OC Funds Outlook
As we enter calendar year 2020, there remains plenty to be optimistic about with the global economy tracking solidly, the US and China have announced an agreement on a “phase one” trade deal and global interest rates remain near record lows and looking likely to stay that way for some time.
The domestic economy has slowed over the second half of the year but there is some cause for optimism from an economic perspective entering the new year, although the awful bush-fires have put a major dampener on the Christmas and new year celebrations and our hearts go out to all of those impacted by this terrible disaster.
The Sino-US trade dispute received a significant amount of air time in 2019 and there has been a raft of ‘false starts’ in reaching agreement on key issues so it is pleasing to see some progress being made with the announcement of the first phase of the deal in mid- December. Whilst the full terms of the agreement are yet to be revealed, it seems that the US has agreed to rescind some existing tariffs and delay the imposition of new ones in order to lower trade tensions (which could materially hurt the economies of both countries).
In return, China has agreed to buy US$40-$50b of US farm products and made fresh commitments to improve intellectual property protections.
The deal is expected to be inked in Washington on January 15 and Trump has said that he will travel to China “at a later date” to begin second round talks.
Whilst the agreement falls well short of resolving the more contentious issues between the two countries, including forced technology transfers and intellectual property protection, the de-escalation of tensions comes as a welcome relief and gives some cause for hope that a broader, more permanent deal is possible, notwithstanding the fundamental ideological differences between the two global superpowers.
In the US, which remains the most influential driver of the global business cycle, the economy is strong heading into 2020, with robust economic growth, the unemployment rate holding a near 50-year low and inflation seemingly in-check.
We have entered an election year in the US and despite the ongoing controversy over impeachment of the incumbent President this is likely to be a sideshow with the broader election, scheduled for November 2020, to take centre stage.
Trump is generally seen as “market friendly” and any indications that he may not be returned to office could trigger a market sell-off.
The actions of the US Federal Reserve (the Fed) will once again be critical to equity market performance.
Rates look to be on hold in the US over the medium term which ought to be supportive of equity markets.
Depending on the path of inflation and employment, investors could begin to price in Fed rate hikes from 2021. We view the Fed’s
monetary policy decision making as the most important policy variable that we will be monitoring in 2020.
The Chinese economy, another major driver of global growth, continues to face headwinds entering 2020.
The People’s Bank of China has recently announced that it would again cut its reserve requirements, freeing up about US$115b to boost lending and spur economic growth.
The move follows similar action in September and suggests that the central government remains concerned about faltering growth, despite signs that the world’s second largest economy is stabilising.
China’s leaders are contending with the slowest pace of growth for almost three decades and the country’s slowdown has rippled through the global economy, including Germany which has narrowly avoided recession as its manufacturing sector has slumped, in part due
to reduced demand out of China.
China’s struggles have impacted much of Asia where it is the dominant economy, as well as Africa, Latin America and other parts of Europe which have seen their manufacturing sectors contract.
China remains Australia’s largest trading partner by a considerable margin so we will be monitoring its economic progress carefully in the new year, particularly its appetite for natural resources which has a large overall impact on the Australian economy.
Little has changed in domestic economy over the quarter and the Reserve Bank of Australia (RBA) kept rates on hold at 0.75% following 25 basis points cuts at each of the June, July and October meetings.
On a domestic front, the national accounts released early in December indicate that the Australian economy continues to grow below the long-term average, expanding by an underwhelming +0.4% in the September quarter, with annual growth rate of +1.7% marginally above the +1.6% recorded in the June quarter.
Whilst this could technically satisfy the RBA’s assessment that the economy has passed a ‘gentle turning point’, we remain cautious on the economy’s trajectory into 2020 and expect at least one further interest rate cut in 2020.
Anecdotally, our straw poll of retailers and service providers suggests that it was a solid, but not spectacular, Christmas trading period.
We remain underweight domestic cyclical exposure heading into the new year, although we expect that there will continue to be companies that perform strongly with Kogan.com Ltd and Baby Bunting Group Ltd among our preferred exposures.
Renewed strength in the property market is a genuine cause for optimism with house values surging +4% in the December quarter according to leading property analytics group, CoreLogic.
The residential market has been bolstered by lower interest rates and an easing of credit conditions and we expect property prices to rise further into the new year, with some bullish commenters forecasting double digit returns in the key Sydney and Melbourne markets.
The sentiment impact of rising property prices is likely to provide a boost to consumer spending in 2020 via the so called ‘wealth effect’ whereby consumers typically feel more comfortable spending money in an environment of rising house prices.
We will be monitoring this carefully into 2020 and will look to add to our retail exposure should the consumer environment improve.
In recent days, tensions between the United States and Iran have soared following the assassination of Qassem Soleimani, who headed the foreign arm of the Islamic Revolutionary Guard, Iran’s elite military force. Soleimani was deeply popular domestically and also amongst Tehran’s allies and both Iranian President, Hassan Rouhani, and the supreme leader, Ayatollah Ali Khamenei, have vowed to exact swift and severe revenge.
The killing, by drone strike, was sanctioned directly by US President Trump, with the US Department of Defence claiming Soleimani was developing plans to attack American diplomats and military personnel throughout the Middle East region.
Global markets have gone into ‘risk-off’ mode following the airstrike and equity markets have retreated, the oil price has spiked above US$70 per barrel and the gold price has hit a six-year high.
It is difficult to predict the long-term effects of this move by the US.
Whilst a retaliatory response can be expected from Iran, the country is struggling economically.
Iran has said it would no longer abide by any limits of an international nuclear deal agreed in 2015, which aimed at preventing Tehran from building atomic weapons.
President Trump has issued a threat to hit 52 Iranian sites “very hard” if Iran attacks American or US assets in retaliation for the attack.
Should hostilities between the two countries escalate - clearly a distinct possibility - a sharp market correction can be expected.
We will monitor developments carefully in the coming days and weeks and stand ready to make any changes necessary to the portfolio.
We have now entered the ‘black-out’ period between the end of December and the February reporting season.
Most corporates are enjoying their summer vacations and those broking firms that are open are operating on skeleton staff.
As such, limited stock-specific news is typically released in the month of January.
January is likely to provide some welcome respite from company meetings for the investment team after a very busy end to 2019, albeit we continue to work diligently throughout the month preparing for the year ahead and making any portfolio changes that may be necessary to deal with the changing geopolitical climate or as a result of the terrible bushfires.
We would like to thank our investors for their ongoing support throughout 2019 and wish you all the best for
a safe and prosperous new year. We enter the 2020 confident our stocks are performing well operationally and that we can continue to deliver attractive long-term returns for our investors.”
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