JANUARY MARKET UPDATE
Australian shares sold off in December, ending 2019 on a sour note for what was otherwise a stellar year for equities. The S&P/ASX 200 Index returned 23.4% over 2019, with the strongest performance coming from the Health Care sector (+43.5%), including large gains from CSL (+48.9%) and Resmed (+37.6%). Although it represents a smaller proportion of the index, the IT sector (+33.5%) also had a very strong 2019. AfterPay (+136.1%) was one of the highest returning shares of the year, while Xero (+90.4%) and Appen (+75.1%) also thrived in the ‘risk on’ environment.
Meanwhile, the Consumer Discretionary sector (+32.4%) pushed back against the ‘retail is dead’ narrative, exemplified by JB Hi-Fi (+70.1%), which reported 3.5% growth in sales in its September annual report, defying its short sellers and proving that in-store and online experiences are both valuable for consumers. In December, the Materials sector (+1.6%) produced the only meaningful gain, while the defensive Utilities sector (+0.8%) was flat. Every other sector was in the red, with the largest fall coming from Consumer Staples (-8.1%), dragged down by Metcash (-14.3%) and Treasury Wine Estates (-13.2%). Communications (-5.8%) was also hit hard due to falls from telcos and a 13.5% drop in Southern Cross Media Group
Global share markets had a strong finish to 2019, at least in local currency terms, with developed markets returning 2.4% in December and 27.4% over the year. The US S&P 500 Index posted 31.5% for the year—its best annual return since 2013. Perhaps unsurprisingly, 23 of the top 50 performing shares over 2019 were from the Information Technology sector, including Apple (+9.9%), which ended the year with market cap of US$1.3 trillion. Interestingly, the Health Care sector, which is the second-largest sector in the S&P 500 after Technology, did not produce a single top-50 performer.
Markets watched trade developments between the US and China closely and appeared optimistic that a ‘phase one’ deal would be successful. European markets entered the new year with some early gains as the German DAX 30 Index prepared to push past its previous all-time high of 13,560 at the start of 2018. Markets were rattled by the US assassination of Iran’s top military general, which resulted in retaliatory strikes from Iran, but so far equity markets have contained their anxiety over the possibility of a broader gulf conflict. Asian markets delivered impressive results over 2019, with China finishing the year strong with a 7.0% return from the CSI 300 Index in December and 39.2% over the year. Japan’s Nikkei 225 Index returned 1.7% in December, bringing the year-end return to 20.7%.
The S&P/ASX 200 A-REIT Index lost 4.4% in December in a horrid month for listed property, taking the shine off an impressive 2019 marked by the success of large diversified managers. Topping the leader board for 2019, however, was Ingenia Communities, which was only brought into the ASX 200 in the December rebalance and gained 65.9% over the year. While two of its resident owned homes have been affected by the bushfires, and tourism revenue is anticipated to be negatively impacted, results are still expected to be within the guidance range. Dwelling approvals rose in November by 11.8%, bouncing back from October’s sharp fall of 7.9%. Total approvals are down 3.8% over the past 12 months but are now up 3.3% on a rolling three-month basis, the first positive gain since April 2019. While this is broadly consistent with the improvement in the property market witnessed in the second half of 2019, the sector is fairly volatile, mostly due to the high-rise segment.
In the US, housing data continues to improve, reflecting lower mortgage rates and reasonable income growth. The NAHB builder sentiment index rose to a 20-year high while housing permits surged to the highest level since 2007.
Through 2019 the yield on the Australian 10-year Treasury fell from 2.32% to 1.37%, reflecting weakening economic conditions and a reversal in monetary policy as the RBA shifted into an easing cycle with three rate cuts. However, it remains above its recent low of 0.89% in October. Australian government bonds returned -1.9% in December but were up 7.6% through 2019, compared to 7.1% from corporate bonds. In the US, the bond market reacted nervously to the US administration’s assassination of Iran’s military general Soleimani, reflected by a nine basis-point drop in the US 10-year Treasury yield.
On the monetary policy front, the US Fed kept the funds rate steady at 1.50–1.75% in December while the latest FOMC dot plot shows the Fed has downgraded its projections for the funds rate, which is now expected to remain on hold through 2020 and to rise to 1.90% at the end of 2021. Yields were generally higher in December. The UK Gilt 10-year yield rose from 0.69% to 0.82% over the month as the general election results produced a sizeable Conservative majority, while the yield on 10- year German Bunds rose to -0.17%, the highest rate in seven months. The yield on the five-year Bund rose just above zero for the first time since July 2019 and the Japanese 10-year yield rose from -0.08% to -0.02%.
What will markets bring in 2020?
Happy New Year and welcome back! It has been a tumultuous time for our country and our thoughts go out to those that have lost homes and loved ones due to the bushfires that have engulfed Australia.
Calendar year 2019 saw most asset classes generate very strong returns with many delivering double-digits returns. Australian equities, as measured by the S&P/ASX 300 Index, returned 23.8%, while global equities, as measured by the MSCI World ex Australia Index AUD, returned 27.6% for the year. At the other end of the asset classes spectrum, bonds also posted strong returns with Australian bonds, as measured by the Bloomberg AusBond Composite 0+ Year Index AUD, returning a solid 7.3% for the year. These returns were generated despite concerns over US-China trade tensions, Brexit, arguably high asset prices and mixed economic news.
A key factor contributing to this market strength has been the fact that interest rates appear to be on hold in the US and possibly heading lower in Australia. This is making investing in growth and interest rate sensitive assets, such as property and infrastructure, attractive when compared to holding your money in cash. Additionally, some of the economic indicators that were trending down, such as the PMI (Purchasing Manager’s Index), seem to have stabilised and the consumer seems to be holding up.
In 2020 we are paying particular attention to three key themes:
Valuations
Asset classes are generally trading at fair to expensive territory with US equities appearing the most expensive based on most valuation measures. While interest rates are low these valuations may be sustainable in the near term. However, we expect that at some point valuations will come back into vogue. Timing turning points is difficult however on a forward-looking basis our expectation would be that ‘expensive’ asset classes will generate lower returns in the future. Based on this we retain our slightly underweight exposure to equity markets heading into 2020 favoring real assets and alternative assets.
The cycle
Much has been written about being late cycle and we think that we are at the later stages of the cycle. There are signs that some economic indicators have stabilised, which markets view favorably. Key things to watch in 2020 will be the consumer and household savings rate, which has been rising, and the possible flow on effect on consumption.
X-factors
Despite strong market returns, 2019 saw bouts of volatility caused by geopolitical issues including the US-China trade tensions. We expect this geopolitical environment to continue in 2020. Furthermore, we have seen geopolitical tensions rise in the Middle East with growing concerns over US-Iran relations. Such events create market uncertainty and market volatility in the short-term.
We wish everyone a prosperous and safe 2020.
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 December 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.
