2018 has proven to be a tumultuous year for the Australian equity market. Key themes driving the market’s decline and heightened volatility have included the increase in government regulations, escalation in trade wars and attempts to control the global oil surplus.
In the short to medium-term we expect volatility will increase as we progress into the final stages of the longest bull market in US history.
We believe a turbulent market presents many opportunities for investors and will look to capitalise on these opportunities as we begin the 2019 calendar year.
Australian Government intervention
The 2018 calendar year brought an increased threat of regulations from the Australian Government, generating increased costs to companies and negative implications for the economy in the short term.
The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry was the biggest issue facing Australian financial stocks in 2018, with billions wiped off the market values of the country’s largest banks. The big four banks earnings fell 6.5% in FY2018 as costs increased and credit growth slowed. This has had negative flow on effects for investors, including the tightening of credit, resulting from banks’ responses to the Royal Commission and regulator APRA, impacting housing prices. In July, investor home lending fell to its lowest level in nine years with property prices expected to fall 5.1% by the end of this calendar year.
With investors and companies alike waiting on an energy plan to be implemented, the debate on energy policy has dragged on without a resolution for months. The National Energy Guarantee (NEG), introduced by the Turnbull Government, aimed to supply cheaper, more reliable power to the market, and to reduce emissions over the decade between 2020 and 2030. As Prime Minister, Scott Morrison has attempted to withdraw his support for the NEG. Many stakeholders, including ex-Prime Minister Malcolm Turnbull view the NEG as a legitimate resolution to the climate and energy policy wars. Labor has been clear for months that if it wins the next federal election it will pursue the NEG. Uncertainty surrounding a clear policy has already had significant negative impact on electricity retailers AGL Energy (ASX: AGL) and Origin Energy (ASX: ORG).
Other policies flagged in 2018 with unknown outcomes which may have repercussions for the economy and investors next year also include:
- the domestic gas reservation policy,
- Labor’s proposed 2% price cap for health insurers,
- franking and negative gearing changes.
When coupled with increased costs this challenging regulatory environment has created uncertainty for equity valuations.
The trade war between the US and China dominated global equity markets in 2018, beginning in January with the Trump administration announcing tariffs on imported solar cells and certain washing machines.
The list of goods covered by the trade war increasingly grew, with $250 billion in US tariffs now held on Chinese goods, and the potential for an additional $267 billion in imports. Beijing responded with tariffs of $110 billion on US imports. For the US, an unintended consequence of the trade war throughout the year was the rise of the US dollar relative to the rest of the world.
With the combination of a tightening central bank and the risks of tariffs, the flight to the US dollar saw it appreciate against world currencies. The implementation of tariffs on China resulted in quasi-tariffs applied to all its trading partners through the stronger dollar.
At the G20 summit in early December, the trade dispute seemed to be placed on hold, at least for the next three months, with both sides agreeing to discuss their issues and China saying it will increase imports from the US. Early 2019 is the deadline for negotiations, with investors cautious on whether the two will come to an agreement.
We expect that a long-term breakthrough would translate to a relief rally in global equities and negligible negative impacts on the global economy. We have previously discussed how the trade war is a strategic conflict rather than the return of ideological protectionism with the range of possible outcomes best understood through the lens of game theory.
The rise and fall of oil
Last year OPEC and non-OPEC producers led by Russia agreed to cap their oil output in a bid to drain a global crude glut. The OPEC agreement ultimately achieved its goal of getting inventories back to the 5-year average.
In May, President Trump announced that the US would be withdrawing from the Iran nuclear deal, pushing oil prices to near four-year highs. In the lead up to Iran sanctions, to be started in November, leading oil producers began pumping extra oil onto the market in order to help alleviate the fears of ‘supply shock’ intensifying. Market commentators began talking of $100 oil on the back of tightness from the Iran sanctions and oil become overbought.
Before the implementation of Iran sanctions, Trump announced six-month exemptions for the largest buyers of Iranian oil so in the month of November oil had a spectacular fall of 22%, the biggest monthly percentage loss in a decade.
Since mid-October, the price of international benchmark Brent crude has fallen almost 18% amid escalating concerns about excess supply and growing demand. This prompted OPEC to make increasingly frequent public statements to the market, promising to tighten supply and reverse price declines. With excess inventory steadily clearing, investors recently sold oil over concerns about slowing economic growth and the US’ decision to grant several waivers to importers of Iranian oil after re-imposing sanctions on that nation.
With sharply falling oil prices due to short-term oversupply OPEC has again announced cuts to production between OPEC and non-OPEC producers to lower supply by 1.2m barrels for a further six months.
The recent cuts will provide support for oil prices in the short term and we continue to monitor if this will change the inventory positions.
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