2018 proved to be a volatile year with asset class performance varying as investors place more focus on the Trump Administration’s approach to global trade and tax reforms, US Monetary Policy normalisation and ongoing issues within the European political system to name a few. Despite the turmoil the global economy continues to gather pace, driven by accommodative monetary policy, growing earnings and strong labour markets. The MSCI World Equity Index closed out the year with an 8.6% gain. Domestically the Australian economy grew at 3.1%, and unemployment eased to 5.4%. The ASX slightly underperformed the global index, rising 8.3% and finished the year on a price earnings multiple of 14.9x, slightly above the long-term average of 14.3x.
The Energy sector was the best performer during the year rising 38.2% as oil prices hit levels not seen since 2014. Higher oil prices also translated into solid gains for the resource sector with Materials rising 25.22%, whilst Healthcare stocks experienced continued strength, up 25.41%. On the contrary, the Royal Commission into Financial Services resulted in negative total returns as the sector finished the year down 3.85% with AMP being hit hardest, falling 31.4%. The worst performing segment in FY18 was Telecommunications with Telstra falling 39% due to cutting its dividend and rising competition.
2018FY Sector Performance:
The US-China trade war appears to be intensifying, with the US imposing tariffs on US$50 billion of China exports, China retaliating tit-for-tat, and President Donald Trump threatening significant further tariffs. China have also lodged a case with the World Trade Organisation against the US with the Chinese commerce ministry calling the US actions “a violation of world trade rules”. It is becoming more apparent that US sanctions are not just about reducing the trade balance but are more broadly about stopping the rise of China and its 2025 plan to transform the country into a high tech, highly innovative manufacturing powerhouse.
The major market uncertainty at the moment is whether this tariff tit-for-tat will turn into a more entrenched trade war or if this short-term volatility will subside with an agreement between the two countries. The current US$50bn is ok but any further increases to the proposed US$250bn could be material, directly impacting Chinese growth and subsequently result in further weakness in the Chinese stock-market. Meanwhile the European Union threatens tit-for-tat tariffs on $294 billion of US exports and Canada says they will take punitive measures in response to the steel and aluminium tariffs.
It is becoming apparent that the Trump Administration is unlikely to back down on the tariff issue as approval ratings remain high and markets continue to rise. We do believe that China is well positioned to deal with the tariffs for the following reasons:
- Tariffs are so far focus on the energy, agricultural, chemicals and medical products; commodities that can be redirected to alternative markets;
- Although it would be difficult for China to match US tariffs, they can retaliate in other ways including via its large share of US national debt, China could crack down on US companies with operations throughout the region and finally China could increase support for North Korea. The above factors have the potential to derail the Trump Administration’s political success in a period leading up to mid-term elections in November this year.
China remains Australia’s number one trading partner, therefore slower Chinese growth could impact our local market, in-particular the resource sector looks to be most at risk as trade jitters have weakened the iron ore price which is at threat of breaking its 2016 uptrend. Ultimately, we believe that investors should not react to the trade war rhetoric with negotiations continuing and the fact that potential risks could evaporate with a proverbial tweet. We maintain our positions in major Australian resource companies with diversified portfolios and continue to build our weighting in Asian equities (see below portfolio positioning).
The Aussie Battler
2018FY was the year that the Australian Dollar finally experienced weakness against many of its global peers, particularly the US Dollar as the economic situation in America remains robust, highlighted by rising inflation and low unemployment rates. As a result, the Fed raised rate from 1.0% to 2.0% during the period with further hikes looking likely as inflation builds. Conversely the Reserve Bank of Australia kept interest rates unchanged at 1.50% (now for 23-consecutive months) flagging concerns about high levels of household debt, benign wage growth and declining terms of trade.
In September 2018 the AUD hit a high for the year of 81c and has since fallen approximately 9%. Over recent years we have been positioning portfolios to benefit from a lower AUD by investing in companies that generate high levels of income offshore as well as investing in unhedged international investments. We continue with this theme going into FY2019 as the correlation between the ASX 200 and the US Dollar index strengthens.
- Domestic Equities – We maintain our overweight exposure to sectors and individual stocks that benefit from attractive long term structural growth with the added benefit of favourable foreign exchange movements in-particular those operating in the Healthcare sector. With infrastructure expected to be a key growth driver over the next year, we maintain our weighting to selective infrastructure companies that are well positioned to benefit from government back growth pipelines, whilst being best positioned to whether market volatility and offer reliable risk-adjusted returns from their quality long life assets.
- International Equities – We continue to take a targeted approach to international equities with a focus on the US technology sector and the Asian region. Despite the recent volatility around emerging market equities (China in-particular) we continue to take a favourable long-term view on the premise that 4 of the world’s 5 largest economies by 2030 are expected to Asian countries (China, India, Japan & Indonesia). Furthermore, Asia continues to remain the most tech heavy index in the world with 32.3% of the index being made up of technology stocks, followed by the US’ 23.8%. Australia has less than 1%.
- Fixed interest – We continue to favour financial hybrids offering attractive fully franked yields and trading at discounts to face value. We will continue with our rotation strategy where appropriate.
- Property – We remain underweight listed property investments with the sector historically providing lower returns when US interest rates rise due to high levels of debt within real estate investment trusts.