Market Commentary
The S&P/ASX 200 Accumulation Index returned 3.9% during the month.
Global equity markets rebounded in January, following a weak December, in response to a more dovish US Fed and China stimulus. Emerging markets outperformed developed markets. In major global developed markets, the US S&P 500 was the best performing market returning 8.0%, followed by the Euro Stoxx 50 and Japan’s Nikkei 225 which returned 5.6% and 3.8% respectively. The UK FTSE 100 trailed, returning 3.6%.
The cash rate remains unchanged at 1.50% with a softening in a tightening rhetoric in recognition of recent market volatility and apparent downside risks. The Reserve Bank of Australia (RBA) maintains its view that the Australian economy is performing well with growth expectations holding at 2.75%, which is expected to result in further progress in reducing unemployment. An improving wage cost index is seen as supporting consumption and raising the inflation to the target 2.0%.
Domestic economic data releases were mixed in January. Residential building approvals for November fell by 9.1%, largely due to the higher density sector which fell 18%. Employment rose in December by a greater-than-expected 22,000 positions. Meanwhile the unemployment rate ticked down to 5.0%. The NAB Business Conditions fell 9 points to +2 in December, the sharpest monthly fall since the GFC, while business confidence held at +3. Retail sales rose 0.4% in November, which was above expectations. The headline Consumer Price Index for Q418 rose a faster-than-expected 0.5%.
In stock specific news, Fortescue Metals Group was the best performer rising 35% for the month supported by rising iron ore prices which were related to potential supply tightness post the Vale dam failure in Brazil.
Sector returns were mostly positive during January. The best performing sector was Energy (11.5%). This was followed by Information Technology (9.3%), Communications (7.8%), Materials (7.0%), Real Estate (6.1%), Utilities (5.9%), Consumer Discretionary (4.3%) and Healthcare (3.9%) which all outperformed the market. The Industrials (3.4%) and Consumer Staples (2.7%) sectors underperformed the market, with Financials (-0.2%) the worst performing sector for the month and the only sector to post negative returns.
Energy was the top performing sector during January supported by a rebound in oil prices following three consecutive months of decline. WTI Crude and Brent oil were up 19.2% and 20.4% in USD terms amid sanctions on Venezuela and a drop in US stockpiles. Top contributors included sector heavyweights; Woodside Petroleum (9.6%), Santos (18.1%) and Origin Energy (10.7%).
The Information Technology outperformed the market during the month. AfterpayTouch (28.3%) was the key sector contributor after it rallied on reports that strong underlying growth and performance had continued in 1H FY19. Wisetech Global (20.4%) and Altium (15.0%) were also amongst the top contributors to the sector.
The Communications sector also outperformed the market. Sector heavyweight Telstra (9.1%) was the key contributor during January. Telstra was boosted by news that TPG is no longer rolling out its 4G mobile network, effectively decreasing competition in the sector.
The Industrials sector underperformed the market during January. Key detractors were Qantas (-6.0%) and Sydney Airport (-2.5%). Qantas fell after Air New Zealand indicated that forward bookings have weakened.
The Consumer Staples sector also underperformed the market during the month. Key detractors were Costa Group (-25.5%) and Elders (-11.3%).
The Financials sector was the worst performer driven by concerns over the impending release of the final Royal Commission report in February and also falling housing prices. Commonwealth Bank (-23.7%), Westpac (-2.0%) and National Australia Bank (-0.9%) were the biggest drag on sector performance. AMP (-7.8%) was also sold off during the month following the announcement its dividend will be cut by 70%. It is noteworthy that the Financials rebounded in early February as the Royal Commissions Final Report contained no surprises.
Outlook
Global economic expansion is continuing. There has been some divergence in relative growth rates in recent months with a slowdown in China, Europe and Japan. While US economic activity remains buoyant, growth momentum is flattening.
The recent volatility in equity markets appears to be in response to a litany of concerns including slowing and divergent global growth, trade wars and the Brexit stalemate.
While the market sell-off in late 2018 has been painful with already cheap cyclical stocks further sold-off, we continue to believe that the accommodative financial conditions in most advanced economies and additional stimulus in China will support the global economy in the medium term, albeit with some lags.
In Australia the RBA lowered the 2019 growth outlook from 3.5% to 3.0%, though the economy remains in good health. As well as high levels of Government-funded infrastructure investment, the RBA have also noted that business conditions remain favourable and that non-mining business investment is expected to increase. The much publicized correction in Sydney and Melbourne house prices is the result of both tightening credit supply and lower credit demand. Importantly, the price declines are not a function of household financial stress and recent falls in mortgage interest rates are also supportive of household budgets.
The divergence between value and growth stocks has been widening over the last five years and has certainly picked up over the past 12 months. During the most recent sell-off, both growth stocks and value stocks fell, with a significant rotation to defensive, low volatility and quality stocks. In our view, these stocks were already priced in ‘bubble territory’. Despite the 16% correction in growth stocks, they are still trading well above the 25-year average. Typically, value stocks outperform when bond yields are rising as they tend to be more sensitive to better economic conditions. The relationship broke down recently as rising bond yields in the US have resulted in the market becoming overly concerned over inflation and thus both value and growth stocks corrected. The tempering view from the US Fed together with the deflation of trade tensions should see underlying fundamentals becoming the primary driver of markets rather than fear. However, the flattening yield curve in the US is invoking fears of a recession and thus risk aversion is heightened.
The heavily stretched valuation gap between value and defensive, low volatility stocks implies the market is pricing in either recession or further deflation. Given our view is that neither is likely in the short to medium term, we believe this continues to provide an attractive entry for rotation into extremely cheap economically-sensitive cyclicals.
