Market Commentary
The S&P/ASX 200 Accumulation Index returned -2.2% during the month. Australian equities posted a negative return during December, while global equity markets recorded broadly positive returns during the month. Emerging markets outperformed developed markets. In major global developed markets, the S&P 500 was up 3.0%, the UK’s FTSE 100 was up 2.8% and Japan’s Nikkei 225 was up 1.7%. The DJ Euro Stoxx 50 was the laggard, rising 1.2%.
The Reserve Bank of Australia (RBA) left the cash rate unchanged at the record low of 0.75% at the December 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 December. The Australian economy grew by 0.4% over Q3 2019, with the annual rate running edging up to 1.7%. Employment rose by 39,900 positions in November (mostly in part-time positions) which was well above expectations. The unemployment rate edged lower from 5.3% to 5.2%. The NAB Survey of Business Conditions was unchanged in November at +4 index points and business confidence fell 2 points to 0, unwinding the increase of last month. October retail sales were flat, missing market expectations of a 0.3% gain. National CoreLogic dwelling prices continued to post gains, rising 1.1% in December.
In company specific news, Lendlease (-8.9%) disappointed the market after announcing only a partial sale of its engineering business, not a full sale that the market was anticipating. Whitehaven Coal (-16.2%) also disappointed the market after lowering FY20 production guidance due to manning issues at Maules Creek, Whitehaven’s largest operation and also impacts from dust events relating to the severe drought conditions in north west NSW.
Sector returns were mostly negative in December. The best performing sector was materials (1.6%), which was followed by the only other positive returning sector, utilities (0.8%). Energy (-1.5%), financials (-1.6%), consumer discretionary (-2.5%), healthcare (-2.7%), industrials (-3.0%), information technology (-4.6%), real estate (-4.8%) and communication services (-5.8%) all posted negative returns for the month. The worst performing sector was consumer staples (-8.1%).
Materials was the best performing sector in December, led by BHP (1.8%), Fortescue Metals Group (9.9%) and Rio Tinto (3.6%). The materials sector benefitted from a broad commodity price rally during December, due to stronger than expected economic data out of China and the reaching of a Phase 1 trade deal between the US and China.
The utilities sector was the only other positive performer this month. APA Group (2.9%) and AGL Energy (0.6%) were the key drivers of outperformance.
The energy sector outperformed the broader market despite posting a negative return. Key positive contributors included Beach Energy (4.6%) and Cooper Energy (13.1%), while Whitehaven Coal (-16.2%) was the biggest detractor.
The yield-sensitive real estate sector underperformed the broader market as bond yields sold off. Stocks that detracted from sector performance included Goodman Group (-8.8%), Lendlease (-8.9%) and GPT Group (-6.8%).
The communication services sector also underperformed during December due to its yield sensitivity. The key detractor was sector heavyweight Telstra (-8.3%), which gave back most of its November gains as bond yields sold off during the month.
The consumer staples sector was the worst performer during the month. Key drivers of the underperformance included Woolworths (-9.1%), Treasury Wine Estates (-13.2%) and Coles (-8.7%).
Market Outlook
Potential resolutions in both the trade dispute between the US and 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 a violent rotation into the value end of the market.
The divergence in valuations between the defensive and low volatility parts of the market and value cyclical 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 dot.com 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.
