2017 in Review - Global Beats Local

By Sze Chuah, Ord Minnett Senior Investment Analyst

2017 has been a year dominated by international equities, mainly from strength in emerging markets. Australia has lagged global equities, but is on track to deliver a total return of about 10% after strong performances in the healthcare, consumer staples, industrials and resources sectors. International fixed income markets have been well behaved, but the returns have been more moderate than last year as central bank tightening in some regions has curbed gains. In macro news, broad-based economic growth upgrades and prospects of US tax reform have outweighed tensions in the political arena.

 

Below are some of the highlights from 2017 at time of writing:

 

1. International equities over fixed income – Equities have been the best performing asset class in the year to date. International equities have been the main driver, up 16.3% in Australian dollar (AUD) terms, buoyed by a broad-based acceleration in economic growth and prospects of US tax reform. Along with improving labour markets, this has prompted several central banks to tighten monetary policy. The US Federal Reserve has raised rates three times this year, the fastest pace since the global financial crisis, and it plans to reduce the size of its balance sheet. The Bank of Canada and Bank of England have both raised rates this year, while the European Central Bank has extended its bond buying program to late 2018, but halved the size to €30bn per month. Fixed income assets have delivered positive returns, but the extent of gains in international fixed income has been minimised by the aforementioned fine-tuning of central bank policy, which has led to higher sovereign bond yields in Europe and short-end US treasuries. On the other hand, a less rosy economic picture in Australia has kept the Reserve Bank on hold during the year, which has assisted the local equity and fixed income markets. Hedge funds and commodities have been the laggards, with commodities showing gains in industrials metals and oil, offset by falls in agricultural and natural gas prices. Ultimately, the commodities index has been lower on translation back into AUD. In US dollar (USD) terms, the commodities index has been flat. Similarly, hedge fund returns have been impacted by the translation back into AUD. In USD terms, hedged funds have returned 7.6%.

 

2. Regional equities – Further reinforcing that the growth recovery has been quite broad-based this year, gains in equities have been strong across a number of regions, not just the US. Emerging markets (EM) gains have been led by double-digit returns in Brazil, China, India, South Korea and Taiwan. In most cases those returns have been enhanced by an appreciation in EM currencies as well. EM equity funds saw strong inflows this year on the back of improving fundamentals in the region and broad USD weakness. In developed markets, Japan and Europe outpaced the US, which was weighed down by its currency. Australia had a slow start to the year, but a second-half rally in small caps and resources has put it on track for a respectable total return of about 10%.

3. Sector highlights – In Australian equities, the only sector to finish in the red this year to date has been telecommunications, after Telstra cut its FY18 dividend and Vocus earnings missed expectations while a takeover offer from suitors failed to materialise. The share prices of both stocks are down more than 25% in the year to date. For a second consecutive year, resources have outperformed banks by a large margin, with the latter impacted by scandals, such as the Australian Transaction Reports and Analysis Centre (AUSTRAC) investigation into CBA, and regulatory overhangs in the form of Australian Prudential Regulation Authority (APRA) capital requirements and the royal commission into the banking sector, managing to deliver positive returns this year only by virtue of its dividend yield. On balance, defensive sectors fared quite well: healthcare rose the most this year, helped by the multi-nationals Cochlear, CSL and ResMed, while the consumer staples sector was also high on the leaders board after Woolworths delivered better sales momentum, and infant milk formula and vitamin names surged following the Chinese government’s decision to back-track on last year’s proposed import restrictions. 

4. Small caps outperformed large caps – For a second year running small caps have outperformed large caps. The Small Ordinaries Accumulation index is up 16.3% year to date, compared to the S&P/ASX 100 Accumulation’s gain of 10.0%. Small Resources (+27.0%) outpaced Small Industrials (+13.9%), as a number of smaller mining and exploration companies rallied on soaring metal prices, particularly those set to benefit from growth in the electric vehicle industry, such as lithium and cobalt.

 

5. Company performance – The top performers in the S&P/ASX 200 have been mainly food staples – A2 Milk, Blackmores, Bega Cheese and Costa Group. The first three have seen sentiment improve after China’s decision to defer import restrictions. Retailing firms have struggled, however – among them Myer, Retail Food Group and Domino’s Pizza – as concerns grow over their business models. 

6. Corporate actions – Buybacks have been back in fashion, with Rio Tinto undertaking a major US$3.5bn on-market buyback of its London-listed shares, but also a US$560m off-market buyback of its Australian listing. Among the companies to announce buybacks this year (primarily on-market) – in some cases to take advantage of share price weaknesses – were Aveo Group, Aurizon, BlueScope, Coca-Cola Amatil, Computershare, Crown, Domino’s Pizza, MYOB, Qantas and Treasury Wine. Meanwhile, Transurban capped off the year with one of the biggest equity raisings, at $1.9bn, to fund the West Gate Tunnel Project, and in takeover activity France’s Unibail-Rodamco has agreed to buy Westfield for US$24.7bn in the biggest takeover of an Australian company on record.

 

7. Macro news this year – The political landscape has remained fragile, but investors are looking through this. While a Brexit deal has moved a step closer and France’s elections went as anticipated, Germany has yet to form government, Australia’s citizenship saga has put the government here at risk of an early election in 2018, while tensions with North Korea are simmering in the background, as is Donald Trump’s hold on the US presidency as investigations into Russian links continue. Nevertheless, the market has looked to other positives – global growth is humming along, there is hope a deal on US tax cuts is imminent, which could stimulate US growth further, while bank repair has continued as higher interest rates help and the outcome from the Basel Committee’s capital framework was better than expected, paving the way for some European banks to explore capital returns. 

 

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