Monthly Investment Review- July 2015
The S&P/ASX 200 Accumulation Index rallied to end the month up 4.4%, following a soft period for markets as Greece made its attempts to reach an agreement with the Eurozone. This was achieved despite falling commodity prices that saw oil and iron ore fall 21% and 10% respectively. A sharp fall in long-term government bond yields supported the defensive sectors and a 5% fall in the domestic currency aided companies with a large offshore exposure. Internationally the Chinese market closed down 14.3%. This is the worst monthly loss in six years and occurred despite extraordinary measures taken by the government to calm investor nerves.
A recovery following the resolution of the crisis in Greece (at least for now) has given way to some unease in the market and weakness in commodities. Key drivers of this unease include:
- US profit results to date have struggled to inspire markets therefore not providing a catalyst.
- Markets remain wary of emerging markets (China in particular) following some soft economic data (flash PMI) and the risk averse attitude of investors following the equities sell off. This is feeding into commodity markets and resource stocks resulting in these sectors hitting lows
We are becoming increasingly cautious about the outlook for the Australian economy based on the following logic.
- We have known for some time that the resource capex spend is about to roll over and that we need other areas of the economy to come to the rescue.
- But housing, especially apartments, is hitting a peak and banks are tightening lending into this segment. At the same time government regulations are affecting the opportunity for foreign investors.
- That leaves service industries like tourism and education as well as infrastructure and the consumer to make up the difference. With national incomes static it is difficult to see the consumer providing too much of the gap and, with the exception of NSW, government urgency on infrastructure is poor.
- This outlook supports lower interest rates and a lower currency.
The implications for our portfolios are that we:
- continue to look for currency-exposed stocks, particularly those that report in A$
- continue to look for quality opportunities in service industries
- minimise domestic cyclical exposures (which thankfully make up a smaller and smaller component of the market).
Hard landing for China
The Chinese equity market volatility has seemingly fed into concerns regarding the economic outlook for China, driving risk aversion and a selling of commodities. There were numerous newspaper reports describing the fall as ‘China’s Great Depression’. We make the following comments:
- The Chinese equity market has corrected, but the only people who have lost money are those who have bought since April of this year.
- The market was very ‘frothy’, having almost doubled from March to June. This move up was speculative, with margin lending increasing as investors chased the returns. Global investors barely raised an eyebrow at this market movement.
- The real economic impact comes from those who had geared up losing real wealth, and any future impact there may be on confidence. Actual economic data has been soft (but it has been soft all year) and the Chinese Government continues to stimulate the economy.
- The size of the Shanghai Index is small and represents only a small proportion of the Chinese economy relative to the size of markets in other developed countries.
The key enduring concern we have is that the steps authorities have taken to protect equities may undermine confidence in the asset class. The movement in commodities has clearly stepped down and this has been reflected in equity prices. The key question is whether this selling is now capitulation and begins to represent an opportunity, or whether it signals a hard landing for China. We think the odds of further government stimulus for China are increasing, which could provide a circuit breaker for the situation. Results for BHP and Rio Tinto that confirm dividends might also create a circuit breaker for these stocks.
We continue to focus on those companies that are best placed to deliver growth via:
- strong business models with structural competitive positions
- exposure to offshore markets so that profits will benefit from the lower A$
- exposure to growing segments of the economy (housing, finance and infrastructure)