Market Commentary
The S&P/ASX 200 Accumulation Index returned 6.0% in February.
Global equity markets continued their rebound during the month, with the Australian equity market the top performing market amongst its developed peers. Developed markets outperformed emerging markets. In major global developed markets, the Euro Stoxx 50 returned 4.4%, followed by the S&P 500 and Japan’s Nikkei 225 which returned 3.3% and 2.9% respectively. The UK FTSE 100 trailed, returning 1.5%.
The cash rate remains unchanged at 1.50%. The Reserve Bank of Australia (RBA) moved to a neutral policy bias during the month, with Governor Lowe confirming that the probability of interest rates moving in either direction appear evenly balanced. The RBA maintains its view that the Australian economy is performing well, although GDP growth had slowed unexpectedly in the September quarter. Underlying inflation remains low, but is above its trough. The RBA’s forecast for the Australian economy is for GDP growth to be around 3% for 2019 and 2% over 2020 and a small downward revision to the underlying inflation forecast for year-end means it is now expected to increase to 2%.
The latest domestic economic data releases were mixed in February. Residential building approvals for December continued their fall (–8.4%) against a market consensus of +2.0%. This sees the year-on-year slump to -22.5%. Employment rose in January to add 39,000 positions, with most of these positions being full-time (65,000 positions), whilst part-time employment fell by 26,000 positions. The unemployment rate remained steady at 5.0%. The NAB Business Conditions rebounded 4 points to +7 in January, while business confidence rose slightly to +4. Retail sales were down 0.4% in December, with November’s number being revised up to 0.5%.
The February reporting season was soft, but better than the market had feared. Weaker guidance has seen EPS growth revised downwards for FY19. While Resources remained resilient with upward EPS revisions, the Industrials ex-Financials were much weaker, with EPS revisions the lowest since 2010. The key positive surprise of the season was from better than expected capital management, with a number of special dividends and buy-backs announced.
Sector returns were mostly positive during February. The best performing sector was Financials (9.1%). This was followed by Energy (7.9%), Information Technology (7.6%), Consumer Discretionary (6.6%), Industrials (6.3%) and Materials (6.3%) which all outperformed the market. The more defensive sectors such as Communications (4.3%), Utilities (3.9%), Real Estate (2.1%) and Healthcare (1.0%) underperformed the market, with Consumer Staples (-1.5%) the worst performing sector for the month and the only sector to post negative returns.
The Financials sector was the top performing sector for February following a rally post the release of the Financial Services Royal Commission final report. The sector heavyweights dominated, with key contributions from Commonwealth Bank (8.8%), ANZ (11.9%), Westpac (9.8%) and Macquarie Group (10.4%).
The Energy sector continued its strong performance for a second month supported by the continued rebound in oil prices. Brent and WTI Crude oil and were up 9.1% and 5.9% respectively in USD terms amid supply cuts and inventory drawdowns. The top contributor was again Woodside Petroleum (9.4%), followed by Santos (8.3%) and Origin Energy (7.2%).
The Information Technology sector outperformed the market in February. Key contributors included Altium (32.3%), Appen (46.9%) and Afterpay Touch (15.9%).
The Real Estate sector underperformed the market in February. Sector heavyweight Stockland Group (-7.4%) was the main detractor to performance followed by Vicinity Centres (-5.7%). Stockland underperformed following weaker 1H19 results due to the weaker housing market and headwinds in the retail parts of its business.
The Healthcare sector also underperformed the market. Key detractors were CSL (-0.5%) and Cochlear (-11.9%). Cochlear was sold off following the release of their 1H19 result which highlighted the company’s challenges for 2019 to maintain its competitive market lead.
The Consumer Staples sector was the worst performing sector in February and the only sector to post negative returns. The key driver was the sell-off in Coles Group (-9.4%) following their 1H19 results which disappointed the market.
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.
While the market sell-off in late 2018 was disappointing, 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 has 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 publicised 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 low mortgage interest rates remain 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 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 Federal Reserve together with the deflation of trade tensions should see underlying fundamentals becoming the primary driver of markets rather than fear. However, the flatter yield curve in the US has invoked 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 a 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.
