The interim earnings through the recent reporting season was mostly in line with what we were expecting with solid results across the companies we hold in our portfolio. The healthcare and resource stocks in the portfolio reflect strong earnings and growth across these sectors, which is pleasing. It was also interesting to observe that markets continued to trade at high valuations despite the relatively benign reporting season.
Before the recent adjustment Australia's equity market had, in our view, been expensive with very low interest rates one of the major factors behind these high valuations. While high share prices were great news for many investors pursuing growth, we remained sensitive to the possible risk of a market downturn. With valuation multiples as high as they have been, we were alert to the introduction of a significant risk factor and what that could do to market sentiment.
As such, the outbreak of and global response to the coronavirus epidemic has sent global markets tumbling and dominated headlines through February and early March. This has spurred a strong negative response from investors.
We saw an equity market contraction in Australia of about 7.7 per cent over the month and a swift response from the Reserve Bank of Australia (RBA) in cutting interest rates by 25 basis points earlier this week to try and soften the impact of the virus on the economy.
Weathering the perfect storm
The combination of high multiples, market uncertainty and now the introduction of a sudden risk factor has clearly weighed on investor confidence and resulted in a significant correction. If markets continue to fall, many income hungry investors will search for affordable buying opportunities.
AFIC is comfortable with the companies it currently holds, and these weakened market conditions have provided the opportunity to selectively top up on many quality companies.
The positioning of the portfolio to focus on higher quality companies has meant AFIC has moved through this recent period better positioned, although still subject to the general downturn in the market.
Staying focused on fundamentals
Our recent performance reflects some of the benefits of taking a long-term approach to investing. Trying to time the market is always difficult, so the focus on investing in quality companies for the long term is one way of trying to reduce general market risk.
Many of the companies that we hold continue to demonstrate that they can sustain growth under various conditions. This is particularly relevant to the healthcare sector. Importantly, this success has not been driven by the success of the sector as a whole, but by excellent products and strong business models that give these companies a sustainable competitive advantage. These are factors that AFIC focuses on when selecting opportunities to invest.
Considering these factors and searching for companies with a history of consistent earnings streams, low debt-to-equity ratios and good management has helped AFIC ride through volatile markets when they occur. In fact, AFIC is often in a position to take advantage of the buying opportunities created by the market conditions such as what we’re seeing now.