Investment Matters

FY-19: a poor start, but good expectations

FY-19: a poor start, but good expectations

The start of FY-19 has been poor for stock markets.

After two strong years (+13.1% in FY-17, +13.7% in FY-18) the ASX (including dividends) as at the end of October (i.e. 4 months in) has returned -4.7%.  The return of -6.5% in October was the worst monthly fall since the -7.3% in August 2015.

Should you be worried?

Those clients who have been attending the CIO Conversation Dinners will be familiar with the graph below.  This is the rolling 12-month return of the Australian share market since 1937.  Crickey!

Rolling 12 moth returns 

Since 1937 the trailing 12-month return of the ASX (including dividends) has moved between +90% and -50%.  And as recently as November 2008 returned -42%.  But by March 2010 this 12-month return had become +44%.  (And the 12-month return to end October 2018 is still positive: 1.6%).

This shows that markets are, and always will be, volatile.  Sometimes we simply forget this fact.  In the short term, the market is simply a popularity contest driven by investors' collective emotions.  Sometimes investors are overexcited, sometimes they are very pessimistic. 

What should never be forgotten, however, is that over any period great than five years the market is a weighing machine (to borrow a quote from Benjamin Graham).  If you own companies that grow, and can pay dividends over time, the short term feelings of fellow shareholders become irrelevant.  And, if the market doesn't recognise the inherent value of a company (as we often see), that company will tend to get taken over, either by a smiling private equity player, or another industry player.  These types of investors look for returns over priods longer than the standard share market investor (who buys and sells their shares on average more than once a year).  Over the long term, the return from investing in Australian shares has been around 12% p.a. (since 1881): this is the blue dotted line in the graph above. 

The key to any prolonged sell off (should this become one) is the starting point.  If markets have reached into the area of over-exuberance, then the downside can be significant (like the 'tech-wreck' in the early 2000s, for instance).  But currently, markets are not priced extraordinarily highly.  In Australia, the current sell-off has put the market back to an average value (i.e. P/E). This implies that positive returns are likely over the next five years.

ASX markets PEs

Whilst we sense a lot of fear on Main Street (the papers are largely on top of most known problems), this fear really is around the economic outlook (e.g. earnings growth) not the price of equity assets (property is a different kettle of fish). 

People are worried about trade disputes, regulation, tax, military conflict, [insert your concern here] and this is now reflected in markets as assets are trading around their long term average prices (plus or minus) compared to earnings.  Whilst some commentators point to low interest rates as having had an exuberant effect on the share market, the price of companies is similar to the long-term average, but the price of money is much much lower.  There isn’t a bubble in stocks. That, however, doesn’t mean they can’t trade lower and even much lower, if worries escalate and growth slows markedly.

The key is to be careful about what we are invested in. 

Personally, I am unhappy with the First Samuel share performance in the first few months of the fiscal year as I thought we would have held up better against the market. 

But, in a way, it simply speaks to the indiscriminate nature of the selloff that has occurred. We have been very careful in the portfolio selections we have made, and the companies we have invested in.  We believe they will continue to grow (as we saw in the GFC), and that their growth will ultimately be recognised, even if the market elects to “vote“ against us in the short term.

We are currently positioned with a lot of cash (25% in your equity portfolio) and a portfolio with a strong dividend growth outlook (earnings should grow at >10%pa) and a good yield (4.6%).  This sell off has made a lot of good companies cheaper.  We will use it carefully, to see if by investing some of the cash we can improve the dividends we will receive this year.  And the rate of growth of those dividends over the next few years. But we will be careful and patient.

Market sell offs are a part of market life.  We are well positioned and will try to use them to our advantage to growth your wealth over the medium term.  We do not know how long this current period will persist, nor how far markets will bend. They will do what they will do.  Ultimately, we will benefit from any bargains and remain quite comfortable in your portfolio positioning.

  -  Dennison