The S&P/ASX 200 Accumulation Index returned 1.8% during the month. Global equity markets rallied in September, with Australian equities lagging major developed markets during the month. September also marked the second largest monthly outperformance of value versus growth in the past decade. Globally equity markets were strong across the board, with developed markets outperforming emerging markets. In major global developed markets, Japan’s Nikkei 225 was up 5.8% followed by the DJ Euro Stoxx 50, which was up 4.3%, and the UK’s FTSE 100, which returned 3.2%. The S&P 500 returned 1.9% during September.
The Reserve Bank of Australia (RBA) maintained the cash rate at the record low level of 1.00%. The RBA were materially more dovish than expected and noted they “would ease monetary policy further if needed”. The RBA acted on these comments by cutting the cash rate by 0.25% to a new record low of 0.75% at the 1 October meeting.
Domestic economic data releases were mixed in September. Employment growth rose a higher than expected 34,700 positions in August, albeit the unemployment rate edged up to 5.3%. Retail sales missed expectations, ticking down 0.1% in July. The NAB Business Conditions index fell by 2 points to +1 in August. Similarly, Business Confidence fell to +1 from +4. National CoreLogic dwelling prices continued to rise, increasing 0.09% in September, with strong gains in Sydney and Melbourne. Q2 GDP held steady at 0.5%, with the annual rate softening to 1.4%.
In company specific news, Nufarm surged 51% after the company announced a deal to sell its South American business to Sumitomo Chemical for AUD 1.18 billion. IOOF was up 26% in the month helped by the Federal Court decision brought by the regulator, APRA, going in favour of IOOF. Costs were also awarded to IOOF. Sims Metal Management fell 9.5% during September after a trading update citing headwinds in ferrous and non-ferrous pricing, as well as higher shipping rates.
Sector returns were mixed in September. The best performing sector was Energy (4.7%) which was followed by Financials (4.1%), Materials (3.1%), Consumer Discretionary (3.0%), Utilities (1.8%), Consumer Staples (1.7%) and Industrials (0.0%). Information Technology (-0.6%), Real Estate (-2.3%) and Healthcare (-2.5%) all posted negative returns. Communication Services (-2.9%) was the worst performing sector for the month.
The Energy sector was the strongest performer this month, with the sector being one of the key drivers of the ‘value’ uplift. Sector heavyweight Oil Search (11.5%) was the largest contributor to the sector seeing some benefit from the drone attacks on Saudi Arabia’s largest oil field, along with Santos (7.2%) and Caltex (11.3%).
The Financial sector rebounded in September following a disappointing results month in August. Key drivers of the outperformance were the ‘big four’; National Australia Bank (8.6%), ANZ Bank (6.7%), Westpac (5.0%) and Commonwealth Bank (2.3%).
The Materials sector also outperformed the broader market with BHP (4.4%), Rio Tinto (5.8%) and Fortescue Metals Group (13.4%) the top contributors to the sector. Fortescue benefitted from raising USD 600 million through a new high-yield bond. The debt restructure extended the maturity of Fortescue’s debt profile and reduced the maximum debt repayable in any one year to USD 750 million.
The Real Estate sector underperformed along with other defensive sectors this month. Key detractors to performance were Dexus (-7.5%), Scentre Group (-2.7%) and Mirvac (-4.1%).
Healthcare underperformed the broader market due to the rotation away from growth and defensive assets. Sector heavyweight CSL (-2.4%) was the main detractor.
The worst performing sector was Communication Services, which was weighed down by sector heavyweight Telstra (-5.6%).
The Australian equities market has been buoyed by a now dovish RBA, elevated iron ore prices and a Coalition victory at the Federal Election that was largely unexpected. The one important factor currently missing is earnings growth. This will be required for the market to sustain its trajectory. FY19 earnings growth for the market is currently close to zero - the worst outcome since FY16 (with the only exception being Resources which has exhibited double digit growth).
The August/September reporting season saw the market turn its focus to FY20 earnings. At the start of the season, the market was forecasting EPS growth of circa 10%, which seemed a little high to us given a macroeconomic backdrop that is challenging at best. Sure enough, downward revisions to earnings during August now have the market expecting EPS growth closer to 6% in FY20. Given the uncertain geopolitical outlook that is impacting business confidence, together with cost pressures that seem to be across multiple sectors, further downward revisions are likely.
The escalation in the US-China trade war, including the export restrictions placed on Huawei and technology sharing by US companies, has led to a now-consensus view that as well as correcting trade imbalances, the US administration is seeking to constrain the rise of China. If accurate, this portends a more protracted and divisive trade war with a permanent constraint on technology transfers. While a trade war ceasefire was declared at the G20 Summit at the end of June, it was short-lived, with China announcing retaliatory tariffs on USD 75 billion of US goods in August, and President Trump announcing a 15% tariff on USD300 billion worth of Chinese imports that had previously been spared.
The trade war has seen a significant ‘risk-off’ trade and flight to safety, which has seen bond yields fall precipitously. Equally, gold has rallied and growth sensitive commodities, such as oil and copper, have seen large price corrections. Equity markets have not avoided this de-risking event, with global markets selling off sharply in May, then recovering in June and July. Furthermore, within equity markets, this flight to safety also continued with defensive and yield sensitive sectors having outperformed.
The underperformance of value versus low-volatility and momentum is the largest divergence seen in history. The extreme positioning and divergence saw a massive reversion in the month of September that resulted in the largest three-day factor rotation witnessed in 30 years. Extreme factor positioning has been the catalyst for the rotation, with better economic news and perhaps some stabilization in the trade dispute required for the value rally to be maintained.
Despite the recent rally in value, investors are still paying a record premium for safety, which reflects the inherent uncertainty of a potential paradigm shift in the global economic framework, with Trump unilaterally dismantling the rules-based, free-trade system that has been built since the Second World War.
We have previously noted that the recent premium paid for safety is largely unprecedented and has never been sustained at such levels. While this remains the case, the change in the environment leaves us cautious in regard to how and when this premium will normalise.