Most global share markets have been weak since end September, with all majors now in negative territory since Jan 2018. The YTD performance of various indexes (at time of writing) has been as follows:
Dow Jones          -1.1%
Nasdaq                 -1.5%
S&P500                 -1.9%
ASX AllOrds        -7.5%
CAC 40                  -8.8%
Nikkei 225            -8.9%
FTSE 100               -9.4%
Hang Seng           -14.4%
DAX                       -15.5%
The VIX has doubled since the start of the year and risen sharply since the end of September.

The VIX is the CBOE Volatility Index and known by its ticker symbol VIX. It is a popular measure of the US share market’s expectation of volatility implied by S&P 500 index options, calculated and published by the Chicago Board Options Exchange (CBOE). It is sometimes referred to as the fear index.

FANG stocks in context

The media is full of stories about the collapse of the FANG stocks that everyone seemed to love just a short while ago and now hates. But put their recent falls in context and it doesn’t look so bad. The following chart shows performances since 1 January 2018: Netflix +49%, Amazon +36%, Apple +10%, Alphabet flat and Facebook -18%. Hardly too concerning.

OIL price smashed

The price of oil has been smashed over the past month from $86 to $65 amidst weak demand and strong supply. Opec has suggested that Saudi Arabia and its partners inside and outside the cartel (such as Russia) might be forced to curb supplies to avoid a build-up of oil stocks. Producers are anxious about a slowdown in the world economy, given trade tensions and currency weakness in emerging markets, which could pressure oil demand. Meanwhile, supply from the US in the form of shale oil continues to rise.
The reversal in the price in recent weeks is adding to speculation that Opec will have to trim supply. In June, Opec and partners had agreed to relax curbs in place since 2017 after pressure from President Trump. Trump called on Opec to increase production to offset declines from Iran after the US reimposed sanctions.
Even as Saudi Arabia pledged to raise output, a move by the US earlier this month to issue waivers to big buyers of Iranian oil and allow more oil on to the global market has created renewed fears of oversupply. Amid chatter about new supply curbs from producers, Trump took to Twitter to prompt Opec into action, saying “oil prices should be much lower”. The snowballing losses will cause pain to investors in the energy sector and have pressured stocks like Woodside Petroleum (WPL) and Oilsearch (OSH) – which are in CBG portfolios.

Global slowdown? – Japanese and German economies both contracted in the 3rd quarter

Worries about a global slowdown have increased after Japan and Germany both said their economies contracted in the third quarter. The problems plaguing them are different, but their size means the pain cannot be ignored: Japan is the world’s third largest economy, while Germany is fourth.
Japan said its GDP shrunk 0.3% in the third quarter. The country recently enjoyed its longest streak of economic growth in decades, but momentum has stalled. Japan’s economy was hit by natural disasters and a decline in exports, a sign that trade protectionism is starting to take its toll on overseas demand.
The contraction adds to signs of weakness globally, with China and Europe losing momentum. Despite the setback, Japan’s government stuck to its view that the economy continues to recover moderately, blaming the contraction on typhoons and an earthquake that halted factories and stifled consumption. But analysts said such factors alone could not explain the downturn, pointing to declines in exports amid slowing Chinese demand and the fallout from escalating trade friction.
The German economy contracted 0.2% in the third quarter, its first decline in more than three years. Data showed the slowdown was mainly due to weak exports and a fall in consumer spending. Global trade tensions have hit the country’s massive car industry. Investors do not expect the German economy to recover rapidly from the weak patch, with concerns growing about the impact of global trade disputes and Britain’s departure from the European Union.
In addition to anxiety about the impact of Trump’s trade policies, German firms are concerned about instability at home where Chancellor Angela Merkel’s coalition has weakened, and Merkel has signalled her intentions to depart.

A weakening of the Australian economy?

The RBA is reasonably confident about prospects for growth in the Australian economy. This from Governor Lowe on 6 November:
“The Australian economy is performing well. Over the past year, GDP increased by 3.4% and the unemployment rate declined to 5%, the lowest in six years. The forecasts for economic growth in 2018 and 2019 have been revised up a little. The central scenario is for GDP growth to average around 3.5% over these two years, before slowing in 2020 due to slower growth in exports of resources.”
Despite such optimism from the RBA, and the seasonally adjusted unemployment rate remaining at 5.0%, we note early warning indicators of deterioration in the Australian economy, with implications for earnings growth and the Australian market outlook.

  • Vehicle sales – down 4.1% YoY;
  • home prices – down 4.6% YoY, but weakness masked by a massive 45% decline in homes selling at auction;
  • housing finance – down 27% for investors and 14% for owner-occupiers from peak levels;
  • money supply growth – slowed to a 26-year low ~2% YoY;
  • NAB business confidence – fallen to below average levels;
  • drought – easing, but lower crop and herd size yet to really impact GDP; and
  • ANZ Job Ads – slowed from double-digit to 3.6% YoY growth.

Australian home prices are declining – down 4.6% Year on Year

Implications of the above point to slower consumption, as falling home prices drive negative wealth effects. They also point to slower business investment and jobs growth, slower private domestic demand and earnings growth. We remain cautious domestic-focused sectors such as retail, media, housing-related and the banks.

The Golden Age of Banking is Over

This is not a new story, but it is an important story. Most SMSF investors and private clients generally are heavily invested in the Big 4 Banks and have enjoyed good returns over the past couple of decades. But there are good reasons to question this strategy, as returns on equity decline (see chart below) and the headwinds for the sector build. While dividend yields remain attractive, there are limited opportunities for the banks to grow. David Walker has written extensively on the sector in the past. Clime and CBG portfolios are underweight banks.

Some indicators listed below:

  • Interest rates are moving higher globally. Bank borrowing costs are increasing
  • Regulation of the banks will increase post the Royal Commission, compliance costs up
  • The rate of bank credit growth has declined and trending lower
  • Real wages are barely growing, reducing the capacity for individuals to borrow
  • Residential property prices are falling, exposing their mortgage books
  • The big 4 banks are overly concentrated on the housing market
  • Bad debts are at extremely low levels, and seem likely to rise, crimping profits
  • Valuations are not particularly attractive relative to global peer group


Asset allocation thoughts:

According to Bloomberg, ASX100 FY19 PE trades at 14.1x compared to ASX Small Ordinaries at 15.9x, that is, a broadly similar earnings multiple. However, the Small Ordinaries Index is offering 4 times the earnings growth. 
Consensus analyst forecasts ASX100 EPS growth of 5.8% for the financial year 2019, compared to ASX Small Ordinaries forecast EPS growth of 22.1%. Thus, 4x the EPS growth at a similar PE multiple. Stock selection is key in this market, and risks are higher. Good reason to consider the Clime Smaller Companies Fund.

Portfolio news:

Bloomberg Intelligence – not an Aussie stock in Top 50 stocks to watch in 2019
The analysts at Bloomberg Intelligence — who track more than 1,900 companies in industries including energy, technology, retail, and finance — identified those that face unusual challenges in the coming year or are poised to release products or services with blockbuster potential. The analysts considered revenue growth, margins, market share, debt, and other factors such as economic conditions and came up with a list of 50 companies worth watching.
If you are interested in international shares, then have a look here:
Of the 50 global stocks of interest, most are from the US. There are also stocks from China, the UK, Germany, France, Japan, Switzerland, Canada, India, Brazil, Russia, Israel. But not a single stock from Australia! Now I’m not suggesting that this list is comprehensive, but it implies that truly diversified equity investors should include some international equities in their portfolios. One could do worse than considering the Clime International Fund.
The CIF has returned 9.5%pa (after fees, to 30/9/18) since inception over 3 years ago, and includes stocks such as Microsoft, Oracle, Alphabet, Roche and Yum! Brands.
Stock of the Week – Appen Ltd (APX) by Vincent Cook

  • APX is the global leader in the provision of human annotated data and is experiencing strong demand growth, driven by the explosion of data and application of Artificial Intelligence to make that data accessible.
  • APX upgraded CY2018 EBITDA guidance by 12% (new range A$62-65m).
  • Guidance is premised on the assumption of an AUD/USD exchange rate of $0.80. We estimate 4.8% upside from the CYTD average exchange rate of $0.75.
  • Upgrade driven by “a sharp increase in monthly revenues, largely from existing projects from existing customers”.
  • We have upgraded FY18,19 EPS by 17% and 15% respectively and increased our price target from $13.20 to $15.30, based on a 24x FY20 PE.
  • Currently holding existing positions, but may incrementally add ahead of 1-on-1 with management in December.
  • We own APX in DSP (Growth) and CBG portfolios.

Quotes of the Week: Howard Marks, Oaktree Capital Management
“There are old investors, and there are bold investors, but there are no old bold investors.”
“We have to practice defensive investing since many of the outcomes are likely to go against us. It’s more important to ensure survival under negative outcomes than it is to guarantee maximum returns under favourable ones.”
“Here’s the key to understanding risk: it’s largely a matter of opinion.”
“There’s a big difference between probability and outcome. Probable things fail to happen—and improbable things happen—all the time. That’s one of the most important things you can know about investment risk.”
“Being too far ahead of your time is indistinguishable from being wrong.”
“The desire for more, the fear of missing out, the tendency to compare against others, the influence of the crowd and the dream of the sure thing—these factors are near universal. Thus they have a profound collective impact on most investors and most markets. This is especially true at the market extremes. The result is mistakes—frequent, widespread, recurring, expensive mistakes.”
Originally published 20th November 2018 on StocksInValue