We expect some of the dominant themes of 2018 to persist into 2019. The strong growth we've seen in the United States, which has been pushing up interest rates and inflation pressure, will continue.
On the political side, the trade tension between the United States and China, and the resulting slowdown in Chinese growth will also likely persist. In Europe, moderating growth and potential risks arising from the Italian bond market are also significant, adding to a backdrop of potential risk events for 2019.
Where do you see the most important opportunities and risks within your asset class?
In Australia, the main area of focus for us has been on the slowdown in the housing market and the tightening of credit standards. This is particularly important for Australian equities given the dominance of banks in the benchmark and we are very cautious about this sector. Additionally, the Banking sector currently has very low levels of bad debts in the system, which is on the one hand is positive, but from such a low base, means we are likely to see an increase in bad debts in 2019.
Mining, the other dominant sector in the Australian market, is one we are wary of due to the slowdown in China. Interestingly, while this slowdown has been occurring, iron ore prices have been consistently strong, which has been encouraging from a cash flow perspective for businesses like BHP and Rio Tinto, within which we have select investments.
Given the headwinds for the banks and miners, which together make up about half of the Australian equity market, we're looking outside these sectors for other opportunities. These include Consumer Staples players, like Woolworths. While this company hit a little bit of an air pocket the middle of the year with a slowdown in sales, it is now re-accelerating. In our view, it is a very well-managed business, a dominant player in its market, and the balance sheet is very strong. We also anticipate some capital return at some point in the early New Year, so strong cash flows and capital returns are very positive in the context of a cautious backdrop.
We also like the outdoor advertising sector and have holdings exposed to the sector. Outdoor advertising is coming back into vogue as part of an advertiser’s marketing mix given how it complements other forms of media. This is especially the case with the digitalisation of the sector, which is reducing the production costs associated with printing and installing advertisements, as well as enabling advertising to be more dynamic and varied by geography and time of day.
The outdoor advertising sector has also consolidated from a five player market down to a three player market, so we think returns and growth will be strong.
In a cautious market, we're looking for interesting bottom-up opportunities and generally if they've got some defensive characteristics or they've done a reasonable acquisition, we're interested in taking a closer look. We added Amcor, a packaging company, in the second half of 2018 as it is mainly exposed to the fast-moving consumer goods segment – a relatively defensive opportunity, which also benefits from a strong economy as well. Amcor has good US exposure and also just completed the acquisition of US competitor, Bemis. While Bemis has been very strong on product development and product innovation initiatives, it was not as strong on the manufacturing side, complementing Amcor, which was the opposite case.
Aside from defensive stocks, the Q4 market correction is throwing up a lot of really interesting opportunities from a bottom-up valuation perspective. With the market now trading closer to 14 times earnings, even though the backdrop is cautious, we think a lot of it is priced in and we're finding really interesting opportunities in the market. Since the Global Financial Crisis we haven't really seen that type of attractive earnings multiple.
Which chart do you think will be a key indicator for 2019?
I think the best indicator that you can focus on for 2019 is US 10 Year Bonds. It reflects what is going on in the interest rate markets, inflation and growth and also some of the geopolitical tensions that may occur in 2019.
If the bond yield is tracking higher, that would suggest inflationary pressures are building and we should be more cautious, growth will obviously be pretty strong in that environment. If it's chugging along and we've got good moderate growth and moderate inflationary pressures, that is an ideal situation for staying long stocks and if yields start to fall rapidly that is obviously where there has been a hiccup somewhere, growth has deteriorated or there's been a political issue.