Well, sadly I’m not writing this week’s note from a high horse.
This month has been a torrid one for investors.
As has been widely reported, the month-to-date falls of -9% in U.S equity indices this December makes for the worst end to a year for U.S share investors since the Great Depression in 1931, nearly 90 years ago.
Australian share-market haven’t fared quite so badly in December, and are only down around -2%, but the month has thrown up its fair share of disappointment with the likes of IOOF (IFL), BWX (BWX), Caltex (CTX) and Adelaide Brighton (ABC) all announcing negative news, and large investor holdings in banks all suffering substantial losses.
On the face of it, it hasn’t been pretty.
As I reported earlier in the week, Australian shares look set to post their first negative year since 2011 and are currently down -5% after taking into account dividends paid.
Next year is unlikely to look materially better with the prospect of a Federal Election hanging over business investment until at least May, and the negative feedback loop to consumer behavior from the falling housing market.
We are definitely expectant of trickier times, although as we have noted in the past 6 weeks, valuations amongst the broader Australian share-market now look more interesting than they have done in perhaps 5 years.
Whilst valuations are more attractive, the pall of uncertainty cast both here and abroad seem to suggest that any bounce is unlikely to be widespread and sustained.
Why Liquidity is Everything – Federal Reserve meeting
The U.S central bank met and raised interest rates by 0.25% to 2.50% as expected and conceded that policy had now reached a neutral setting. Fed members continue to see a further 2x 0.25% interest rises in 2019, but also admitted that they weren’t on a pre-determined course and that future policy moves would be apolitical and data dependent.
As important, or more so, was the Fed’s remark that so-called ‘Quantitative Tightening’ was going to plan and would continue to plan.
This is perhaps the more pressing issue, and as we have highlighted on more times than we care to remember, the single reason why asset markets across the world are now coming under pressure, be they global share-markets or on the local scene, local residential housing.
It’s all about liquidity.
In the United States, ‘Quantitative Tightening’, has withdrawn almost US$400m from the U.S financial system, and this number will double by June 2019. U.S annual money supply growth is currently running at its lowest rate in 8 years.
In Australia, annual M2 money supply is a shade over 2% and at the lowest rate since 1991, and this is the result of bank credit rationing in the wake of the Royal Commission.
In China, annual M2 growth is +8% and its lowest growth in recorded history.
In Japan, despite ongoing Quantitative Easing, M2 growth has collapsed to its lowest growth in 6 years, and lastly in Europe, with the cessation of the European Central Bank’s bond-buying program due in days, you can bet your bottom dollar, that European M2 money supply growth will rapidly deteriorate in 2019 from its recent 4.4% annual rate.
When liquidity dries up, market participants turn to selling assets to offset the short-fall, and this can be in the form of running down cash reserves as well as asset sales.
In Australia the effect has already been felt with our collapsing household savings rate, and in 2019 it will be felt in the form of further forced selling of residential investment property I suspect.
This week of note
As I have alluded to above, it certainly hasn’t been a pretty week for investors, but there are some notable observations.
Australian long bond yields are now back at a 2-year low and reflect a growing concern that the ‘credit crunch’ is becoming more pervasive across the wider economy.
In the U.S, major transport player Fed-Ex disappointed investors with a weaker economic outlook, pointing specifically to a softening global growth outlook.
Australian residential auction clearance rates last weekend made a new low (virtually lowest number since early 2012) at 43.8% and seem absolutely set for a trip into the 30%’s as we enter the autumn selling season.
We haven’t yet seen the forced selling of property, and it feels inevitable, although I do note that regulators are increasingly motivated by the tightening in lending conditions such that this week APRA made the small step of removing the 30% cap on interest-only mortgages written by lenders.
It’s only a small step, and it won’t influence matters yet, but it is, I think, a sign of where we are headed once we are past the February 2019 release of the Royal Commission findings into the Australian financial services sector.
In China, where I think we should be focused in the coming months, we saw some early, tentative steps toward policy easing with reports that personal tax cuts will be the top priority for Chinese authorities in 2019.
On top of this there was a report indicating a willingness by authorities in one city, Heze, to ease rules around selling of residential property.
Across China, since 2017, people have been forced to hold property for at least 2 years before selling, thus significantly dampening property speculation and the rapid house price growth.
Any easing of this policy would be a positive signal for Chinese property markets, and thus economic acceleration.
Healthscope (HSO) – with they or won’t they
We should hear news from possible suitor Brookfield at some point Friday or Monday as to their intention, or not, to pursue a formal takeover bid for the group.
BWX (BWX) – hugely disappointing, but it had to happen
BWX sadly lowered 2019 profit guidance for the second time in 6 weeks by a still ‘eye-wateringly’ high -20%.
There are many negatives associated with the downgrade, not the least of which is the poor information flow within the organization that could allow the group to make such a material amendment to guidance in such a short period of time.
But I would like instead to focus on the positive, and the fact a new CEO has now sought to draw a line under the operational difficulties afflicting the business in early 2018, and to re-cast guidance in a manner reflective of where the business had to be restructured before it could again go forward.
Nothing in the last 12mths at BWX has been done particularly well, but this in large part comes back to the manner in which the business was previously run under the founder and former CEO.
Going forward, the business is in possession of an excellent brand, being Sukin, and the ability to now see the benefit of this sales growth reflected in group earnings, free from the side distraction of systems integration, management change and retailer de-stocking.
We hold hope and expectation that the underlying business continues to grow and is capable of delivering a base-line of $40m+ in EBITDA, which leaves the stock now on around 8x cash earnings.
What from here for markets?
Without wishing to re-hash the note we sent earlier in the week, you should expect the following in early 2019
- Continued local economic softness, and a fall into the mid-60s for the AUD
- The ASX200 to be at or near its low point around 5350-5400 (3% lower than today, and 4-5% lower than where we were in October)
- Australian major banks to see downgrades at February results and trading statements, and bank stocks to fall a further -10% in 2019
- Chinese authorities to announce fresh policy stimulus during January which ought to help investor sentiment near term
- S share-markets to find an interim low within 2% of here and to bounce in early 2019, albeit any bounce in equities will be an opportunity to take again lighten positions
2019 will be a tricky year again.
Our tactical decision to reduce weights to GROWTH assets in March 2018 now looks prescient, and we see nothing on the horizon to turn collectively more bullish on risk assets.
There will be stocks and funds that do well in this environment regardless of market conditions, simply ensure, as we continue to stress, that portfolios are well-diversified and biased to a defensive bent for the interim.
Wishing you all a very happy summer holiday. We will be back again in print on Friday 18th January 2019.
Jono, Guy and Jordan
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Australian Market Index
Thursday 5pm Values
|S&P / ASX 200||5581||-81||-1.4%|
|Property Trust Index||1420||+1||+0.1%|
Key Dates: Australian Companies
|Mon 24th December||Div Pay Date – NABPC, WBCPE, WBCPF, WBCPH|
|Tue 25th December||Merry Christmas!|
|Wed 26th December||Boxing Day|
|Thu 27th December||Div Ex-Date – NABPD|
|Fri 28th December||N/A|
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|U.S. S&P 500||2506||-145||-5.5%|
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