2018 was marked by a notable increase in market volatility and a decline in global economic growth from its previous high in the first part of the year. This has been reflected in a pull-back in most equity markets and an increase in expected volatility.
The increase in volatility has been the culmination of a number of factors including, increased geopolitical tensions, primarily in the form of protectionist measures by the US with its key economic partners China and Europe, a normalisation of interest rates in the US, tightening of liquidity, and idiosyncratic issues impacting specific stocks and sectors such as the technology sector, which was a key growth engine of the US market.
On the home front we have seen house prices decline causing concerns on the possible impact on the broader economy. The current environment comes off a period of extraordinary market returns supported by accommodative monetary policy, liquidity being pumped into global markets via quantitative easing as well as some sugar hits in the form of corporate tax cuts in the US. We believe that we are in the late stages of the cycle. However, late cycles can vary in their duration. Late cycles have lasted as long as five years in the 1960s when productivity was strong and wages and inflation were low, and more than three years in the 1990s. Beyond these long late cycle environments, typically late cycles, have lasted for 12 to 18 months.
While we see economic and liquidity conditions becoming more challenging, we do not think that we have reached the tipping point in terms of the economic cycle. We are also beginning to see some value appear in markets however we think it is too early to allocate to some of these areas at this point.
The S&P/ASX 200 Index returned -0.1% through December, rebounding in the first week of January 2019 as Wall Street recovered slightly from a horror end to 2018. The ASX outperformed global shares, holding up well compared to other major markets. Volatility, measured by the ASX 200 VIX Index, remained elevated through December, rising above 20.0 before easing slightly into the new year. Materials (+5.3%) was the best performing sector in December, with BHP (+11.5%) rising on the back of news that it will pay a special dividend of US $1.02 per share (A $1.42) following the completion of its US $5.2 billion share buyback, while Rio Tinto (+7.1%) ended the month higher after confirming the sale of its Grasberg mine interest in Indonesia. Gains in the Health Care sector (+2.9%) were led by pharmacy distribution business Sigma Healthcare (+16.3%) following a merger proposal from rival Australian Pharmaceutical Industries (-5.8%), the owner of pharmacies Priceline and Soul Pattinson. Within the Communications sector (-5.1%) it was a tough month for media, with Nine Entertainment (- 21.4%) still struggling after its high-profile acquisition of Fairfax, while telcos were also in negative territory as the ACCC voiced concerns over the proposed merger between TPG (-10.4%) and Vodafone.
Global shares fell 4.4% in Australian dollar terms in December as major developed markets plummeted on fears of slowing global economic growth and the prospect of an escalation in trade conflict. The US S&P 500 Index fell 9.0% in December, dropping to a low of 2351 points (its lowest level since April 2017) and recovering to above 2500 in the new year. Trade tensions between the US and China continued to impact markets, while a standoff between the Trump White House and Congress over immigration and the funding of a border wall has created additional uncertainty, resulting in a partial shutdown of some government departments. The start of the new year greeted Apple (-11.7%) investors with lower guidance for its first quarter, which pointed to a significant drop in operating income on the previous year. Higher prices for the iPhone has been offset by weaker demand, most obviously in China. The STOXX Europe 600 Index fell 5.6% in local currency terms, with the Retail (-8.0%), Bank (-7.7%) and Auto (-7.2%) sectors hardest hit. In Asia, Japan’s Nikkei 225 Index fell 10.3% in local currency terms and China’s CSI 300 Index dropped 5.1%.
Global bonds measured by the Barclays Global Aggregate Index returned 5.8% in December in Australian dollar unhedged terms and 1.4% in hedged terms as yields in major developed markets fell through December and early January. The end of the ECB’s quantitative easing was expected to put upward pressure on European yields, even in Germany where there is a relative scarcity of safe government Bunds, but so far there are few signs of this happening. The US 10- year Treasury yield fell from 2.99% to 2.69% in December, before dropping as low as 2.55% in early January 2019. Similarly, the Australian 10-year Treasury yield fell from 2.59% to end 2018 at 2.32% before falling further to 2.18% in the new year. Germany’s 10-year Bund yield fell from 0.31% to 0.24% in December, while the 5-year yield fell further into negative territory from - 0.27% to -0.32%. Japan’s 10-year government bond yield also dipped into negative territory, falling from 0.087% at the start of December to -0.045% in early January 2019. In December yields on US 2-year government bonds rose above those for 3 and 5 years for the first time since 2008, while the spread between the 10- and 2- year Treasury yield narrowed to below 11 basis points, raising fears of a potential economic recession.
The S&P/ASX 200 A-REIT Index returned 1.7% in December as the outlook for interest rate rises softened and bond market yields fell. Shopping centres came under pressure in December, with falls from Shopping Centres Australasia (-3.4%) and Vicinity Centres (-2.6%), but overall the sector has maintained its high occupancy rates in the face of the online onslaught. On the other side of the equation, industrial property manager Goodman Group (+3.7%), whose biggest tenant is Amazon, saw a 26.2% rise in its share price over 2018. Viva Energy REIT (+8.7%) was the top performer in December, with investors attracted to its relatively high yield and low levels of leverage that allow for some debt-funded growth. December saw the completion of Oxford Properties’ $3.4 billion all-cash acquisition of the Investa Office Fund, consisting of investment grade office buildings in Australia’s CBDs. While Australian REITs were able to stand their ground in December, the fate of global listed property was tied to the deep falls in equity markets, which saw developed market REITs outside of Australia fall 6.3% in hedged terms. US REITs were no exception, falling 8.5%, with the biggest falls coming from Hotels (-13.4%), Offices (-11.7%) and Malls (-11.0%).
The Australian equity market (as measured by the S&P/ASX 200) started the year off much like the previous finished, although most of the steam had been taken out of the rally with January producing a solid +1.20% return. February was much more muted with the uncertainty of an imminent reporting season hanging over the market however with better-than-expected results, coupled with softer-than-expected domestic inflation data, March provided some highlights as Australian shares hit new record highs. The quarter ended on a high with March producing +3.27% closing the quarter off with an attractive +5.53%.
2023 made for another very interesting year in investment markets as macro / regime driven events resulted in extreme shifts in investor sentiment on an almost monthly basis. Investors chose to shoot first and ask questions later in what can best be described as a year of maximum noise.
The Australian equity market (as measured by the S&P/ASX 200) started the September quarter with a flurry but ended up in the red as the global “higher-for-longer” narrative (interest rates) coupled with the ever-increasing cost of living concerns caused consumer confidence to wane.