Tuesday, October 14 2014
The following market update could be read in conjunction with the Monthly Investment Review for September.
Ebola and other concerns
One of our concerns over the past month was that the US had not really had a pullback and that Australia could be dragged down if a pullback developed in the US market. Since month end we have seen the US fall around 6%. The Australian market is down around 1.5% (which reflects our earlier falls). We assess the reasons for the US pullback below. We note the US has enjoyed very low volatility throughout the year and a pullback is not an unexpected event. Our sense is that the market has been looking for a reason to sell off. We present recent market concerns and assess the veracity of the concerns as well as some of the opportunities.
The US media has adopted a heightened level of hysteria regarding Ebola. This has contributed to poor market sentiment. The risk is that this poor sentiment begins to impact behaviour such as travel which can have an economic impact. We see this risk as low. Ebola is not contracted via an airborne virus (like SAARS or the flu) and as a consequence it is seen as having less risk of contagion. The majority of cases in humans have occurred as a result of human-to-human transmission. The World Health Organisation (WHO) notes that during an outbreak, those at higher risk of infection are:
- health workers;
- family members or others in close contact with infected people; and
- mourners who have direct contact with the bodies of the deceased as part of burial ceremonies.
WHO also advises that the risk of infection for travellers is very low since person-to-person transmission results from direct contact with the body fluids or secretions of an infected patient. As a consequence we would expect Ebola concerns to ease over time given there is unlikely to be a rapid acceleration in the outbreak.
Beheadings, Hong Kong protests, and shirt fronting Russian Presidents; we have certainly seen an increase in geopolitical uncertainty this year. The market has tended to handle these concerns in their stride but we suspect they are impacting the consumer and general confidence to a degree. The issues could become more of a concern were they to deteriorate significantly. To date we note US reluctance to become dragged into another delayed war, the Chinese are handling the Hong Kong protests with surprising maturity and even Putin appears to be easing off Ukraine (in response to business unrest in Russia).
European growth slowing
We have seen a string of economic data from Europe which suggests their economic malaise continues. The IMF then downgraded global growth which added to market concerns. We note the IMF forecasts remain above most in the market and we have never seen their forecasts as being indicative of future market direction. Nonetheless European growth remains elusive. We suspect Europe will need to redouble their efforts to avoid deflation including a further round of quantitative easing and perhaps further fiscal stimulus. However nothing in Europe happens quickly. They are hamstrung by the bureaucratic nature of the European Union so our expectations remain low. Europe might take years to recover, however, we continue to see a steadily recovering global economy. We note markets and global growth managed to navigate a 20-year deflation of the Japanese economy. A US recovery and growth elsewhere should be enough to drive global equities so long as further shocks are limited.
The oil price has been soft. It began to weaken due to temporary oversupply and the strengthening US$ (which is seen a negative for commodities and drove financial sellers into the market). The weakness in oil was seen as proof of the weakness in global growth which led another round of selling. A benefit of this vicious cycle is that it is quite stimulatory to the global economy.
As noted in the September monthly a lower currency is very helpful for a range of domestic companies including those operating offshore, exporters and those that compete with importers. We estimate every 10% fall in the currency adds up to 8% to profits of the market (all other things being equal).
The US still looks like it could weaken a little more, and this could impact on our market. However the Australian market has now pulled back a significant amount and we are seeing value open up in a range of stocks. We are seeking to use the volatility to lock in the gains on the stronger performing stocks in our portfolio and add to those positions which become oversold. We have added to Bank of Queensland, Henderson’s and Aurizon in recent weeks and reduced Lend Lease and Recall.