Happy New Year!
I’m looking forward to 2019.
It could shape up to be one of the most interesting years in global markets for a long time.
See below an overview on 2018 and my outlook for 2019.
Last year ended with extreme volatility and negative returns. Over 90% of all asset classes: property, equities, commodities & bonds went down.
In the world equity markets investors concentrated on two main concerns:
Other concerns were (and continue to be) the Banking Royal Commission in Australia and abroad, Brexit, and slower growth in the Eurozone.
USA – the S&P 500 dropped 6% to 2,507 points
China – the Shanghai Composite, fell 24% to 2,494 points. It under-performed due to the slowing growth in China
Australia – the S&P/ASX 200 was down almost 7% to 5,646 points
For the 4th time in 2018, the US Federal Reserve raised interest rates a quarter of a percentage point from 2.25% to 2.5%.
When there is not a significant difference between short and long term yields, this ‘flattening yield curve’ triggers concerns of a possible slowdown in economic growth (or even a recession) in the USA. The 10-year Treasury bond is yielding 2.71% which is only 17 basis points above the 2-year bond at 2.54%. If the markets were really confident, there would be a much wider spread between these yields.
Unemployment numbers are at a 49 year low at 3.7%. There are concerns about the speed of wages growth and inflation.
The US$ is expected to weaken this year due to:
1. the US Debt is now approximately US$22 trillion
2. a more neutral interest rate policy by the US Federal Reserve.
Oil – prices were extremely volatile because of supply concerns and global uncertainty. The price of Brent oil went from US$61/barrel to US$76/barrel and then fell dramatically US$45/barrel by the end of year.
Gold – if the US$ falls and inflation increases, gold is likely to rise in value.
2018 was a tough year for the AU$ dropping over 10%. It was affected by the threat of increased global interest rates and falling commodity prices. It ranged between US$0.81 and US$0.69. It is currently around US$0.72.
Based on recent opinion polls, Labor has a good chance of ousting the Liberals in the May 2019 Federal Election. This has intensified the examination of some of the ALP policies and their possible impacts eg. getting rid of dividend franking credits, limiting private health insurance increases and negative gearing for real estate.
Lower than anticipated economic growth and the possibility of global trade slowing down thanks to US trade tariffs, had the Reserve Bank of Australia (RBA) maintain interest rates at their all-time low of 1.5%.
Based on tighter lending standards by banks and consumers focus on repaying down debt, property is likely to continue falling by at least another 10% .
Australia has an exceptional record of 27 years without recession. A slowdown in capital expenditure, construction and the housing sector were major factors in Australian economic growth being down from 3.1% in 2017 to 2.8%. The inflation rate is at 1.8% just below the target range of between 2%- 3%. This is another reason for the RBA’s decision to maintain the record low cash rate at 1.5%. The forecast for interest rates looks like it will remain steady for the next year.
Expected growth for the Australian economy is around 2.7% over the next year or two which is encouraging. The economy is expected to be supported by increased investment in businesses and public infrastructure. The outlook is also quite positive for growth in resource exports.
In 2019, I expect the US share market to reflect slowing economic growth and earnings expectations. A lot will depend on the outcome of US/China trade negotiations and the initial positive influence from US tax cuts will lessen. Following the severe 20% correction in the US market from October to late December and 10% market rebound over the past 3 weeks, I think it’s very likely market volatility will continue to remain high during 2019.
Just as each stock has an actual and a forward price/earnings ratio (PE Ratio), so does each sector and each stock market. This PE ratio is calculated by dividing the market price of a share by the earnings. The Australian stock market is currently valued on a forward consensus price earnings ratio of 13.8 times. This is 6.1% below the long term average of 14.7 times. This means our market is currently under-valued.
The Australian stock market is very attractive for investors who are looking for yield in the current low interest rate environment. The forward consensus dividend yield is 5% (80% franked) for the ASX.
I am expecting the Australian share market to deliver an average return, over the next 12 months, of approximately 8%. However, a well-constructed stock portfolio can easily deliver twice this return.
I personally look for individual stocks in sectors that are grossly under-valued but have excellent earnings growth that will outperform the average. Example: Ramelius, a gold producer, was on a PE of 4 times when I first purchased the stock at 11c. Twelve months later, the stock was 61c – a return of 450%.
Oil Search (OSH) – is the largest oil and gas exploration and development company incorporated in Papua New Guinea, which operates all of Papua New Guinea’s oilfields. OSH is involved in an integrated upstream natural gas and liquefied natural gas (LNG) development, operated by ExxonMobil. The PNG LNG Project is a 6.9 million tonne per annum (MTPA) integrated LNG project. The gas will be sourced from the Southern Highlands and Western provinces of PNG. It is expected to produce more than 9 Tcf of gas and 200 Mmbbl of associated liquids over its 30 year life. OSH’s net 2P reserves were booked at 504 Mmboe. The earnings growth outlook for OSH for future LNG exports looks excellent, especially with an expectation that oil will trade between US$55 and US$65 barrel during 2019.
BlueScope Steel Ltd (BSL) – is a flat steel producer and supplier of steel products and solutions focused on the global building and construction markets. It operates in Australia, North America, China, Indonesia, India, Vietnam, Malaysia, and Thailand. BSL has made impressive earnings growth over the past 2 years and this is expected to continue in 2019 and beyond. The stock has fallen from a high of $19 in July 2017 to a recent low of $10.60 in late Dec. It is now trading on a low earnings multiple of just 8 times with an average Return on Equity (ROE) of 17%. I am expecting a good technical rebound or move back up in the share price during 2019.
Challenger Ltd (CGF) – specialises in retirement income products, annuities, life insurance and funds management. As baby boomers continue to move into retirement, it is inevitable that annuities will become a major and rapidly growing product. Dividend yield is 4% fully franked and ROE is expected to be approximately 16% this year. Most brokers have a valuation of $12 for CGF which is 30% higher than the current share price.
Macquarie Group (MQG) – an Australian multinational independent investment bank and financial services company providing key services across asset management, corporate and asset finance, banking and financial services, commodities, global markets, and capital advisory services. The group is well diversified and has proven risk management strategies to adapt to changing economic and financial market conditions.
Sonic Healthcare (SHL) – an Australian company that provides laboratory services, pathology, and radiology services. The Sydney-based company has its roots in the pathology practice of Douglass Laboratories, and since has become one of the largest diagnostic companies. It is the world’s third largest pathology provider with significant operations in the USA, United Kingdom, Germany, Switzerland, Belgium, Australia and New Zealand. A continuing long term demand for pathology services, means the group has further international expansion opportunities.
Wesfarmers Ltd (WES) – is a diversified business operating in department stores, home improvement and office supplies, resources, chemicals, energy & fertilisers and industrials & safety products. WES had a recent trading update that was a slight downgrade in regards to department store sales. However, Net Debt of the group has been reduced from $3.6bn to $0.3bn and the gain on the demerger of Coles which is non-cash is around $2.1bn-$2.3bn. I am expecting a positive re-rating of the share price for WES following the demerger of Coles, a stronger balance sheet, and good earnings outlook for the group for 2019.
Nine Entertainment (NEC) – is an Australian and media entertainment group with television broadcasting and program production; and digital, internet, subscription television, and other media sectors. Business operates in the four divisions: free-to-air television, digital publishing, video-on-demand (advertising and subscription) and content production. The company acquired Fairfax Media last year which will increase earnings growth for the group in 2019 and beyond. The stock price is trading on a low earnings multiple (PE) of just 9 times and pays a fully franked dividend of 10 cents per share which equates to an attractive dividend yield of 6.4%.
I believe the above selection of stocks (properly managed) will form a well-balanced, diversified and defensive portfolio. These stocks should provide protection against market volatility and give a combination of growth and income in 2019.
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Best wishes for a bright and prosperous 2019.