Overall we think that current weakness will prove to be another ‘reality check’ for a market that had got ahead of itself, rather than a precursor to something more serious.
Global growth remains around trend. Companies are finding it easier to hike prices. The producer price index (PPI) excluding energy is high in the United States and the UK. Consumer prices are noisy, but almost every US and European consumer price index (CPI) is around its 20-year average. Domestic demand remains firm in most major economies, with the strength of the labour markets an important support. Global trade is threatened by US action, but it is important to stress that this is US-focused and not a general trade dispute.
Indeed, ongoing rate hikes, US Fed balance sheet reductions, and massive amounts of US bond issuance to finance fiscal deficits are leading to increasing vulnerabilities for both financial assets and the prospects for economic growth over coming quarters. In our view, this vulnerability is evidenced by the recent acute spike in market volatility.
Market volatility in context
Market corrections are healthy and normal – US equities have navigated five technical corrections (+10 per cent falls) since the GFC, and many other shorter bouts of nerves. US shares have dropped by +3pc on 18 occasions since the GFC. Note however, that the frequency of these events has picked up in 2018.
The Australian economy continues to tick along despite consumer caution, higher energy costs and falling house prices. Higher energy costs in particular have been a headwind for local manufacturers over the past 12 months but many companies are managing it via wholesale deals directly with energy suppliers or seeking alternative renewable sources.
Price rises and cost cutting initiatives will also help but this only goes so far. Good companies, however, will always find a way to navigate through no matter how difficult the operating environment. Two companies that have been adept at navigating through some headwinds are Orora (ORA) and Reliance Worldwide (RWC).
Orora’s Australasian business has been dealing with raw materials and energy cost pressures and while this has had a negative impact on earnings, the company has found multiple ways to mitigate the effect via investing in more energy efficient equipment and partnering with renewable energy providers to save costs.
Reliance has also had some headwinds, in particular due to recent changes made to US import duties that is affecting product imports from China into the US, the company’s biggest market. RWC has plans to limit this impact by either sourcing products from other countries or pushing through price rises and as a result, is largely shielded from any further changes to US import duties.
Due to their flexible business models and well-regarded management teams both Orora and Reliance remain two of our key picks in the Industrials sector. Both companies also have meaningful operations in the US so will benefit if the AUD/USD continues to weaken.
- Boh Burima Financial Adviser (Authorised Representative: 000341081) Morgans Financial Limited | ABN 49 010 669 726 | AFSL 235410