THE past year was another challenging one for investors, as debt ructions in Europe and a moribund US economy put a dampener on sentiment.
The Australian's Katherine Jimenez spoke to five leading lights of the investment community about their outlook for 2011
The participants:
Hugh Giddy: senior portfolio manager at Investors Mutual Limited.
Matt Williams: deputy head of equities at Perpetual Investments.
Simon Shields: head of equities in Australia at UBS Global Asset Management.
Paul Taylor: head of Australian equities at Fidelity Investments.
Crispin Murray: head of equity strategies at BT Investment Management Limited.
WHERE do you see global and local equity markets heading over the next 12 months?
Giddy: Most equity markets are highly correlated, and commodity prices and non-US dollar currencies have recently moved largely with equity markets. The so-called risk on trade means buy almost anything cyclical and avoid the safety of the US dollar or cash.
Unfortunately, I see little fundamental underpinning for taking on risk, given the weak backdrop for growth: debt remains too high, fiscal stimulus is fading and even China's impressive miracle is likely to slow. I don't believe Ben Bernanke's Fed's desperate and unjustifiable experimental loosening of monetary conditions must cause inflation.
Japanese quantitative easing did not work. When speculators realise Bernanke cannot work magic as he pretends, selling may ensue. Commodity prices are over-bought and equity markets may be fairly subdued.
Williams: Forecasting markets is difficult if not impossible, but the short answer is that if the US economy continues to improve and China growth holds together, then global and local equity markets could have a reasonable year.
Looking back in history after such large sell-offs, like the one we experienced in 2008-09, it generally takes around seven years to reach the former high point (in this case 6845 for the S&P/ASX 300 in November 2007), so if we were to reach that figure in a similar time frame it would imply about a 10 per cent per annum market return over the next four years.
Crucially, this all relies on China growth continuing, which is not a given, considering the PRC has spent the last year trying to slow their economy -- at some point they may succeed.
Shields: Both GDP and company earnings across the globe are generally still recovering from the global financial crisis. These increasing growth rates are good for equity markets, which are still trading below average valuation multiples. Australia is particularly well positioned to benefit from the ongoing growth that is occurring in emerging markets due to their demand for our resources.
We also expect that the massive US economic stimulus provided by the Fed will belatedly gain traction in 2011, resulting in a pick-up there in investment, employment and consumer spending. This will improve investor confidence and equity prices globally in 2011.
Taylor: Next year is likely to see a continuation of the global economic trends of a slower growth developed world combined with higher growth emerging markets. While global equities remain attractively valued, it is likely to be the growth of emerging markets that will attract investors and deliver these markets a good year of performance in 2011.
Australia is similarly well positioned in 2011. The Australian market is very attractively valued, well below historical valuation multiples. Australia will benefit from the high economic growth from emerging markets and the resultant positive impact on demand for resources and commodity prices.
We are, however, likely to see the Reserve Bank of Australia continue to raise interest rates through 2011. But, all in all, combining the fact that the Australian equity market remains very attractively valued, with these overall strong growth prospects, could mean that we see quite a strong performance from the Australian equity market in 2011.
Murray: The Australian market has been consolidating for over a year, as the market has factored in the potential risk of a further global economic slowdown. The greater awareness of risk means the market looks better value and more opportunities are presenting themselves. We believe that while policy in China is looking to check growth, it will not lead to a significant slowdown and, as a result, will mean commodity demand is underpinned.
In addition, we are seeing the early signs of a recovery in the US, driven by private sector investment and a greater availability of credit to small business. The main risk is in Europe, where the sovereign debt issues are going to prove difficult to resolve. Overall, the Australian market should post reasonable returns, albeit investors need to be vigilant given the issues in Europe and the US.
What local sectors do you expect to over-perform and why?
Giddy: This year has surprised many who expected a strong recovery. Instead, without the government's wasteful fiscal stimulus, and given higher interest rates locally to move to more normal levels, retail sales are struggling and many parts of the economy are doing it tough.
I don't view this as likely to change much. If the economy is not particularly robust, the sectors that perform best are those that don't rely heavily on economic growth. Defensive sectors such as food, beverages and healthcare may do well, particularly if the current disdain for the US dollar reverses. Some of the highest-quality businesses are in these defensive areas, yet many are quite attractively priced.
Williams: Reasonably priced companies exposed to the mining boom should do well, again as long as China holds together. Stocks like Orica, Coal & Allied, and BHP fit this bill. I also like selected consumer exposed stocks, including News Corp, Tatts Group, Premier Investments and Crown. If our market overall is to do well next year, we will need to see better stock price performance from the major banks, which remain index heavyweights but are currently out of favour with local and overseas investors. I like CBA and WBC at these prices.
Shields: Australia's two-speed economy should even out a bit next year, as the benefits of increased employment and wages flow through to the workforce more generally. As long as the RBA doesn't keep pushing up interest rates this should help consumer and transport-related stocks, which have been laggards in 2010, such as David Jones, Toll and Asciano.
Stocks with exposure to the US should do well as that economy picks up, such as James Hardie, News Corp and Aristocrat. Investment-related financial stocks such as AMP and Computershare have been de-rated significantly and should also recover as equity markets improve.
Taylor: I am currently overweight industrials, healthcare, and resources. The overweight in the industrials sector is from key positions in mining service companies, engineering firms as well as specific structural growth companies such as MAp Airports and Seek.
Next year should be not only a strong demand year for these companies and subsectors, but they should also be able to achieve quite strong pricing power through the year. The mining services and engineering firms should benefit from the very significant investment planned in major resource and infrastructure projects.
This strong demand should lead to an improvement in contract terms. In the healthcare sector, I like the industry leaders and/or those benefiting from structural growth themes. In resources, Rio Tinto remains one of the standouts in the sector from both a growth and valuation perspective.
Murray: We see the multi-speed economy being a real issue that will lead to significant divergences in earnings growth for different sectors. We believe the resource sector will be underpinned, particularly in the first half of the year, but we see the value more in the larger diversified stocks, which have lagged the smaller resources. We also see stocks leveraged to mining investment and volumes doing better as new projects start ramping up.
What local sectors do you expect to under-perform and why?
Giddy: In a subdued economy, cyclical companies (which include banks) will continue to do relatively poorly. Resources depend on how long China can sustain investment and construction at a ridiculously high proportion of GDP, and how many speculators are prepared to keep making the bet the US dollar will weaken and commodity prices strengthen. Short supply in a particular commodity is seldom the reason for recent price strength.
Williams: Retail stocks remain under pressure and given our contrarian style we are starting to look at these, but the short-term outlook remains difficult. Listed internet stocks in Australia seem to trade on higher multiples than comparable offshore stocks, and second and third-tier mining stocks look dangerous after some very strong months.
Shields: Resources stocks, particularly small resources, have had a great run in 2010. Unless we see commodity prices continue to climb, it is unlikely they will be able to maintain this outperformance. Indeed, any attempt by China to slow its rate of growth could cause a sharp temporary pull-back in commodity prices, which would cause a fall in the resources sector. If the US economy strengthens, so will the US dollar and we should see gold stocks significantly under-perform.
Taylor: Due to the rising interest rate environment, through 2011 residential property prices are likely to remain relatively flat and consumer demand is also likely to remain subdued. Household savings rates have been on the rise and credit card statistics indicate that consumers have been paying down their debt.
Households in Australia remain quite cautious and have been acting very prudently. Disposable income growth has been at good levels, but retail sales growth has been well below the levels that align with the significant growth in household savings.
I remain cautious on smaller discretionary retailers, which will continue to get squeezed between higher rents and weaker demand as well as residential property. Companies and sectors without pricing power are also likely to struggle in 2011.
Murray: The property sector has re-established itself as a defensive low-risk asset class, which could under-perform if we see the market rally on better economic prospects.
When do you think the next bull market is likely to return?
Giddy: We are already in a bull market by most definitions. The market is up much more than 20 pre cent off its lows last March and has not had a correction of 20 per cent.
The index is still well below its pre-GFC high, but there has been so much subsequent new share issuance I'm not sure that level is a good benchmark.
Timing markets is extremely hard. I believe in buying good quality stocks and collecting the yield without being overly focused on movements in the index.
Williams: Mining companies, particularly second and third-tier ones, are in a bull market right now. The S&P/ASX 300 Resources index is up 8 per cent this year, while the Small Resources index is up 23 per cent. Meanwhile, the Industrials Index is down 8 per cent over the same period.
So, the question is when will industrials recover? Valuations look OK and dividend yields are relatively attractive, but we will need to see earnings growth being upgraded plus a little bit of PE multiple expansion for the scenario I've outlined earlier to come true.
Shields: I expect we will see a significant pick-up in our stockmarket in 2011, unless the RBA keeps putting up interest rates. I think it is likely to be a good year for US equities too, as the US economy recovers on the back of their low interest rates, quantitative easing and deficit spending. A strong US stockmarket will help push ours along.
The attractive equity prices that we have today and the low interest rates across the developed economies should also encourage a pick-up in mergers and acquisitions. A boom in M&A would also help push up stock prices next year.
Taylor: I am quite positive on the prospects for the Australian equity market in 2011.
The long-term positive fundamentals of the Australian market remain in place and valuations levels are currently very attractive. We see many opportunities to buy great quality companies at attractive prices.
Combining this strong growth outlook with the attractive valuations levels could well mean a strong Australian equity market performance in 2011.
Murray: I believe it is unlikely that we will see a market that rises so strongly and broadly that it feels like a true bull market for some time. We are likely to see returns being better than cash, but lower than the long-run average of 12 per cent. Even in a more positive scenario where global growth is firmer, the market return will be held back by the need for the RBA to check growth to facilitate the investment relating to the mining and energy sectors.
We are likely to see shorter, sharper cycles, where periods of growth are shorter-lived as they will be used to normalise interest rates elsewhere in the world. That said, the divergences within the market will be greater than we have seen in previous years, which will lead to a better ability for investors to beat the broader indices.
Where do you think the local market will end at the end of 2011?
Giddy: It's a real guess, but I think the index has as much chance of going down as it has of going up, so I would not be surprised to find that the index is little better than 4700 in a year.
Note that the headline index does not capture dividends, which may be a significant part of investor return. However, I must emphasise that, with careful stock picking and a focus on dividends, one could definitely make a decent return out of equities in such a scenario.
Williams: We do not base our portfolios around picking a future index level, but each year at Perpetual, in December, the investment team write on a whiteboard their individual pick for the market level for the next December. My pick for 2011 is for 5300, based loosely on my views as given above. But it should be noted I have never won this competition!
Shields: We don't set a target for the market to reach by a particular point in time. Right now we see the market as significantly undervalued outside of the resources sector, because it is pricing depressed earnings with depressed multiples. As long as the RBA doesn't put up interest rates too much, and there is no significant hiccup in Chinese demand, we should see a significant pick-up in our market in 2011.
Taylor: The Australian equity market has been the best-performing market in the world over the long term. Over the very long term, the Australian equity market has delivered a nominal return of about 12 per cent per year. This excellent performance has been driven by strong fundamentals like a high population growth rate, an excellent and low-cost natural resource base, good corporate governance and high real dividend growth in Australia.
While 2010 is likely to end below this long-run average performance, I think the prospects are looking quite reasonable for 2011. Given the strong growth outlook and attractive valuation levels, 2011 is potentially shaping up to be a better-than-average year.
Murray: Declined to comment.
