Economic & Market Briefing June 2018

Wealth Creation = Advice + Management


Diversified Investment portfolios showed continued positive performance for the 12 months ending 28 June 2018. This was especially pleasing given the rising political tension over the past quarter as well as the current macroeconomic environment. Equity markets, although not without several hiccups, have moved primarily upwards; seemingly focused on the continued improving economic data indicating an expansion in global activity.

To better understand the economic and market influences over the first half of 2018, as well as gain further insight into Financial Year 19, we have summarised a selection of commentaries from market leaders. The following provides an overview as to the current positioning of economies and markets both in Australia and overseas.

Fiscal Year 18: In Review

Economic Summary

Have markets started to drown out the noise amplified by ‘media’ headlines in favour of economic data… or are they just becoming complacent? The fiscal year can seemingly be split by the calendar; with the 2017 half-year providing strong growth, while 2018 has seen a return to more challenging conditions. Recently we have seen increased potential geopolitical threats, escalating trade tensions and a firm upward path for interest rates in the United States. Add to this, the ongoing Brexit negotiations and concerns over the political outlook in Italy, which, at its heart, questions the sustainability of the Eurozone. This comes just as the European Central Bank slows its stimulus program, ensuring there is no shortage of uncertainty to be navigated by investors. With all this turbulence it is of no surprise there have been numerous volatility spikes. Nonetheless, against this hazy backdrop, equity markets have managed to post impressive absolute returns.


Australian Economy

The Reserve Bank of Australia held official interest rates for another quarter, with current estimates looking to the next rate rise in early 2019. This has been strongly foreshadowed given the entrenched low inflation environment, which normally brings with it lower nominal investment returns. Despite this, there have been some promising signs that the pace of Australian business activity is picking up, with the NAB survey showing current conditions just below record highs. Unemployment is expected to remain between 5.0-5.5% while wage and price growth should gradually lift towards 2.5%. The frontpage economic growth number for the nation is expected to be around 2.75-3.25% for the fiscal year, which is approaching its ‘speed limit’ of growth. The Australian Dollar fell by 4% for the year, with 2018 again encompassing the volatility; with the yearly high of US$81.35 in January and the low of US$73.23 in June.

Global Economy

If you read the headlines, you would struggle to believe that the global economy is in good health. Yet the world economy is thriving; and continues to gather pace, with the International Monetary Fund expecting above-average growth of 3.9% for the next two years. Increasing earnings growth, coupled with slowly rising interest rates in most developed nations, maintains the attractive outlook for equities in relative terms. This is conflicted by the background of rising political risk, especially the risk of trade wars (summarised below), which is further heightened by the temporary political cover generated by this ‘sugar rush’. Tensions are high; notably with global growth becoming increasingly dependant upon the U.S. Economy, currently underpinned by tax cuts, strong corporate earnings and a strong job market. The other pressure point is that if America accelerates and the rest of the world slows, widening differentials in interest rates would be expected to further strengthen the American dollar. Fixed interest and other income-oriented asset classes continue to be challenged by the prospect of rising inflation and tighter monetary policy.

Although the plethora of economic indicators remains exuberant, there are various key risks we are continuously evaluating. These include;

  • The danger of extensive fiscal stimulus into an already ’hot’ U.S. economy with full employment, resulting in a dislocation between Fed rates and inflation, a.k.a overheating.
  • The inverse risk is just as worrying; as globalisation matures, economies may generate solid economic growth without inflation.
  • The continual pressure on various markets with high asset prices and valuations as interest rates continue to move materially higher.
  • As well as other, more headline-friendly risk themes; Donald Trump, Oil prices, Australian home prices, Wages & Jobs and Geopolitics.


Battle-lines drawn.
A full-blown trade war between America and China looks likely.

As Donald Trump threatens further tariffs on Chinese imports, the prospect of a deal is receding. It is becoming increasingly likely that the once phoney trade war between America and China will develop into the real thing. Rising tariffs are the biggest threat to global growth. On June 15th the White House confirmed that a 25% tariff on up to $50bn of Chinese imports would soon go into effect, the first of which is now in force. Three days later, after China promised to retaliate, the president expanded his ‘list’, by as much as $400bn.

The president is unafraid of escalating trade disputes because he believes he has a winning hand. America buys from China almost four times as much as it sells there, limiting China’s ability to match tariffs. We hope Mr Trump doesn’t overestimate his bargaining power; as China could simply raise existing tariffs higher or ‘harass’ American firms operating in China. The real risks remain dormant; as tariffs are likely to further strengthen the US Dollar and temporarily push up inflation, making it harder for central banks to cushion the blow. Whatever form this conflict takes, and however long it lasts, there will be no winner


Market Summary

Domestic & International Market Movements
Australian Equities

Although not without periods of significant volatility the ASX/S&P ASX 200 Accumulation Index has had a strong fiscal year, returning 13.01% for the period. The return of the Australian Index places it within the top third of all major global exchanges. The chart below highlights this performance;

ASX/S&P ASX 200 Accumulation Index – 12 months to 28 June 2018

Sector Review

The leading industry group for the year was Autos & Components (up 42% - Consumer Discretionary) followed by Pharmaceuticals & Biotech (up 39% - Healthcare) and Energy (up 38%). At the other end of the scale was Telecom (down 35%), followed by the Banks sector (down 6.7%) and Utilities (down 5.7%). Of the Australian Market size categories, the Small Ordinaries had the strongest performance for the period.

Taxation Changes for Australian Managed Funds

A new regime for the taxation of managed investment schemes was introduced on the 5 May 2016. The Attribution Managed Investment Trust (AMIT) regime is designed to provide greater flexibility for managed funds and fairness for their investors. Funds now have the discretion to accumulate income in a Fund and reflect this within its unit price. Investors are taxed on income that is attributed to them on a ‘fair and reasonable basis’ each financial year. Morningstar has recently completed a review of the new AMIT tax regime and have concluded that it ‘may help to limit the impact of ongoing unitholders being faced with a lumpy income distribution when a large investor redeems’. All else equal, investors should prefer funds that have elected into the AMIT regime.


Global Equities

Global equity markets followed suit and managed to post impressive returns against a difficult backdrop. All developed markets had positive returns for the fiscal year with the majority delivering strong double-digit gains. The MSCI World ex Australia index returned 15.39% for the year to 30 June 2018. Stimulatory U.S. initiatives buoyed these returns and the flow-on effects have been felt in global growth markets.

The S&P 500 Index has had another strong year, returning 14.37% to 30 June 2018. The market has remained relatively insulated from the trade war tensions and has recovered strongly since the early year volatility spikes. IT stocks powered the US bourse, which was the strongest performer among major developed markets and drove a wedge between growth and value stocks. The US energy sector also had a solid quarter as oil prices rallied.

The Eurozone economic recovery has continued albeit at a slower rate than last year. The region is again feeling the impact of political uncertainty, with the prolonged political stalemate in Italy dominating recent market moves. MSCI Europe Ex UK has returned 3.51%, affected significantly by the -4.07% loss during the calendar year thus far. Across the channel, the U.K. economy is regaining traction as international investor confidence increases on the outlook of a soft-Brexit. The FTSE 100 TR has again lagged most developed economies, though has posted strong returns of 8.73%.

The Japanese equity market (Nikkei 225 Average PR) has had a year of two halves, the latter being one of the weakest within developed markets (-2.02%) however still producing strong double-digit return for the fiscal period (11.34%). Geopolitical uncertainty on the Korean peninsula, disappointing factory output and a possible global trade war have contributed to market weakness over the last quarter.

The MSCI Emerging Markets Index returned 12.33% to 30 June 2018. Emerging economies have been fronting the impact of a stronger US dollar and many countries (Brazil, Mexico etc.) face the prospect of higher interest rates as central banks seek to defend their currencies against higher US rates. Although Chinese macroeconomic data remained firm, its markets have been rattled by trade spats with the three major indices down an average 6.74% for the month of June.


The Heavyweights of Global Equities

Hamish Douglass and Kerr Neilson go head to head

Facebook and Google, the two companies that have done more to disrupt the global media and advertising industries than any others in history, are the common links between Australia's two most successful managers of international money.

But the direct "apples to apples" comparisons between Hamish Douglass at Magellan Financial Group and Kerr Neilson at Platinum Asset Management ends with these two stocks being in their flagship portfolios. The investment strategies adopted by Douglass and Neilson are very different and that is reflected in the returns they are likely to earn in the 12 months to June 30.

The latest available figures, which are for the year to May 2018, show Douglass's flagship fund, the Magellan Global Fund returned 9.7 per cent while Neilsons's flagship Platinum International Fund returned 14 per cent. On the surface that's a big win for Neilson over Douglass. But a longer-term analysis shows them performing neck and neck over time.

Over three years its Magellan 8.4 per cent and Platinum 8.32 per cent, over five years its Magellan 14.3 and Platinum13.89, over seven years its Magellan 17.7 and Platinum 12.96 and over 10 years its Magellan 13.5 and Platinum 10.5.

It is definitely worth exploring the divergent strategies of Douglass and Neilson because of the lessons it carries for investors who want to build their own portfolios by copying the greats or are thinking about choosing managed funds in these volatile times.

Neilson built his reputation over the past 20 years primarily serving the interests of retail investors. Today Platinum has about $27.7 billion in funds under management and his stake in the company is worth about $1.7 billion.

Kerr Neilson

He will step aside as chief executive and chief investment officer of Platinum this weekend and hand the reins to Andrew Clifford, who co-founded the firm in 1994. Clifford says Neilson will continue to be part of the Platinum investment team. For example, in the past month while in Japan visiting companies, Neilson churned out a four page note for Clifford recommending investment in a high growth company.

Platinum differs from Magellan because of its long standing interest in Asia, particularly Asian emerging markets. Neilson and Clifford have always been counter-intuitive. Over the past 20 years they launched specialist funds in technology, global brands and Japan at the same as other investors were taking a negative view of these strategies. The Platinum International Fund has pushed back against the US-centric view of the world. Over the past five years it has been moving East. Asia Pacific now accounts for about 51 per cent of the portfolio. As of May about 20 per cent of the fund was in Chinese shares, 13 per cent was in Japanese shares and seven per cent in Korea.

Neilson and Clifford regard China as the investment opportunity of a generation. This strategic imperative explains why Samsung is the largest position in the Platinum International Fund. Clifford says this stock is one of the world's leading technology companies and has the most integrated business model for the manufacture of smart phones.

Clifford likes Facebook because he says that with a profit growth of 40 to 50 per cent its forward price earnings multiple is actually below double digits. He says it is hard to find value of this kind in most tech growth stocks. Other notable stocks in the fund include Ping An Insurance, one of the largest insurers in China, and Jiangsu Yanghe Brewery, a fast growing manufacturer of white spirits.

Clifford says the significant change in the fund's portfolio in the 2018 financial year has been the shift into energy, materials and industrials. The fund has a large holding in the miner and commodities trader Glencore, which is one of the largest suppliers of seaborne thermal coal. Other stocks in the top 10 positions in the portfolio include Technip, Siemens, Royal Dutch Shell and Intel Corp

Douglass has had a far more rapid rise to prominence then Neilson. He pitched his fund management skills at institutional investors in the United States and won huge mandates. In the space of 10 years he has built a business with $67.3 billion in funds under management. His stake in Magellan is worth about $500 million.

Hamish Douglass

Douglass is similar to Neilson in that he is a brilliant stock picker but he has carved out a reputation as an insightful thinker able to interpret the complexities of global macroeconomics. His aim is to position his flagship fund to avoid volatility. Analysis of the flagship fund's returns show Douglass has been able to achieve consistent outperformance against benchmarks. Compared to its peers, Magellan has an "outperformance consistency" of 90per cent.

While the Magellan Global Fund only just beat its benchmark in the year to May 2018 the strategy has, according to Douglass, captured 100 per cent of the upside in markets and only 50 per cent of the downside. The returns achieved this year have been struck despite having about 18 per cent of the fund invested in cash.

Douglass says the fund has avoided Chinese technology stocks in favour of the platforms in the US including Google, which trades under the Alphabet title, and Facebook. He is also a huge fan of Apple which he says is one of the world's most impressive subscription businesses. He says Facebook has yet to really capitalise on the advertising opportunities in its range of other businesses including Whatsapp.

The Magellan Global Fund has a big holding in Kraft Heinz because of expectations the company will be part of a larger rationalisation caused by disruption. The fund has been a long standing owner of Visa and Mastercard and that has delivered in spades. Douglass thinks Starbucks is a company that his under appreciated and under valued.

One of the companies that he is most excited about is Crown Castle International which owns telecommunications towers in the US. He is such a big believer in the prospects for this company that he was willing to take up $US1 billion of a $US3billion capital raising done by the company to help pay for Lightower, which was bought for $US7.1 billion.

One conclusion to be drawn from this data and from other analysis of the performance of the funds against their benchmarks is that the Magellan and Platinum are complementary.


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Reserve Bank of Australia, OECD, Australian Stock Exchange, Australian Financial Review, JP Morgan, Morningstar Australia, Colonial First State, Market Index, International Monetary Fund, The Economist.


All care has been taken in preparing this report. However, please note we base our financial product research on current information provided to us by third parties (including financial product issuers) which we cannot necessarily verify. While we use all reasonable efforts to obtain information from reliable sources, we do not guarantee the data or content contained herein to be accurate, complete or timely. To the extent that our research is based on information received from other parties, no liability is accepted by Investment Professionals, its affiliates nor their content providers for errors contained in the report or omissions from the report. Past performance is no guarantee of future performance. Index returns are based on the country of domicile currency returns.


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