Quarter in review – June 2018

On the face of it, the June quarter was exceptional with the ASX 300 up 8.4%, especially after a tough March quarter (ASX 300 was down 3.8%). The ASX 300  not only outperformed the MSCI World index (-0.1%), but also US S&P500 (+2.9%), as global markets reacted more negatively to slowing China data, US dollar strength and an escalation of rhetoric around trade wars.

The best performing sectors for the quarter were Energy (+19.7%), Healthcare (+16.4%) and Consumer staples (+11.9%). The underperforming sectors were Telecommunication (-13.7%) facing to worsening industry conditions and the under-siege Banking sector (+1.2%).

Some of the key issues for the quarter were:

1. Tariffs and Trade Wars

The Trump administration continued its pursuit of trade conflict and sanctions. Whilst the main issue relates to tariffs being slapped on Chinese goods, the Trump administration appears to be escalating tariff disputes with its historic allies like Europe and Canada. These trade issues have been overhanging financial markets and with the first round of tariffs on Chinese goods kicking off in early July, this issue will remain in the forefront as a key threat that may cause a global economic slowdown.

2. China slowdown

Related to the trade issue has been the manifestation of a slowdown in economic growth in China. As President Xi Jinping has now consolidated his power, there appears to be a greater effort at managing the country’s growth agenda, focusing on the quality of growth and reducing financial risks in the system. China’s economy is pivoting away from the heavy pollutive industries to a consumer-led service economy.

There is growing focus on the high indebtedness of the non-financial corporate sector (SOEs) and the government is trying to stymie the growth of the shadow banking sector. It is unclear if faced with a trade-related slowdown, whether China will resort to its old tested ways of reviving the economy through a debt-fuelled property and infrastructure stimulus.

3. Energy

The US withdrawal from the Iran Nuclear Deal unilaterally has jolted the oil markets (WTI up 10.5%), especially in a period where oil demand has been strong and there have been supply disruptions in several countries, including Venezuela, Libya and Nigeria. The US has threatened to reimpose sanctions on Iran in November 2018. The Organisation of the Petroleum Exporting Countries recently met and agreed to increase daily production by 1m barrels to help stabilise the oil price. Iran exports roughly 2.5m barrels per annum, so the market has taken the view that crude prices will stay elevated for the foreseeable future.

4. US dollar

The USD has been strong and that has started to take a toll on emerging markets. The US Federal Reserve (Fed) raised the Fed Funds rate by 25 basis points in June to 1.5%. At the post decision press conference Fed Chair Jerome Powell referenced the ‘very strong’ US economy several times, implying that there is ample scope for the Fed to continue raising rates into Financial Year 2019 (FY19). Whilst the markets are now pricing in two more hikes this year, the long end (US 10 year) peaked at 3.12% in May-18 and is now at ~2.82%. The flattening yield curve has equity markets worried of an impending recession.

5. Sydney and Melbourne house prices are falling

Median Sydney house prices are down 4.5% year-on-year whilst Melbourne are down 2% from the Nov-17 peak. A recent report by influential broker UBS has contended that the impact of credit tightening by Australian banks considering Royal Commission-led and ASIC scrutiny around responsible lending may lead to an economic slowdown.

6. M&A Activity picked up during the quarter

The world is still awash with cheap capital and foreign interest in Australian assets is elevated, with CK Infrastructure Holdings’ cash bid for APA Group; Hometown and Brookfield have both made a bid for Gateway Lifestyle (a portfolio holding); French outdoor media company JC Decaux made an offer for APN Outdoor. Of relevance to the portfolio and as a further part of the shake-up of the outdoor media space, Ooh! media is acquiring street furniture and transit advertising business, Adshel (subject to ACCC approval) from HT&E.

Detailed Fund commentary is available to our subscribers via the form below.