Australian Investment Market Context
As we stand today (December 18th), the Australian share-market looks set to record its first NEGATIVE year since 2011.
The ASX200 is down -4.5% year-to-date including dividends (over -8% in price alone), and this is broadly comparable to the S&P500 which is down a similar amount, however the fall in the Australian Dollar means that Australian equities have still underperformed their foreign peer group by between 5% and 8%.
The ASX200 is down -12.5% from its highs in late August.
The Australian Financial sector, which includes all banks, insurers and advisory groups has fallen over -12.5% year-to-date including payment of all dividends.
Whilst there might be little reason for widespread optimism, in Australia at least, we feel that the share-market is within sight of its lows given forward valuations are bouncing around near 6-year lows.
Australian bond indices, which incorporate all government, semi-government and corporate bond issuance, have risen +3.8% in the year-to-date.
This year is a reminder that all portfolios should ensure they are well-balanced, diversified, and in light of our current view, cautiously positioned.
All of our diversified model portfolios (from high-growth to defensive) have positive returns in the 12 months until the end of November, well above the -1% fall in Australian shares in that time, and just under the returns provided by Australian bond markets.
Key Issues for Portfolios
At a global level, the withdrawal of liquidity is the single most attributable reason for weakness in global equity markets in the second half of 2018.
In the United States, the US Federal Reserve has withdrawn US$400bn from the financial system through ‘quantitative tightening’, a number that will have doubled by mid-2019.
In Australia in the wake of the Banking Royal Commission, Australian housing finance is running down -8.5% on last year and at the slowest rate of growth since 2010.
On account of this, Australia’s rate of money supply growth to the economy is now its slowest since the 1991 recession.
It is precisely this constriction of money supply going on globally that is forcing asset prices down as investors, businesses and households liquidate assets to compensate for tighter cashflows.
In Australia we have further reason to pause, that being the uncertainty in relation to a possible (perhaps quite likely) change in Federal Government in May next year, and the prospect of a significantly different government agenda on all manner of issues but particularly tax.
This uncertainty, alongside the weakness in housing, is beginning to lead to an increasingly rapid slowdown in domestic economic activity and may even result in Australia’s first ‘technical recession’ since the early 1990s (2 consecutive quarters of negative economic growth).
Investment Portfolios and a Federal Labor Government
We have made much of this situation since the Labor Federal Opposition tabled their tax policy back in March.
Nothing new has changed and Labor still seem focussed on removing the repayment of excess franking credits to investors from the 1st of July 2019, only now they seem a far greater likelihood of winning government.
We would repeat our view that Australian franked income sources will continue to underperform, and that Australian portfolio investors will evolve their portfolios (as our recommended portfolios have) away from franked income to more adequately reflect capital growth and non-franked income.
We see international equities continuing to find investor support as indeed we see investors expand their horizons to reflect the quality income generative abilities offered by mortgage funds, and both short and long-term corporate bond and senior loan funds.
As a re-cap for investors, some income options available to investors looking beyond blue-chip shares and hybrid securities are:
- MCP Master Income Trust (MXT) – senior debt offering running yield of 5.5%+ (6mth annualized) currently
- Latrobe 12-mth term account – mortgage fund offering 5.7% annual return for those on Macquarie WRAP (5.2% and locked up for 12mths for those not on WRAP)
- Qualitas Real Estate Income Fund (QRI) – recently listed mortgage fund offering a targeted 8% annual income
Many of these funds and products have been mentioned in the past and have been included in our portfolios for varying degrees of time. We are also evaluating a couple of new opportunities to enhance the options in this space as we continue to look for sources of good risk-adjusted returns.
It is our opinion that it is best to blend several of these funds to achieve the desired risk-adjusted return.
Lastly, fixed-term and lifetime annuities are also increasingly offering investors good value for their high security.
You should talk to you advisor on these, but returns offered are now in the 3-4% range
IOOF (IFL) – a quick update
This stock has been hugely disappointing and has undone a lot of the good performance made in our Australian equity portfolios in 2018 by the likes of Afterpay (APT), APN Outdoor (APO), QUBE Holdings (QUB), Vocus (VOC), Macquarie Group (MQG) and Magellan Financial (MFG).
Whilst the stock is down some -50% since we initially recommended it, we feel compelled to hold on for a better resolution to the current regulatory and managerial uncertainty.
At best management have failed to appreciate the new climate of financial sector regulation, at worst they have failed to uphold several key regulatory tenets and their indifference towards the regulator could see the company even more heavily scrutinised than before, potentially leading to large compensatory claims not yet obvious in the recent public discourse.
It is precisely this uncertainty and the risk of heavy payouts that leaves the stock wallowing on near 7x future earnings.
We do feel the market is pricing in a higher degree of negativity than will transpire, albeit we freely admit to dealing on uncertain assumptions, and so would suggest clients hold their patience with us on the tentative expectation that the situation resolves itself in a more favourable fashion as the case unwinds.
Stocks we continue to love in 2019
A reminder of our favoured names for 2019 are AMCOR (AMC), Challenger (CGF), Downer (DOW), Afterpay (APT), SEEK (SEK), BWX (BWX), Magellan Financial (MFG) and Nufarm (NUF).
We will be back with a proper, full-length summary of our expectations for 2019.
In the meantime, thank you for your kind support in 2018 and we wish you and your loved ones a happy and healthy summer ahead.