Despite the higher market volatility, equity market returns for the 2018 financial year were solid with an 8.6% return for the ASX 200. When you include the dividend, the total return was in the low double digits. Impressive. Investors head into the new fiscal year with strong returns and a good earnings momentum.
The continued improvement in earnings over the past year was driven predominately from the resources and commodity sectors which were benefiting from the solid global growth. Not all sectors contributed. Clearly the telco (Telstra) and bank sectors were not good performers and unfortunately they will continue to face some challenges in the year ahead. The only positive will be their payout ratios as they will continue to deliver dividends for the yield hungry SMSF investors.
The forecast for the fiscal year ahead for the ASX 200 is 6,550 target. As with all forecasts, context is important as there are many moving parts. The target implies a 5.75% capital return before the dividend, so a little bit lower versus the long run expected return of equities as an asset class.
Company earnings will need to continue to grow over the next year (market cap adjusted) whereby strong contributions from the resources, commodities, energy, diversified financials and healthcare sectors would need to continue.
The interest rate environment is a very important factor. Despite improving profits for specific sectors, there is a clear slowdown in housing related activity which has partly been engineered from policy makers. Further, there is a clear tightening in credit conditions as loan-to-value (LVR) ratios will continue to fall and borrowing rates for investors and home owners will continue to rise. Therefore, the official cash rate will need to remain at the historic low of 1.5% for the foreseeable future, well into the second half of 2019. The RBA have been successful in dampening the housing markets over exuberance over the past 18-months.
The AUD will also need to remain under the 0.75 level and preferably lower over the next year. It is an over simplification, however, a lower Aussie dollar tends to lead to improved local earnings for companies receiving USD earnings (resources and healthcare for example). Broadly, the earnings for the ASX index tends to benefit from a lower AUD.
Business confidence and conditions will also need to remain solid. Various business surveys show that conditions have improved, reflecting (naturally) the improved confidence levels which are a good leading indicator. Global growth momentum, strong domestic immigration and the lower AUD have all helped corporate Australia. Further, Canberra has been able to deliver some reform post the May Budget. This is a positive development despite the ongoing noise that is a function of the adversarial nature of politics. Government has delivered on some key reforms however more is required going forward.
A steady global growth momentum, cash rates remaining at historic lows, a low AUD, improving business conditions and a continued supportive Canberra are all required to help drive earnings momentum forward and the ASX higher in the 2019 fiscal year. If all these various conditions are delivered, the ASX target of 6,550 will be comfortably met.
On the risk side there are many to consider in the year-ahead. Equity markets reflect future earnings and therefore are volatile by nature. The fallout from trade tensions, the China corporate debt surge, higher US cash rates are just some of the risks being priced in to some degree. This will ensure volatility will be a constant reminder as you search for growth.
While a risk-on is still the preferred position for the year ahead some profit taking will be natural. More specifically, the ex-100 equity universe will continue to offer good opportunities however there are risks within the small cap sector. Corporate debt (investment grade) continue to offer good risk adjusted yield (coupons) and non-AUD equities (developed markets) and some non-listed USD and EUR assets offer some value.
CIO | Atlas Capital
Director | Salter Brothers Asset Management (SBAM)