The Australian stock market is set to post its first annual decline since 2011 after three consecutive years of gains. As of 22nd December, 2015, the ASX200 index stood at 5,117 points and is down 5.4% for the year. While the ASX200 looked like it would break through the 6,000 mark back in March and April, it subsequently followed a downtrend for the remainder of the year.
The best performing sectors were Utilities, Industrials and Healthcare while the worst performers were Energy and Materials. Financials were mixed as regulatory challenges and capital raisings diluted shareholders.
The Reserve Bank of Australia (RBA) slashed the interest rate twice this year. The first rate cut of 25 basis points was announced in January, which boosted stock market returns at the beginning of the year. The RBA then reduced the interest rate by a further 25 bps to 2.00% in May. Governor Glenn Stevens stated that the cut was needed to encourage borrowing and spending activities in the economy and stimulate an increase in household demand.
Energy and Resource Stocks Tumble amid Commodities Selloff
Global commodity prices across the board slumped to multi year lows in 2015 amid slowing demand from emerging economies and surplus supply. Crude oil prices have fallen to ten year lows as oil producers around the world, especially members of OPEC, have failed to lower production levels as many fear they will lose market share. Gold prices continued to ease throughout the year as well as a stronger USD as well as declining physical demand weighs on the commodity.
As mentioned earlier, Energy and Material stocks were hit the hardest as Rio Tinto (ASX:RIO) lost ~25% year-to-date while the world’s largest miner BHP Billiton (ASX:BHP) and Fortescue Metals (ASX:FMG) have lost more than 30% for the year. Pureplay energy companies suffered the most as Santos (ASX:STO) and Origin Energy (ASX:ORG) declined approximately 50% during 2015.
Both resource and energy stocks significantly underperformed the broader market as investors continued to reduce exposure from volatile mining and exploration companies.
Regulatory Changes Weigh on Bank Valuations
The financial regulator Australian Prudential Regulation Authority (APRA) increased the risk weight attributed to home loans from 16 percent to a minimum of 25 percent. The regulatory change is only applicable to the Big Four banks and Macquarie Group (ASX:MQG), and will come into effect on July 1, 2016. As a result, the banks were forced to raise capital in order to comply with the changes. Australia and New Zealand Banking Group (ASX:ANZ) and Westpac Corporation (ASX:WBC) raised $3 billion and $3.5 billion respectively, while CBA (ASX:CBA) and Nab (ASX:NAB) raised $5.1 billion and $5.5 billion respectively.
Over the past three years, the Big Four banks steadily increased cash profits which resulted in healthy dividend growth for investors. Following three years of capital growth, the ‘big four banks’ are set to finish the year in the red. Whilst CBA and WBC have managed to recover since the ‘August selloff’, especially ANZ and NAB continue to experience downward pressure.
Among the second tier banks, Bank of Queensland (ASX:BOQ) is up approximately 11% for the year, while on the other hand, Bendigo and Adelaide Bank (ASX:BEN) is down by more than 11% as investors and analysts alike were disappointed by the results.
Small-Mid Cap Stocks Back on the Radar
Wise-owl favours the growth potential of small and mid-cap companies as we consider the current market environment to be favourable for these stocks. The Small Ordinaries have gained 3.2% as of yesterday, significantly outperforming the ASX200 during this year.
Moreover, investors seem to favour small and mid-cap companies which may be attributed to the so called ‘Turnbull effect’. Malcom Turnbull, appointed as Prime Minister earlier this year, actively encourages start-ups and promised financial support for entrepreneurs.
Business Confidence reached a two-year high in November, according to the latest report released by Nab. The bank attributes the 8.3 percent surge of the index to Turnbull’s leadership. In the recent mid-year budget, the prime minister allocated $1.1 billion to boost innovation and encourage small businesses. The Nab business report has also pointed towards a shift from mining to non-mining companies as the cheaper Australian dollar and lower commodity prices make investors wary of the mining sector.
Small cap companies such as Bulletproof (ASX:BPF) or Freelancer (ASX:FLN) have enjoted strong buying pressure. Meanwhile, high yield stocks like Telstra (ASX:TLS), Woolworths (ASX:WOW) or Wesfarmers (ASX:WES) ran out of favour as investors seek growth opportunities elsewhere.
Investors Worry about Contracting Chinese Manufacturing Activity
As China’s economy transitions to a more service based economy, manufacturing activity has continued to contract throughout the year. The government eyes slower yet more sustainable growth. The country’s GDP fell from 7.4% in 2014 to 6.8% in 2015. The country’s imports fell more than 13% compared to 5 years ago.
Australia is significantly impacted by the slowing economy, as China remains Australia’s most important trading partner. Whilst the slowdown sparked a selloff in commodities, Australia is also heavily dependent on Chinese demand for its iron ore exports and other resources. The disappointing manufacturing data from China has also been causing broad-based declines in the Australian resource sector.
It was a year to forget for Chinese investors as The Shanghai Composite Index slumped more than 40% in as little as four months. The Chinese government’s lose monetary policy and aggressive promotion to invest in stocks on borrowed capital, inevitably resulted in a so called ‘stock market bubble’. During the selloff more than 1,400 companies had to enter a trading halt to prevent further losses. However, Chinese stocks have stabilised in the final quarter of the year to gain approximately 20% as investors hope for a more sustainable long-term growth trajectory going forward.
Australian Dollar at 6-Year Low
The Australian dollar slumped to a six year low, a level that was not seen since the GFC. As many investors consider the local currency to be a ‘mining currency’, lower commodity prices and falling interest rates put pressure on the value of the currency. At the same time, the weakness in the AUD can be contributed to a strong USD, which gained against most other major currencies as the US economy continues to strengthen and the FED started tightening monetary policy.
A low AUD is beneficial for local exporters as the goods and services produced in Australia become cheaper relative to other importing countries. The RBA stated several times that it targets a low AUD within the target range of 70-72 cents as it believes this would provide an essential boost to the economy.
Winners & Losers of 2015
Blackmores (ASX:BKL): The pharmaceutical company has risen more than 300% due to growing demand for its vitamins and infant formula overseas, especially from China
Dominos (ASX:DMP): The company has been growing both organically and through acquisitions as Domino’s continues to grow its market share in Europe. DMP is up more than 120% year-to-date.
Freelancer (ASX:FLN): Wise-owl recommendation Freelancer has surged over 160% this year. The software company has expanded its business operations through acquisitions and also attracted the attention of large institutions.
A2Milk (ASX:A2M): The A2Milk company’s announced an increase in demand for its infant milk products in China, which sent its share price surging. A2M is up nearly 200% for the year.
Qantas (ASX:QAN): Airlines are set to post record profits in 2015 amid favourable conditions for the industry. Qantas returned to profit as a result of successful execution of the ‘Transformation Program’. The stock is up approximately 65% for the year.
Bellamy’s Australia (ASX:BAL): Bellamy’s offers profitable exposure to organic food demand. We are attracted to the Company’s sales record, domestic foot print, and ongoing growth opportunities.
BHP Billiton (ASX:BHP): BHP slumped to a 10-year low as the company faces headwind from low prices of its key commodities and after the Brazilian government is set to sue BHP and joint venture partner Vale over the accident at its Samarco project in Brazil.
Santos (ASX:STO): Santos’ market value has halved during 2015 as the company suffers from the ongoing rout in crude oil price. The challenging environment forced the company to raise $2.5 billion through an entitlement offer at $3.85 per share.
Origin Energy (ASX:ORG): Origin posted a net loss of $658m during FY15 and raised $2.5m to strengthen its balance sheet in light of the challenging business environment.
Dicksmith (ASX:DSH): The electronics retailer fell more than 83% this year as it wrote down $6 million worth of inventory.
Author: Simon Herrmann
Dec 23, 2015
Simon is a financial analyst at independent research firm Wise-owl specialised in small-mid cap growth opportunities and ethical investment opportunities. Simon's aim is to disrupt the cliché approach to investment decision making as he believes that socially and environmentally responsible behaviour is a necessity to long-term wealth creation. Simon has a deep fundamental understanding of the global financial landscape and has compiled 300+ research reports, valuations and corporate appraisals. Simon is commonly featured in major media outlets and his research is published weekly in The Australian.