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- The following changes were made to the portfolios this month. Core Portfolio: Sold Commonwealth Bank (CBA), purchased Macquarie Group (MQG). Income Portfolio: No change.
- The following dividends were accrued this month. Income Portfolio: ANZ (80cps), NAB (83cps), WBC (94cps) and AST (4.9cps). Core Portfolio: ANZ (80cps), JHG (51.3cps), MQG (360cps) and NAB (83cps).
- The forecast net yield on the Income Portfolio is 4.5%, while the Core Portfolio has a forecast net yield of 3.9%, inclusive of the respective cash positions.
- Our cash position in the Core and Income Portfolios is 18.1% and 21.0% respectively.
* Inception 31st Dec 2010
Overview of Markets
International Equity Market Performance
For much of this year, equity markets have enjoyed a healthy climb, assisted by a dovish tilt from central banks, as well as the possibility of a trade deal between the US and China. As we entered May, the S&P 500 was at an all-time high. However, just six days into the month, investors were tested by the announcement that the US would be moving ahead with tariff increases on US imports from China. Equity markets performed poorly over the month, with Asia ex-Japan, most emerging markets and the US markets all losing more than 6%. US Treasury yields fell, with markets now pricing in more than 3 Federal Reserve (Fed) rate cuts by the end of 2020.
Trade negotiations between the US and China broke down, but the impact so far has been felt more in equity markets than the economy. From 10 May, the US increased the tariff rate on USD 200 billion worth of Chinese imports from 10% to 25%, and announced that it may impose a 25% tariff on the remaining USD 300 billion worth of Chinese imports. This led to China retaliating by increasing the tariff range from 5-10% to 5-25% on USD 60 billion worth of imports from the US.
Rising import tariffs could affect the US economy as well as China. In the US, inflation could rise, and growth for 2019 is likely to be lower as a result. The worry from here will be that capex intentions fall further due to ongoing trade uncertainty, which could begin to filter through into job losses and falling consumer confidence. The flash numbers for the US manufacturing purchasing managers’ index (PMI) fell in May. The headline index fell 2 points to 50.6, while the new orders component fell below 50, into contractionary territory, for the first time since 2009. US consumer confidence is holding up for now, though, with May’s reading rising to a very healthy 134.1 from 129.2 last month.
April’s headline personal consumption expenditure index (PCE), the Fed’s preferred measure of inflation, was just 1.5% year on year (y/y). In the minutes of the 1 May Federal Open Market Committee meeting, policymakers concluded that the current inflation shortfall is transitory, suggesting the Fed is comfortable with rates being on hold rather than delivering the cuts that markets are currently pricing in. However, recent comments from vice chair Richard Clarida suggest the Fed would be willing to cut rates if the data indicated a material deterioration in the economic outlook.
While it is good news for corporates with higher levels of borrowing that rates remain on hold, the subdued level of inflation due to limited pricing power is a possible cause for concern. May’s US jobs report saw the unemployment rate fall to 3.6% and wages growing at 3.4% y/y. The prospect of rising costs through higher wages, combined with limited revenue growth due to the slowdown in global growth and subdued inflation, had led analysts to forecast that US earnings for the first quarter would fall by around 3% vs a year ago. Reporting season concluded with no earnings growth over the same quarter last year for S&P 500 companies—better than the expectations for negative growth, but much weaker than the over 20% earnings growth seen last year.
Eurozone data in May was somewhat mixed. The flash manufacturing PMI fell to 47.7, indicating contraction, while the employment component also dipped below 50. There were some positive signs in the data, though. The new export orders component, while still below 50, did tick higher, and Eurozone consumer confidence picked up in May to its highest level this year. The initial estimate for Q1 GDP also beat expectations, with annualised growth of 1.6% over the last quarter.
The concern in Europe, much like the US, is that trade uncertainty filters through to the labour market and starts to hurt the service sector, which has so far proved more resilient. The latest employment growth numbers in Europe have been solid, though. The first estimates of employment growth for Q1 show a pickup to 1.4% quarter on quarter, annualised.
Stimulus in China could help Europe in the second half of this year, and another positive factor for the region is that the US has put the discussion over global auto tariffs on hold for up to six months. Europe ex UK equities fell by 4.8% over the month.
The European Parliament elections, which took place from 22 to 26 May, yielded a generally positive result for the European project. Populist or Eurosceptic parties gained seats compared to the last election in 2014, but they underperformed expectations. The centrist parties of the EPP and S&D remain the largest two parties in parliament despite losing their combined majority. For now, the results are more likely to have bigger implications at the national level, particularly in Italy, Greece and the UK.
The re-emergence of trade tensions is likely to have economic and policy implications for China. The failure to agree a trade deal with the US increases the risks to the growth outlook. With the introduction of further tariffs, the Renminbi fell against the US dollar by 2.5% in May, which could offset some of the impact of the tariffs on exports to the US. However, the tariffs introduced so far could drag on China’s GDP growth by around 0.8% points across this year and next. Of course, these estimates could worsen in the event of further tariffs on the remainder of the exports to the US, or they could improve if a further policy response is delivered by the Chinese authorities.
So far, the policy response to the slowdown in Chinese growth has been significant but measured. May saw reserve requirement ratio cuts, albeit on a smaller scale than those made earlier this year, amounting to roughly 20 basis points. The announced tax cuts on personal and corporate incomes also show the appetite from the authorities to help stabilise growth. While, more recently, it looked like these stimulus measures were beginning to take hold, the latest data was much weaker than expected. Retail sales and industrial production (IP) data was particularly weak, with IP falling to 5.4% year on year in April, from 8.5% the month before. There were some distortions in these releases due to the Lunar New Year, but the weaker data does mean that, against a backdrop of increased trade tensions, the authorities are likely to continue to increase stimulus measures. The extent of the stimulus delivered will, of course, be important for the Chinese economy, but also for broader emerging markets and Europe.
In the emerging world, India saw the conclusion of its six-week long general election, with Narendra Modi’s Bharatiya Janata Party (BJP) winning an absolute majority in the lower house. This provides some clarity on the policy outlook, and focus will now shift to unlocking the potential for long-term growth in India, which will be one of the key challenges and priorities for the BJP.
Australia’s ASX200 Accumulation Index (including dividends) was up 1.7% for the month of May outperforming global markets after the euphoria of the Liberal National coalition victory in the Federal election. For the quarter ended 31 May 2019 the accumulation index was up 4.9% while for the 12 months ending 31 May 2019 the index was up 11.1%, well ahead of the MSCI Global Accumulation Index and the US markets.
Australian economic data was soft with over the month of May March quarter GDP growth remaining weak as private sector spending in the economy fell for the second quarter in a row. Annual growth has now slowed to 1.8% year on year, its weakest since the GFC. While strong public spending, improving investment and strong net exports should help keep growth positive it’s likely to be constrained as the housing construction downturn continues and consumer spending remains under pressure. In terms of the latter retail sales fell again in April and car sales remained weak in May. On top of this ANZ job ads continued to trend down in May pointing to slowing jobs grow & April housing finance (while dated by the election result) remained weak.
The news wasn’t all negative. Flowing from a continuing large trade surplus Australia’s current account deficit has fallen to its lowest since the 1970s (meaning less reliance on foreign capital inflow) and the pace of decline in home prices slowed further in May according to CoreLogic. Our view remains that the combination of the confidence boost from the election, rate cuts, a relaxed mortgage serviceability test & help for first home buyers will help home prices bottom by year end but a quick return to boom time conditions is unlikely given still very high house prices and debt levels, continuing tight lending standards and a rising trend in unemployment. Meanwhile the housing construction cycle has only just started to turn down and lags the house price cycle and so still has a long way to fall.
8 of the 12 sectors in the Australian market were stronger in May with Communications, Mining, Healthcare and Materials the key contributors. The Consumer Staples, Technology and Energy sectors were the key detractors.
The Communications, Info Tech and Property Trusts sectors have had the best returns (capital gains plus dividends) in the 12 months to 30 April 2019. The Energy sector has now recorded a negative return over the past 12 months.
ASX200 Best and Worst
Lynas Corp (LYC), Domain Holdings (DHG) and Evolution Mining (EVN) were the three best performing stocks in the ASX200 for April. Costa Group Holdings (CGC), Reliance Worldwide (RWC and Nufarm (NUF) were the three worst performing stocks in the ASX200 for May.
The Core portfolio underperformed the ASX200 Accumulation index for the month of May, by 0.3%, while the Income portfolio underperformed by 1.0%. The Core portfolio was 0.3% behind the benchmark for the rolling quarter to May, while the Income portfolio performed in line with the benchmark.
The Core portfolio has underperformed the benchmark ASX200 Accumulation Index for the 12 months to 31 May 2019, by 1.0%, while the Income portfolio has outperformed by 7.4%. Both portfolios continue to outperform the benchmark on two, three and five year timeframes, 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.
Both portfolios have significantly outperformed the benchmark on two, three and five year timeframes, on both absolute and risk adjusted measures.
Patersons Australian Core Portfolio
The Core Portfolio underperformed the benchmark ASX200 Accumulation Index for the month of May primarily as a result of our exposures to Janus Henderson (JHG). JHG’s share price had been recovering well since the start of the year, however its 1Q19 result in early May disappointed investors with continued funds outflow, despite relative 3yr investment trends improving to the strongest level in 18 months. While near-term weak flows will no doubt continue to test our patience, with supportive markets underpinning AUM, tight FY19E cost control assisting operating margins and ongoing buybacks supporting EPS, JHG’s 8.9x forward PE and 6.1% dividend yield offer attractive compensation.
During the month, we switched out of CBA into MQG. CBA has historically traded at a premium to its major bank peers due to lower financial risk and a long history of sustainable earnings and dividend growth despite slow system credit growth and pressure on funding costs. We believe that this premium is no longer warranted, especially given CBA's strong emphasis on home loans in a slowing credit environment and likely increase in mortgage delinquencies. CBA was trading in line with our $74.26 valuation and while the stock was in a long term uptrend, we saw, and still see emerging risks on the horizon.
The Income Portfolio underperformed the benchmark ASX200 Accumulation Index for the month of May as a result of our exposure to QBE Insurance (QBE), AGL Energy (AGL), Arena REIT (ARF) and Tabcorp Holdings (TAH).
QBE had been performing well after its restructuring and rebuilding continues after it reiterated 2019 earnings guidance at its AGM. Despite lower global interest rates and a slowing economic backdrop, QBE's underlying fundamentals are improving, with increases in insurance premium rates and first-quarter investment returns rebounded from a disappointing end to 2018. The stock was sold down late in the month after the market was concerned about QBE’s exposure to US floods via its crop insurance division and its exposure to Brexit.
AGL was sold down after a number of brokers reduced target prices on the stock as wholesale power prices may have peaked, suggesting further downwards pressure on retail prices as the government looks to introduce regulated default market offers in response to higher retail prices. AGL also disclosed it had made a preliminary approach to acquire Vocus (VOC). Meanwhile, ARF took advantage of its strong share price to raise equity to acquire and develop a number of social infrastructure properties.
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.
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.