This is a preview of our Model Portfolio Update. To view this report in full visit the Patersons Client Portal.
- The demerger of Coles Group (COL) from Wesfarmers (WES) occurred during the month.
- The following dividends were accrued this month. Income: ANZ (80cps), AST (4.9cps), NAB (99cps) and WBC (94cps). QVR: ANZ (80cps), DLX (14cps), JHG (49.3cps), and NAB (99cps).
- Our cash position in the QVR and Income Portfolios is 20.4% and 21.4% respectively.
International Equity Market Performance
International equities were up 1.0% for the month of November, although were lower in the November quarter, with the MSCI All-Country Total Return Index (incl. dividends) down 6.2%, on increased market volatility caused by concerns around the outlook for global growth, combined with geopolitical instability. US markets were up on average 1.3% for the month, slightly ahead of international markets but underperforming Asia Pacific markets and some Emerging Markets. The Dow Jones industrial Average was up 1.7% for the month, but down 1.6% for the quarter while the S&P500 was up 1.8% for the month and down 4.9% for the quarter, in US$ terms. The NASDAQ was up 0.4% in the month, but lost 9.6% in the quarter, after the selloff in the large-cap FAANG stocks (Facebook, Amazon, Apple, Netflix and Google-parent Alphabet), with the five tech giants all sustaining declines of 20% or more from their highs, pushing them into technical bear-market territory.
European markets were down on average 1.8% for the month and were down on average 7.5% for the quarter to 30 November, led by ongoing weakness in French and German indexes, while the UK was down 6.1% for the quarter despite the tortuous Brexit negotiations. Asia Pacific markets were up on average 3.2% for the month, with Hong Kong the best performing market in November, up 6.1%. However, Asia Pacific markets were down on average 3.5% for the quarter. Emerging Markets were up on average 2.0% for the month as the Turkish market bounced, while EM were down on average 0.4% for the quarter, thanks to a strong performance by the Brazilian market.
For the year to 30 November 2018, the NASDAQ is still the best performing developed market index, up 6.6%, while the Shanghai Composite is the worst performer, down 22.0%. Broadly speaking, US indices have outperformed global indices in the last 12 months, followed by Japan, while all other international indices underperformed.
Volatility has returned with vigour over the past two months, despite international equities posting a slight positive month in November with plenty of macro uncertainty to weigh on investor sentiment. The two biggest have been: 1) the escalating trade war between the world’s two largest economies, and 2) the Federal Reserve seemingly intent on raising rates and pulling liquidity out of the financial system without acknowledging the interdependent and highly-leveraged global economy – until recently, that is.
In addition, there has been the US mid-term elections, populist movements worldwide (including France’s violent Yellow Vest protests), the Mueller investigation, threats of impeachment, failing Brexit negotiations, Italy’s tenuous debt situation, deteriorating emerging market economies, China’s attempt at deleveraging as growth slows, an imminent battle in Congress over raising the debt ceiling and building “the wall,” and so on. All of this has served to increase investor concern about the sustainability of economic strength and where we are in economic cycle.
In regards to trade, it does appear that Trump and Xi have made progress after their meeting at the G20 summit. This, despite the arrest of the CFO of Chinese conglomerate Huawei for violating sanctions against Iran and Trump’s tweet proudly proclaiming to be a “Tariff Man”, even while promising his willingness to sign any reasonable trade deal presented to him. Further tariffs are hold until 1 March 2019 after China confirmed the 90-day timetable and has indicated it will push forward with negotiations, reportedly restarting imports of certain US products. While the negotiations could derail ahead of the deadline there is a strong incentive for both sides to make a deal to resolve the issue before it weakens their respective economies.
As for the Fed, Chair Powell, finally seems to be acknowledging that the global economy feels the impact of rising US rates and a strengthening dollar, and this pain ultimately finds its way back home in an interdependent and highly-leveraged global economy. The key message from the Fed is that it remains upbeat on the US economy, which is consistent with another hike in December, but that rates are now "just below…neutral" and it needs to be aware of potential headwinds to growth, which is all consistent with the Fed being open to a pause and slower pace of rate hikes next year.
Following a hike in December, the Fed is likely to lower its “dot plot” of rate hikes for 2019 and replace the reference to “further gradual [rate] increases” in its post meeting statement with a reference to being more data dependent. A pause on rates in the first half of next year is now highly likely, particularly if core inflation continues to remain benign. A slower more cautious Fed would be positive for markets as it would reduce fears of a US downturn and take some pressure off the $US which would provide some relief for emerging markets and commodity prices.
The fall in the US market has seen the forward 12-month Price Earnings (P/E) ratio for the S&P500 come back to a more realistic level at around 15.0 times after starting the year at 18.5 times, a decline of circa -19%. This P/E ratio is below the 5-year average (16.4x) but above the 10-year average (14.6x) and appear attractive relative to low bond yields. Much stronger-than-expected corporate earnings reports and enormous share buybacks programs have served to increase the denominator of the P/E equation, while the numerator (i.e. price) hasn’t had to fall quite as far as it otherwise would have to hit -19% on P/E. Still, this is one of the three largest drops in forward P/E since 1991. Even in 2008, during the depths of the Financial Crisis and Great Recession, the forward P/E only fell -18% (because earnings fell so precipitously). So, investor sentiment today seems completely out of line with the analyst community and corporate sentiment. It’s essentially pricing in an imminent recession and 5% Treasury yields. The question is whether analysts are on the verge of slashing estimates.
US earnings are continuing to rise, the estimated (year-over-year) earnings growth rate for Q4 2018 is 13.4%. If 13.4% is the final growth rate for the quarter, it will mark the fifth straight quarter of double-digit earnings growth for the S&P500. All eleven sectors are expected to report year-over-year growth in earnings. Seven sectors are projected to report double-digit earnings growth, led by the Energy, Financials, and Industrials sectors. For the year to December 2019, analysts are projecting earnings growth of 8.6% and revenue growth of 5.6%, as the impact of President Trump's corporate tax reform put through earlier this year, roll-off.
European markets have continued to underperform, on concerns around decelerating growth in manufacturing, given weak manufacturing purchasing managers’ indices, the change of government in Italy and rising political uncertainty such as Brexit and the “yellow vest” demonstrations in France.
Emerging markets slowed their declined in the month of November, with the MSCI Emerging Markets Index up 2.9% in local currency terms, although was still down 6.5% for the quarter. The underpinnings of this recovery are a plateauing in the US dollar and falling oil prices, which are changeable indicators, but more dependable than a moment’s bonhomie between Presidents Donald Trump and Xi Jinping.
Australia’s ASX200 Accumulation Index (including dividends) was down 2.2% for the month of November significantly underperforming global markets. For the quarter ended 30 November 2018 the index was down 9.3% while for the 12 months ending 30 November the index was down 1%, slightly below the MSCI Global Accumulation Index, and well below the US indices which were up, on average 5.4%.
The Australian dollar closed November at 73.1 US cents, after hitting a new 20-month low of 70.2 US cents in late October, a combination of heightened trade tensions between the United States and China, a shift into US dollars and month-end capital flows. With the Fed still hiking, albeit with a likely pause, and the RBA firmly on hold until the end of 2019, there is ongoing downwards pressure on the Australian dollar, which we still see falling to around $US0.70, having recently broken below $US0.72.
A weak third quarter GDP print and slowing retail sales, combined with falling house prices and a regulatory imposed credit squeeze saw some moderation in economic activity. Meanwhile political risk increases as the Government lost its majority in the lower house, while an upcoming election sees a likely change in government.
Meanwhile the yield on the Australian 10-year bond closed down 2 basis points for the quarter at 2.59%, after reaching a peak of 2.79% in mid-November, as growing global growth concerns saw a flight to safe haven assets. The upside risks for bond yields is less in Australia given much higher unemployment and underemployment and while the RBA is likely to remain well behind the US in raising interest rates.
Australia’s September 2018 quarter GDP report was worse than expected, with year-on-year economic growth of 2.8%, down from 3.1% in the previous quarter, representing the weakest pace in two years. Household consumption growth, the largest part of the economy at over 50%, was weak, driven by soft spending on discretionary items. However, this was partially offset by strong government investment and solid growth contribution from the external sector. Employee pay growth remained subdued, leading households to divert more money away from savings to sustain spending levels.
As was widely expected, the RBA’s long-time neutral monetary policy stance remained in place at the December board meeting, with the benchmark rate left unchanged at 1.50%. The accompanying rates decision commentary indicated that while the RBA sees the global economic expansions continuing, it does concede that ongoing trade tensions are starting to impact global economic growth. With regard to global inflation, whilst remaining low, the RBA highlighted an acceleration in wages growth which could lead to a pick-up in core inflation given tight labour markets. The RBA also made first mention of credit spreads widening, reflecting a tightening in financial conditions in the advanced economies.
On the domestic front, the RBA remains concerned about the outlook for household consumption and the impact of the drought on the farm sector. The strong labour market has led to some pick-up in wages growth, while the RBA expects the economy to continue to grow above trend which should see some further lift in wages growth over time, although this is still expected to be a gradual process.
The RBA highlighted that the credit tightening process is now impacting housing credit, with some lenders having a reduced appetite to lend. The central bank reiterated that the low level of interest rates is continuing to support the Australian economy and its central forecast was for domestic inflation to be higher “than it is currently”.
Retail sales for October remained subdued, growing 0.3% (3.6% year on year), while September’s 0.2% increase was revised down to 0.1%. Non-food sales, a better indicator of discretionary spending patterns, grew by 0.5% (3.3% year on year). Another big fall (-0.4%) in New South Wales was also reported, creating renewed doubt about broader spending growth across the country given the downturn in the housing market.
Jobs growth remained strong in October, with unemployment remaining down at 5%, while wage growth perked up a bit further in the September quarter. However, underemployment remains very high at 8.3% and wages growth has only really picked up because of a faster increase in the minimum wage and public sector wages, and is still stuck around 2% year-on-year. Credit growth remained soft in October with credit to property investors growing at its slowest on record and owner occupier credit continuing to slow. Meanwhile, business credit growth has picked up, possibly reflective of stronger investment in the non mining sectors.
11 of the 12 sectors in the Australian market were weaker in November, with Technology the only positive contributor. The Energy, Consumer Discretionary and Materials sectors were the biggest detractors. For the November quarter, all 12 sectors were weaker, with the Healthcare, Consumer Discretionary and Energy sectors the biggest detractors.
The Health Care, Info Tech and Resources sectors have had the best returns (capital gains plus dividends) in the 12 months to 30 November 2018, while the Utilities Telecommunication, Banks, Financials ex Property, Consumer Discretionary, Industrials and Energy sectors recorded negative returns over the past year.
Small cap stocks (exASX100) underperformed large cap stocks (ASX100) in October, before recovering in November. Very large cap stocks (ASX20) are trending just above large cap stocks and have performed better during the recent correction.
ASX100 Best and Worst
Qube Holdings (QUB), Qantas (QAN) and Healthscope (HSO) were the three best performing stocks in the ASX100 for November.
Clydesdale bank (CYB) was the worst performing stock in the ASX100 after announcing disappointing preliminary 2018 results, with a statutory loss of £145 million after tax.
The QVR portfolio underperformed the ASX200 Accumulation index for the month of November while the Income portfolio outperformed the benchmark, however both portfolios remain ahead of the benchmark for the rolling quarter to November. The QVR portfolio has moved below the benchmark ASX200 Accumulation Index for the 12 months to 30 November, down 2.1%, with 1.1% of underperformance relative to the benchmark, while the Income portfolio is up 3.1% for the 12 months, 4.1% ahead of the benchmark. Both portfolios have significantly outperformed the benchmark since inception on both absolute and risk adjusted measures.
NB: Prior to March 2013, the performance of the portfolios was calculated assuming an equal weighting to each stock.
Note that it is not unusual for the Income portfolio, which is defensive in nature, to outperform the market during bear markets and underperform during bull markets. On the other hand, the Model portfolio is expected to outperform its benchmark in all market conditions over the long term.
The QVR Portfolio underperformed the benchmark ASX200 Accumulation Index for the month of November as a result of our exposures to Mining and Resources, in the form of South32 (S32) and Woodside Petroleum (WPL), as the sectors were impacted by weaker commodity prices on fears of a global slowdown. Diversified Financials, in the form of Janus Henderson (JHG) and Challenger (CGF), were also detractors, given their leverage to markets and the second order impact on future fund flows.
Positive contributors included our Bank holdings (ANZ, CBA and NAB), while our exposure to defensives in the form of Sydney Airport (SYD), Cash and Charter Hall (CHC) aided the portfolio.
The Income Portfolio outperformed the benchmark again this month, thanks to our large cash position as well as our exposure to key defensive positions in Arena REIT (ARF), the banks (ANZ, CBA, Nab & WBC), AGL, Spark Infrastructure and Charter Hall (CHC).
Negative contributors to performance were our exposures to Alumina (AWC) and Woodside Petroleum (WPL), while the demerged Coles Group (COL) and Wesfarmers (WES) both underperformed.
In the charts below, we have distinguished the Miners separately from the Materials GICs sector and the Banks from the Financials GICs sector. We remain underweight Banks in both portfolios.
Read the full report
Warning: This report is intended to provide general securities advice, and does not purport to make any recommendation that any securities transaction is appropriate to your particular investment objectives, financial situtation or particular needs. Prior to making any investment decision, you should assess, or seek advice from your adviser, on whether any relevant part of this report is appropriate to your financial circumstances and investment objectives.