Quarter in review: December 2019

Despite a modest retracement in the month of December, the Australian equity market finished the December quarter up 0.7%. This capped a stellar calendar year for the local market up 23.8%, the strongest year since 2009.

The local market did significantly underperform global equity markets in the December quarter, with the S&P 500 up 9.1% and emerging markets up 11.7% after responding positively to the announcement that the US and China had reached a Phase 1 agreement in the ongoing trade war. At a sector level the standout performer was Healthcare (+13.6%), led by CSL, with growing expectations of an FY20 earnings upgrade. Energy and Materials were sought after as improving global PMI and reduced trade tensions point to stronger economic activity in 2020.

The major sectoral drag on the market was the Financials Sector (-5.8%), hit by high profile regulatory problems at Westpac and a generally anaemic Bank reporting season. Consumer Staples (-2.5%) and the Real Estate Sector (-0.5%) also underperformed, reflecting rising bond yields both locally and globally.

The key developments for the quarter were:

  1. US Federal Reserve (Fed) cuts rates by 25 bps in October, but now on hold into 2020 – This was the third FOMC cut to the Fed funds rate in 2019 as expected, but the Fed also signalled an intention to take a pause in the easing cycle. At subsequent meetings in November and December, the FOMC left the funds rate unchanged, while the updated “dots” indicate that a large majority of the committee members forecast keeping policy on hold for the duration of 2020.
  2. Real progress in the ongoing US-China trade dispute – After months of posturing and rhetoric the parties appear to have reached an agreement to move to “Phase 1” of a trade deal, with formalisation expected in mid-January 2020. The deal is expected to include an agreement on intellectual property treatment, China agreeing to buy an additional US$200bn of US goods, currency stability and a reduction in 50% of tariffs imposed by the US on Chinese imports.
  3. RBA distances itself from QE but keeps the door open to further rates cuts in 2020 – From a monetary policy perspective the RBA cut the official cash rate for the third time in early October 2019 by 25 bps, down to 0.75%. In the following two meetings it left rates unchanged. However the minutes to the RBA’s December decision reflected a more dovish tone, while the guidance was unusually specific about prospects for a re-evaluation at the next meeting, stating “it would be important to reassess the economic outlook in February 2020, when the bank would prepare updated forecasts”, at which point the Board “had the ability to provide further stimulus to the economy, if required”.With some concerns over a deteriorating local economy, the RBA Governor delivered a highly instructive speech in November entitled “Unconventional Monetary Policy: Some lessons from Overseas” which was used as a platform to outline what Quantitative Easing in Australia might look like, in the unlikely event of it becoming an option.
  4. Australian economic signals remain mixed – The recovery in Sydney & Melbourne house prices continues and this is expected to lead to an uptick in turnover transactions in 2020, which should cause a positive ripple effect through the economy. November retail sales were released and reflected a solid lift as Black Friday Sale becomes a more significant event for retailers and bargain savvy consumers. However broad-based feedback suggests more muted trading in the more traditional December holiday trading season.
  5. MYEFO surplus on track, but no immediate stimulus – The mid-year update indicated the government was on track to deliver a budget surplus of $5 billion for 2019/20, down slightly from the budget estimate of $7.1 billion, as a consequence of a slower global economy, with low wages growth and the ongoing drought weighing on the domestic economy. Beyond additional funding to the aged care sector, Treasurer Frydenberg resisted calls to bring forward planned future tax cuts or introduce any new stimulus packages.
  6. Energy Prices rise on improving growth expectations and simmering geopolitical tensions – A combination of positive developments in the US-China trade dispute and signs of an uptick in manufacturing PMI are supportive of stronger global economic growth in 2020 and more robust oil demand. This was reflected in a solid increase in energy prices over the quarter with Brent Oil rising 11.3% to US$66/bbl. Moving into 2020, any escalation in the current hostilities between Iran and the United States could result in a geopolitical uncertainty premium on top of a more favourable supply/demand dynamic, as it appears US shale production growth is likely to be less than expectations.
  7. Brexit: the people have voted “Get on with it”– The UK general election hands Boris Johnson and the Conservative Party a clear and decisive mandate to expedite the UK’s timely exit from the European Union. The issue has hung over the UK economy for over 2 ½ years and has claimed the political scalps of two PMs. While all the details remain to be ironed out, the commitment to the path is locked in and the certainty should help decision making for both corporates and consumers.
  8. Catastrophic bushfires grip Australia causing widespread habitat destruction and property damage – While the immediate impacts are profound as regional communities seek to rebuild and recover, some longer-term issues including any impact on local and international tourism flows, the cost and availability of property insurance, the suitability and security of food supply and a more philosophical discussion over the impact of climate change will occupy the thoughts and minds of political and business leaders.

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