share market review 30th september 2018 · 2019-06-13 · 1 | p a g e daniel rolley, cfa (head of...

1 | P a g e Daniel Rolley, CFA (Head of Research)

Share Market Review – 30th September 2018

Australian Share Market Review and Outlook

The ASX 200 finished the September quarter marginally higher, up 0.2% to 6208. The strongest

sectors during the quarter were Telecommunications (M&A activity) and Information Technology

(appetite for growth stocks reaching euphoric levels). Key underperforming sector during the

quarter was Materials (due to concerns over China economic growth).

The Telco sector has been the worst performing on the ASX over the last year due to the well-

publicized challenges facing the sector, which was partially reversed this quarter due to M&A

activity, with TPG Telecom and Hutchison (owner of Vodafone) announcing a merger deal. The TPG

deal brings together the fixed broadband assets of TPG and the mobile assets of Vodafone and will

result in significant cost savings through shared overhead costs. The deal in no way alleviates the

competition challenges facing the sector, and in our view is a small negative for Telstra given a more

competitive player in the form the merged TPG/ Vodafone entity.

Our ASX 200 year-end target is 6180 which is broadly in-line with current levels. Our model is based

on consensus earnings forecasts of ASX 200 companies for 2018 and 2019. This forecast assumes

earnings grow at 7% and 9% respectively in 2018 and 2019. Given the modest equity market return

expectation for the next 6 months we reiterate the importance of sector and stock selection.

Above: The ASX 200 is trading at 10-year high above the technically and psychologically important

6000 level


Sector Highlight: Resources

Commodity prices have sold off during the year, taking resource stocks with them - the MSCI World

Metals and Mining index is down 20% year to date. The culprits for the selloff include (i) concerns

over economic growth in China, (ii) dislocations and disruptions to global growth from US led trade

wars and (iii) the strength of the US dollar (commodity prices move inversely with the dollar). It is

important to keep in mind the strength of the sector over the last few years, which is up 100% since

the low in 2016.

As the global economic cycle matures we remind clients that rising inflation will be supportive of

commodities prices. Unlike previous cycles the big mining companies are handing cash back to

shareholders (ala RIO buyback) rather than squandering it on overpriced acquisitions (ala BHP US Shale

Assets). The other notable positives for investors in the sector is the strength of balance sheets and

quality of assets. These two characteristics mean that any prolonged weakness in commodity prices

can be withstood by the likes of Rio Tinto and BHP Billiton. While cooling commodity prices is no fun

for investors in the sector, the free cashflow generation and dividends provide a steady stream of

income to offset short term capital volatility.

Ticker Name

Dividend

Yield

Price Earnings

Ratio Free Cash Flow Yield

BHP BHP Billiton 5.20% 14 11%

RIO Rio Tinto 5.30% 12 10%


Performance Tables

Returns (%) Current 3 Month 6 Month 12 Months YTD

S&P/ ASX 100 5099 0.2 7.8 7.6 2.2

S&P/ ASX 200 6208 0.2 7.9 8.3 2.3

S&P All Ordinaries 6326 0.6 7.9 9.2 2.6

S&P 500 (United States)

2914 7.2 10.4 15.7 8.1

ASX 200 Sectors

Returns (%) 3 Month 6 Month 12 Months

Consumer Discretionary -0.2 7.1 16.9

Consumer Staples -2.5 5.6 19.2

Energy 1.5 18.8 27.2

Financials -1.4 -2.7 -4.1

Health Care 3.1 16.4 40.6

Industrials 2.8 7.4 9.2

Information Technology 4.7 11.8 36.4

Materials -6.3 0.6 10.4

Telecommunications 21.9 -0.2 -2.1

Utilities -5.0 1.3 -2.5


US Share Market Review and Outlook

The US share market posted another strong gain for the quarter, putting on 7.2% and taking the 12-

month growth rate to 16%. Gains were led by Health Care, Industrials and Financials.

Notable stock performances from our House names include Apple (+22%), Honeywell (+15%) and

Amazon (+18%). Underperformers came from Facebook (-15%), and the deeply cyclical

Semiconductor sector, with Intel (-5%) and Applied Materials (-16%) both having soft share price

reaction to reasonable quarterly earnings results.

We flagged a more cautious stance on Facebook prior to its poor result, and in our view the

operating environment is likely to get worse before it gets better. On semi-conductors, we think the

semi cycle will be firmly supported by longer term structural growth trends (from increasing data

storage, transmission and processing) but acknowledge the markets short-term worries may weigh on

the sector over the next few months.

Lead indicators for economic expansion remain firmly in expansion territory, on both the

manufacturing and services side of the economy. Tax cuts and government spending is helping

provide additional boost to business confidence. In the labour market there are signs of tightening

conditions with wage inflation starting to pick up. The Federal Reserve is on track to lift rates 2 to 3

times in 2019, as part of its rate normalisation process. Our expectation is that interest rate increases

will be shallow and gradual, and thus not a headwind for company profits and share prices over the

next 12 to 18 months.

Leading Economic Indicators point to continued expansion, earnings growth remains robust and

valuations are broadly in line with their 20-year historical average.


Fixed Income Review

Bond Yields lift

Bond Yields in Australia and the US both moved higher during the quarter, with relative strength

shown by US yields as the Federal Reserve positioned for more interest rate hikes and signs of

tightening in Australia remain at least 12 months away. This action helps explain the weaker

Australian Dollar which finished the quarter down 2% to US$0.72. We reiterate our view that the 30-

year bond bull market has finished, with the result being higher interest rates (and inflation) over the

coming years. This will impact all asset prices including equities, and we look for investments that can

maintain their purchasing power in real terms (i.e. preferring floating interest rate securities all else

equal).

Credit Spreads remain contained

The difference between high yielding corporate bond yields and “safe” government treasuries

reflects the markets risk appetite or aversion. Currently the difference is near decade low levels which

signals that lenders are not concerned about higher risk companies being able to pay their debts. This

is supportive of risk markets more broadly, as it means that companies can borrow at affordable rates.


Asset Allocation: Equities Dividend Yield vs Cash Yield: United States cash rates a viable alternative

to equities dividend yields

In Australia there remains a yield advantage from equities (vs cash), whereas in the United States

that advantage has eroded over the last few years as equities yields have declined (due to rising

share prices) and cash rates have increased. That is, United States cash rates are offering a viable

alternative to Equities on an income basis for the first time since 2009. This is important from an Asset

Allocation perspective as we get later in the cycle, considering both capital preservation and income

generation from defensive assets like cash and floating fixed income securities.

Australian equities dividend yields still command a premium over cash rates (i.e. Australian equities

look attractive vs cash on a yield basis). Rising interest rates in the United States has pushed the

Dividend Yield premium over cash to nearly zero (i.e. Equities equally attractive to cash on a yield

basis).


International Equities: Comparing Sector Valuations and Growth

We have been an advocate for investing in International Equities for a range of reasons, including

the complementary sector exposures that one can access by going offshore. This includes Industrials,

Technology and Health Care. Two important factors that also illustrate the attractiveness of

International investing is the relative valuation and growth between Australian and United States

equities. In the charts below, we highlight the attractive valuations (lower Price Earnings multiples)

and attractive growth rates (higher earnings growth rates) by sector.

Valuation: US offers more attractive stock valuations in the Health Care, Industrial and Technology

sectors than Australia. In addition, the US has greater depth and provides a fruitful hunting ground

for active investors.

Earnings Growth: US companies offer comparable or significantly higher earnings growth rates than

Australian companies.

0

5

10

15

20

25

30

35

Price Earnings Ratio

AU US

-30

-20

-10

0

10

20

30

40

Earnings Growth (%)

AU US


Equities Style Comparison: Value vs Growth

We think about the equity market in terms of style: Growth (companies with higher earnings growth

rates and valuation multiples) and Value (companies with higher dividend yields and lower valuation

multiples). Growth has outperformed Value over the last decade and has reached extreme levels.

When we group stocks by valuation multiple (High, Medium and Low), we observe that the most

expensive stocks in the market continue to get more expensive (that is, stock prices increase due to

investors willingness to pay a higher price for a given level of earnings).

The key implications of this is that the margin of safety is getting thinner, and like a rubber band being

stretched, will eventually snap back when earnings growth rates moderate. In practical terms this

behaviour results in prices falling due to both valuation and earnings contraction.

Investment implications of this are that we are leaning our portfolios towards lower valuation stocks

and are increasingly focused on the level and direction of growth rates being offered by expensive

high multiple stocks.

Growth stocks have outperformed Value stocks over the last decade.

This type of behaviour was most pronounced prior to the “Tech Wreck” in the year 2000. We think it

is prudent late in the economic cycle to be somewhat contrarian and protective of investment capital

by having a very close watch on company valuations and trimming expensive positions.


A Global Equities Mandate: Making the most of the best-quality investment opportunities across

the world

We have been advocating that investors should be seeking to invest in the highest quality

companies, with the best growth prospects that are the most attractively priced vis-à-vis a global

universe of stocks. Historically there have been many obstacles to thinking globally, including physical

access to foreign stock markets, knowledge gaps, currency risk and asset-liability mismatch.

In 2018 some of these barriers do not exist anymore, including access to markets and knowledge.

There will always be currency risk (unless you engage in FX hedging) and asset-liability mismatch, but

we believe investors with a medium to long term investment horizon should be able to plan for this.

In the tables below, we compare a range of domestic and international companies across sectors to

illustrate various fundamental characteristics, including valuation (Price-Earnings multiple), income

(dividend yield), growth (EPS Growth), quality (Return on Equity) and valuation-adjusted for growth

(PEG). Our observations are that there are generally higher quality, better growth and cheaper

valuation opportunities offshore vis-à-vis domestic listings.

The hurdle rate for any domestic investment, in our view, should be the global diversified best in

class companies such as Apple, Johnson & Johnson, JP Morgan and Honeywell. As such, we advocate

thinking globally for any equities allocation discussion, and setting a high bar when it comes to

benchmarking our domestic equity investments.

United States Listed Opportunities

Australian Listed Opportunities

Sector Name PE Yield EPS Growth ROE PEG

Technology Apple 15.8 1.5% 18% 49 0.9

Alphabet 24.9 0.0% 20% 18 1.2

Health Care Johnson & Johnson 16.5 2.7% 8% 34 2.1

Amgen 14.0 2.7% 6% 42 2.3

Consumer Discretionary Home Depot 20.9 2.1% 15% 716 1.4

Amazon 81.2 0.0% 103% 33 0.8

Financials JP Morgan 12.0 2.7% 17% 14 0.7

Industrials Honeywell 19.3 1.9% 10% 34 1.9

Telecommunications Verizon 11.3 4.5% 9% 39 1.2

Sector Name PE Yield EPS Growth ROE PEG

Technology TechnologyOne Ltd 29.4 2.2% 13% 30 2.2

Altium 45.7 1.6% 27% 33 1.7

Health Care CSL 33.1 1.4% 13% 42 2.6

Cochlear 41.0 1.7% 12% 42 3.5

Consumer Discretionary JB Hi-Fi Ltd 11.9 5% 2% 24 7.7

Wesfarmers 18.7 5% 4% 13 4.8

Financials Macquarie Group 15.3 5% 7% 16 2.2

Industrials Brambles 18.5 3% 7% 20 2.8

Telecommunications Telstra 15.7 5% -15% 16 -1.1


Disclaimer

The opinions expressed in this presentation and the accompanying documents are those of the

Chancellor Portfolio Services Pty Ltd and are subject to change. Although all information in this

presentation and documents is obtained from sources believed to be reliable and in good faith, no

representation of warranty, express or implied is made as to its accuracy or completeness. The

document may not be reproduced or copies circulated without prior authority from Chancellor Portfolio

Services Pty Ltd (ABN 88 079 006 367) (AFS Licence No. 241429). The information provided during this

presentation must not be relied on to make a n investment decision. It is not an offer or

recommendation to acquire an interest in the products or securities mentioned.

You should consider your own personal circumstances and obtain professional advice before making

any decision about whether to acquire or continue to hold any investment in the products or securities

mentioned in this presentation and accompanying documents.

Your investment is subject to investment risk, including possible delays in repayment and loss of income

and capital invested. The repayment of capital or income is not guaranteed in any way by Chancellor

Portfolio Services or it employees. Performance can be volatile and future returns can vary from past

returns.

This presentation and accompanying documents is intended to provide general information only and

has been prepared by Chancellor Portfolio Services Pty Ltd without taking into account any particular

person’s objectives, financial situation or needs. Investors should, before acting on information

provided in this presentation, consider the appropriateness of this information having regard to their

personal objectives, financial situation or needs.

share market review 30th september 2018 · 2019-06-13 · 1 | p a g e daniel rolley, cfa (head of...

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