high of 5850.9.
- The ASX 200 net dividend yield has fallen to 4.5% compared to its historical average of 4.86% in this time – a full standard deviation away.
- Australian government bonds also fell to record lows and are reinforcing the flight to equities with bond-like characteristics.
- The January rise has seen the ASX now trading almost two standard deviations from its historical P/E average of 13.1 times. At 16.1 times earnings on a 12-month forward basis, there is no doubting the ASX is expensive.
- Perhaps more concerning about the P/E ratio is the fact earnings per share (EPS) growth in FY15 is forecasted to grow at a measly 2.1%. Finding discounted equities in the current market (without exposure to commodity risk) is rare, as the flattening of the yield curve is making bloated trades very toppy.
- Business conditions remain weak and the likelihood of further rate cuts is growing, as inflation and growth fall and unemployment starts to rise. EPS growth in the first part of FY16 will be just as benign, even with the rate cuts – consider the time it takes for these macro tools to filter into the actually economy.
- A near-term catalyst for a further move higher will remain the chase for yield. However, considering the bloated nature of this trade, the upside appears limited and any reversal in the bond market will see equities shed as investors jump back to the low-risk bond market.
Ahead of the Australian open
Ahead of the open, we are calling the ASX up 30 points to 5830 as anticipation around CBA’s numbers builds. The fact iron ore moved higher and Greece may finally be able to find a deal with the EU-IMF troika has also added to global market sentiment. Today will likely define how the ASX trades over the coming earning season as signs of dividend growth will signal further biding in yield.