So that was 2018, what about 2019?
It was a bit like the old footy cliche that gets thrown out in every post-match interview: “It was a game of two halves”…
Is 1 Year all that important?
Before I go any further, I want to stress the point that in the context of investment markets, one year is an incredibly short period of time. The shorter the time period for an investment, the closer it becomes to speculation. There are so many yardsticks in markets that are obsessed with the short term, and this presents its own problems. Consider the thousands of fund managers competing against each other to win funds – they get measured on performance. But usually not 10 year, 20 year, 30 year performance. Often, it’s the current year’s performance figures that carry the most weight. So, the fund managers focus on this, which leads to some trading decisions based on the wrong motivations. When this behaviour is spread across an entire market – such as the Australian equity market – then you see some irrational movement in company prices. We are definitely seeing this right now as we round out what has been a fairly volatile few months.
With that in mind, what did happen this calendar year in terms of numbers?
Australia – S&P ASX 200
Returned a negative -6.90%
– Down 13% from the high of August
Australia – Small Ordinaries Index
Returned a negative -11.26%
– Down 19% from the high of August
US – S&P 500
Returned a negative -7.03% for 2018
– Down 18.3% from the high of September (this includes a rebound of 5.7% in the last few sessions)
– Note the difference in returns of the ASX top 200 and the Small Ordinaries, which is comprised of the small and mid-cap companies. Over the preceding 6-7 years, the small and mid caps are where so many investors have added meaningful alpha to portfolios. This trend was well and truly bucked in 2018.
So that’s the story of the indexes, but at a micro level there was more to it than the market drifting lower this year. We saw companies severely punished not just for weaker numbers, but also for anything less than a stellar outlook. This was particularly pertinent in the small to mid-cap space where we saw outlooks change quickly, and share prices punished savagely. No investor will ever get every pick right, but it’s important to assess what went wrong and what can be learnt so as never to fall victim to the same mistake.
2018 saw a reversal of the trend that had played out over the preceding three years, which was a high premium put on new companies coming to market that proved themselves. This year saw new entrants treated with scepticism even after they proved themselves in their first set of numbers. If they missed their first numbers, they were dealt with swiftly and harshly.
This led to a broader market sell-off for a couple of reasons:
- Portfolio protection (fund managers locking in profits elsewhere from companies that hadn’t yet downgraded)
- The implication being the sectors were hurting, therefore fund managers selling companies that hadn’t yet downgraded
This meant we saw quality companies being dragged down by the sub-par performance of peers.
While this is frustrating, it is also something that happens in the equity market and something that presents opportunities. There are many in the investment community happy to put 2018 behind them, as it was a tough year.
Looking to 2019
When we look to the global economy, the IMF is predicting global growth has peaked in 2018 and that US growth will shrink from 3% to around 2.5%. When looking at the US there are a couple of interesting factors at play:
• Quantitative Easing (where the Federal Reserve was pumping money into the economy) has come to an end
• Interest rates are rising
• Corporate tax cuts have been absorbed into corporate earnings
Those three factors in isolation are not overly positive for equity markets, so when combined will most likely put a cap on equity valuations in the US.
Looking at Australia, I’m a little more positive. This from the recently published Morgans Investment Watch:
“Domestically, the economy continues to track slightly above trend with GDP growing at 3.3% for Q3 2018. Surveys of business conditions remain above average and job creation continues at strong pace averaging 21 thousand new positions per month in 2018.”
There will be positives in the Australian market, but there is also cause to be extra vigilant in company selection. Below are just a couple of thoughts:
With house prices falling – for many Australians this is by far their asset of largest value – and banks cutting back lending, this has flow-on effects for many industries. Retail will suffer, and the larger retailers will get more creative to attract business, e.g. extended interest-free periods on financing new purchases. As we’ve seen in recent times, this starts entering the realm where ASIC takes a dim view. It’s tough and going to get tougher for the retailers.
Banks are under the spotlight from a Royal Commission which is never positive for share prices. Many question where their growth will come from. I don’t think they’ll grow much more (if any) than the economy this year but that doesn’t mean I’m negative. I think that is priced in, and you’ll see the banks extract efficiencies from their businesses by way of cost-cutting. The big four banks are paying dividends at close to the highest they’ve been since the GFC, and I think with the exception of NAB, those dividends are sustainable – for now.
Franking Credits are a focus with the inevitable change of Government, given Bill Shorten has said he will scrap refunding them to shareholders. This helps explain some of the weakness in bank share prices, but even if you were to allow for zero franking credits, the banks are still paying a very healthy yield.
Of all the things humans are good at, prediction is not one of them. So I will never try to predict what the market will or won’t do, especially in a time frame such as a year. What I will always do is try to find quality businesses that are selling at fair, or cheap prices. When everyone around you is panicking, that’s exactly when you’ll find the most bargains – it’s a matter of having the cojones to back your judgement!
So here’s to 2019!