This has been a tumultuous year for the Australian equity market. Key themes driving the decline and heightened volatility have included the increase in government regulations, escalation in trade wars and attempts to control the global oil surplus.
An increased threat of regulations from the Australian government generated 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. Earnings at the big four banks fell 6.5 per cent in the 2018 financial year 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, affecting housing prices. In July, investor home lending fell to its lowest level in nine years, with property prices expected to fall 5.1 per cent by the end of this calendar year.
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 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 via 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.
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 five-year average. In May, president Donald 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 on to the market 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 November oil had a spectacular fall of 22 per cent, the biggest monthly percentage loss in a decade.
Since mid-October, the price of international benchmark Brent crude has fallen almost 18 per cent 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 1.2 million 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.
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.