December 2019 Newsletter

Dear Esteemed Clients and Friends,

It has been a stellar year in equity markets globally in 2019.  Generally, recession fears are heightened when euphoria and unending optimism abounds in equity markets.  However, pessimism has been very evident across all equity markets, yet the bulls have made hay while the sun shines!

Market volatility has been somewhat elevated and 2020 looks set to be an interesting year with the election in the US and the Brexit deadline fast approaching.

In the US, opposition to Trump in the elections seems to be losing strength. For example, Elizabeth Warren, one of the possible candidates, wants to ban share buybacks.  This is almost seen as un American by the voters. Probability has Trump back in.  So far, he has overstepped the US/China trade negotiations and needs to dial down and come to some resolution pre the election. However, post the election in 2020, given he cannot be re-elected post that presidential term, he has nothing notionally holding him back in doing what he wants to do. This creates some uncertainty (and anxiety!) from 2020 elections onwards. In recent manufacturing numbers, the US is showing signs of a slowdown and the trade issues with China seems to be taking a toll.

In China, the GDP per capita has grown markedly over the past 5/10 years.  They have successfully transitioned their economy from a manufacturing centric to a more balanced economy with a tilt towards services sector reliance. Local consumption (including in the rest of Asia) has continued to improve thereby decreasing reliance on global trade somewhat (but not enough in my view as yet). The US/China trade conflict is benefiting peripheral Asian countries such as Vietnam and the Philippines as well. The Hong Kong political issue, however, remains delicate. The issue here has to do with not just control and dominance from mainland China, but also with huge wealth disparity. Hong Kong has one of the highest concentrations of Billionaires in the world (similar to Manhattan). Yet, the housing affordability is worse than even in Australia for the majority (including youth).  For example, a 100 square meter apartment in not a prime location costs around US$2M.  In prime locations, this is double or more! Therefore, there is no easy solution to this issue.  It is, however, important to note that Hong Kong makes up only 3% of GDP of China. This is a far cry from the 25% it was at the time of the handover from the British. Therefore, China can remain (hopefully) calm and restrained in its dealings with Hong Kong during this turmoil.

In the UK, Brexit uncertainty has caused a significant reduction in investment by companies.  However, this uncertainty has been decreasing and the UK is likely to pick up going forward. Unemployment numbers have decreased and there is an abundance of good quality companies there that have growing revenue streams and markets. In Europe, employment participation rate is over 73% and growing.  This means jobs are plentiful and wage growth seems to be coming through with little to no inflation.  This means purchasing power is improving as is disposable incomes.  This should translate into GDP growth through spending and consumption. In Germany, Angela Merkel’s party seems to be losing power.  However, Germans are quite conservative by nature.  Any change to the balance of power, we believe, will have little impact on their policies and their economy in the long run. However, only time will tell.

Finally, looking back home, The Reserve Bank anticipates a strong rebound in GDP growth, with annual growth accelerating from 1.4% currently to 3.1% by end-2021.  Although it is natural to forecast a recovery after an economic slowdown in recent times, there is uncertainty about the pace and degree of recovery.  The Reserve Bank has persistently overestimated growth.  Further deterioration in the US/China trade conflict will apply downward pressure on our economy given our reliance on China. This, in addition to the drought and weather conditions (and fires) is keeping our economy under pressure. However, retail sales seems to have improved but business conditions now seem to be more subdued.

“The business sector has lost significant momentum over the past year or so, putting at risk the optimism around business investment and possibly employment going forward. Overall, we see this as a demand driven issue with private sector demand the weakest since the GFC. It may well be the case that the economy needs further stimulus in addition to the monetary and fiscal support provided so far to support demand and see a lift in business activity and confidence” said Mr Alan Oster, Chief Economist for NAB. Therefore, It will be interesting to see whether or not Australia also succumbs to negative interest rates in due course.

Overall, whilst we have enjoyed significant equity market returns in 2019, and being mindful of momentum possibly driving further returns, we are somewhat cautious with a focus towards “value”, which has underperformed in recent times. Post the 2018 November market correction, we have increased equity exposures in our portfolios but still remaining slightly conservative against our benchmarks on the whole.  This should provide some stability in volatile times and some protection should we see another correction at some time in the future. Finally, I leave you with a quote from one of the Great Value Investors, Howard Marks:

“You can’t predict, [but] you can prepare.”

Warmest Regards

Aziz Meherali