Every February and August, most Australian listed companies reveal their profit results and guide how they expect their businesses to perform in the upcoming year. While we regularly meet with companies between reporting periods to gauge their business performance, the reporting season offers investors a detailed and externally audited look at the company's financials.
The February 2025 company reporting period that concluded last week highlighted how volatile earnings season can be when the market is at all-time highs. Share price volatility over the month was compounded by Trump's erratic trade policies, imposing and then reversing tariffs dented market confidence. The dominant themes of the February reporting season have been that the consumers continue to hold up, a strong US Dollar, inflation and cost management and a solid economic outlook. This week's piece looks at the key themes from the reporting season that fared last week, the best and worst results and how the Domestic Equities Portfolio performed over the month.
This February reporting season has proven to be more volatile than previous years. The average intraday share price move was 7% from the stocks that reported. Over 20 companies in the ASX 200 saw their share prices move by more than 10% on the reporting day. Small earnings misses saw significant share price moves; similarly, small earnings beats saw large share price movements. For example, A2 Milk posted a small $6 million increase in profits, which saw a $800 million increase in the company's market capitalisation on results day. Conversely, Viva Energy reported a $60 million fall in profits, and $1 billion was wiped off its value on February 25th!
In previous years, we saw prices move similarly to underlying earnings almost one-to-one, but this reporting season saw companies' share prices move over two times earnings revisions. The increased volatility has been attributed to the impact of high-frequency trading funds on setting prices on results day, with long-term holders likely to wait until after meeting management teams or even after the conclusion of reporting season in March before making significant portfolio changes. In February, Woolworths' share price saw a +2.5% gain after releasing their profit results, before falling all afternoon and finishing by -4%. Very frustrating for shareholders of the grocer.
The first dominant theme for the February reporting season was the strength of the domestic consumer. In November 2022, Westpac's economists forecasted a grim year for 2023. The much-feared fixed interest rate cliff is expected to see unemployment rise to 4.5%, an 8% fall in house prices, bad debts spike and retail sales grind to a halt.
Two years on, the February 2025 reporting season showed that consumer demand had not skipped a beat. JB Hi-Fi sales increased by 10% as consumers still demand the best technology and electronic products that will benefit from the AI rollout. Similarly, Kmart and Bunnings Warehouse owner Wesfarmers saw increased sales across its two flagship stores as consumers continued to trade down items, especially to Kmart's Anko brand.
On the negative side, consumers are unwilling to spend on large projects, including building new homes or upgrading bathrooms and hearing implants. This was seen in the results of Reece, which saw profits fall -19%, driven by lower housing starts due to high capital costs in both the United States and Australia. Cochlear surprised the market after reporting that in the USA, cost-of-living pressures have delayed some users' replacement of ageing sound processing technology due to higher out-of-pocket expenses to fund new sound processors.
Since these companies opened their books last August, the Australian Dollar has depreciated against most international currencies, including the US dollar. While this is a negative for those planning ski trips to Aspen or summer trips to Miami, it is a positive for companies that earn profits in the United States or Europe but pay Australian Dollar dividends. The shareholders in these companies saw a free 5% uplift in their dividends from positive currency movements. The clear winners from the weaker Australian Dollar were the commodity miners, who saw their revenue priced in US dollars while their costs largely remained in Australian dollars. Australian companies with a large US presence have also benefitted from this, including Amcor and Brambles, Woodside, CSL, ResMed and QBE Insurance.
Tariffs were frequently posed to management teams in February with a global presence or operations in the USA. However, most Australian companies selling goods or services in the USA should not have a major impact as their manufacturing facilities are generally close to their customers. For example, CSL collects plasma via its network of collection centres scattered throughout the USA, which is then converted into biotherapies at a plant in Illinois. Similarly, Amcor tend to locate their packaging plants close to their US-based customers such as Unilever, Nestle, Novartis and Pepsi, as shipping empty PET drink bottles across borders makes little economic sense.
The main loser from tariffs is likely to be Rio Tino, which will have a 25% tariff on their aluminium from Canada, acquired in their 2007 takeover of Canada's Alcan. Rio mines bauxite in Australia and Brazil, which is then refined into alumina and aluminium in Canada to take advantage of low hydroelectric power costs, and the finished aluminium is sent to customers in the USA.
Breville currently derives half of its sales from the United States, and most of its manufacturing plants are in China, which currently has a 20% tariff on its goods. Explosive manufacturer Orica has a large manufacturing plant in Canada, sourcing cheap natural gas in Alberta to service blasting customers in the USA. The company's Canadian-made ammonia nitrate will now have tariffs placed on it. Conversely, rival Dyno Nobel (Incitec Pivot) may enjoy a sales boost courtesy of Orica from their cheaper explosives produced in Wyoming and Louisiana.
Commonwealth Bank provides a good look through the economy during reporting season, with Australia's largest bank holding over 17 million customer accounts. Consequently, the banks' financial results and accompanying 172-page reporting suite give investors an insight into the health of the various sectors of the economy. CBA showed minimal bad debts and rising dividends but also that higher interest rates had differing impacts across their customer base. While discretionary spending had been cut back along with savings for customers between 20 and 54, older customers above 55 had increased spending and savings.
Insurers continue to have their best results season since the GFC as they enjoy higher premiums, lower claims inflation, lower adverse weather events, and sound investment returns. Suncorp expects gross written premiums to increase by low-mid double digits and margins from inflation moderations. Similarly, QBE expects its gross written premium to increase by mid-single digits over the coming year while benefiting from subsiding cost inflation.
During reporting season, Atlas looks closely at company dividends, particularly the direction of dividends. While our investors appreciate income, the rationale for looking closely at dividends is that increasing dividends is a sign of earnings quality. Our view is that talk and guidance from management can often be cheap, and company CFOs can use accounting tricks to manipulate reported earnings. However, paying out higher dividends tends to signify that "insiders, " company directors, don't see any imminent negative issues.
Looking across the top 20 stocks (that reported the other banks having different financial year-ends), the weighted average dividend increase was 0%. The five companies that reduced their dividends, BHP, RIO, Woolworths, Woodside, and Santos, saw weaker commodity pricing.
On the positive side of the ledger, Suncorp, QBE, Northern Star, and Brambles offset the cuts, posting solid increases in cash flows to their shareholders. Across the wider ASX 200, dividends declined by -6% in February.
Over the month, A2 Milk, Computershare, Fletcher Building, Eagers Automotive, and NIB Insurance delivered the best results. Despite the uncertain economic environment, especially around the softening of consumers, these companies were able to grow sales and expand gross margins along with providing optimistic outlooks.
Looking on the negative side of the ledger, Mineral Resources, Viva Energy, Reece, and WiseTech reported poorly received results by the markets. The common themes amongst this group were lower commodity prices (Mineral Resources and Viva Energy) and weaker-than-expected outlooks for higher PE companies (WiseTech and Reece).
Before the February 2025 reporting season, everyone expected that the insurers would have strong financial results, benefitting from slowing claims inflation and higher investment returns on their billion-dollar investment floats. This saw record profits from QBE Insurance and Suncorp, but none better than Medibank Private's results. Medibank continues to grow profits and market share in the Australia Private Health market, which has benefitted from higher premiums, higher uptake of short-stay hospitals and claims inflation slowing. During February, the government approved an average 3.73% increase in health insurance premiums ahead of cost increases. These strong results were achieved while simultaneously returning $1.6 billion to customers through their commitment not to benefit or profit from the pandemic. This is a great outcome that will help Medibank continue growing its market share and benefit the brand and stakeholders.
Overall, we are reasonably pleased with the results from the reporting season for the Atlas Portfolio. In general, the companies in our Portfolio were able to increase earnings and dividends, with some reporting record dividends in a more challenging economic environment.
As a long-term investor focused on delivering income to investors, we look closely at the dividends paid out by our companies and whether they are growing. After every reporting season, Atlas looks to "weigh" the dividends that our investors will receive. While share prices move every second between the hours of 10 am and 4 pm, dictated by changing market emotions, ultimately, the sole reason for buying a share is to access a share of the company's profits paid in the form of dividends.
Indeed, in the February reporting season, we saw several companies, such as NIB and Woolworths, give optimistic outlooks, while cutting dividends. This sends a mixed message to investors, and we would prefer to follow the cash rather than the words! Using a weighted average across the Portfolio, our investor's dividends will be +6% greater than the previous period in 2024, and significantly ahead of the 0% dividend growth seen in the top 20 Australian companies that reported and the -6% decline across the wider ASX.
The Portfolio's dividend increase was also ahead of inflation, which was 2.4% over the period, thus maintaining purchasing power for investors who fund their retirement off income. Based on this measure Atlas are pleased with the results from the February 2025 reporting season.
All asset class returns were positive over the 1-year period to February 2024. The Trump presidency and policy uncertainty have resulted in material market volatility over the quarter and negative returns in equities and listed property over the 1-month and 3-month period.
Source: Allied Wealth, Morningstar.
Economically, global and domestic GDP growth while moderate remain positive. Corporate earnings have remained steady but within the listed market, large companies have seen outsized earnings growth compared to smaller counterparts. Despite the Goldilocks (not to hot, not too cold) environment, the largest forces driving markets have been policy uncertainty tied to US trade and fiscal policy. Market reaction has been extreme but in-line with the persistent uncertainty.
Uncertainty around US trade policy has been the largest driver of market movement over the recent period. Since the inauguration of Donald Trump on the 20th of January the administration has threatened and implemented a 25% trade tariff on Canada and Mexico; with a 20% trade tariff imposed on China. At last count, the Trump presidency has threatened trade tariffs and reversed the decision 6 times in the matter of 7 weeks in office. In our view, trade tariffs are a bad idea and represents an effective tax on the end consumer.
Liberalisation of trade over the last 100 years combined with technological specialisations have resulted in an interconnected global supply chain – e.g. assembly of cars today rely on multiple parts manufactured globally across different countries. Thus, any tariffs affecting the flow of good across borders results in more expensive production costs which is then passed on to consumers by companies looking to maintain their profit margins.
We believe the motivations for tariffs are driven by Trump’s desire to implement a broad range of tax cuts while keeping the US fiscal budget balanced. In Trump’s view, the implementation of tariffs is expected to raise massive amounts of government revenue to offset losses from reduced tax.
Source: Statista
However, Trump has likely underestimated the detrimental effects to US consumers including the impact of trade retaliation from Mexico, Canada and China. These are the three largest US trading partners, and we expect its effects to be felt far and wide.
Other avenues of budget reduction have been staff cuts by DOGE run by Elon Musk. We estimate to date DOGE has been able to reduce the government budget by US$ 400 billion which is a far cry from the US$ 2 trillion in cuts promised. More than 70% of the annual federal budget is represented by social security payments, Medicare and Medicaid. Any cuts to these programs directly affect the lowest income cohorts within the community. Excluding the large items, other material components of the budgets are defence spending and interest payments. Unless there are material cuts to any of these categories, it is unlikely that DOGE will be able to meet its stated objective.
We believe that the Trump administration will go ahead with the tax cuts which will further increase the federal costs. This will in turn result in an increase in government debt and translate into increased annual interest payments.
More concerning is the impact of the trade tariffs. Even under the best-case scenario where implemented tariffs are withdrawn, we believe the trade policy uncertainty will persist. We have seen evidence of companies delaying investment and hiring decisions. This will continue to weigh on growth over the medium term.
In the worst-case scenario of escalating trade tariffs, including retaliation by Canada, Mexico, China and the European union, we believe the impact to the global economy will be large. There are no winners in a trade war. In this scenario, we expect a short-term rise in inflation reflecting the passed-on costs of tariffs, followed by a large drop in output and consumption (effectively an economic recession).
Comparing the range of scenarios, we believe there is a wide dispersion of outcomes. Additionally, there is an added complexity of timing. The short-term economic pain for consumer does not necessarily mean a dire outcome for large multi-national companies who are likely to be more resilient. However, the evolution of trade policy (both US and trading counterparties) at this time is unknown and thus we prefer to maintain our market exposure within the portfolio.
| Asset Class | Portfolio Stance | Commentary |
| Domestic Equities | Neutral | We maintain a Neutral portfolio stance in Australian equities. Post the drawdown experienced in February and March, valuation for the asset class has started to look attractive, even adjusting for the potential earnings degradation. |
| International Equities | Neutral | We have maintained a Neutral position in International Equities; but within the asset class, have selected to maintain the marginal overweight to hedged International Equities (relative to unhedged). We believe the currency has moved too far and looks cheap from a valuation perspective. |
| Property and Infrastructure | Neutral | Property and infrastructure as an asset class have remained volatile and reactive to interest rates. Australian listed property remains a more concentrated market compared to global listed property. |
| Fixed Interest | Neutral | We maintain a Neutral portfolio stance. The evolution of trade policy, potential for economic recession and inflation have a wide set of implications for the asset class. In balancing both the upside and downside maintaining a neutral stance remains the prudent course of action. |
| Cash | Neutral | We have retained a Neutral cash allocation in our portfolios for buying opportunities should equity valuations reach attractive levels. |
In-line with the current outlook, the Investment Committee has elected to retain the Neutral portfolio stance, while maintaining our overweight to hedged international equities relative to unhedged. Focusing on the long-term, we are actively monitoring the equity market drawdown playing out today with a view of increasing our equity allocation should market valuation become compelling.
Allied Wealth Investment Committee
Allied Wealth's core principles
You are welcome to pass on this commentary or our contact details to anyone whom you think would benefit from our services.
Disclosure
The information provided in and made available through this document does not constitute financial product advice. The information is of general nature only and does not consider your individual objectives, financial situation or needs. It should not be used, relied upon, or treated as a substitute for specific professional advice.
We recommend that you obtain your own professional advice before making any decision in relation to your particular requirements or circumstances.
Allied Wealth Pty Ltd is a Corporate Authorised Representative of Allied Advice Pty Ltd for financial planning services. AFS Licence No. 528160
All asset class returns were positive over the 1-year period to October 2024; despite the marginal market drawdown experience in the month of October. Strong performance of Australian Listed Property over the year was primarily driven by the performance of Goodman Group which has an outsized allocation within the index.
Source: Allied Wealth, Morningstar.
Portfolios continue to maintain a Neutral asset class position; but with an overweight to hedged International Equities relative to unhedged. The relative currency position has been a strong return contributor over the September quarter; but has been volatile over the month of October. Outcomes of the US elections have implications for long-term monetary policy which make it difficult to take a directional view. Equity market valuations are expensive but can continue to rally further despite deteriorating consumer conditions. We provide further discussion on the outlook in the section below.
The US Elections concluded with a Republican win, and Donald Trump back in the presidential office for another 5-years. More importantly, apart from winning in all US swing states the Republican party won the majority across the US House of Representatives and Senate.
Source: NYTimes
Whilst the selection of key staff remains ongoing, President Trump has already indicated the key areas of focus are expected to be trade tariffs, tax cuts, government spending, immigration and border security – the first 3 have broad financial market implications. We provide some discussion points below.
We expect trade tariffs to be imposed on China at first, but will also be extended to Europe, Asia and Emerging Markets over time, with the primary goal of driving manufacturing back into the United States. However, implementation is expected to be disorganised given Trump’s temperament. The uncertainty is likely to weigh on corporate capital expenditure globally except for companies planning to relocate production back to the United States. Over the short-term, we do expect this to be beneficial for US growth but may result in materially higher inflation and interest rates over the longer term.
On the campaign trail, President Trump has floated several policy ideas including extending the Tax Cuts and Jobs Act, reducing corporate tax rates and exempting various income from income tax; all of which are stimulatory in nature. While the equity and equality of the proposed tax policy is debatable, the economic effects are stimulatory.
Proposed spending plans on the campaign trail has indicated that the US budget deficit is likely to increase by an estimated US$ 7.8 trillion under the Trump regime. However, the establishment of the Department of Government Efficiency (or DOGE for short) led by Elon Musk and Vivek Ramaswamy has promised more than US$ 2 trillion of savings via restructuring of government agencies, slashing regulations and dismantling government bureaucracy. It remains to be seen how this will shape out over the course of the next 5 years.
Despite the conclusion of the US election, we think there remains policy uncertainty. Over the short-term apart from tariffs on Chinese goods, we believe the economic impact from the election is minimal. Trajectory of US monetary policy in response to moderation in US (and global) inflation will likely be the key market driver over the short-term. We note across both developed and emerging markets, policy rates have been lowered and this is broadly positive for risk assets, incentivising more M&A activity.
Over the longer-term, the combination of extensive trade tariffs and government spending may have large inflationary implications in the US. This situation could be grim particularly if developed market central banks are forced to raise interest rates and trigger a rolling recession to battle runaway inflation.
For now, we have chosen to retain a broadly Neutral stance with an overweight in hedged international equities relative to unhedged. The Australian Dollar (relative to US Dollar and Euro), at current valuations still look cheap relative to history.
| Asset Class | Portfolio Stance | Commentary |
| Domestic Equities | Neutral | We maintain a Neutral portfolio stance in Australian equities. On a price-to-earnings basis, Australian equities look marginally overvalued relative to history, however the magnitude is not large enough to warrant a change in portfolio stance. |
| International Equities | Neutral | We have maintained a Neutral position in International Equities; but within the asset class, have selected to maintain the marginal overweight to hedged International Equities (relative to unhedged). |
| Property and Infrastructure | Neutral | Property and infrastructure as an asset class have remained volatile and reactive to interest rates. Australian listed property remains a more concentrated market compared to global listed property. |
| Fixed Interest | Neutral | We maintain a Neutral portfolio stance. The outcome of the US election is likely to have longer-term implications for the asset class. However, over the short-term, we expect more moderation in interest rates. |
| Cash | Neutral | We have retained a Neutral cash allocation in our portfolios for buying opportunities should equity valuations reach attractive levels. |
In-line with the current outlook, the Investment Committee has elected to retain the Neutral portfolio stance, whilst maintaining our overweight to hedged international equities relative to unhedged. We continue to monitor market condition but believe current positioning remains the most prudent course of action.
Allied Wealth Investment Committee
Allied Wealth's core principles
You are welcome to pass on this commentary or our contact details to anyone whom you think would benefit from our services.
Disclosure
The information provided in and made available through this document does not constitute financial product advice. The information is of general nature only and does not consider your individual objectives, financial situation or needs. It should not be used, relied upon, or treated as a substitute for specific professional advice.
We recommend that you obtain your own professional advice before making any decision in relation to your particular requirements or circumstances.
Allied Wealth Pty Ltd is a Corporate Authorised Representative of Allied Advice Pty Ltd for financial planning services. AFS Licence No. 528160
Equity markets which rallied over the first half of 2024 experienced a large drawdown in late July/early August of 2024. However, the drawdown was short-lived with a strong recovery experienced over the remainder of the month. We provide the asset class performance as at the end of August 2024 below. Of note is the impact of currency, with the strengthening of the Australian dollar more supportive of Hedged International Equities vs. Unhedged.
Source: Allied Wealth, Morningstar.
Over Q2 and into Q3 2024, portfolios continue to maintain a Neutral asset class position; but with an overweight to hedged International Equities relative to unhedged. The relative currency position has contributed positively to performance as the Australian Dollar rallied relative to US Dollars and Euros over the assessment period. Given the confluence of market events, we find it hard to take a directional view on risk assets, choosing instead to focus on relative valuation. We provide further discussion on the outlook in the section below.
Our investment outlook since the last quarter has not changed materially, but we have seen some softening in economic conditions. Labour markets have weakened as companies continue to rationalise labour costs and pass on inflation through price increases. This was observed in the recent earnings season where companies have broadly maintained their profit margins despite falling revenues.
Across developed economies only US equities have continued to demonstrate positive earnings growth, but these have been primarily tech related companies. Consumer cyclical and discretionary sectors remains broadly challenged, tied to the weakening consumer. Stock market concentration remains an ongoing issue with a small number of companies accounting for a substantial percentage of the global equity index. From a valuation perspective, equity markets today continue to trade at the higher end of its historical range.
Domestically, weaker consumer dynamics is observed in the younger age groups. Most age cohorts have continued to draw down on savings to fund the increasing cost of essential goods. For the older cohorts, discretionary spending continues to grow but we attribute some of the increase to the higher cost of goods and services.
Source: Commonwealth Bank June 2024 Earnings Presentation
Over the quarter, we have seen the US Federal Reserve soften its stance on monetary policy; indicating a rate cut is expected in September. This is different from the Reserve Bank of Australia who is likely to maintain tight monetary policy given the stickier domestic inflation experience.
US elections are set for the 5th of November with campaigning now in full swing. We remain quite indifferent to either of Trump or Harris presidency. What remains clear is that irrespective of a Republican or Democrat win, we expect higher levels of government spending to persists. While there has been some debate around the sustainability of US federal debt, we think as long as debt serviceability is maintained this situation will likely continue.
As stewards of your capital, we remain primarily focused on the financial market implications for your portfolios. Despite elevated levels of market volatility, we are becoming more constructive on the corporate earnings outlook. However expensive valuations continue to give us pause.
Within international equities, we continue to maintain an overweight in hedged international equities relative to unhedged. The Australian Dollar (relative to US Dollar and Euro), at current valuations still look cheap relative to history.
| Asset Class | Portfolio Stance | Commentary |
| Domestic Equities | Neutral | We maintain a Neutral portfolio stance in Australian equities. On a price-to-earnings basis, Aust equities looks marginally overvalued relative to history, however the magnitude is not large enough to warrant a change in portfolio stance. |
| International Equities | Neutral | We have maintained a Neutral position in International Equities; but within the asset class, have selected to maintain the marginal overweight to hedged International Equities (relative to unhedged). |
| Property and Infrastructure | Neutral | Property and infrastructure as an asset class have been volatile over the previous quarters. Deal volume remains low, and the asset class remains susceptible to interest rate expectations due to the bond-like nature of income returns. We continue to retain a Neutral position. |
| Fixed Interest | Neutral | In-line with changes discussed previously, we have decided to neutralise the overweight in the asset class. Whilst the trajectory of interest rates remain uncertain, yields in this asset class today are attractive. |
| Cash | Neutral | Cash yields remain attractive. We have retained cash in our portfolios for buying opportunities should equity valuations reach attractive levels. |
In-line with the current outlook, the Investment Committee has elected to retain the Neutral portfolio stance, whilst maintaining our overweight to hedged international equities relative to unhedged. We continue to monitor market condition but believe current positioning remains the most prudent course of action.
Allied Wealth Investment Committee
Allied Wealth's core principles
You are welcome to pass on this commentary or our contact details to anyone whom you think would benefit from our services.
Disclosure
The information provided in and made available through this document does not constitute financial product advice. The information is of general nature only and does not consider your individual objectives, financial situation or needs. It should not be used, relied upon, or treated as a substitute for specific professional advice.
We recommend that you obtain your own professional advice before making any decision in relation to your particular requirements or circumstances.
Allied Wealth Pty Ltd is a Corporate Authorised Representative of Allied Advice Pty Ltd for financial planning services. AFS Licence No. 528160
What to do with the big Australian banks is one of the major decisions for both retail and institutional investors alike, with the banks comprising over 27% of the ASX 200. Early in 2024 several major investment banks recommended that investors sell all the big four banks based on valuation concerns, declining earnings and the expectation of rising bad debts. However, on average, the big 5 Australian banks have had a stellar 2024, up 33%, significantly ahead of the ASX 200's return of 12%. Similar to their half-year results in May, Australia's banks delivered a steady reporting season, reporting solid results, steady dividends and, once again, very low bad debts.
In this piece, we look at the major themes that have played out over the November 2024 bank reporting season in the 700 pages of financial results released, including the regional banks awarding gold stars based on their performance over the last six months and how Allied Wealth’s picks fared.
Australia has a concentrated banking system with the top 5 having a market share of 73% and looks rather similar to Canada which has 5 large banks. Since the GFC, the banking oligopoly in Australia has only become stronger, with foreign banks such as Citigroup exiting the market and smaller banks such as St George, Bankwest, and now Suncorp being taken over by the major banks.
This contrasts with the USA which has 4,500 banks, while this sounds great for competition, it reflects regulations that since the Civil War prohibited banks chartered in one state from opening a branch or subsidiary in another state, thus protecting local banks from interstate competition. This makes comparisons between the US and European banks on valuation terms somewhat simplistic, with the Australian banks deserving a valuation premium as they are safer (lower loan losses) and more profitable (higher margins and ROE).
Additionally, unlike the US banks the Australian banks benefit from recourse-lending on mortgages and don’t have to offer 30-year fixed term mortgages. Homeowners can’t easily walk away from a house and mail the keys back to Westpac if they find themselves in a negative equity position!
While our political masters bemoan the concentrated banking market structure, having a strong, well-capitalised banking sector looked to be very desirable in 2023 with the collapse of Silicon Valley Bank & Signature Bank in the USA and in the wake of UBS' forced takeover of Credit Suisse.
In November, bad debts were one of the first items investors looked at in the bank reporting packs, checking whether the bank was successfully negotiating the "fixed rate cliff" and the uptick in corporate insolvencies. In November, ASIC reported a 39% increase in corporate insolvencies over the 2024 financial year, with 42% concentrated in construction, restaurants and cafes.
Bad debts have remained low in 2024, with all the banks reporting extremely low loan losses. Macquarie Bank reported the lowest bad debts, 0.01% of gross loans, reflecting their focus on mortgages to higher-earning borrowers, with Bank of Queensland at the same level.
The level of loan losses is important for investors as high loan losses reduce profits, and this dividend erodes a bank's capital base. This reporting season has seen low bad debts translated into better-than-expected profits and, thus, higher dividends.
Net interest margins are always a major topic during the banks' reporting season, with most investors going straight to the slide on margin movements in the immense Investor Discussion Packs. Generally, bank net interest margins have recovered from the lows seen in 2022, as when the prevailing cash rate is 5%, it is much easier for a bank to maintain a profit margin of 2% than when the cash rate is 0.1%.
Small changes in the net interest margin significantly impact bank profitability due to the size of a bank's loan book and guide future profitability. For example, Westpac's net interest margin increased by 0.03% in the second half of 2024. Whilst this sounds very insignificant, Westpac's income increased by $214 million over the second half when applied over a loan book of $807 billion!
Typically, Westpac and Commonwealth Bank enjoy a higher net interest margin than ANZ and NAB due to their higher weighting to mortgages, which enjoy a higher net interest margin than corporations that can canvass banks in Japan or Europe for borrowing needs. In the second half of 2024, NAB saw a slight margin decrease, with ANZ and Westpac posting small increases.
The November 2024 season saw smaller increases in dividends than we have seen in recent periods, though unlike cash earnings, which declined, the banks posted higher dividends in aggregate. This was achieved due to a combination of higher dividend payout ratios and a falling share count as a result of the billions in bank shares that have been bought back and cancelled by all banks. For example, since November 2021, Westpac has reduced its share count by 6% after buying back $7 billion in shares, with other banks making similar moves. The winner of the star was Westpac, with a dividend increase of 6%.
Overall, we are happy with the financial results from the banks owned by the Australian Equity Portfolio in November. The three main overweight positions, Macquarie, ANZ and Westpac, increased their dividends, and all three have significant on-market share buybacks, which will support share prices. In the last quarter we have been slowly reducing our exposure to CBA on valuation grounds and are likely to continue to do so with Australia’s largest bank trading on 25 times earnings with a market capitalization of $256 billion.
Throughout 2024, many analysts have called investors to sell all their bank stocks, pointing to stretched valuations and high house prices. Australia's major banks continue to surprise the market positively with how they have navigated turbulent market conditions. In 2024, the banks all have cleaner loan books, no offshore distractions, minimal operations in adjacent industries such as insurance and funds management and offer a more significant margin of safety than they have had at other times in their history.
The equity market rally experienced over the March quarter stalled in April as investor sentiment moderated. Comparing forward pricing of interest rates in January vs. April 2024, we note there has been a material shift in expectations. Inflation which was on a downtrend has remained sticky around the 3%-4% mark.
Figure 1: Asset Class Performance as at 30 April 2024
Source: Allied Wealth, Morningstar.
Coming into 2024, portfolios retained a marginal underweight risk and an overweight in hedged international equities relative to unhedged.
The underweight in risk assets detracted from the return outcome over the March 2024 quarter as stock markets experienced a narrow market rally; this compared with the overweight to hedged international equities relative to unhedged which was broadly neutral over the assessment period.
Rally in risk assets was attributable to 2 key themes, equity earnings which have proven resilient over the last 2 quarters and have continued to pick up steam at the index level, and extremely positive risk-on sentiment contributed in part by expectations of interest rates falling. The latter theme has not played out as the market expected with stickier and higher inflation for longer leading to a market sell-off in April.
We note that this market environment is very unlike a lot of history and provide further discussion on the outlook in the sections below.
The economic and geopolitical rivalry between US, Europe and China has evolved into global trade protectionism with national security increasingly cited as a reason for trade tariffs and loose fiscal policy (government spending). Over the last quarter, we have seen US and Europe provide fiscal support (via tax breaks and funding assistance) to manufacturers of semiconductors, electric vehicles, and solar panels – with the intention of bolstering local manufacturing capabilities.
Moving forward, we expect to see more protectionist measures from both US and Europe (vs China); but how this will escalate remains too early to tell. The recently implemented tariffs on Chinese goods will incentivise the build-out of local factories over the next few years, reversing decades of trade globalisation.
As stewards of your capital, we remain primarily focused on the financial market implications for your portfolios. We expect this theme to be both supportive of economic growth and inflationary. On the equity side we expect this to translate into further earnings growth, but upside participation is skewed towards tech and defence sectors.
The build-out of local manufacturing capability represents additional capital expenditure which over the short-term basis will support economic growth; but the higher labour costs associated with the production of goods is expected to be passed through to the end consumer. Thus, we continue to expect inflation to be structurally higher over the medium to long term.
Overall while there are positive implications for corporate earnings; we remain concerned that the structurally higher inflation will also mean higher borrowing costs for businesses and consumers. In balancing the upside and downside considerations based on our investment outlook, we have decided to neutralise our underweight to risk assets.
Within international equities, we continue to maintain an overweight in hedged international equities relative to unhedged. The Australian Dollar (relative to US Dollar and Euros), at current valuations still look cheap relative to history.
| Asset Class | Portfolio Stance | Commentary |
| Domestic Equities | Neutral | We have maintained a Neutral portfolio stance in Australian equities. On a price-to-earnings basis, Australian equities look marginally overvalued relative to history, however the magnitude is not large enough to warrant a change in portfolio. |
| International Equities | Neutral | We have chosen to neutralise the underweight in International Equities; but within the asset class, we have selected to maintain the marginal overweight to hedged International Equities (relative to unhedged). Across international equities, corporate earnings have proven more resilient than expected. |
| Property and Infrastructure | Neutral | Property and infrastructure as an asset class have been volatile over the previous quarters. Deal volume remains low, and the asset class remains susceptible to interest rate expectations due to the bond-like nature of income returns. We continue to retain a Neutral position. |
| Fixed Interest | Neutral | In-line with changes discussed previously, we have decided to neutralise the overweight in this asset class. Whilst trajectory of interest rates remains uncertain, yields in this asset class today are attractive. |
| Cash | Neutral | Cash yields remain attractive. We have retained cash in our portfolios for buying opportunities should equity valuations reach attractive levels. |
In-line with the outlook, the Investment Committee decided to neutralise our marginal underweight in growth assets; but have elected to maintain our overweight to hedged international equities relative to unhedged. We continue to monitor the geopolitical situation but at this juncture believe neutralising the portfolio over/underweights remains the most prudent course of action.
Yours faithfully,
Allied Wealth Investment Committee
You are welcome to pass on this commentary or our contact details to anyone whom you think would benefit from our services.
The information provided in and made available through this document does not constitute financial product advice. The information is of general nature only and does not consider your individual objectives, financial situation or needs. It should not be used, relied upon, or treated as a substitute for specific professional advice.
We recommend that you obtain your own professional advice before making any decision in relation to your particular requirements or circumstances.
Allied Wealth Pty Ltd is a Corporate Authorised Representative of Allied Advice Pty Ltd for financial planning services. AFS Licence No. 528160
We have some really exciting news that we are thrilled to announce! Recently, we have been honoured with nominations for two prestigious industry awards that really highlight our commitment to the financial services industry.
First up, we were finalists for the Best Independent Dealer Group at the Australian Wealth Management Awards. This nomination, and us as finalists, recognises our commitment to provide every single one of our clients with independent, client-focused financial advice that is tailored to meet your unique needs.
This recognition is a real testament to the hard work and expertise of the entire Allied Wealth team and their commitment to delivering exceptional financial advice and outcomes to every single one of our Allied Wealth clients, every single time.
As well as that nomination, Allied Wealth’s very own Greg was nominated for the Dealer Group Executive of the Year at the IFA Excellence Awards. Greg’s leadership has been instrumental for steering Allied Wealth in the right direction and he is committed to his clients every single step of the way and the wider Allied Wealth team is so proud to see his efforts and achievements recognised at such a high level.
These nominations reflect our main mission at Allied Wealth – to help our clients achieve their financial goals through independent, unbiased advice and planning. Our nominations and our finalist placing serves as motivation for us to keep raising the bar in the financial services industry, keep getting those nominations and continue to be an award-winning financial advice provider in Australia.
We want to thank all our clients, whose trust and support is a key factor in our success and our journey, we are dedicated to continuing to provide you with some of the best (award nominated!) service in the industry.
Stay tuned as we update our website to proudly display these nomination badges!
If you have any questions or would like to learn more about how Allied Wealth can help you secure your financial freedom, you can contact us today.
Whether you need help with retirement planning, investment advice, wealth management planning or anything in between, our team can help you every single step of the way.
The May 2024 bank reporting season was the mildest and most boring in the past decade, with the major banks all reporting solid results, large share buybacks and very low bad debts. The major banks continue to show their resilience in the face of challenges such as the 2018 Royal Commission into Financial Services, COVID-19 lockdowns, system issues in 2021 from expected zero or negative interest rates, and the "fixed-interest rate cliff" from late 2022 that was forecasted to put the country into a recession as discretionary spending collapsed, defaults spiked, and house prices plummeted.
In this Allied Wealth quarterly, we will look at the themes in approximately 900 pages of financial results released over the past ten days by the financial intermediaries that grease the wheels of Australian capitalism.
Net interest margins are always a major topic during any of the banks' reporting season, with most investors going straight to the slide on margin movements in the immense Investor Discussion Packs. Banks earn a net interest margin [(Interest Received - Interest Paid) divided by Average Invested Assets] by lending out funds at a higher rate than borrowing these funds either from depositors or on the wholesale money markets. Generally, bank net interest margins have recovered from the lows seen in 2022, as when the prevailing cash rate is 5%, it is much easier for a bank to maintain a profit margin of 2% than when the cash rate is 0.1%.
Small changes in the net interest margin significantly impact bank profitability due to the size of a bank's loan book (which ranges from $700 billion to $1.1 trillion) and guide future profitability. Going into this reporting season, many in the market expected a significant fall in the banks' net interest margins due to stronger competition within the mortgage market and increased deposit funding costs. May 2024 saw some downward pressure on interest margins, but less than expected, with management teams reporting a moderation of mortgage competition. Commonwealth Bank again wins the gold star in 2024 with the highest net interest margin.
Gold Star
During the COVID-19 pandemic, Australian interest rates fell to record lows as the RBA established the Term Funding Facility (TFF) to offer low-cost three-year funding to banks. Between March 2020 and when the TFF closed in June 2021, Australian banks borrowed $188 billion at rates between 0.1% and 0.25%, which was then lent as fixed-rate mortgages in 2020 and 2021 at mortgage rates between 1.75% and 2.25% to around 800,000 borrowers. These low-rate mortgages began expiring in mid-2023, converting to variable loans around 5.5%.
With every cash rate hike, the questions became louder about the negative impact of this fixed rate cliff on retail sales, bank bad debts and house prices, with market experts predicting 2023 and 2024 to be very poor years for the banks and retail sales, as borrowers were unable to afford the higher mortgage payments. However, in mid-2024, the economy has proven more resilient than expected, and unemployment remains close to all-time lows. Borrowers and the banks have managed this transition to higher rates, far better than was expected, building up savings buffers. Indeed, despite increased financial pressures, RBA data shows that less than 1% of home loans are in 90-day arrears, a figure that is lower than before the pandemic - RBA Financial Stability Review.
Bad debts have remained low in 2024, with all the banks reporting extremely low loan losses. Macquarie Bank reported the lowest bad debts of 0.00%, with ANZ not far behind with 0.01% loan losses. The level of loan losses is important for investors as high loan losses reduce profits, and this dividend erodes a bank's capital base. This reporting season has translated low bad debts into increased share buybacks and dividends.
Atlas see that the low level of bad debts is a combination of the bank's managing loan book, stronger than expected economic conditions and more conservative lending than we saw from the banks 2000-07. We believe that the loans to developers, property syndicates and troubled industrial companies that went bad in 2008-2010 now sit with non-bank lenders and private debt funds rather than the big four banks.
Gold Star
A feature of the May 2024 banks reporting season was solid dividend growth, with ANZ, CBA, and Westpac increasing their dividends and NAB holding their dividend flat. In the first half of 2024, the big four banks generated $15.6 billion and will return $11 billion to shareholders through dividends or a 71% payout of profits generated throughout the half. Higher dividends reflect the combination of low write-offs from bad debts, minimal new investments (outside ANZ) and high capital levels.
The winner of the star was Westpac, with a dividend increase of 7% or 29% if a special dividend is included. In 2024, all major banks (including Macquarie) will be paying a dividend per share higher than in 2019.
Gold Star
Capital ratio is the minimum capital requirement that financial institutions in Australia must maintain to weather the potential for loan losses. The bank regulator, the Australian Prudential Regulation Authority (APRA), has mandated that banks hold a minimum of 10.5% of capital against their loans, significantly higher than the 5% requirement pre-GFC. Requiring banks to hold high levels of capital is not done to protect bank investors but rather to avoid the spectre of taxpayers having to bail out banks, as has been done in the USA and UK.
In 2024, the Australian banks are all extremely well capitalised, so much so that ANZ, NAB, and Westpac announced on-market share buyback extensions to return capital to shareholders. During the bank reporting season, NAB announced a $1.5 billion share buyback extension on top of their 200 million remaining from their previous buyback, Westpac announced a $1 billion extension on top of their $600 million remaining from their previous buyback, ANZ announced a new $2 billion share buyback and Macquarie announcing they still have $1.35 billion to buy back from their $2 billion buyback announced in November. For investors, this not only supports the share price in the coming months but reduces the amount of outstanding shares to divide next year's profits.
In addition to buying back shares to reduce capital, all the big banks, including Macquarie, have neutralised their dividend reinvestment plan (DRP), which allows shareholders to take their dividends in additional shares rather than cash. Neutralising the DRP sees the bank buyback shares on-market equivalent to the new shares issued to shareholders. In May 2024, Atlas estimates that this will see additional net purchases of around $900 million in shares from ANZ, NAB, Westpac and Macquarie.
While buying back shares on the market and then cancelling them is positive for shareholders as it reduces the divisor on future bank profits, bank management teams are awarded bonuses based on their return on equity (ROE). Obviously, buying back shares reduces the equity, thus boosting ROE.
Gold Star
Overall, we are happy with the financial results from the banks owned by the Allied Wealth Australian Equity Portfolio in May. The three main overweight positions, ANZ and Westpac, increased their dividends, and Macquarie Bank showed a 49% increase in net profits in the second half, which also guided to increased profits in FY25. All three announced significant on-market share buybacks, which will support share prices.
All banks showed solid net interest margins, low bad debts, and good cost control. Profit growth is likely to be tough to find on the ASX over the next few years, with earnings for resources and consumer discretionary likely to retreat; however, Australia's major banks continue to positively surprise the market with how they have been able to navigate turbulent market conditions. In 2024, the banks will all have cleaner loan books, minimal offshore distractions, and a greater margin of safety than they have had in the past.
During February and August every year, most Australian listed companies reveal their profit results, and guide how they expect their businesses to perform in the upcoming year. Whilst we regularly meet with companies between reporting periods to gauge how their businesses are performing, reporting season offers investors a detailed and externally audited look at the company’s financials.
The February 2024 company reporting period that concluded last week displayed stronger-than-expected results in a higher inflationary and interest rate environment. The February reporting season’s dominant themes have been a resilient consumer, strong cost management, moderation in inflation and a positive economic outlook. However, many companies performed very well against the headwinds of higher inflation and interest rates, but not all performed well. In this week’s piece, we look at the key themes from the reporting season that fared last week, the best and worst results and how the Portfolio performed.
Going into the February reporting season, the market was expecting the themes that didn't occur in August 2023, cost inflation, higher interest costs, and slowing retail sales, to happen this reporting season. However, once again, the reporting season demonstrated that many companies have managed a higher inflation and interest rate environment much better than many expected, with around 40% of companies reporting beating market expectations. Looking through the ASX companies that exceeded expectations were in the IT, Consumer Discretionary and Real Estate sectors. Conversely, disappointments were clustered in the Energy, Materials, and Healthcare sectors, primarily related to falling commodity prices and rising costs.
The first dominant theme for the February reporting season was the strength of the domestic consumer. In November 2022, Westpac's economists forecasted a grim year for 2023, the much feared fixed interest rate cliff expected to see unemployment rise to 4.5%, an 8% fall in house prices, bad debts to spike and retail sales grinding to a halt.
However, February 2024 showed continued consumer demand for technology and electronic products, with sales growing across the JB Hi-fi brand. Similarly, with Wesfarmers, Kmart increased profits by 27% as consumers looked to trade down to lower price point options and the success of its Anko brand, which is now stocked in Canadian department stores. Consumers were also willing to treat themselves to fashionable jewellery from Lovisa and 4WD accessories from ARB.
Conversely, with the cost of living increasing, the wagering environment has had a downturn, which saw Tabcorp revenues and active users decreasing across both digital and cash wagering. Similarly, consumers weren't as willing to spend on bedding and furniture at Harvey Norman, with sales falling by 9% in Australia.
Across the major supermarkets, a theme that stood out was that food inflation had moderated throughout the first half and into the first six weeks of the next half. During the half, Woolworths saw average prices for fruit and vegetables decline by 6% and average prices for meat fall by 7%, driven by lower livestock prices and an increased supply of fruit. Paradoxically reporting expanding profit margins in February was a case of poor timing for Woolworths, as it will see the company appear before the Senate Select Committee into Grocery Prices; consequently, its share price declined by 8% over the month.
In contrast, companies with revenues linked to inflation continue to benefit; the best example is toll road operators Transurban and Atlas Arteria, which saw increased revenues from higher traffic volumes and inflation-linked tolls. For a toll road, the most significant cost is interest, with the ongoing costs of operating a toll road once built being minimal. Both toll road companies were very active in extending their loan book from 2020 to 22, during a period of the lowest recorded interest rates in five thousand years of human commerce. For example, in mid-2021, Atlas Arteria sold €500 million of 7-year bonds priced at a coupon rate of a mere 0.17%. While this looks low, in early 2020, the company managed to sell €500 million of bonds, paying no coupons with a negative yield of -0.077%! Effectively, bondholders were paying the company to hold their money, a situation that economists such as Adam Smith or John Maynard Keynes would have never foreseen. Since January 2023, tolls have increased by +7.6% on Atlas Arteria's French toll roads, resulting in profit margin expansion from higher revenues and minimal change in expenses.
During reporting season, a dominant theme that continued through was cost control and cost cutting, with over a third of companies reporting that cost pressures have now passed their peak. JB Hi-Fi cost management surprised markets, only increasing by 5%, despite the retailer facing wage and rent growth pressures. JB Hi-Fi benefitted from staff operating more efficiently and more online sales, with online sales in the last half of 2023 increasing to $736 million, up from $170 million in the same period pre-COVID-19.
On the flip side, some companies saw such costs surge, such as Ramsey Healthcare, which saw their costs increase by over 11% and their profits fall by 40%, driven by labour costs and occupancy costs. Similarly, the miners saw cost pressures and weakening commodity prices, which squeezed margins. Diversified miner South32 had a particularly rough month, with reported profits falling 92% due to higher costs, production issues and falling nickel, aluminium and manganese prices.
Commonwealth Bank provides a good look through the economy during reporting season, with Australia's largest bank holding 16 million customer accounts. Consequently, the banks' financial results and accompanying 231-page reporting suite give investors an insight into the health of the various sectors of the economy. CBA showed minimal bad debts and rising dividends but also that higher interest rates had differing impacts across their customer base. While discretionary spending had been cut back along with savings for customers between 20 and 54, older customers above 55 had increased spending and savings.
Insurers had their best results season since the GFC as they enjoyed higher premiums, lower claims inflation, lower adverse weather events, and sound investment returns. Suncorp expects gross written premiums to increase by low-mid double digits and margins from inflation moderations. Similarly, QBE expects its gross written premium to increase by mid-single digits over the coming year while benefiting from subsiding cost inflation.
Looking across the top 20 stocks (that reported – the other banks have a different financial year-end), the weighted average dividend increase was 0%. The three companies that reduced their dividends, BHP, Rio, and Woodside, saw weaker commodity pricing.
On the positive side of the ledger, QBE, Origin, and Fortescue offset the cuts, posting solid increases in cash flows to their shareholders. Across the wider ASX 200, dividends declined by -8% in February.
Over the month, Lovisa Holdings, Wisetech Global, Reliance Worldwide, NextDC, and ARB Corporation delivered the best results. Despite the uncertain economic environment, especially around the softening of consumers, these companies were able to grow sales and expand gross margins along with providing optimistic outlooks.
Looking on the negative side of the ledger, South32, Corporate Travel Management, Healius, and Whitehaven Coal reported poorly received results by the markets. The common themes amongst this group were lower commodity prices (South32 and Whitehaven) and slowing sales with high PEs (Healius and Corporate Travel Management).
Before the February 2024 reporting season, conglomerate Wesfarmers would not have been near the top of any investor's picks after a stellar performance in the August 2023 reporting season. Many in the market predicted Wesfarmers' profits would go backwards following a softer economic outlook for domestic consumers and weaker lithium prices. However, the opposite happened with their flagship business, Bunnings, maintaining its earnings and Kmart increasing their profits by +27%, driven by its lowest price position and consumers moving to their Anko brand. Anko has been so successful in Australia that Kmart now offers its Anko product in Canada through the Hudson Bay Company (Canada's Myer). Wesfarmers was up +16% for February 2024.
Overall, we are reasonably pleased with the results from the reporting season, with most of our portfolio companies able to increase earnings and dividends with some reporting record dividends in a more challenging economic environment.
As a long-term investor focused on delivering income to investors, we look closely at the dividends paid out by our companies and whether they are growing. After every reporting season, Atlas looks to "weigh" the dividends that our investors will receive. Our view is that talk and guidance from management can often be cheap, and company CFOs can use accounting tricks to manipulate earnings. However, paying out higher dividends is a far better indicator of how a business will perform in the future. Indeed, in the February reporting season, we saw several companies such as Harvey Norman, South32 and Nine Entertainment Holdings give optimistic outlooks while cutting dividends heavily. This is a mixed message to investors, and we would prefer to follow the cash rather than the words!
Using a weighted average across the Portfolio, our investor's dividends will be +7% greater than the previous period in 2023 significantly ahead of the -8% dividend fall in the wider ASX 200.
The Portfolio’s dividend increase was also ahead of inflation which was 4% over the period, thus maintaining purchasing power for investors that fund their retirement off income. Additionally, every company held in the portfolio was profitable and paid a dividend. Atlas are pleased with the results from the February 2024 reporting season on this measure.
Yours faithfully,
Allied Wealth Investment Committee
You are welcome to pass on this commentary or our contact details to anyone whom you think would benefit from our services.
The information provided in and made available through this document does not constitute financial product advice. The information is of general nature only and does not take into account your individual objectives, financial situation or needs. It should not be used, relied upon, or treated as a substitute for specific professional advice.
We recommend that you obtain your own professional advice before making any decision in relation to your particular requirements or circumstances.
Allied Wealth Pty Ltd is a Corporate Authorised Representative of Allied Advice Pty Ltd for financial planning services. AFS Licence No. 528160
As we begin 2024, we want you to know what a privilege it is to serve as your advisor. Hopefully each quarterly newsletter gives you some insights into our thinking and its evolution as we are confronted with new information and ideas in an ever-changing financial landscape. As always, we strive to maintain a balanced approach with awareness of both upside return and downside risks.
Asset class volatility has continued into 2024, with large return variations observed quarter-on-quarter. Indeed, we have seen correlated asset class performance over 2023 and we think this behaviour will likely continue over the short term. Over the 3-months to January 2024 all asset classes printed positive, driven primarily by market expectations of policy rate cuts over the first half of 2024.
Source: Allied Wealth, Morningstar.
Coming into Q4 2023, we implemented an overweight allocation in hedged international equities relative to the unhedged position. This decision contributed to performance as the Australian Dollar strengthened over the period. Over the quarter, portfolios have maintained a marginal defensive bias expressed as an underweight in growth assets in favour of defensive assets – this position has marginally detracted from relative performance over the quarter. The combined asset allocation decisions are net positive and additive to long-term portfolio returns. While we are pleased with the results, we would emphasize that the asset allocations decisions have been made both from the perspective of risk mitigation as well as alpha generation.
Source: Allied Wealth, Morningstar. Note: Returns are based on an asset allocation index returns which do not include manager and advice fees so actual portfolio returns will vary. The purpose is to determine if our tactical asset allocation decisions are adding value over the Strategic Asset Allocation for each model.
Strategic Asset Allocation Review
In Q4 2023, we conducted a Strategic Asset Allocation (SAA) review of client portfolios across the risk spectrum – Moderate, Balanced, Growth and High Growth. Review includes an assessment of our current Capital Market Assumptions and long-term implications for the baseline SAA.
Our analysis of asset class returns and risks suggests that while there are short-to-medium term market considerations of note, the relative attractiveness of asset classes have not changed over the long-term (20-years forward). Structurally, we see a rise in income yields across asset classes, more so in bonds and credit compared to equities. The attractive level of income has resulted in an increased allocation to Income Alternatives across Moderate, Balanced and Growth portfolios.
One of the key themes discussed at the Investment Committee was narrow market representation. Looking through the market indices we note that positive performance in international equities was primarily driven by strong performance in a small number of large-cap tech stocks (Microsoft, Google, Nvdia, Meta, Apple and Amazon). While there is an argument to be made that large-cap tech is overvalued, we have seen positive earnings growth which continues to support the lofty valuations. However, we note in most cases (exception being Nvidia) a material contribution to earnings growth have been job cuts in the second half of 2023.
The AI boom remains the gift that keeps on giving. Despite record number of lay-offs in the tech sector, companies continue to invest in AI and data processing which has led to strong demand for both software and hardware. This trend has also percolated across property and infrastructure. We have seen substantial investments in data centres and energy infrastructure, supported by new equity and debt raisings. Investors continue to be extremely bullish on these themes coming into 2024.
We believe that central banks globally are mostly at the tail-end of their hiking cycle. Tight monetary policy has led to softening of economic conditions and moderation in inflationary pressures. Inflation remains on the higher end of the target range at around 3%, and we expect this to continue over the first half of 2024.
Investor sentiment remains too bullish for our liking. At this point, equity market valuations are expensive but as history indicates, expensive valuations may persist over long-periods of time. Our analysis suggests that equity valuations today include an expectation that interest rate will fall in H1 2024 followed by earnings growth coming into H2 2024. This thesis at current valuation does not leave much room for error and thus we have remained cautious.
Geopolitical conflict continues to be an ongoing theme. With the US presidential elections in November 2024, primaries have already commenced. Polling and voting to date suggest the upcoming election will be a Trump vs Biden showdown. Irrespective of which candidate wins, we expect further escalation of trade conflict between US and China.
Following the investment committee discussion, members agreed to retain the current asset allocation stance which reflects 1) a marginally defensive stance overweight cash and fixed interest in favour of an underweight in international equities and 2) within international equities, an overweight in hedged international equities relative to unhedged. Despite the appreciation of the Australian Dollar (relative to US Dollar and Euros), current valuations still look cheap relative to history.
In-line with the outlook, the Investment Committee decided to maintain our marginal underweight in growth assets in favour of an overweight to defensive assets; and an overweight to hedged international equities relative to unhedged. Given the current market environment we have thought it appropriate to maintain the cautious stance but will look to reassess our position should it be warranted.
Thank you once again for your continued trust and confidence. We wish you a fruitful and prosperous 2024.
Yours faithfully,
Allied Wealth Investment Committee
What sets Allied Wealth apart
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You are welcome to pass on this commentary or our contact details to anyone whom you think would benefit from our services.
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Disclosure
The information provided in and made available through this document does not constitute financial product advice. The information is of general nature only and does not take into account your individual objectives, financial situation or needs. It should not be used, relied upon, or treated as a substitute for specific professional advice.
We recommend that you obtain your own professional advice before making any decision in relation to your particular requirements or circumstances.
Allied Wealth Pty Ltd is a Corporate Authorised Representative of Allied Advice Pty Ltd for financial planning services. AFS Licence No. 528160