The March quarter saw extremely strong returns across all asset classes, which was largely a reversal of the very tough 4th quarter of 2018. Investors got the green light following a coordinated central bank U-turn, with the US, Europe, and Australia all moving back to an easing bias, following weakening economic data across the board. Investors were further encouraged by Chinese central bank and government stimulus, and emboldened by the expectation that a trade war resolution was near.
Australian economic data continued to weaken over the quarter with manufacturing and retail sales both weak, business conditions and confidence both falling at the same time, sharp declines in dwelling approvals and housing finance with consumer confidence taking a hit, all leading to the Reserve Bank of Australia significantly revising lower their economic growth and inflation forecasts, and potentially contemplating rate cuts over the course of the year. The quarter also saw a heavily anticipated budget announcement, with an early Federal election anticipated.
Global economic data also weakened with synchronised falls across industrial production and manufacturing, with Eurozone economic growth stagnating yet again and stubbornly low inflation forcing the European Central Bank to cast aside policy tightening for the foreseeable future. US data was more mixed, with jobs data remaining strong, inflation in line and holding course but not moving higher, and housing data recovering after some weaker numbers in Q4 of 2018.
The US central bank confirmed their policy reversal, no longer looking to raise rates this year and also seeking to slow the pace of their balance sheet withdrawal. US politics did its best to disrupt markets with a rather long government shutdown over a widening budget deficit and funding for the wall, with President Trump turning his trade rhetoric on Europe.
Both the Chinese central bank and government were forced into providing stimulus with the effects of the trade war and high household and corporate debt levels resulting in a contraction in manufacturing and weaker data across retail sales, car sales, and exports. The weaker data also came following the 2018 calendar year where the Chinese government largely stepped away from providing any stimulus, with the economy growing at 6.6%. The economic growth target for 2019 has been set at 6-6.5%.
In contrast to the weakening economic data, strong asset class returns saw Australian equities up nearly 11% boosted by the resources sector and global equities up over 11% with particular strong returns from US tech stocks. In light of central bank U-turns, interest rate sensitive asset classes like listed property and listed infrastructure were up a stellar 14%. Even defensive assets did well, with Australian bonds up nearly 3.5% and global bonds up nearly 3% for the quarter.
The Aussie dollar traded in a narrow band against the US dollar, finishing the quarter largely flat at
From a portfolio perspective, overall numbers were very pleasing, with returns generated well
above relevant peer groups and benchmarks. The main contributors were: investment selection
across each asset class with Bellmont Consolidated Equities, Flinders Emerging Companies, T.
Rowe Price Global Equities, and PIMCO Diversified Fixed Interest all outperforming; asset
allocation also added value via Australian small companies, global equities, and both Australian
and global listed property allocation. The main detractors included: investment selection in global
equities, with Magellan and Vanguard producing lower returns than the benchmark in a strongly
rising market; and investment selection within bonds, with T. Rowe Price Dynamic Global Bond
Despite the wild fluctuations in markets over the last 6 months, returns from our Bellmont Consolidated Equities portfolio remain very solid, with our 11.4% p.a. return since inception almost 4.5% p.a. ahead of the index over the same period. Shorter term returns have been just as impressive, with a 12 month return of 19.1% compared with 12.1% for the ASX200 Accumulation Index, and an incredible 16.2% return in the June quarter alone, outperforming the index by more than 5.3%.
Of course if the wild volatility of share prices in the last 6 months tells us anything, it’s that any point in time calculation of returns is going to be impacted enormously by the relative enthusiasm or otherwise of market participants at that point in time. Over time though, the long term performance of a portfolio will be determined by the earnings growth of the companies it comprises.
On this front we were fortunate to have a reasonably robust H1 2019 reporting season in February, albeit definitely not as strong as the outstanding results our companies achieved in FY18. Interestingly, and in contrast to results seasons of previous years many companies managed to deliver reasonable top-line revenue growth, but often this didn’t manage to filter down to earnings growth of the same magnitude. Conveniently, when individual companies didn’t manage to report earnings in line with the market’s expectations, the market reaction was savage - often excessively so - providing us with juicy opportunities to add to our holdings in the period in both Blackmores (BKL) and Flight Centre (FLT) at levels that we believe position us well for strong future returns.
As our worst performer in the period though with a -8.0% return, Blackmores (BKL) deserves
closer attention. Despite generating solid 11% revenue growth for the first half as a result of a
strong performance from their SE Asian business, earnings were flat as increased marketing
spend in China failed to generate the desired sales boost, with the company’s Chinese sales
growth falling well below many of their peers. The weak result saw a vicious 35% intra-day selloff in the company’s shares, providing us with an opportunity to increase our weighting in the
company by around 2% at approximately $90 per share, almost 50% lower than where they were
trading just 6 months earlier. Following on from this was the surprise announcement that CEO
Richard Henfrey had “resigned” (at the suggestion of the board), with Director and 23%
shareholder Marcus Blackmore confessing that the board made the wrong decision in appointing
Henfrey CEO after the resignation of Christine Holgate, with an external candidate with
experience developing a consumer business in China likely to have been a better option for the
business at that point. While this string of events is no doubt unfortunate, it doesn’t change our
view of the quality and significant long term potential of the business. And while the fact that the
CEO needed to be removed is no doubt a negative, the fact that he WAS removed is in our
opinion an enormous positive - showing that the board (and Marcus Blackmore in particular)
know the business well enough to be able to identify when it’s not operating to its potential, are
willing to admit when they’ve made a mistake, and make the difficult calls necessary to rectify
that mistake and improve the long term performance of the business. While we don’t expect a
sudden turnaround in either the business performance or share price, from these levels we’re
confident of achieving solid returns in the coming years.
With an incredible 80% return for the quarter, our best performer in the period was Fortescue Metals Group (FMG), which rallied strongly on the back of increased iron-ore prices, as well as a significant narrowing of what had been enormous discounts for lower grade ore, which had been making life particularly difficult for the company in the past few years. Having bought more shares at just over $4.00 at the last systematic portfolio rebalance back in November when the company was well and truly out of favour, we are definitely reaping the rewards of our contrarian view now with the share price closing out the quarter at $7.11.
Also continuing to perform well in the quarter was one of the companies singled out for its good performance in the December quarter as well - leading Australian SaaS provider Technology One (TNE), which rallied another 34% in the period. When we initially purchased our shares in Technology One (TNE), in April and May 2018, we were delighted to be buying into what we consider to be absolutely one of the best businesses on the Australian Stockmarket, albeit at prices that we considered to be fair for a company of its quality - but definitely not a bargain.
We expected that with the reasonable price we had paid, and the company’s strong earnings growth prospects we had a very good likelihood of achieving something in the order of a 13% per annum return over a 5 year time horizon from our investment. Fast forward 12 months and we were not too far off in terms of the total return potential, but have been pleasantly surprised to achieve those returns in 1 year, not 5! Importantly though, this return has not been achieved by a massive increase in the company’s earnings over this period. Earnings have grown, but only by 14% since we first purchased our shares.
The majority of our return has come instead from an increase in the company’s P/E ratio - which has the effect of both increasing our current returns, while decreasing likely future returns (assuming earnings prospects for the business haven’t changed - which they haven’t). With future returns from these levels likely to be only modest, even with continuing solid business performance, we made the difficult decision to exit our holding, and look to redeploy those funds in more compelling opportunities.
While we have no idea whether the market's strong start to 2019 will continue, pause or even reverse, we remain very comfortable with the high quality portfolio of companies that we have assembled, and the ability of their managers to navigate whatever conditions come their way, and collectively grow the earnings of our portfolio at a solid rate over time.
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