A new dawn for financial markets

With double-digit returns seen during 2018/19, it seems likely Australia’s ongoing stream of positive returns are set to continue with the market set to reach all-time highs 12 years after previous highs during the mining boom. But with house prices falling, several new financial policies enforced on 1 July and volatility caused by the US/China trade war, will 2019/20 be as good as the previous one?

Already, there have been two significant economic events in 2019 – the re-election of the Coalition Government and the two cuts by the Reserve Bank of Australia (RBA) – so Australia will be facing rather different circumstances than it had at the start of the year. 

POLITICS

Possibly the biggest event this year has already taken place with the re-election of the Coalition government at the 18 May Federal election.  

It was a shock victory for the Coalition who defeated frontrunners Labor after a five-week national election campaign. For markets, it was a positive as it ended a period of uncertainty and ushered in a second term of ‘more of the same’ for the Liberals under Prime Minister Scott Morrison. 

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Prior to the election, Australians had held off making big decisions due to the uncertainty around proposed tax changes put forward by Labor. This included holding off house purchases due to fears around possible negative gearing changes but since the election, house purchases have begun to pick up again with Sydney and Melbourne reporting a rise in residential property prices in June for the first time since 2017. Hopefully this is an early indicator that prices are at or near the bottom of their downturns. 

Dale Gillham, chief analyst at Wealth Within, said the positive reaction to the election result was because it was a case of ‘better the devil you know’ for businesses who had already priced in the potential negative effects of Labor.

“Businesses didn’t trust [Labor candidate] Bill Shorten, especially financial companies, as he was cracking down on underperforming union-backed industry super funds and the removal of franking credits. Whereas now we know who the Prime Minister will be for the next three or four years and we know what his policies are.”

In the aftermath of election day, the ASX 200 rose 1.7 per cent while the Big Four banks rose between six to nine per cent, reassured by the lack of a Labor government which could have dented their profits by reducing the capital gains tax discount and imposing higher bank levies.

Randal Jenneke, manager of the T. Rowe Price Australian Equity Strategy, said the re-election of the same Government indicated Australians voted for growth and jobs rather than the ‘more radical agenda’ put forward by Labor. 

“The clear election outcome rewarded investors with a short-term bounce across most sectors. As the excitement fades, the market’s focus is expected to return to more fundamental factors, such as the ongoing trade and tariff tensions between the US and China and domestic housing weakness.”
As to what the Coalition will look to do with its second term, Shane Oliver, chief economist at AMP Capital, said he expected more fiscal policy and infrastructure spending. 

“The share market should keep going up as investors had feared a Labor Government would be negative for bank, consumer and property stocks. The Federal government will look to do more fiscal spending, infrastructure spending and also focus on removing business regulation that has held back investment,” he commented.

MONETARY POLICY 

Oliver’s desire for more fiscal spending from the Morrison government was echoed by the RBA as it tries to get monetary policy under control. 

For the first time since 2012, Australia saw its interest rates slashed to 1.25 per cent in June, then to 1 per cent the following month. This is a record low for the country and makes them the sixth-lowest interest rate in the world. That is not all; speculation among economists remains rife that there will be a third cut this year which could see them come down below 1 per cent.

Governor Philip Lowe said the RBA’s reasoning behind the second cut was that inflation remained subdued, the housing market remained soft and the Australian economy was growing below trend. But unlike after June’s meeting, Lowe said in July that monetary policy would only be adjusted again ‘if needed’ to support sustainable growth.

However, once there had been a third cut, it is likely the RBA would need to find an alternative option if further support was needed, said Oliver. 

“Rates could be cut to 0.5 per cent but it would not be worth cutting them after that. It is more likely the Bank will do quantitative easing (QE) or fiscal policy. Doing QE would be a last resort but they could do it if it was needed. It would more likely be a combination of the two things,” he said.

Governor Lowe has already called on the Federal Government to do more to help the RBA in terms of fiscal spending and said monetary policy by the RBA should not be relied upon as the only option.

Speaking at an event in Darwin on 2 July, he said: “One option is fiscal support, including through spending on infrastructure [….] It is appropriate to be thinking about further investments in this area, especially with interest rates at a record low, the economy having spare capacity and some of our existing infrastructure struggling to cope with ongoing population growth.

“Another option is structural policies that support firms expanding, investing, innovating and employing people.

“Monetary policy does have a significant role to play and our decisions are helping support the Australian economy. But, we should not rely on monetary policy alone. We will achieve a better outcome for society as a whole if the various arms of public policy are all pointing in the same direction.”

Chris Rands, fixed income portfolio manager at Nikko AM, said: “I don’t think the RBA will deliver what the market expects, as many have been talking 0.5 – 0.75 per cent cash rates and quantitative easing. The economic data does not yet warrant this, so we would likely need to see a further economic slowdown before forecasting this outcome.

“Easing out of the European Central Bank and Federal Reserve could take some of the weight off the RBA. Should this improve the global outlook, the RBA may be able to adopt a slightly more positive tone.”

STOCKMARKETS

Moving away from fixed income and looking to equities, experts were sure the stockmarket would continue rising and would approach record highs this year. 

In the 2018/19 financial year, the S&P ASX 200 returned 11.5 per cent while the S&P ASX All Ordinaries index returned 11 per cent and industry experts said they expected stockmarkets would remain in positive territory, although returns would be unlikely to reach double-digit highs again.

Oliver said: “For the next six to 12 months, I think we will have reasonably good returns as global growth will pick up and the valuations on equities are not onerous. They will not be as strong as they were in the past 12 months but will still be good.

“We are only 1.5 per cent away from a record high on the All Ordinaries index but it has taken us 12 years to reach this point from the last record high during the mining boom. We haven’t had quantitative easing and the strong Aussie dollar has held us back.” 

This was echoed by Gillham who said it had taken Australia 140 months to approach a record high again, which he described as a ‘massive’ amount of time relative to normal market cycles.  

“The Australian stock market has so far traded up consecutively for the past six months, which is the second-longest period for a sustained rise over the last 10 years.  

“While a move down in the All Ordinaries index is inevitable, I don’t expect it to start moving down until late July/early August. Right now we are searching for a new all-time high before falling into the next low, which will occur sometime in late September/early October.

“Many may be concerned about the speculation of a significant fall in the market but the expected fall later this year is just part of normal market movements.”

As to potential detractors from stockmarket performance, there was universal agreement the ongoing trade war between the US and China remained the biggest risk to markets. 

US President Donald Trump and Chinese Premier Xi Jinping have been locked in tariff discussions for more than a year and the US has slapped tariffs on US$250 billion worth of Chinese goods while China has retaliated with US$110 billion tariffs on US goods. Although there have been periods of hiatus between the two countries, they seem far from reaching an agreement yet. It is even more pressing for Trump as he is starting his re-election campaign and will want to appear a successful negotiator before the election in November 2020. 

Jenneke said: “The risk is that the longer the current impasse continues, the more collateral damage there is likely to be to the global economy. History shows that spikes in policy uncertainty can weigh on consumer and business sentiment.

“Companies respond by reducing inventories and capex plans with adverse consequences for GDP growth and employment. The global economy is considerably less robust today than 12 months ago. So any negative spillovers from US/China trade fears are coming at a very inopportune moment.”

The impact would most likely be felt by the US, where tariffs could mean higher prices on consumer goods and fuel, but if the US enters into a recession, Australia will be unlikely to go unscathed as well as feeling the effects of rising volatility. 

However, JP Morgan’s chief economist, Kerry Craig, highlighted Australia has actually been a beneficiary of the trade war conflict thanks to the rising price of iron ore which had reached a five-year high of $126 per tonne driven by Chinese steel demand. The price had also benefitted from a dam collapse in Brazil at iron ore producer Vale which has taken millions of tonnes of production offline. 

“It’s said there are no winners from a trade war but Australia has been a beneficiary due to the iron ore price so we are actually gaining from it,” said Craig.

PORTFOLIO ACTIVITY

With the expectation of increased volatility and less-than-stellar returns from stock markets, managers were unsurprisingly taking defensive positions in their portfolios. 

Jenneke said: “The rising external risks and strong performance year to date has made us turn more cautious near term. We increased cash and reduced exposure to high-beta, economy-sensitive stocks and added to more high-quality, defensive, lower-beta stocks. 

“These changes were intended to protect against another sell-off while maintaining our positions in high-quality companies that we expect to drive alpha over the medium term.”

Craig said: “It is not the time to put everything in cash but you do have to be aware of the risks and be wary of how to position yourself. We are also talking to clients about diversification and uncorrelated return streams available from real assets such as property and infrastructure.”
As to specific sectors which could do well in 2019/20, Gillham tipped areas such as financials, energy, materials and consumer staples. 

“Companies like BHP Billiton, Rio Tinto and Fortescue Metals are going to drive the market and have a lot of upside, as do banks, led by Macquarie.Insurers also offer a potential value opportunity,” he said.

“We continue to see good opportunities in stocks with exposure to the Chinese consumer and select multinational structural growers with big offshore operations. We maintain our overweight position in healthcare, industrials and business services, and consumer staples,” added Jenneke.