15 Jan December Market Commentary
The title above says this is the December monthly commentary, and traditionally the end of year note includes a review of markets and their performance over the last twelve months. Whilst we will follow that pattern immediately below, we will then take the opportunity to provide some context to the volatile first couple of weeks of market activity in 2016, and then more importantly share our long term views and the events that are likely to influence how we manage your portfolio for the long term.
The Australian ASX200 index fell by 2.1% in price terms over the year just completed, but managed to eke out a positive 2.6% return when dividends were included. Somewhat similarly, the index tracking the Financials sector was down by less than 1% and provided investors a 4.7% return due to the attractive dividend income. As has been widely reported it was a very difficult year for the Resources sector which finished the year 25% down even after accounting for dividends. Internationally, and in local currency terms, the US market managed a gain of about 1% while across the Atlantic London’s FTSE 100 fell by about the same amount. In Europe the story was better however, perhaps starting to reflect the economic recovery underway, with the broad European market finishing 11% up on 2014’s close, and similar results in the indices for both Germany (+10.0%) and France (+13.5%). Rounding off the Developed Markets we also saw Japan’s Nikkei 225 add 11% for 2015.
It may come as some surprise that in fact there were also similar results for several of the mainland Chinese equity market indices. The index that tracks 300 companies listed on both the Shanghai and Shenzhen exchanges returned 10.6% for the year, though of course that figure masks significant volatility that has continued in the first weeks of the new year. Finally, let us conclude this introductory discussion by covering currencies and commodities. The Australian Dollar has recorded another significant decline over the year, falling by almost 11% against the US Dollar, though has been relatively stable in the 70c to 75c range for the second half of the year. If we look back at year end values for our currency we see US$1.04 at the end of 2012, falling to US$0.89, US$0.82 and now US$0.73 in the subsequent years. Of course the collapse in the oil price has been dramatic and widely reported, last year falling to US$37 a barrel down from US$98 at the end of 2013. And for Australian mining companies the impact of an even steeper decline in iron ore prices has been profound, falling over the last two years from US$135 to US$71 and then US$44 at the end of December.
2015 was certainly a challenging year and volatility has characterised the start of 2016. Yesterday the most prominent story on the Sydney Morning Herald’s home page carried a headline “Sell Everything”1 and warned of a cataclysmic year ahead. Seemingly as somewhat of an afterthought this same piece noted however that austerity policies were over in Europe, that fiscal policy in the US was expansionary, and that China’s slowdown had hit bottom in June and been followed by an admittedly fitful recovery. One can’t help but wonder how many readers made it that far in the article, or whether their conclusions, and more importantly their sentiment, would have been based solely on the headline. We will also keep an eye out and let you know when we see the follow up piece where the lead story on the Herald’s web site will be “Time to Get Back In”.
In the meantime, these sorts of episodes remind us of the importance of a consistent approach to portfolio management that is understood and accepted by all the parties involved. To be clear, we are not in the business of making short term calls such as “Sell Everything” and then moving an entire portfolio to cash and bonds, as we do not believe that investment managers are able to consistently make these sorts of calls accurately. Our management of your portfolio will continue to be informed by our long term views and we will continue to regularly share these forecasts with you along with our thinking that supports them.
Before we move on to the discussion below of the regional macroeconomic environment, we provide a couple of observations about the first two weeks’ market activity for 2016. After a rally late last year, the ASX200 is now trading back where it was in mid-December, also where it was in mid-November, and again where it was in both late September and late August. In other words, despite the reporting and the sensational headlines the trading range that has prevailed since August 2015 for now, as of mid-January, remains intact. Is it possible that this may not continue to be the case? Of course it is, though whether this would be in the form of a sentiment driven decline or a fundamentally supported rally, is not something about which we make short term predictions.
The first significant economic data for 2016 confirmed continued strong jobs growth for the US economy, though once again this was accompanied by somewhat lacklustre wage growth and benign inflation. This combination though is expected to support the Federal Reserve’s normalisation of monetary policy, and expectations are moving closer to 50/50 that a second rate increase may be forthcoming from the committee’s meeting in March. This assumes of course that the subsequent data continues to affirm that the recovery remains on track. The trajectory of that economic recovery remains below what officials would like to see, but nonetheless significant progress has been made.
This, though, provides an important reminder that we need to be clear about how we analyse a country’s economy as opposed to their equity market. In our forecasts we have for some time been expecting profits to revert lower, that is to adjust downwards to levels more consistent with both their own historical averages and sustainable levels observed in industries around the world. To date this has not occurred. However, there may be signs that gravity is starting to assert itself, as the Wall Street Journal recently noted: “A comprehensive measure of companies’ profits across the U.S.—earnings adjusted for inventory and depreciation—dropped to $2.1 trillion in the third quarter, down 1.1% from the second quarter, the Commerce Department said Tuesday. Compared with a year earlier, profits fell 4.7%, the biggest annual decline since the second quarter of 2009. That marked only the second time profits have fallen on a year-over-year basis since the recession ended in mid-2009.”2 Other sources report that the trend is likely to have been extended to the results for Q4 profits, and of course this comes at a time when interest rates are now starting to increase, which may put downward pressure on valuations.
Intervention by authorities to support a struggling share market is not a course of action in which the Chinese are alone in having pursued in recent years. Following the financial crisis there were a range of measures implemented in share markets including our own, extending to a ban on short selling particular companies, which otherwise allows speculative investors to bet on shares prices falling. That said, the extent and manner in which the Chinese have gone about their own attempts to support their markets have undoubtedly served to weaken sentiment globally, and has led some to question the efficacy of the Chinese leadership. In part what has led to the violent intra-day moves in early 2016 has been an acknowledgment that many of these policy measures were ineffective, including recently a so called ‘circuit breaker’ that shut down markets when they declined by more than 7% in a short period. While the international markets remain skeptics for the time being, the Financial Times3 has reported that a new cabinet office has been established to better co-ordinate financial and economic policy, a move seen as a tacit admission of the recent policy mistakes.
As for the economic transition in China, it remains a story of steady progress being made but with much more to do. Respected China observer Stephen Roach summed this up recently:
The results have been mixed. China has been highly successful in its initial efforts to shift the industrial structure of its economy from manufacturing to services, which have long been viewed as the foundation of modern consumer societies. But it has made far less progress in boosting private consumption. China now has no choice but to address this disconnect head on.4
Current and coming reforms have been designed explicitly to address this issue, and are expected to feature prominently in the 13th Five Year Plan which will be announced in March 2016.
We will focus predominantly on the Australian economy and investment outlook in our January monthly commentary that will be published in a few weeks’ time. Let us note however for now that our economy continues to perform in line with expectations, albeit ones that have been moderated in recent times. Evidence continues to mount that we are managing the process of transition away from the investment led mining boom, that exuberance in parts of the residential housing market is abating and importantly that the labour market is continuing to perform strongly. Jobs data just released shows more full time jobs added and our unemployment rate steady at 5.8%.
1. Ambrose Evans-Pritchard, “RBS tells investors: ‘Sell everything’” – smh.com.au. 12-Jan-16.
2. Kate Davidson & Theo Francis, “Falling Corporate Profits Blur US Growth Outlook” – wsj.com. 24-Nov-15.
3. Tom Mitchell, “Chine to set up unit to co-ordinate economic and financial policy” – ft.com. 13-Jan-16
4. Stephen Roach, “China’s Macro Disconnect” – Project Syndicate. 25-Nov-15.
NOTE: It is important to note that each portfolio is managed to its own mandate, which can mean that activity mentioned above is not reflected in your own portfolio. This may be because it is more beneficial to your portfolios after tax performance to complete the trading at a different time, or may be due to individual customisation that you have requested. This flexibility is an integral part of the investment process. If you would like to discuss the tailoring of your portfolio please contact your Adviser.
DISCLAIMER: The information in this commentary has been provided for publication by Implemented Portfolios (ABN 36 141 881 147. AFSL Number 345143). The information has not been verified by Implemented Portfolios or Adapt Wealth Management (ABN 33 711 661 027 Corporate Authorised Representative of Paragem Pty Ltd AFSL 297276) but is believed to have come from reliable sources as noted in the acknowledgements. No Liability is accepted by Implemented Portfolios, or Adapt Wealth Management Pty Ltd, its Directors, officers, employees or contractors for any inaccurate or incorrect information. The information is a broad commentary and there is no intention that a client should act on the information without seeking professional assistance from their own advisers (legal, tax, accounting, financial planning) for suitability in respect of their unique circumstances.
About Reuben Zelwer
Reuben Zelwer established Adapt Wealth Management in 2011 to help time poor clients achieve financial freedom. For over 15 years, Reuben has helped professionals, executives, business owner and those approaching retirement make the most of their circumstances by making good financial decisions. Reuben’s professional practice is complemented by substantial voluntary work, which has included setting up financial literacy and savings programs in the local community.