Patersons Model Portfolio Update - October 2018
Patersons Model Portfolio Update - October 2018

Topic

QVR Portfolio up 12.6% and Income Portfolio up 13.9% for the 12 months to 30 September, compared with the benchmark at 14.0%

Changes

  • There were no changes to the model portfolio this month.
  • The following stocks went ex-dividend during the month – QVR portfolio; AMC, BHP, CSL, RHC & S32. Income portfolio; ARF & SKI.
  • Our cash position in the QVR and Income Portfolio is 19.0% and 20.2% respectively.

International Equity Market Performance

Global equities were up 0.4% for the month of September, while US equities were mixed with strong outperformance by the Dow, up 1.9% for the month, while the S&P500 was in line with global markets and the Nasdaq underperformed, down 0.8% for the month.  For the rolling quarter, the MSCI All-Country Total Return Index (incl. dividends) was up 5.0% while the S&P500 was up 7.2%. European stocks were down average up 0.6% for the month of September and up 0.4% for the quarter.
 
Asia Pacific markets were up on average 2.8% for the month of September, and up 2.2% for the quarter, while Emerging Markets were up on average 4.0% for the month of September, and up 2.9% for the quarter. For the year to 30 September 2018, the NASDAQ is the best performing index, up 23.9%, while the Shanghai Composite is the worst performer, down 15.8%.  Broadly speaking, US indices have outperformed global indices in the last 12 months, followed by Japan, while all other international indices underperformed.

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While markets saw a relief rally in response to the latest tranche of US/China tariffs being less than feared, it’s clear the US trade threat is far from over. The proposed fifth round of US/China trade talks didn’t happen. China has released a defence of its position and is going down its own path on the trade issue by announcing more big tariff cuts and reducing non-tariff barriers and seeking to offset the impact of US tariff hikes by policy stimulus rather than engaging with the US on its gripes. And tensions between the US and China appear to be broadening, with the Trump Administration accusing China of interfering in the mid-term elections and some low-level signs that military tensions may be rising too. 
 
The US Federal Reserve (Fed) provided no surprises, hiking rates by another 0.25%, describing the economy as strong and indicating that further gradual rate increases are likely. While the Fed is no longer describing monetary policy as “accommodative”, it’s far from tight either and Fed officials’ interest rate expectations point to rates rising above the Fed’s estimate of the long-run neutral rate which is currently at 3%. We expect another hike in December and three more hikes next year. US data remains strong, with a new 18 year high in consumer confidence, strong consumer spending and durable goods orders and rising imports. Meanwhile, core inflation in August remained at the Fed’s 2% target, indicating no need for the Fed to get more aggressive in raising rates.
 
Eurozone economic sentiment slipped in September, but remains strong and private lending continues to accelerate. Meanwhile, core inflation fell back to just 0.9% year-on-year supporting the view that European Central Bank rate hikes are a long way off. News that the Italian Government will target a 2019 budget deficit of 2.4% of GDP has pushed the euro down and is a negative for Italian shares and bonds. 2.4% is not low enough to reduce Italy’s public debt-to-GDP ratio and will lead to some conflict with the European Commission. However, it’s far less than the 5-6% of GDP feared a few months ago and is not high enough to see the rest of Europe pressure Italy too much (particularly as France and Germany don’t want to fuel Italian anti-euro populist sentiment). Rather, the rest of Europe is likely to leave market forces via higher Italian bond yields to discipline Italy. So not good for Italian bonds but not a disaster for the Eurozone.
 
The Japanese labour market remained strong in August, industrial production rose and core inflation in Tokyo edged up to 0.6% year-on-year, but it’s still a long way from the Bank of Japan’s 2% target.

ASX200 Performance

Australia’s ASX 200 Accumulation Index was down 1.3% for the month of September, underperforming global markets. For the rolling quarter, the index was up 1.5% and the for the 12 months ending 30 September 2018 it was up 14.0%, making the Australian index one of the better performing indices globally, just below the US indices. The Australian dollar recovered from its August lows but weakened into the end of the month against a broadly firmer US currency as widening yield differentials and strains in emerging markets took their toll.  The latest hike from the US Federal Reserve has left US two-year yields at 79 basis points over those in Australia, the largest premium in modern history.  Markets are pricing in at least three more Fed hikes but no move from the Reserve Bank of Australia until early 2020, given subdued inflation and wages growth.  The yield on the Australian 10-year bond at 2.67%, while the RBA left short term rates on hold at its October meeting. While recent economic growth and jobs data has been good, inflation and wages growth have yet to pick up, and the slide in home prices risks accelerating as banks tighten lending standards which in turn threatens consumer spending and wider economic growth.

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In Australia, there was good news on the budget, but the risks around house prices appear to be mounting and rising petrol prices pose a threat to consumer spending power. The 2017-18 budget deficit came in at $10 billion, which is $8 billion less than expected in May. While part of this owes to spending delays, the Government has announced more spending ahead and risks remain around wages growth, it nevertheless indicates that the Government has some scope to provide more stimulus ahead of the next election. And ABS job vacancy data remains very strong, up 16.5% year-on-year, albeit it did slow down a lot in the 3 months to August.
 
However, the risks around the housing market are continuing to mount, with more banks withdrawing from SMSF lending and signs of a crackdown on property investors with multiple mortgages, as the banks move to comprehensive credit reporting (i.e. sharing information on customer debts) and focusing on total debt-to-income ratios. The latter is significant, given estimates that nearly 1.5 million investment properties are held by investors with more than one property. Credit growth to property investors remains very weak as tighter lending standards and falling investor demand impact. Petrol prices pushed higher on global oil supply concerns, with more upside likely as supply from Iran and potentially Venezuela is cut at a time of strong global demand and low stockpiles. The weekly Australian household petrol bill is now running over $10 a week higher than a year ago. So, while higher petrol prices (if sustained) will add to headline inflation, they will also cut into household spending power and dampen spending elsewhere, which will keep underlying inflation down.

Sector Performance

Of the 12 sectors in the Australian market, 4 sectors were higher in September with the Energy, Mining and Materials sectors the biggest contributors, while the Healthcare and Consumer Discretionary sectors were the biggest detractors.  For the September quarter, the Telecom, Technology and Healthcare and sectors were the biggest contributors, while the Utilities, Mining and materials sectors were the biggest detractors in the quarter.

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The Info Tech, Health Care and Energy sectors have had the best returns (capital gains plus dividends) in the 12 months to 30 September 2018, while the Banks are the only sector to have recorded negative returns over the year.

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In the last month, small cap stocks (exASX100) have once again outperformed large cap stocks (ASX100), after the gap had closed over the preceding two months.  Very large cap stocks (ASX20) are trending in line with large cap stocks, although have performed better when the market declined. 

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ASX100 Best and Worst

Northern Star (NST) was the best performing stock in the ASX100 for September after announcing the acquisition of the Poco Gold Mine in Alaska from Sumitomo.
 
South32 (S32) was higher on positive earnings upgrades on a rebound in commodity prices, while a large broker added the stock to its Conviction Buy list.
 
CSR Limited (CSR) was weaker after a broker cut their target price by 22% $3.50 per share
 
CSL Limited (CSL) was subject to profit taking in growth stock, experiencing a PE derating .

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Portfolio Performance

Both the QVR and Income portfolios outperformed the ASX200 Accumulation index for the month of September. Both the QVR and Income portfolios are now ahead of the benchmark for the rolling quarter to September. Both portfolios gained ground against the benchmark ASX200 Accumulation Index for the 12 months to 30 September, with the Income portfolio essentially inline while the QVR portfolio underperformed by 1.4%.  Both portfolios have significantly outperformed the benchmark since inception on both absolute and risk adjusted measures.

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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.


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QVR Portfolio

The QVR Portfolio outperformed the benchmark ASX200 Accumulation Index for the month of September with the portfolio benefitting from our overweight exposure to Resources, with South 32 (S32), Rio Tinto (RIO), BHP Billiton (BHP) and Woodside Petroleum (WPL) the key contributors.  Our relatively large cash position was also a contributor.
 
CSL Limited (CSL) was our biggest detractor for the month, with other detractors being ANZ Banking Group (ANZ), Sydney Airport (SYD) and Janus Henderson (JHG).

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Income Portfolio

The Income Portfolio outperformed the benchmark again this month, thanks once again to our exposure to Woodside Petroleum (WPL). Other positive contributors included Arena REIT (ARF), Telstra (TLS) and Tabcorp Holdings (TAH).
 
Negative contributors to performance were our exposures to the bank sector, especially ANZ Banking Group (ANZ), while our exposures to defensive utilities and infrastructure stocks AGL Group (AGL) and Spark Infrastructure (SKI).

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Sector Breakdown

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.

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