Monthly Perspective | January 2019

A new year brings a turn in sentiment and new opportunities. Whilst 2018 ended on an extremely sour note, the first few weeks of 2019 has seen some relief and optimism come back into the markets. This month, we envisage the possibilities that 2019 could bring.

As equities stumbled to the worst December since the Great Depression in 1931, bonds rallied on safe-haven demand. Exacerbated by weak trading volumes during the holiday period, nearly all asset classes ended the year in the red. Unless you were in cash or a short-seller, 2018 was not a happy year.

Since the turn of the year, sentiment has rebounded on hopes that trade issues will be resolved and Chinese stimulus will boost growth. From the recent bottom on 21 December 2018, the S&P/ASX 200 has rebounded 6% at the time of writing. In the US, the S&P 500 was one of the worst performers for December as it gave back much of the outperformance earlier in 2018 but since bottoming on 4 January, it has also bounced over 5%. The Euro STOXX was just 2% short of a bear market, bottoming on 27 December and has since rebounded over 5%. Meanwhile, Japanese indices actually did go into a bear market, dropping 21% from the recent peak at the start of October, bottoming on Christmas day. It has since rebounded 5% but just back to where it was on Boxing day.

Bonds bounced amid the pessimism in December, with the global index bouncing nearly 2%. US 10-year government bond yields fell to 2.55% in early January just less than two months after breaching 3.2% in November. It has since retraced some of this movement and the yield currently sits around 2.7%. Similarly, the 10-year Australian government bond yields fell to 2.17% in early January from 2.76% in November but has since retraced to close to 2.3%.

As the Australian Dollar tends to be driven by sentiment around China and global growth, the AUD followed equities in turning lower, falling below 70 US cents briefly in early January but has retraced and is now trading around 71.6 US cents.

Economic overview

As property prices continue to decline domestically, the Australian economy has also shown some weakness, with the consumer sentiment and activity indicators falling. Employment figures were mixed as the number of employed rose more than expected but was driven by part time jobs.

On the back of global worries, multiple speakers from the Federal Reserve have indicated a more flexible approach to monetary policy and a willingness to pause rate hikes if economic data deteriorates as inflation remains at a reasonable 2.2%. However, inflation may be pressured as the US employment figures showed ongoing strength, with wages rising more than expected. Personal spending and retail sales also came in strong, indicating that the US consumer remains in good health. Furthermore, economic activity indicators and industrial production remain robust, so rate hikes are still likely, but the comments from the Federal Reserve had its desired effect in calming financial markets. Despite the positive data, the partial government shutdown that has dragged on for a month will likely have a significant impact on the economy though history has shown that once the government resumes usual business, this impact is reversed fairly quickly.

Figures out of other economies were not as cheery. Europe, Japan and China all look to have slowed worse than expected. The slowdown in China was the most significant given it is now the second largest economy in the world and the biggest contributor to global economic growth in recent times. Manufacturing indicators now show slight contraction though services remain at a decent level. In response, the Chinese government has cut Reserve Requirement Ratios for its banks, which will release more cash to the economy, and also announced plans to reduce taxes.

The trade negotiation remains a big driver of what happens next, with markets starting to price in some sort of resolution or cease fire. Elsewhere, Brexit continues to be more like a soap opera than real life and will continue to be a drag on both the United Kingdom and European Union economies.

Thoughts for the year ahead

Summary

  • Expect another year of largely flat share-market returns in 2019, but opportunities to profit from likely volatility remain. The peak in U.S share-markets is in.
  • Economic growth will be mixed – slight recovery in China, late-cycle plateauing at best in the United States, deteriorating backdrop in Australia driven by credit-rationing and election uncertainty
  • Politics to be a contributing factor to equity market volatility – Australian Federal Election, U.S/China trade negotiations, BREXIT endgame, intra-European deficit politics and U.S Presidential/Congressional relationship all have the ability to create issues
  • Australian income opportunities such as MCP Master Income Trust, Qualitas Real Estate Income and Latrobe 12-month term account look attractive

After what was a very disappointing end to 2018, share-markets around the world have started the new year positively, regaining over half of their losses and bouncing some +9% from their lows in the case of the ASX200.

The new year optimism stems from a belief that trade issues between the United States and China will be resolved simply because to do not would be to the significant detriment of both countries and their respective leaders.

However, the slowdown in U.S economic activity and forward business confidence late in 2018 has shaken the market’s faith in forward earnings, and perhaps deservedly so.

The U.S economy is a decade deep into its post-GFC recovery, interest rates are rising and the Federal Reserve is well underway in its efforts to withdraw excess liquidity from the U.S and global financial system.

We see this as being the pre-eminent investment theme in 2019, much as it was in 2018, and that U.S equity market’s will be hard-pressed to overcome this rising handicap to economic growth.

U.S equity market valuations are far more stretched than those elsewhere around the world, unsurprisingly I guess, because their economy has done the best in recovering from the GFC.

Elsewhere, in Asia particularly, valuations look far more compelling, and so we feel investors will do well to broaden their international exposures to include funds with heavier biases to markets outside of the U.S, such as Orbis Global Equity Fund, Platinum Asia, WCM Quality Global Growth and Antipodes Global Fund.

Magellan Global Fund remains a core exposure and we are thrilled with its outstanding performance in 2018, however we think 2019 might prove to be a year where the aforementioned funds spend more time in the spotlight.

In Australia, share-markets look to be on the slightly cheap side of history and are now at a shade over 14x forward earnings which is around a 5-year low. This is a nice place to start the year, but with the economic outlook for Australia softening, we think earnings forecasts for the most part will be revised lower as 2019 endures.

This detracts from the low starting valuation for Australian shares, and means we think markets will struggle to make major headway in the coming 12mths.

Despite this over-arching market indifference, we do think there will be many opportunities to generate positive returns.

In fact we feel 2019 looks a lot like 2014, 2015 and 2018, and we did particularly well in each of the two first years, and pretty well last year until December when we were socked with IOOF (IFL) and BWX (BWX), both of which we expect to recover.

We think Australian equity holdings such as Afterpay (APT) with its viral rate of growth, Challenger (CGF) with a new legislative framework in support of annuity products, SEEK (SEK) with its exposure and heavy investment in China and Nufarm (NUF) from its burgeoning intellectual property in omega-3 infused canola, all stand strong chance of outperforming.

Key considerations as we start the new year

Ask yourself and your advisor the following questions:

  • Do I have cash on hand to take advantage of opportunities as they arise from likely volatility in 2019?
  • Have I adequately diversified my income generation such that it is not entirely dependent upon Australian franked income?
  • Are my international equity exposures diversified to include non-U.S equity market exposure such as Orbis Global Equity Fund, Platinum Asia, Antipodes Global Fund or WCM Quality Global Growth?
  • Are my Australian equity exposures inclusive of secular growth opportunities present in stocks such as Afterpay (APT), Challenger (CGF), SEEK (SEK) and Nufarm (NUF)?

Conclusion

It is likely Australian and U.S share-markets make their peak early in 2019 fueled by the current optimism for a U.S/China trade resolution.

Whilst we don’t expect major downside to persist, we do believe it quite possible that Australian and international shares again test the lows seen in late 2018.

The U.S economy is coming to the back-end of a 10-year expansion and it is getting increasingly harder to stimulate for positive gain. Equity valuations in the United States continue to price in a degree of optimism that might prove difficult to deliver upon.

In Australia and the rest of the world, equity valuations look far less worrisome, however the outlook for economic and corporate improvement remains mixed, albeit China has the potential to show some improvement as 2019 progresses.

Want more information?

This month’s perspective highlights that market sentiment on all asset classes is constantly changing. It is important for us to quickly recognise any threats, to preserve your investment capital or to identify early investment opportunities to maximise any return advantages. At Partners Wealth Group we don’t get complacent with the current state of play and constantly monitor investments and your portfolios.

If this article has raised questions regarding your personal situation, please contact your Partners Wealth Group advisor directly or on 1800 333 143.

 

This article contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.