MB Fund November portfolio performance – Part 1

One of our core investment themes is that international stocks are the best asset class for Australian investors at this point in the cycle. To date, this has been the right call, with our international portfolio increasing over 13% over the last 4 months on the back of a weak Australian dollar, favourable stock selection and strong international markets.

Last month we posed the question of whether its time to switch to a different asset class. In November we changed our answer to that question. While we think there is still significant scope for the Australian dollar to fall, we need to balance this with valuations and potential risks. To this end, we took some profits in a number of portfolios and increased our cash weights.

It’s a nuanced argument – balancing potential upside vs the risks. We have taken the view that we would prefer to see stock markets lower or a period of consolidation to allow fundamentals to catch up with prices.

To be clear, we don’t think that we have reached the end of the current investment cycle. But we do think share markets have run ahead of fundamentals and so we have raised cash and are waiting for fundamentals to catch up with prices or markets to pull back before we look to re-invest.

Our suggestion continues to be that investors need to position their investments early rather than trying to time the market.  During November our Tactical Funds continued to handily beat benchmarks:

Nucleus November performance

Source: Linear, Factset.

The returns above include fees and trading costs on a $500,000 portfolio. Note that individual client performance will vary based on the amount invested, ethical overlays and the date of purchase. The benchmark returns do not include fees.

This month we have separated this report into 2 parts. This first part deals with the asset allocation, the second part looks at stock performance.

 The Way Forward

As a reminder, we look at the key themes facing our portfolios as being:

  1. China: Rebalancing is occurring, the question is how fast Chinese authorities allow it to occur. For anyone who missed it, we held a webinar during the month where we ran through in detail the key issues https://www.youtube.com/watch?v=b9ZM5fkes9o
  2. Trump: Taxes are the next key decision point, and after failures in healthcare he is looking for a win. We are expecting there to be 2 facets – tax cuts and encouraging companies to bring back cash. Both are USD bullish. We are running a webinar Tuesday 19th December on this topic – see https://proton.nucleuswealth.com to register.
  3. Europe: Grinding recovery. We are not expecting great things, but note that the number of political risks has reduced in recent months. The major long-term issue is still the significant imbalances between Germany and most of the rest of the Eurozone, but no real flashpoints at the moment.

US

Trump tax cuts are now taking shape and there look to be relatively few impediments at this stage.

Our core position is that Trump is trying to engineer a boom. It will not be sustainable and will likely be followed by a bust that leaves the US economy in a worse position but that is a future problem – positioning the portfolio for the boom is the current issue.

The proposed tax cuts are badly targeted by giving most of the benefit to the rich and to companies, trickle down is unlikely to work, the tax cuts are unsustainable, and they are only a short-term “sugar hit” for the US economy, I understand all the negatives.  But if it is anywhere near Trump’s promise then it’s going to be such a huge stimulus that you don’t want to stand in the way of it as an investor.

So, we want to play the boom, keeping a sharp eye on the bust. Valuations and sentiment have run so hard recently that we have pulled back our equity exposure. If we see earnings catch up or if we see a decline in markets, we will likely buy more equities.

Our portfolio positioning on this basis remains:

  1. overweight international stocks from an asset allocation perspective
  2. overweight stocks with US exposures – subject to valuation. The practical implementation of this has been buying non-US stocks that are exposed to the US.
US Market EPS

Source: Factset

US Market EBIT Margin

Source: Factset

US Market EBIT Margin

Source: Factset

China

In China data continues to be muddied by winter/pollution shutdowns. Our view is:

  • the shift to consumption-led growth rather than investment-led growth will require a greater shift than many recognize. This shift will be a significant negative for commodities/the Australian dollar
  • current growth rates are unsustainably high, inflated by rapidly increasing Chinese debt. The increase in debt has been required in order to hit the growth targets, so removing the growth targets will help refocus local party officials to more sustainable policies
  • Activity still seems to be slowing, although the next few months are going to be more difficult to get an accurate read on economic activity as the Communist Party Conference in Beijing has led to the shutting down of a considerable amount of industrial manufacturing, in particular, steel production. We would expect that some of the strength in commodity prices in July/August reflected the bringing forward of production in front of the shut down. Then, the weakness in September represents the shutdown, which we expect to continue for the next couple of months. Finally, there is likely to be a bounce in Q1 2018 due to “catch-up” production. So, the true trajectory is going to be difficult to ascertain accurately until we are through this period.
  • we are probably 6-12 months away from being able to see whether the removal of growth targets makes a big difference or not – they have the potential to foreshadow a seismic shift to a more sustainable growth model. I suspect the outcome will be that with the Communist Party Conference done now the impetus will switch to slowing the economy as much as possible, but with any sign of unrest the debt taps will be turned back on.

Our expectation is that China is going to continue to “glide” lower to try to normalize the capital expenditure to consumption in-balance that we discussed in our recent webinar.

China Capex to GDP

It is our view that the Chinese economy will continue to slow over the coming years – Japanese style lost decades, and low inflation/deflation remain more likely than a dramatic bust, which means a grind lower for commodities and the Australian dollar.

Our portfolio positioning on this basis remains:

  1. considerably underweight Australian stocks from an asset allocation perspective
  2. underweight resource stocks within equity portfolios

Tactical Asset Allocation Portfolio Positioning

In our tactical portfolios, we own cash, bonds, international shares and Australian shares. We tend to blend these portfolios for clients so that each investor receives an exposure tailored to their own risk and income requirements.

The broad sweep of our asset allocation over the last 12 months was to ride the Trump Boom, switch into Europe in March / April as the US became overvalued and then switch back into the US as the Euro rallied and the USD fell.

The next chapter, which we started during November, has been to reduce our international holdings after an almost 15% rise in the last 4 months.

Over the month our bond holdings added to performance, as expectations for interest rate rises in Australia were tempered. We expect this will continue to be a feature of the bond market.

We remain underweight shares in aggregate, slightly overweight international equities and significantly underweight Australian.

Over / Underweight positions by portfolio

Nucleus Asset AllocationSource: Nucleus Wealth

Tactical Foundation Portfolio

Our tactical foundation portfolio is designed for investors with lower balances, it uses exchange-traded funds for its international exposure rather than direct shares. The reason for this is parcel sizes,  you can’t buy half a Google (Alphabet) share directly and so we use exchange-traded funds which buy baskets of stocks instead. The tactical portfolio is a balanced fund, not as aggressive in its holdings as the growth fund nor as conservative as our income fund.

Over the month in the tactical foundation portfolio, we sold down our international exposure from overweight to neutral.  The fund continues to be underweight Australian stocks.

Epilogue

In summary, our view continues to be that Australian investors are better off holding international investments at this point in the cycle.  The past four months have obviously taken a big step in this direction, with international stocks providing almost 15% in just four months.  While structurally we see this rising, it is unlikely to move in a straight line .

Our intention is that our portfolio is positioned to take advantage of our key themes but minimise risk in the event that our themes take longer than expected to resolve themselves.

We usually find that big picture macro themes take a long time to resolve themselves in financial markets, but when macro theme resolve themselves they do so quickly – usually too quickly to reposition your portfolio if you are not already invested.

Register your interest now (if you haven’t already):

Damien Klassen is Head of Investments at Nucleus Wealth.

The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. Damien Klassen is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Integrity Private Wealth Pty Ltd, AFSL 436298.

Comments

  1. i keep getting a ‘Missing CSRF token cookie’ message when trying to apply for some more information?

  2. Thanks for the update!

    Do the month on month figures include currency changes? (ie if the USD has gone up X% against the AUD, then all US shares in the portfolio are taken as going up that X% in addition to whatever change they had in USD share price)?

  3. Would it be possible to reveal your holdings/positions for each of those markets/sectors? If not for public but atleast for members?

  4. In your investment approach, are you separating out decisions around asset class (i.e. international equities) and currency movements ? If so, shouldn’t you be hedging your IE exposure ?