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2019 could be the Year of the Answer for global equities markets. Well, if not clear-cut answers then at least some clarity on key questions confounding bulls and bears.
Four questions stand out: two global, two local. The biggest is the pace of United States interest-rate rises. Having assumed rate rises would continue into 2019, the market is pricing in fewer (or even no) rate rises. That implies the US economy is poised to slow next year, a risk reflected in lower-than-expected job figures in December.
The second question is the US/China trade war. Witness this month’s volatility in global equities when investors panicked that the US/China trade truce would be short-lived. An escalating trade war will weigh on global growth and on China, which is bad news for Australia.
Locally, the top question of 2019 is whether Sydney and Melbourne property markets have a hard or soft landing. Most commentators favour a moderate, manageable cooling in property prices that doesn’t crunch the banking sector or economy. But Australia’s weaker-than-expected growth figures this month reinforced the property slowdown’s effect on household consumption.
The fourth question is regulatory/political uncertainty. It’s not just the effect of the Hayne Royal Commission on banking regulation. It’s the upcoming Aged Care Royal Commission, energy-market reforms, State and Federal elections, and government swamping industries with extra regulation. A Labor Government, which according to opinion polls appears increasingly likely, will add to uncertainty with its negative gearing and franking policies.
Nobody knows for sure how these issues will play out. My view is US rate rises will be slower than the market expects, the US/China trade war will have more brinkmanship before being resolved, Australian property prices will have a manageable landing and regulatory/political uncertainty will have a larger negative impact than markets expect.
One certainty is continued high market volatility in 2019 as the answers to these four questions become clear. Put another way, larger market sell-offs and rallies as bulls and bears slug it out. Volatility in October was a taste of what’s ahead in the next 12 months.
If I’m right, 2019 will be another challenging year for share investors, but also a year of extraordinary opportunity and bargain hunting. Value is rapidly returning to global and Australian equities after a horrendous sell-off since October.
However, this is no time to be invested fully in equities or to take aggressive bets on pricey stocks. I’m not convinced this downtrend has run its course.
Make no mistake: there will be terrific bargains in 2019, possibly in oversold cyclical stocks later in the year. For now, I’m focusing on defensive names and do not see the latest sell-off as another “buy the dip” situation before a next big run higher, although that view could change quickly if the extent of recent market falls continues.
Once we get through a difficult 2019, my medium-term view on Australian equities (1-3 years) is bullish. The economy is still in good shape, population growth is a tailwind and, unusually, we are having a property correction during record-low interest rates and low unemployment.
Addressing an overheated property market and rampant household debt when conditions are robust – rather than during a crisis – is vital to setting up economic and market gains in the medium term.
The upshot is the next 12-month period is a time to reposition portfolios for medium-term gains. To be careful, patient and value focused. To be defensive. To preserve capital.
That thinking informs my three stock ideas for 2019: Coles Group, UK-focused bank CYBG and Auckland International Airport. They are stocks I’d buy now because of their defensive qualities, yields and valuations. These stocks should be relatively less affected if the market storm worsens.
Investors who want to pounce on higher-growth stocks during market sell-offs in 2019 could consider: Macquarie Group, Unibail-Rodamco-Westfield, BHP Billiton, ResMed, Xero, IDP Education, Reliance Worldwide Corporation, G8 Education, REA Group, Seek, James Hardie Industries, Carsales.com and Invocare.
Here is a snapshot of the three stocks, followed by two that look overvalued:
I follow demergers closely, principally because they have a habit of outperforming in the year after being set free from their parent company. That will be true of supermarket giant Coles, demerged from Wesfarmers this year.
Coles’ consumer-staples offering has defensive qualities in a slowing Australian economy; households might cut back on discretionary items but they still need to eat. Also, big supermarkets are less affected by online competition compared to discretionary retailers.
Although competition from Woolworths and, increasingly, Aldi is growing, Coles’ sheer scale should underpin moderate earnings and dividend growth. The well-run supermarket has shown it can innovate through clever pricing and promotions and should be invigorated as a standalone business that is not competing for capital within Wesfarmers.
Coles won’t star, but an expected 5.1% yield, fully franked, should take the total return to low double-digits; an attractive outcome given its defensive qualities and evaluated market risks.
Coles also listed on ASX at a significant valuation discount to Woolworths – about 4 PE points on some broker numbers. Woolworths deserves to trade at a valuation premium to Coles, but not by that much, creating scope for a steady re-rating of the latter.
The National Australia Bank spin-off halved from its 52-week high of $6.36. The UK regional bank’s earnings disappointed in FY18 and Brexit remains a risk. Poor sentiment towards bank stocks also contributed to CYBG’s big sell-off.
CYBG has much work to do. The mid-size bank is dwarfed by the UK’s big-five banks, has a lower return on equity and poorer-quality franchise – reasons why NAB spun-off its UK business after years of weak performance.
But every problem is an opportunity and every stock has its price. CYBG has much scope for operational improvement as management drives efficiency gains, better customer service, product development and stronger marketing. CYBG’s takeover of Virgin Money, approved in October, is a good move as Virgin Money has earnings upside.
At $3.22, CYBG is on a prospective Price Earnings (PE) multiple of 7 times. The total return (including dividends) is down 44 per cent over a year – an astonishing fall for a bank.
Macquarie values the bank at $5 share, expecting near-term pricing pressures to continue but “long-term value at current levels”. CYBG, the UK’s largest challenger bank, looks badly oversold on that view.
I have written favourably about the New-Zealand airport operator several times and it remains a preferred idea. AIA’s one-year total return (including dividends) is 21% and over three years its average annual return is 11%, Morningstar data shows.
AIA makes this list for three reasons. First, its defensive qualities. Like Sydney Airport, AIA is a monopoly in its market and better placed to withstand a slowing economy and market. As NZ’s largest airport it handles more than 20 million international and domestic passengers annually.
Second, AIA has significant scope to expand its commercial property portfolio thanks to its large land bank and will benefit from ongoing retail redevelopment at its terminals.
Like Sydney Airport, AIA is superably leveraged to growth in inbound Asian tourists. Asia’s unfolding middle-class boom and its effect on Trans-Tasman tourism has been one of my favourite themes.
Third, AIA’s valuation still appeals. Its forecast PE multiple, using consensus analysts, of 31 times FY19 is high, but less than comparable listed airports. Sydney Airport, for example, is on 40 times, although it deserves a premium as it is a higher-quality asset in my view.
Morningstar values AIA at $6.90 a share, suggesting the stock is fully valued at the current price. I expect AIA to do better than that and provide a low double-digit return in 2019 (with dividends) – a decent result given the risk profile.
AIA is not without risk: regulatory challenges are a recurring concern amid pushback on its proposed per-passenger fee pricing from the New Zealand Commerce Commission. But AIA will perform better than many stocks if the market turbulence increases in 2019.
Each stock below is a quality, well-run company with good long-term prospects. But, for now, looks overvalued given market conditions and is a candidate for profit taking. That said, if markets continue to tumble at the current rate, it will be time for buying, not selling.
None of the stocks below should be considered as “avoids” or warrant immediate selling. Rather, some judicious trimming of exposures from investors who sensibly want to lift the cash holding in portfolios so they can rotate into cheaper stocks in 2019 as opportunities emerge.
The iconic airline operator is a tough inclusion on this list. It is one of Australia’s best-run companies in my view and an 18 per cent fall from the 52-week high suggests the stock’s overvaluation has already unwound.
Qantas has had many tailwinds in the past two years: an international and domestic tourism boom, good consumer confidence, lower fuel prices and weak competition. It capitalised on these conditions superbly, but its peak may have passed for now.
Qantas would look a lot more interesting below $5 and might get there in a hurry.
The sub-regional and neighbourhood shopping centre has been one of my favoured Australian Real Estate Investment Trusts (AREITs) over the past few years. SCP’s one-year annual total return (including distributions) is 21% and over three years it is 13%.
SCP is benefitting from Australia’s strong population growth and I like its exposure to consumer staples (through anchor tenant Woolworths) and lower exposure to discretionary retail.
After its rally this year, SCP is on a premium to Net Tangible Assets (NTA) of about 18% on my calculations. Beware AREITs on high NTAs in this market, amid signs that the sale prices for smaller shopping centres are slightly easing relative to their book values.
SCP is a well-run AREIT with good long-term prospects to service a larger population. Its valuation premium has just run too far, too fast, for now, in this market.