- There were no changes to the model portfolio this month.
- The following stocks went ex-dividend during the month – QVR portfolio; CBA, CGF, JHG, RIO, TLS & WPL. Income portfolio; AGL, AWC, CBA, MFG, QBE, TLS, TAH, WES & WPL.
- Our cash position in the QVR and Income Portfolio is 18.2% and 19.8% respectively.
Equity Market Performance
Global equities were up 1.2% for the month of August, while US equities outperformed global equities with the S&P500 returning 3.0% for the month, the Dow +2.2% and the NASDAQ +5.7%. For the rolling quarter, the MSCI All-Country Total Return Index (incl. dividends) was up 4.3% while the S&P500 was up 7.3%. European stocks were down average up 3.1% for the month of August and down 1.7% for the quarter.
Asia Pacific markets were up down average 1.3% for the month of August, and down 3.1% for the quarter, while Emerging Markets were down on average 3.1% for the month of August, and down 4.7% for the quarter. For the year to 31 August 2018, the NASDAQ is the best performing index, up 26.1%, while the Shanghai Composite is the worst performer, down 18.9%. Broadly speaking, US indices have outperformed global indices in the last 12 months, followed by Japan, while all other international indices underperformed.
The crisis in Turkey took centre stage in August, with a significant devaluation of the Turkish Lira, prompting fears of contagion spreading to other emerging markets. Turkey got into trouble largely thanks to populist “growth at any cost policies”, its leader’s populist rejection of higher interest rates and an international bailout. While Eurozone bank exposures to Turkey aren’t big enough to cause a major problem (they are mostly small relative to balance sheets and are likely to have been hedged) and global trade exposure to Turkey isn’t big enough either to cause a major problem with most other emerging markets being in far better shape both economically and politically, financial contagion remains a risk for emerging markets.
US data remains mostly solid. While pending home sales fall, continuing the run of softer housing conditions, home prices continue to rise, and a dip in business conditions PMIs, albeit to still strong levels, but continuing strength in underlying capital goods orders. Meanwhile, consumer confidence is at a new 18-year high, personal spending is rising strongly with strong income growth keeping the savings rate high, jobless claims remain very low and the goods trade deficit widened in July as imports picked up. Meanwhile core inflation rose back to the US Federal Reserve’s 2% inflation target. All of which is consistent with ongoing but gradual Fed rate hikes. Federal Reserve Chair Jerome Powell’s Jackson Hole speech reiterated the case for being gradual in raising rates, with the Fed seeking to avoid moving too fast and shortening the expansion and moving too slow risking overheating.
Meanwhile, the June quarter profit reporting season wrapped up on a strong note with earnings up around 27% on a year ago. 83% of the S&P 500 companies reported beat earnings estimates by an average of 5.5% and 71% have beat on sales estimates.
Eurozone business conditions PMIs were basically stable in August – up a bit for services, down a bit for manufacturers – suggesting that growth has stabilised at a still reasonable level after slowing earlier this year. Economic sentiment fell a bit further in August but the German IFO business conditions index rose strongly, growth in bank lending is continuing to trend higher and unemployment has now fallen to 8.2%, which is still high but down from a peak of just over 12% in 2013. Meanwhile, core inflation fell back to 1% year-on-year in August which will keep the ECB relatively dovish, especially given the threats from emerging markets and Italy.
Japanese data was mixed with a continuing very tight labour market (helped by a falling population) but another slight fall in industrial production. Core (ex-fresh food and energy) inflation rate rose to 0.3% year-on-year in August from 0.2%, which is good but far from being enough to move the dial for the Bank of Japan..
Just when it seemed Chinese growth is slowing, its PMIs surprisingly rose in August. Not a lot, but they remain at levels consistent with good growth and suggest that the deleveraging campaign and trade war fears are not having a huge negative impact.
The global trade threat from the US remains high and looks like ramping up further with more tariffs on China. News that the US and Mexico have reached agreement on a revised trade agreement and that Canada may join too, leading to a revamped and renamed NAFTA, is a good sign and coming on the back of the US/Korean trade deal and the start of negotiations with Europe signals that Trump is not ‘anti trade’ per se, but just wants what he regards as fairer trade for the US. But it’s clear that with Trump still threatening to pull out of the World Trade Organisation, saying that the EU offer to remove auto tariffs “is not good enough” and with indications that the threatened next bigger round of tariffs on China will soon be implemented, it’s clear that the trade war risk is continuing to rise. The public comment period on threatened tariffs of up to 25% on US$200 billion of US imports from China ends on Thursday and it’s likely they will start to be implemented soon thereafter, possibly in instalments. If fully implemented, it will mean that around half of imports from China will be affected, albeit it’s only 10% of total US imports – so we are still a long way from 1930. Negotiations between the US and China are unlikely until after the mid-terms and a possible Trump/Xi summit in November, so trade will be a continuing source of market volatility for a while yet. A lack of progress in US/North Korean negotiations are also adding to US tensions with China again.
Australia’s ASX 200 Accumulation Index was up 1.4% for the month of August, outperforming global markets. For the rolling quarter, the index was up 6.2% and the for the 12 months ending 31 August 2018 it was up 15.4%, making the Australian index one of the better performing indices globally, just below the US indices. The Australian dollar hit new 18 month lows in the last week of August, a combination of heightened trade tensions between the United States and Canada, further weakness in emerging market currencies and month-end capital flows. The increase in bank funding costs that has led Westpac to raise mortgage rates is a further tightening of monetary conditions and comes at a precarious time for the housing market. In addition, Australian political risk has increased as an election approaches in about six months and recent economic data suggest some moderation in activity. Meanwhile the yield on the Australian 10-year bond closed up at 2.52%, down 13 basis points for the month as growing trade war concerns saw a flight to safe haven assets.
Australian economic data remains mixed. June quarter business investment was disappointing, with an unexpected decline in the June quarter and investment plans for the current financial year still pointing to falling mining investment and soft growth in non-mining investment. At least the big drag on growth from slumping mining investment is largely behind us. Meanwhile, soft building approvals add to evidence the housing construction cycle has peaked and credit growth remains soft as investor lending continues to fade and personal and business credit remain weak. Notwithstanding solid economic growth in the first half of the year, our view remains that growth going forward will be weaker than the RBA is expecting.
The June half Australian earnings reporting season is now wrapped up and results have been solid, but not spectacular. 44% of results have surprised on the upside, which is in line with the long-term norm, the breadth of profit increases was impressive with 77% reporting higher profits than a year ago which is the strongest since before the GFC and compares to a norm of 66%, 86% have increased their dividends or held them constant and 62% of companies have seen their share price outperform the market on the day results were released. 2017-18 earnings growth have come in around expectations at about 8%, with resources earnings up 25% thanks to solid commodity prices and rising volumes and the rest of the market seeing profit growth of around 5% with bank profits seeing a 2% fall but strong profit gains for insurers, health care, gaming and utility stocks. Key themes have been continuing strong dividend payments, some pressure from higher raw material costs, outperformance by high quality offshore exposed companies and softer than expected guidance.
Australian mortgage rates are on the rise, with Westpac and some smaller banks moving and other big banks likely to follow. This was no real surprise, given the rise in money market borrowing rates this year which has seen the gap between bank bill rates and the RBA’s cash rate blow out well beyond normal levels. While bank bill rates have fallen back a bit in the last month or so, the gap remains over 20 basis points higher than it has averaged over the last decade or so. Since banks get around 35% of their funding from this or related sources, it cuts into their margins unless they pass it on in the form of higher lending rates. Small banks had already moved and now it looks like the big banks are starting to follow – having delayed moving in the hope that the money market will settle down which it hasn’t (and probably won’t given slowing growth in bank deposits meaning more competition for money market funds). While the rise in mortgage rates on average is small at around 15 basis points, it’s still another dampener on consumer spending and home buyer demand, particularly given many borrowers will fear that more rate hikes will follow. It will hit the home buyer market particularly in Sydney and Melbourne at a time when it’s already down. As such it’s a de-facto monetary tightening and is yet another reason for the RBA to remain on hold for longer.
Of the 12 sectors in the Australian market, 7 sectors were higher in August with the Technology, Telecoms and Healthcare sectors the biggest contributors, while the Mining and Materials sectors were the biggest detractors. For the July quarter, the Technology, Healthcare and Telecom sectors were the biggest contributors, while the Mining and Materials sectors were the only detractors in the quarter.
The Energy, Health Care and Info Tech sectors have had the best capital gains in the 12 months to 31 August 2018, while the Telecommunications, Utilities and Financials sectors have experienced capital losses over the year.
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.
ASX100 Best and Worst
TPG Telecom Limited (TPM) was the best performing stock in the ASX100 for August after announcing a merger with Vodafone Hutchison Australia. The tie-up will create a company with an enterprise value of about $15 billion, bringing together TPG's more than 1.9 million fixed-line residential subscribers and Vodafone Hutchison's roughly 6 million
mobile-service subscribers. Each of Australia's telecom operators has struggled in recent years with intense competition that has been heightened as the Federal government rolls out its nationwide broadband network, which sells capacity to the operators that in turn sell broadband services to consumers. TPG had previously announced a plan to roll out a competitively priced mobile telecom network to challenge the country's three incumbents.
A2 Milk (A2M) rebounded in August after announcing its 2018 financial results, which beat most analysts’ expectations, with its net profit after tax jumping 116%, while confirming the growth potential in for its nutritional products in China and liquid milk in the US.
Iluka (ILU) was the worst performer for the month after providing a more subdued outlook for zircon markets at its half years result. While Iluka is seeing strong demand for its products, supply is still tight and the high price of substitutes is holding back some buyers from making the switch. However, Chinese ceramic producers are facing environmental scrutiny, hurting low-quality producers. Iluka's zircon sales to China--its biggest market--fell 11% on-year in 1H while they were flat to other parts of Asia and the Americas.
Origin energy (ORG) reported a strong set of numbers at its full year result, although they were marred by higher corporate costs and a slightly weaker-than-anticipated performance by the integrated natural gas divisions. ORG elected not to pay a dividend, which disappointed some in the market who were expecting some form of dividend, although the company stated that it expected to be able to re-commence dividend payments to shareholders in in FY19, However, overall guidance for the coming year was a disappointment, while the market was surprised by the prospect of higher maintenance spend at Origin's LNG export business than previously assumed.
The QVR portfolio underperformed the ASX200 Accumulation index for the month of August, while the Income portfolio outperformed the benchmark. The Income portfolio is now ahead of the benchmark for the rolling quarter to August, while the QVR portfolio has slipped behind. Both portfolios have slipped behind the benchmark ASX200 Accumulation Index for the 12 months to 31 August 2018, although since inception, both portfolios have significantly outperformed the benchmark 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 August with the portfolio impacted by our exposure to Financials and Materials. The wealth managers Challenger (CGF) and Janus Henderson (JHG) were the biggest detractors after reporting somewhat disappointing results, while our exposure to Miners in the form of Rio Tinto (RIO), BHP Billiton (BHP) and South32 (S32) were impacted by weaker commodities prices as the market reacted to growing trade war fears and emerging markets risk, putting global demand at risk. Amcor (AMC) was also weaker after announcing a major acquisition of US packing rival, Bemis.
Positive contributors included our exposure to CSL Limited (CSL) which reported a very strong set of numbers at its result, along with a continued positive outlook. Telstra (TLS) benefitted from the announcement of a merger between TPM and Vodafone, on the basis the merger would reduce the level of intense competition in the Telecoms industry. Other positive contributors were our exposures to Charter Hall (CHC), Woodside (WPL) and Dulux (DLX).
The Income Portfolio outperformed the benchmark this month, thanks once again to our exposure to Magellan Financial Group (MFG). Other positive contributors included Telstra (TLS), QBE Insurance (QBE), Wesfarmers (WES), Charter Hall (CHC) and Alumina (AWC). A number of stocks went ex-dividend during the month, bolstering our cash position.
Negative contributors to performance were our exposures to the bank sector, especially Westpac (WBC) and Commonwealth Bank (CBA) while our exposure to AGL Energy (AGL) also detracted for the month.
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.