By Donald Williams, Platypus Asset Management, as published in IFA Magazine (December 2010)
A year ago we wrote that 2010 was likely to be a transition year for the share market, a time of consolidation following the strong recovery in 2009.
Unfortunately that’s exactly how it played out, meaning it was a difficult and frustrating year for equity investors.
As the chart below shows, every sector spent more time in negative territory than it did above zero, and at the time of writing the materials sector looks like it will be the only one to deliver a decent return for the calendar year.
The market was handicapped by a number of events and issues that arose during the course of the year. While many of these concerns have now been dealt with, there are still a few that have yet to fully play out, and it’s timely to review some of the ‘big events’ of the year to see where potential problems still exist, and get a feel for what 2011 might hold.
2010 – an eventful year
At the top of the list of big events are the European credit crises, with the first one, in Greece, the reason for the initial downward turn in January. Sovereign debt concerns returned later in the year, and Ireland was ultimately forced to accept an International Monetary Fund (IMF) bailout in November, while Portugal and Spain remain a concern.
The Reserve Bank of Australia (RBA) has also had a major and, in our view, unnecessarily negative, impact on the market in 2010. Its excessively aggressive stance on interest rates reversed the nascent recovery in the domestic economy and affected the earnings and ratings of most domestically exposed companies, especially retailers.
Finally, as the recovery in the US economy levelled off in the middle of the year, a number of economists and strategists argued forcefully that the US was headed for a double-dip recession. It took several weeks of consistently strong data in October and November before the double-dip club was silenced.
2011 – a year of growth?
Looking ahead, the only truly dark cloud on the horizon is the European sovereign debt issue. The markets concerns are unlikely to disappear any time soon, and the focus will simply roll from one country to the next.
Although we expect “successful” bailouts to continue, these will only delay the inevitable restructuring of the sovereign debt for most of the countries that have to tap the IMF. While the market is less sensitive to these events than it was a year ago, ongoing concerns in many countries over the level of debt and the ability to service it will continue to drive volatility in markets.
Despite this sense of gloom and its impact on markets and investor sentiment, at Platypus we are upbeat about the year ahead, for a number of reasons.
The key to any upswing in the local equity market is the US market. As the chart below shows, US companies have enjoyed a rapid recovery in profitability over the last 12 months and this is expected to continue in 2011. Unlike the Australian experience, earnings estimates have been consistently revised upwards through the course of 2010, and record profits are expected from US corporates in 2011.
Despite this, the US equity market has traded mostly sideways through the course of the year and remains 30 percent below the 2007 peak. At long last, economists have started to revise up their expectations for US gross domestic profit (GDP) growth in 2011, which will only enhance the profit outlook.
For the local market we are expecting a total return just under 20 percent, made up of 15 percent earnings growth and a dividend yield of four percent. The main driver as always will be the US market; however we believe there is reason to be optimistic about the Australian market from a bottom-up perspective.
For the last 12 months, earnings estimates for Australian companies have been revised lower due to the insipid recovery in the domestic economy and the strength of the Australian dollar. Looking ahead, it is likely that the RBA will be far less aggressive in hiking rates next year, which will give the domestic economy the opportunity to gain some momentum. As a result, the strength and breadth of profit growth from Australian companies should improve, and we would be surprised if corporate activity (M&A) did not pick up materially in 2011.
In addition we are expecting commodity prices to at least remain at current levels for the next 12 months as the China growth story continues and the US recovery gains traction.
In the short term, we are expecting mining companies to lead the market as they have since July. With the economic outlook improving in the US we also think that energy stocks will perform much better in 2011 than they have this year. The oil price has crept back towards $90/bbl and we would not be surprised to see it trade to $100/bbl in 2011. The major oil stocks are yet to factor in higher oil prices next year which we believe is more likely to occur than not.
Although we are not expecting market-leading returns from the banks next year, they are still likely to provide double digit returns as the domestic economy shows signs of improvement and credit growth recovers from abnormally low levels.
The best returns in the market next year could well come from domestic cyclicals, including retailers and industrials. These groups have not performed well this year due to the impact of rising interest rates; however we expect that the economic environment will be much more supportive for these businesses by the middle of next year.
Overall, our view is that 2011 will be a more positive year than 2010, with sustainable market gains to be achieved. Investors should expect to see some much-needed growth, building on this year’s consolidation, in the share market.
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* Donald Williams is chief investment officer at Platypus Asset Management, an Australian equities joint venture partner of Australian Unity Investments.
Important Information
The information in the Market News Centre has been prepared by the product issuers Australian Unity Funds Management Limited ABN 60 071 497 115, AFS Licence No 234454; Australian Unity Property Limited ABN 58 079 538 499, AFS Licence No 234455; and Australian Unity Finance Limited ABN 35 114 646 070. It contains general information only and does not take into account your individual objectives, personal circumstances, financial situation or needs. While every care has been taken in the preparation of this information, we reserve the right to make corrections. You should seek your own financial advice from a financial services licensee or an authorised representative and you should read the relevant, current Product Disclosure statement (PDS) or Prospectus before making any investment decisions. You can obtain a copy of the current PDS or Prospectus by visiting australianunityinvestments.com.au or by calling 13 29 39.
