Market Commentary
The S&P/ASX 200 Accumulation Index returned 0.7% in March.
Global equity markets continued their rebound during the month. Developed markets marginally outperformed emerging markets. In major global developed markets, the UK’s FTSE 100 returned 3.3% despite Brexit woes. The Euro Stoxx 50 and S&P 500 both returned 1.9%, while Japan’s Nikkei 225 was flat.
The cash rate remains unchanged at 1.50%. The Reserve Bank of Australia (RBA) has recently changed its tone, with a speech from Governor Lowe indicating that the probabilities of either a rate cut or hike appear evenly balanced.
The latest domestic economic data releases were mixed in March. Q4 GDP disappointed for the second consecutive quarter, with a weak 0.2% gain for the quarter and 2.3% for the year. Residential building approvals for January bounced back, recording a 2.5% increase. Year-on-year approvals remain in the doldrums at -28.6%. Employment rose modestly in February, adding 4,600 positions, after a very strong January. The unemployment rate nudged lower to 4.9%. The NAB Business Conditions index eased 3 points to +4 in February, while Business Confidence fell 2 points to +2. Retail sales were up 0.1% in January, an improvement on December’s fall.
In company specific news, Westpac announced a re-organisation of its wealth business. The changes will see Westpac exit its loss making financial advice business, transferring existing clients to Viridian Advisory. The remainder of BT Financial will be folded into Westpac’s Consumer and Business divisions. Wesfarmers made a conditional, non-binding, indicative proposal to acquire Lynas Corporation which was subsequently rejected by the Lynas Board.
Sector returns were mostly positive during March. The best performing sector was Real Estate (5.5%). Other sectors posting positive returns included Communications (4.0%), Consumer Staples (3.9%), Materials (3.5%), Information Technology (2.7%), Industrials (1.9%), Healthcare (1.3%), Consumer Discretionary (1.3%) and Utilities (1.3%). Financials (-2.7%) and Energy (-4.1%), were the worst performing sectors for the month and the only sectors to post negative returns.
The Real Estate sector outperformed the market in March as global bond yields rallied strongly, benefitting yield sensitive sectors. Sector heavyweights, Scentre Group (6.2%), Stockland Group (10.0%) and Goodman Group (4.3%) were the key contributors to performance.
The Communications sector also outperformed in March. Sector heavyweight Telstra (6.1%) was the key driver. The stock outperformed despite a lack of news, however there is speculation that a bullish broker report contributed to the outperformance.
The Consumer Staples sector benefitted from the market shift to defensive stocks. Woolworths (6.0%) and Coles (4.6%) were the key contributors to performance.
The Financials sector underperformed as the market began to focus on deterioration in short-term fundamentals in retail banking, driven by the ongoing effects of the Financial Services Royal Commission. The major banks were the key detractors, particularly ANZ (-7.0%), Commonwealth Bank (-4.5%) and Westpac (-3.9%).
The Energy sector was the worst performer, despite oil prices rising amid supply tightness following OPEC cuts and outages. Underperformance was driven by profit taking following recent outperformance, weakness in Australia’s east coast gas market and ongoing carbon related concerns. The key detractors were Woodside Petroleum (-4.5%) and Oil Search (-4.8%).
Outlook
Global economic expansion is continuing however 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 relatively 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.
