The ASX 200 Index rallied 8.27% over the 2018 financial year to finish at 6194 points, near its 10-year high. It was a solid year with no major surprises. A strong performance in June led by energy stocks helped the index post a remarkable result. Over the year all but three sectors of the ASX 200 index put in a solid performance. Of the sectors that did well, it was all energy and metals & mining. Healthcare and Information Technology also fared well. Financials and Telecommunication sectors were the underperformers this year around. Telstra fell 39% which is still the country’s most widely-held stock. But it wasn’t just our market that fared well, the US market did even better. The NASDAQ returned +22.31% beating the S&P 500 +12.17% and the Dow Jones +13.69%. The Chinese market didn’t do so well, it fell 10.81%. UK was up +4.43% and Germany down -0.16% this financial year.

Some of the key thematics that played out throughout the year were a booming resources sector that rose on the back of higher commodity prices and a thriving energy sector supported by rising oil prices. The falling Australian dollar was also key contributor. High growth companies such as CSL, A2 Milk and Aristocrat Leisure continued to shine and have shown no sign of stopping. We are however concerned that these stocks have very little room to miss expectations. Any disappointment could see them fall from grace very quickly. On the downside, the Royal Banking Commission played havoc with the big four banks and AMP placing immense pressure on them to change their vertically integrated structure and employ stricter lending conditions. Banks have already started enforcing strict compliance regulations and have tighten up investment lending. It’s having a much welcomed cooling effect on the housing market. As a result we can expect to see weaker lending and softer house price growth. This all translates into softer earnings grow at the big four. Last year CBA fell (-11.4%), followed by NAB (-6%), Westpac (-3.7%), ANZ (-2%) and AMP fell -31.41%. Macquarie Group bucked the trend with its shares rising nearly 40%.

The top three performing stocks for the year were, Appen Group 241%, AfterPay Touch Group 224% and A2 Milk +178%. The worst performing were Sigma, Telstra and G8 Education.

Themes of 2019:

Whilst we don’t have a crystal ball there are certain themes we think will play out in the 2019 financial year. Here are a few of the main ones and how they may affect your portfolio.

  • Trade war. Whilst Trump’s trade war games against China have largely been background noise, the start date for US tariffs on Chinese goods is just around the corner. It may soon become a reality. The trade legislation states that the United States would have to act within 12 months of the date at which the United States trade representative initiated its investigation of Chinese trade practices. This implies the Trump administration has until August 18. If it proceeds the US will impose 25% tariffs on $50bn worth of Chinese exports to US. If a trade war breaks out, it could really put a dent on both the US and Chinese economies. US companies that manufacture in China such as Apple will wear bear the brunt of the tariffs.
    Positive Effect – Looking at the table below, Australia is one of the best placed countries if a trade war does break out. For example, Australia can sell beef to China as the US deals with a 25% tariff on their beef or Australia can sell Aluminum to the US as China will deal with export tariffs on their Aluminum. Australia effectively is exposed to a double market grab.
    Negative Effect – But if a trade war breaks out, China could look to penalize the US by creating numerous headaches i.e. selling US bonds or suspending rare earths exports.  About 20% of US consumer goods come from China, so the impact is significant. Australia could be caught in the cross fire of this tit for tat trade war.  Aussie companies that export from China to the US could be caught in the middle. However the greater risk to the Australian economy is a failure of global trading rules.

  • Interest rates. The US Federal Reserve is in a rate hiking cycle and has indicated another 4 rate rises are on the table. US rates sit at 1.75%. It’s a sign of growing confidence that the US economy is doing well. Unemployment is at record lows and tax cuts combined with government spending will drive economic growth. Inflation is forecast to rise. The recent rise in US rates has caused a knock on effect to the Australian dollar. The $A peaked at US81.09c and has fallen all the way back to US73c. A weaker dollar is a boon to Australian exporters and commodities. The last time the RBA moved official interest rates was August 2016. The cash rate has sat at 1.5% and financial markets aren’t fully priced for another increase until late 2019.
    The European Central Bank will too begin the process of its easy money-exit via the gradual exit of its quantitative easing (QE) program. The ECB says monetary policy will remain accommodative even after the end of its bond purchases. Effects – While the RBA sits on hold, US rates are widely expected to rise 4 times this year, making the greenback a more attractive investment and in turn pulling the Australian dollar lower. Wholesale funding costs rise, which means Australian banks are more than likely to increase mortgage rates, putting pressure on the housing market. At the same time a lower Australian dollar is a positive for exporters and most local businesses. The rising cost of capital will mean overseas purchasing will become more expensive, a negative for importers, online shoppers and the price of petrol. A lower Aussie dollar also means exports such as coal and iron ore become cheaper for other countries to purchase. A positive for our miners.

  • Property Market. Last financial year we saw a definite change in direction of residential house prices in Sydney and Melbourne. Some economists have called it the ‘top of the market’ and are predicting a downturn in house price this year. With Australian banks being forced to impose “out of cycle” mortgage rate hikes due to rising global interest rates, we see a continued cooling effect in the property market this year, however we don’t see any signs of a property bubble burst.
  • Bank recovery. 2018 was a tough year for the big four banks following a sell-off triggered by findings from the Banking Royal Commission. Banks are now trading at their biggest discount to their average valuation in years and paying huge grossed up dividends of around 10%. They look extremely attractive. However the outlook for the major banks remains negative according to most brokers. With the outlook for housing loan growth to remain challenging, a recovery in the banking sector could still be some time off.
  • Australian LNG Exports. According to a report published by the federal department of industry, innovation and science, Australia is tipped to overtake Qatar as the world’s largest exporter of gas before being overtaken by the US in the mid-2020’s. The rise in exports is expected to be driven by the recent completion of the US$54bn Gorgon LNG project off Western Australia, Chevron’s second Wheatstone LNG train coming online, Inpex’s Ichthys project ramping up production, and Shell’s floating LNG ship Prelude coming into full operation. The IEA says global LNG market is forecast to grow by 30% by 2023 to 505bcm with China accounting for more than a third of the growth. It’s good news for Australia’s three heavy weight oil producers, Santos (STO), Woodside Petroleum (WPL) and Oil Search (OSH). 

Overall we think economic growth is still supportive for equities. If you trawl through the press you’ll find every broker with an ASX 200 end of year forecast. For example Morgans’ is tipping the index will hit 6200 by year-end or Citi which thinks it will be closer to 6500. We caution investors to not read into these forecasts too seriously but to take them with a grain of salt. They’re almost always wrong. Instead focus on what is currently going on and position accordingly.