Market Commentary

The S&P/ASX 200 Accumulation Index returned 5.0% during the month. Australian equities significantly outperformed global equity markets in January, as the coronavirus weighed on global sentiment. Emerging markets underperformed developed markets, dragged down by China, which was particularly hard hit being at the epicentre of the virus. In major global developed markets, the S&P 500 was flat, Japan’s Nikkei 225 was down 1.9%, the DJ Euro Stoxx 50 was down 2.6% and the UK’s FTSE 100 was down 3.4%

Domestic economic data releases were mixed in January. On the inflation front, the Consumer Price Index rose 0.7% during the fourth quarter, while the annual rate ticked up to 1.8%. Both results were marginally above consensus. Employment rose by 28,900 positions in December which exceeded expectations. The unemployment rate edged lower from 5.2% to 5.1%. The NAB Survey of Business Conditions fell in December to +2.7 points and business confidence turned negative, falling from 0 to -1.9, the lowest level since July 2013. November retail sales were up 0.9%, beating market expectations. National CoreLogic dwelling prices continued to post gains, rising 1.0% in January.

In company news, a number of stocks were hit hard by fears over the coronavirus, including Qantas (-9.8%) and Flight Centre (-10.8%). Pre-reporting season downgrades also impacted a range of stocks. Downer (-9.3%) lowered its earnings guidance due to underperformance in its Engineering, Construction & Maintenance division, as well as mining project commencement delays. Treasury Wine Estates (-19.8%) also downgraded guidance, due to both execution and market issues in the US.

All sector returns were positive in January. The best performing sector was health care (12.0%), followed by information technology (11.1%) and consumer staples (8.2%). These were closely followed by communication services (8.1%) and real estate (6.1%) which also outperformed the broader market. Sectors that lagged included financials (4.7%), consumer discretionary (4.6%), industrials (2.0%), materials (1.8%) and energy (0.7%). The worst performing sector was utilities (0.6%).

The health care sector surged in January, thanks to outperformance from CSL (13.2%), Sonic Healthcare (10.2%) and ResMed (14.4%). The sector benefitted from the rush to defensive, quality, growth stocks.

Information technology also outperformed strongly. Key contributors included Afterpay (31.7%), Computershare (7.2%) and Altium (14.7%).

The consumer staples sector bounced back from its underperformance in December. Key drivers of the outperformance included Woolworths (15.7%) and Coles (11.5%). Food price inflation following the drought, bushfires and the decision by Kaufland to cancel its Australian expansion plans aided supermarket performance during the month.

In a reversal of fortune from December, materials were a laggard in January as global risk off sentiment took its toll on commodities. Key detractors included Newcrest Mining (-2.4%), Rio Tinto (-1.6%) and BlueScope Steel (-5.4%).

The energy sector also underperformed the broader market due to the sharp fall in oil prices. Key detractors included Origin Energy (-3.0%) and Viva Energy (-10.4%). Viva Energy underperformed as a result of deteriorating regional refining margins, while Origin Energy was impacted by softening electricity prices.

The utilities sector was the worst performer locally this month, in contrast to the sector being the best performing sector globally as investors sought refuge in defensive stocks. AGL Energy (-2.8%) was the key detractor, while APA Group (2.1%) was also a laggard.

Market Outlook

Despite being only one month in, 2020 has had a rocky start, with positives such as the signing of the phase one trade deal between the US and China being overshadowed by rising geopolitical risks in Iran and then growing fears regarding the impact of the coronavirus emanating out of China. There were signs in 2019 that global industrial production had bottomed, and fundamental data in China has shown improvement with both Chinese imports and new export orders ticking up recently. Given the uncertainties posed by the coronavirus, the improvements in Chinese data may be short-lived, however, we remain hopeful regarding the overall global growth outlook given the willingness of central banks to maintain liquidity in times of crisis. In Europe, Brexit finally took place on 31 January, and Britain now enters an 11-month transition period where it will need to strike a trade deal with the European Union. Eyes will also be on the US this year, with the presidential election taking place in November.

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, however, with the uncertainty surrounding the coronavirus, the prospect of growth headwinds for at least the first quarter of 2020 could see global markets weighed down in the near-term. Once there is a growing confidence that the epidemic is being contained, we would expect the market to recover. We remain of the view that the cheap valuations and extreme positioning of the market still has the potential for a violent rotation into the value end of the market once the bad news subsides.

The divergence in valuations between the defensive and low volatility parts of the market and value cyclical sectors remain 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.

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. The valuation divergence simply illustrated by the gap between high and low PE names remains extreme and thus there is significant further upside potential in the portfolio as and when market valuations correct to more appropriate levels.