Market Commentary

The S&P/ASX 200 Accumulation Index returned 3.3% during the month. Australian equities posted solid returns during November, as global equity markets recorded broadly positive returns during the month. Emerging markets were also positive but underperformed developed markets. In major global developed markets, the S&P 500 was up 3.6%, the DJ Euro Stoxx 50 was up 2.8% while the UK's FTSE 100 was up 1.8%. Japan's Nikkei 225 was the laggard, up 1.6%.

The Reserve Bank of Australia (RBA) left the cash rate unchanged at the record low of 0.75% at the November meeting. The RBA reiterated that they would ease monetary policy further if needed “to support sustainable growth in the economy, full employment and the achievement of the inflation target over time”.

Domestic economic data releases were mixed in November. Employment fell by 19,000 positions in October, which was well below expectations. The unemployment rate edged back up to 5.3%. Retail sales also missed expectations, recording a 0.2% gain in September. The NAB Business Conditions Index rose by 1 point to +3 in October while Business Confidence also rose to +2 from 0. National CoreLogic dwelling prices continued to rise, increasing 1.5% in November, the fifth consecutive month of gains.

In company specific news, Caltex (26.7%) was sharply higher following a non-binding indicative conditional takeover offer from Canadian-based Alimentation Couche-Tard. Westpac (-10.5%) plunged following allegations from AUSTRAC regarding contraventions of the Anti-Money Laundering and Counter Terrorism Finance Act 2006. By month end, Westpac's CEO, Brian Hartzer, announced he would be stepping down following intense public and political pressure and the Chairman also brought forward his retirement to 2020.

Sector returns were mixed in November. The best performing sector was Information Technology (11.0%), which was followed by Healthcare (8.9%) and Consumer Staples (8.3%). Communication Services (7.5%), Energy (7.5%), Consumer Discretionary (4.9%), Materials (4.7%) and Industrials (4.1%) were also positive. The worst performing sectors were Real Estate (2.4%), Utilities (-0.6%) and Financials (-2.1%).

Information Technology was the best performing sector in November, led by Xero (17.8%), Computershare (11.9%) and Afterpay Touch (9.5%). Xero's 1H20 result was largely in line with consensus, however the highlight was strong subscriber growth domestically, following the launch of mandatory Single Touch Payroll for employers with greater than five staff.

The Healthcare sector was also a strong performer this month. Sector heavyweight CSL (10.7%), Cochlear (10.6%) and Ramsay Health Care (6.6%) were the key drivers of outperformance.

The Consumer Staples sector also outperformed. Key contributors included Woolworths (6.5%), a2 Milk (22.7%) and Coles (8.5%). a2 Milk's AGM update provided upgraded EBITDA margin guidance which was well received by the market.

The Real Estate sector underperformed the broader market as yield sensitive stocks suffered as the yield curve steepened. Stocks that detracted from sector performance included Charter Hall (-4.3%), Cromwell Property (-7.5%) and Viva Energy REIT (-3.5%).

The Utilities sector also underperformed given its yield sensitivity. Key detractors included APA Group (-5.6%) and AusNet Services (-3.2%). APA underperformed after the Council of Australian Governments (COAG) published its Regulatory Impact Statement on gas pipelines, which was broader in scope than just tinkering with the existing framework.

The Financials sector was the worst performer during the month. Key drivers of the underperformance were Westpac (-10.5%), National Australia Bank (-6.8%) and ANZ Bank (-4.2%). The banks were impacted by a number of factors, including softer profit results from NAB and ANZ, the prospect of further capital raisings by the major banks, and the AUSTRAC civil proceedings against Westpac which further damaged sentiment towards the sector.

Market Outlook

Potential resolutions in both the trade dispute between the US-China and Brexit are looking a little rosier, as markets start to price in a slow return to stability. However, we remain a long way from 'normal' and it appears we have been in this situation before over the past 12-18 months, with little relief in geopolitical tensions.

Geopolitics has been one of the largest drivers of the slump in global growth and corporate profits over the past year. Therefore, less stress could be a powerful catalyst for a cyclical revival. Compounding this are the cheap valuations and extreme positioning of the market that has the potential for violent rotations into the value end of the market.

The divergence in valuations between the defensive and low volatility parts of the market and riskier sectors is still at heightened levels. This relative valuation bubble between value/cyclical stocks versus low volatility/defensive stocks is at a level that even exceeds the valuations of the late 1990s. We believe this reflects concerns around global growth which has been exacerbated by geopolitical issues such as the US-China trade war and Brexit, as well as slowing global growth. In our view, the market’s concerns are overdone.

The US economy remains around trend and the Federal Reserve has pivoted from tightening to an easing bias that may help steepen the yield curve. The Chinese deleveraging that was a feature of 2018 has ended and stimulatory measures are now showing their effect in activity levels. As the market gains comfort that the global economy is slowing, but not collapsing, we believe valuation parameters will normalise.

Further, any resolution or partial resolution of the key geopolitical risks will reduce the downside risk of further deceleration in growth due to elevated uncertainty. Recent dialogue between the US and China and hopes of a deal regarding trade negotiations is a significant step in the right direction.

We remain positioned to take advantage of the global economy moving away from outright bearishness and risk-off, to a more moderate growth environment. The defensive bond-sensitive and quality names remain in 'bubble' territory and would be expected to correct heavily when the market moves into more rational territory. As seen during September, reversion trades in favour of value stocks can happen quickly and aggressively. Despite these moves, the valuation divergence is such that there is significant further upside potential in the portfolio as and when market valuations correct to more appropriate levels.