The Outlook For Australian Equities In 2012

Australia’s economy might be in better shape than those of other developed nations, but will this be enough to translate into rising local share prices in the New Year? Paul Taylor, head of Australian equities at Fidelity Worldwide Investment and portfolio manager of the Fidelity Australian Equities Fund, says banking crises are generally followed by sovereign debt crises and these tend to be followed by increasing inflation.

The events in Europe are part of this bigger cycle. It’s not the end of the world, but you have to be aware of what it means – for the local market, local companies and local investors. One thing that the latest gyrations in Europe will definitely lead to is slower global growth and a prolonged recovery period. This will impact our currency, exporters, consumer demand and more. Despite this, there are still pockets of good growth in the local economy and market, with several companies remaining in good shape and growing well – and not valued as such.

We’re in a very different environment to that of the original global financial crisis (GFC), which was all about debt on corporate balance sheets. Through the GFC Australian companies repaired their balance sheets and are now in a much better position. Though some strengthened more than others. Investors need to take a back to basics approach and seek good companies with good cash flow. Investors need to find the structural growth opportunities, find which companies are growing faster, which companies have really good industry positions and the best growth opportunities.

Stocks that can provide both growth and yield will be bid up by the market. There are several listed companies that are paying dividend yields that are well above that of bank term deposit rates and these will increasingly be in demand from investors seeking consistent income from the market. What investors should try to do, what I am trying to do, is to withdraw the macro influences from a portfolio as much as possible. You can only do this by taking a bottom-up stock picking approach.

While European economies will take a long time to recover, markets should recover more quickly, albeit it will still take some time.
Kate Howitt, Portfolio Manager Australian Equities at Fidelity Worldwide Investment, says there are four issues that will drive markets in 2012.

One of the main factors to include markets in 2012 is that it will become clear that ‘halfway house’ solutions for the Euro won’t work, so 2012 will either see a push towards European fiscal integration, or the dismantling of the single currency in its current state. Germany must decide on the fate of the eurozone – and this will have significant impacts for the rest of the global economy. A second factor is that markets will grapple with the ability of the US to maintain its current slight positive economic momentum. US election-year inertia means fiscal policy is unlikely to be a factor, either in stimulating the economy or in implementing the cuts required to by the extension of the debt ceiling.

If the US economy needs further stimulus it will again have to come from the Fed, most likely this time in the guise of asset purchases of residential mortgage backed securities in an attempt to provide relief to homeowners via lower mortgage rates. A third factor will be the outcome of the current policy debate in China between reformers who would like to see a faster rebalancing of the Chinese economy towards consumption by continuing the squeeze on investment, and the provincial authorities who are supportive of reflationary policy moves.

The outcome here has obvious implications for China’s demand for raw materials and hence Australia’s terms of trade, commodity stocks as well as domestic interest rates. We know that the Reserve Bank of Australia (RBA) will be responsive to any weakening in the economic outlook for Australia, but it also seems clear that it doesn’t want to see house prices grow to any meaningful extent in the interest of restraining household debt levels and so it will remain vigilant to any signs of housing market exuberance. Fourth, the net outcome of these situations will be seen in the currency markets. A stronger US$, ongoing restrictive Chinese policies and lower RBA cash rates would weaken the A$; while reflationary moves by either the Fed or the Chinese authorities could easily see the A$ sustained back above parity for much of the year.

These factors would have different impacts on different asset classes over 2012.
The RBA appears to remain comfortable with flat nominal house prices. So property is unlikely to be the stand-out asset class. Given the macro uncertainties it is also hard to see cash returns trend up in the next 12 months, with bank deposit rates already dropping recently. Accordingly, cash may no longer be king and its attraction is likely to weaken.

That leaves us with equities. But, why would you possibly want to buy equities when the world is so grim? Stepping back from the headlines, we know that the local equity market is offering close to a 5 per cent dividend yield – with even higher yields from selected blue chip stocks such as the banks, Telstra and REITs. We know that our banks are some of the strongest in the world, corporate gearing is at 30 year lows and earnings are generally below cycle-peaks, with the market offering reasonable valuations, yield support, solid fundamentals and the potential for reflationary policy moves.“These factors suggest it may not be too long until we are back to 2009 where there was a greater risk to not holding equities. Markets tend to ‘climb the wall of worry’. So even though Europe is unlikely to be ‘solved’ in any quick way, an end to the uncertainty would likely give rise to a relief rally.

By | 15.12.2011

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