IML’s view on sharemarket movements in August 2017
The Australian Market in August – driven by reporting season
The Australian sharemarket had a mixed month with strength in the Resource sector offset by weakness in Industrials with the S&P/ASX 300 eking out a gain of +0.7%. The Resource sector gained +4.4% led by heavyweights BHP and RIO Tinto. This was thanks to a further +3.7% gain in iron ore, a rally in the gold price and the oil price steadying around the USD50 a barrel over the month. BHP rallied strongly despite announcing a below consensus result as investors warmed to the company’s announcement that it will be looking to sell out of its US shale business and return the funds to shareholders. Despite the strength in commodity prices, the AUD changed little over the month, holding its level of close to 80c against the USD.
Industrial stocks had a lacklustre month during August with the All Industrials sector down -0.2% after a mixed reporting season. While many companies met their FY17 expectations, the forward guidance and outlook for FY18 for many companies underwhelmed investors. Good quality companies such IAG Group and CSL delivered a robust set of numbers, however they sold off in the wake of their FY18 guidance. Many high growth companies trading on lofty valuations were also heavily punished if expectations were not met so that over the month there were significant falls in the prices of companies such as Domino’s Pizza, Realestate.com and Healthscope.
Specific company news that dominated the headlines in August
In company news for August, Telstra fell over the month after it surprised investors by cutting its FY18 dividend from the current level of 31 cps to a lower than expected 22 cps from FY18 onwards. Telstra stated that this new level of dividend represented a payout ratio of 70-90% post NBN earnings and also included an unspecified special dividend component. Subsequent explanations by management indicated that 22 cps was a level of dividends that the company felt was sustainable for the foreseeable future and was a level from which the company felt it could look to grow from.
Over the month investors had to contend with the revelation of AUSTRAC’s investigation into CBA for non-compliance with anti-money laundering protocols. This has resulted in a class action from shareholders, the announcement that long serving CEO, Ian Narev would leave the bank by June 2018 and APRA announcing an investigation into the operational risk and governance of the bank. Despite releasing a record profit earlier in the month, CBA fell almost -7% over the month as investors focused on the potential fall out of the AUSTRAC investigation.
IML’s portfolios in August
Many of our Funds had a challenging month during August when comparing returns to their benchmark. Our low weighting to the volatile Resources sector weighed on our relative performance. Several of our core mid cap industrial holdings such as Pact Group, Steadfast and Ansell were sold down despite announcing solid FY17 results and increased dividends, as investors were underwhelmed with the release of conservative FY18 guidance statements. Having looked closely at the results for all of these companies, we remain comfortable with their 3 to 5-year outlook and used weakness in their share prices to top up on our holdings.
For more commentary on August performance for specific IML funds you can read our Fund updates.
The last 12 months: short-term factors dominating investor sentiment
In IML’s 20 years of existence, we’ve inevitably seen periods of underperformance by our Funds when short-term factors dominate investor sentiment. We believe that we are seeing this once again in the Australian sharemarket and we believe it is important during times like these to not lose focus of our long-term objectives. Evidence of this ‘short-termism’ can be seen from the chart below showing the large dispersion in returns of the main ASX sectors over the last 12 months.
Resource Sector - this volatile sector has rallied very strongly based on spikes in commodity prices to well above expected long-term prices, thus for example iron ore is up +40% since June. The long-term sector outlook remains relatively unattractive and we advise caution on extrapolating current commodity prices into the future.
Banks – IML is soon to release a paper titled “Is the dream run of Australia’s Big 4 coming to an end?” In short, we believe investors should tread carefully and that an index type weighting is not prudent from a diversification perspective at this point in the cycle.
Non-bank Industrials – this diverse universe appears to have been forgotten about in recent times. Many of the companies held in IML portfolios in this portion of the market continue to grow their earnings and dividends, but many stock prices in this segment are down year-on-year. It is this diverse universe where we believe selective long-term value in quality stocks can be found. We continue to focus on quality companies with capable management who, through their own initiatives, can grow their earnings in the years ahead.
Staying focused on the long term
We remain cautious given the continued low growth and highly competitive economic environment which is making it difficult for many companies to grow their earnings. While the Resource sector is the one grabbing all the attention at the moment as commodity prices stay firm, we continue to focus our attention on good quality companies that we believe are well positioned to sustainably grow their earnings and dividends in the years ahead while also maintaining a healthy level of cash in our portfolios as we await opportunities to buy good quality stocks at the right level.
At times like this, short-term results can be mixed and underperformance can be unavoidable for a stock picker like IML. As an investor with a proven and disciplined focus on ‘quality’ and ‘value’ we will continue to populate our portfolios with quality companies that we believe will continue grow their earnings and dividends over the next 3 to 5 years, in what we believe will continue to be a relatively challenging low growth and competitive environment.
We will continue to hold our focus on delivering consistent, long-term results for our clients and we will not get caught up in noise or fads.