DECEMBER MARKET UPDATE
After a shaky start to the December quarter, Australian shares rebounded in November, returning 3.3%, but lost momentum in the first week of December. November’s gains were driven by strength in Health Care (+8.9% and +51.7% over 1 year), while Materials (+4.7% and +31.9% over 1 year) continues to support the index. This despite weakness from the major Financials sector, which slipped 2.1% over the month as the major banks were marked down due to the lower interest rate outlook, which doesn’t bode well for lending margins. Meanwhile, Westpac (-13.1%) was the latest to be hit with negative headlines. If returns in December hold up, the ASX 200 will be on track to deliver a return of around 26% for the 2019 calendar year, which would be the highest return investors have seen since 2009.
November was a good month for Australian growth shares, with the Information Technology sector gaining 11.0%, led by popular names like accounting software provider Xero (+17.8%) and artificial intelligence training provider Appen (+12.0%). In the Health Care sector, CSL (+10.7%) had another excellent month, while Cochlear (+10.6%) and Ramsay Health Care (+7.5%) also performed well. Within the Consumer Staples sector (+8.3%), a2 Milk (+22.7%) recovered from a mid-year slump, while CEO Jayne Hrdlicka announced she will step down after 18 months at the helm.
November saw global equities extend their strong run over 2019, supported by an easing of trade tensions but generally at odds with economic data, which has been mixed. Markets responded favourably to the prospect of a ‘phase one’ trade deal between the US and China, while the US market made it through Q3 earnings season in high spirits with 80% of firms beating expectations, although earnings overall were mostly flat on the previous year. The MSCI World Ex-Australia Index returned 4.7% in November and 23.5% over 12 months in Australian dollar terms, with weakness in the Australian currency providing a significant tailwind.
The US S&P 500 Index returned 3.6% in US dollar terms, led by the Information Technology sector (+5.2%), while Financials (+4.8%) has been among the top performing sectors in 2019, with banks and fund manager names benefiting from recent market strength. European shares, measured by the broad STOXX Europe 600 Index, rose 2.7%, led by the Information Technology (+5.7%) and Resources (+5.0%) sectors. In Asia, Japan’s Nikkei 225 Index rose a modest 1.6%, while China’s CSI 300 Index fell 1.5% and Hong Kong’s Hang Seng Index fell 2.0%. Emerging markets continue to benefit from a relatively stable US dollar and a dovish US Fed, although geopolitical risks remain a source of uncertainty.
While underperforming the rest of the ASX 200 in November, Australian listed property has enjoyed an equally impressive year, returning 27.0% over the 12 months ending November. A lift in housing demand, along with record-low interest rates, have boosted property values, lifting the A-REIT sector across the board. Mirvac Group (+5.3%), one of the country’s largest residential communities and high-rise developers, has benefited from the recovery in property prices in 2019, posting gains of 60.6% over the past 12 months. Mirvac has continued to add to its portfolio and is on a short-list of contenders for Nine Entertainment’s $200 million North Shore headquarters.
The retail sector was mixed in November, with French owned Unibail-Rodamco-Westfield gaining 4.2% and Scentre Group rising 2.9%, while Vicinity Centres was flat at 0.4%. In the office sector, vacancy rates are expected to tighten, especially in Sydney and Melbourne, while limited space and robust demand is supporting the industrial segment. In the US, REITs had a challenging month as Shopping Centres (-1.5%) and Regional Malls (-0.3%) lost some steam and Office Property (+0.7%) was flat in US dollar terms. While cap rates are relatively low, they are reasonable given the low interest rate environment.
In Australia, a fall in yields saw a modest return from fixed interest in November, with government bonds returning 0.86%, beaten slightly by corporate bonds, which returned 0.72%. While a risk-on environment has prevailed through 2019, bonds have performed reasonably well, with Australian government bonds returning 9.6% over the year to the end of November, compared to 8.0% from corporate bonds. While the RBA is not completely dissatisfied with the effect of recent rate cuts, the likelihood of further cuts in 2020 mean yields may have further to fall.
In the US, the Fed is once again growing the size of its balance sheet in the wake of the repo rate spike in September. The Fed will purchase US$60 billion per month at least until the June quarter of 2020. After inverting in August, the spread of 10-year over 2-year US Treasuries is stable but remains narrow, ending November at 17 basis points. US yields moved higher in November, with the 10-year yield rising nine basis points to end the month at 1.78%. Yields in other major economies rose, but negative yields still pervade the marketplace. The German 10-year Bund yield rose from -0.41% to -0.36% and the Japanese 10-year yield rose from -0.14% to -0.08%. The UK 10-year Gilt rose from 0.63% to 0.70%.
Trade hopes fuelling 'mini-cycle'
Markets continued their upward trajectory in November. When you look at the returns across key asset classes over the last 12 months most asset classes have generated double digit returns. Growth assets such as equities and listed real assets generated over 20% for the year ending 30 November, while bonds generated high single digit to double digit returns. This has been a great outcome for investors and certainly well above Lonsec’s long-term expected returns for asset classes.
Part of what has fuelled these high returns, post markets getting the wobbles after the US yield curve inverted in August, can be attributed to markets pricing in the avoidance of a recession and the expectations of a potential recovery in growth. We have witnessed such ‘mini-cycles’ in the past, in 2013 and 2016, however what is different this time is that EPS growth is more muted and other factors which contributed to previous mini-cycles, such as the US or Chinese fiscal stimulus, are less likely to have an impact.
So what does this mean for markets? We think markets may experience a short-term upswing as the ‘mini-cycle’ plays out. We have therefore slightly adjusted our dynamic asset allocation tilts deploying some of the excess cash in our portfolios towards Australian equities. Our overall asset allocation continues to have a defensive skew with the objective of diversifying the portfolios by asset type and investment strategy. This positioning reflects our broader view that asset prices are stretched and that while some economic indicators have stabilised, we believe we are closer to the end of the cycle.
Key Economic and Market Risks
Return to solid global growth with modest inflation
Positive: Current concerns over a slowdown in economic growth turn out to be overblown. China stabilises growth around 6.0 – 6.5% while US growth holds well above trend. Europe and Japan improve after a weak 2018, supported by extremely easy policies. Emerging market economies recover. Bond yields remain relatively low as inflation remains contained. Equities resume their rally. Positive for cyclical exposures.
US Fed is slow to ease policy
Negative: With US growth slowing, partly as a result of the uncertainty over trade, the Fed is expected to ease policy. However, member concerns about labour market tightness and inflation, along with a desire to avoid being caving to political pressure, means the Fed refrains, at least initially. Markets weaken.
European political risks intensify
Negative: The rise of populist parties across Europe leads to policies aimed at reducing immigration and backtracking on globalisation. Recent developments in Italy are a case in point, with a rise in the fiscal deficit adding to already high debt levels, raising the risk of further rating downgrades and concern over the euro. The prospect of a hard Brexit and the resulting economic dislocation causes markets to panic. Equity markets suffer and defensive assets outperform.
Global geopolitical risks intensify
Negative: Responses from US trade partners over tariff rises results in a trade war and protectionist policies as the new political norm. While the two Koreas appear to have defused tensions for now, there is still a risk that the situation could become inflamed, while uncertainty over the position of other major powers undermines risk appetite and markets.
US and China fail to reach a trade deal
Negative: Failed trade negotiations between the US and China lead to a prolonged trade war and an escalation in tensions. This leads to lower growth as real consumption declines and heightened uncertainty undermines investment. Financial markets experience weakness and volatility, adding to the weaker outlook.
Chinese “hard landing”
Negative: The Chinese authorities are slow and too timid in their response to the current cyclical and structural downturn given their increased emphasis on financial stability. This causes a sharp downturn in the property market, exposing high levels of local government debt and undermines consumer spending. The yuan is allowed to depreciate, and capital outflows intensify. This leads to GDP growth well below 5.0%. Negative for the global economy but also the Australian economy, equities, commodity prices, emerging markets and particularly resources and the Australian dollar. Bonds outperform.
Low interest rates, tax cuts, and stronger commodities
Positive: With cash and mortgage rates at, or near, record lows, the currency at reasonable levels, and a sharp improvement in the fiscal position allowing for tax cuts, the domestic economy surprises to the upside. This, along with a renewed lift in global growth and commodity prices, and strengthening infrastructure investment, flows through to domestic employment, incomes and growth. Domestic equities lift. RBA signals eventual tightening.
Australian fails to avoid a recession
Negative: Despite rate cuts, fiscal easing and easier lending conditions, weaker global growth exposes Australia’s imbalances and high debt levels. Households continue to roll back spending in the face of rising unemployment, low wages growth and uncertainty, but this time there are no sectors coming to rescue the domestic economy. Investment turns down, any housing recovery is aborted, and the government is slow to ease fiscal policy. The bank sector is impacted. The Australian dollar weakens, and equities and bond yields move lower.
Asset Class Analysis – Long Term
The graph below shows the performance of various asset classes from November 1999 onwards. Some asset classes are noticeably more volatile than others in the shorter term but most asset classes have generally tracked upwards over the longer term. In general, investors are better placed by having a medium to longer term time horizon when investing in equities and downturns should be considered in the context of this time horizon.
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