2015 will not go down as a great year for many investors. Those who invested offshore unhedged should do okay, as the Australian dollar fell from 0.8175 US cents to the low 70c. However, a crunch in commodity prices, together with concerns about sluggish world growth, kept downward pressure on the Australian share market. Property investors fared a little better, with both residential and commercial property benefitting from the Reserve Bank of Australia’s call to lower the cash rate twice, which finished the year at 2.0%. While helping to keep bond yields down, term deposit investors were probably feeling more pain by year’s end.

Before looking at 2016, let’s dive into what happened in 2015, particularly with respect to the performance of the different market sectors and components, to see if this offers any clues as to what we should expect.

A RECAP OF 2015

At this same time last year, I described my key macro investment themes for the share market in 2015 as:

• Continued low interest rates (the yield sectors will continue to perform);
• Lower AUD – moving down towards 0.70 US cents;
• Positive lead from the US markets;
• No pick up in commodity prices;
• Growth running slightly below trend in Australia; and
• Low oil prices will lead to a rise in consumer spending in Australia.

Most of these themes came into play. Interest rates stayed low, and some of the yield sectors performed strongly. The AUD fell against the USD, and while we didn’t get a strong positive lead from the US markets, we didn’t get a negative lead either. The Australian economy grew at 2.5% in the year to September, slightly below trend, and although you can’t really attribute these directly to oil prices, retail sales growth of 3.9% was a little stronger than expected, while measured consumer confidence finished the year on a high.

The big one was commodity prices. While they didn’t rebound in 2015 following a weak 2014, I didn’t expect the carnage to continue in 2015. Oil prices fell from USD 54 a barrel to below USD 37; iron ore from USD 68 a tonne to under USD 39 a tonne; and copper from US 285c per pound to US 207c per pound.

As a result, the Australian sharemarket was largely a tail of two halves. Very weak performances in the resources sectors, offset by strong performances in the sectors able to benefit from a lower AUD. It looked set to finish the year marginally in the red, because the largest sector, Financials, didn’t make any headway due to capital issues by the major banks.

The following table shows the total returns of the major sectors that make up the ASX, together with their weighting as part of the S&P/ASX 200 for the calendar year to 11 December. For example, the Financials sector, which comprises the major banks, regional banks, insurers and diversified financials, generated a total return for the year of minus 1.1%. It is the largest sector by market capitalization, accounting for 41.0% of the S&P/ASX 200.

While the overall market (as measured by the price index) was down 7.1%, when dividends are included, the return was -2.8%.

Interest rate sensitive sectors such as Utilities and A-REITs (property trusts) recorded strong gains, while dollar sensitive sectors (Industrials and Consumer Discretionary) also fared well. The other standout was Health Care, with a return of 12.3% for the year, on the back of the continuing demographic tail winds of an ageing population and increased demand for health services. The sector also benefitted from a lower AUD, as many of the leading companies generate the bulk of their sales offshore.

The Materials sector, which comprises miners such as BHP and RIO as well as packaging companies Amcor and building suppliers Boral, was a laggard with a return of -19.8%. Energy stocks were hammered, with the sector down 31.5% for the year.

Sector Returns

Interestingly, the top 20 stocks by market capitalisation underperformed compared to the broader market. Reversing a trend that has been in place for the last 3 years, the top 20 stocks lost 6.8% compared to the market’s overall 2.8%. The Midcap 50, stocks number 51st to 100th by market capitalization, added 6.0%, while the Small Ordinaries (stocks number 101st to 300th), added 4.2%,

ASX Component Returns

Peering further into the top 20 stocks, following table ranks the stocks by total return in calendar 2015, which includes movement in their share price, dividends and any capital return (for example, the demerger of South32 from BHP). Macquarie Group, with a return of 45.1% leads the pack, while Origin Energy at -55.6% brings up the rear.

Materials and energy stocks made up the rear four places, while stocks benefitting from a weaker AUD (Macquarie, CSL, QBE and Westfield) filled four of the top five places. Woolworths, with a return of -20.5%, was a major disappointment as it lost momentum to Coles (owned by Wesfarmers) in the supermarket wars, and was challenged by problems in its Big W dividion and loss making Masters homewares division.

Amongst the financial stocks, Westpac and CBA, which have stronger domestic retail banking franchises, outperformed the other two major banks, ANZ and NAB. ANZ underperformed Westpac by almost 12%. Telstra also lagged, as the market started to search for stocks with a stronger growth profile.

The top 20 ranked by return in 2015 (to 11 Dec)

THE BIG ISSUSES FOR 2016

If we consider 2016 in the context of 2015, the same two themes – commodity prices and the direction of the Australian dollar – standout as the big issues for the Australian share-market. Add to these the question on US interest rate policy, and whether a change in the trend in the USA will impact the European, Japanese and Chinese Central Banks who have been applying massive monetary stimulation, or in the case of the Reserve Bank in Australia, an easing bias.

Although it would be nice to call an end to the commodity rout, there is no evidence yet to suggest that prices have bottomed, let alone started to find a floor. This is largely a production glut, and while some of the price weakness is due to an amelioration of demand as world growth remains tepid, production needs to be pared back. This is no doubt already underway – it just a question of how quickly supply and demand get in balance again.
The Australian dollar looks like it has found good support around 70 US cents, however it is hard to see it making substantial headway if feeling the headwinds of lower oil, iron ore, coal and copper prices. Given its historical tendency to go up with the stairs and down with the elevator, the risk play says that it is better to be positioned expecting the latter rather than the former.

And with the Reserve Bank of Australia operating with an easing bias and the European and Japanese central banks making it clear that they will do “whatever it takes”, global monetary policy is going to remain accommodating. A second US interest rate rise in late 2016 can’t be ruled out, however this would arguably be a positive for markets as it would mean that the US economy is expanding at a faster rate. The more likely scenario is that world growth remains tepid and in response, global monetary policy is stimulatory – meaning that demand will continue for higher yield investments.

HOW TO PLAY 2016

For investors where income, particularly tax-advantaged income from the inclusion of franking credits is a key investment objective, I suggest being underweight the resource sectors and moderately overweight any higher yielding sector that also benefit from a lower Australian dollar. Stock selection can also be used to bias the portfolio for a lower AUD.

How to play Financials and Consumer Staples? 2015 wasn’t a great year for the major banks, mainly due to the impact of the capital raisings they each undertook, and with this now behind them, there is more upside here.
While shareholders will need to get used to lower ROEs (Return on equity), interest rates aren’t going up in a hurry and there are no signs of any pick up in bad debts. My inclination is to moderately overweight this sector. On the other hand, Consumer Staples had a horrible year in 2015, and while it might be tempting to take a contrarian approach, the supermarket wars are far from over. With new entrants Aldi and Lidl taking the fight to Woolworths, Coles (Wesfarmers) and IGA (Metcash), there is a lot of margin at risk. Moderately underweight.

The suggested sector positions for a portfolio focusing on income are shown in the table below.

2016 Sector Allocations – Income

Growth investors may want to take out some insurance in relation to the resource sectors, by being moderately close to index weight and being quick to change the position to overweight if it starts to look as though commodity prices have bottomed. Healthcare is another standout sector, and although it has been a star performer over the last 3 to 5 years and the multiples are expensive, the tailwinds remain strong. Stocks can also be biased to those companies that will benefit from a lower AUD or earn their revenue offshore.

The suggested sector positions for a portfolio focusing on growth are shown in the table below.

2016 Sector Allocations – Growth