By Prasad Patkar, portfolio manager at Platypus Asset Management
Last year was difficult for investors, and unfortunately the first half of this one is likely to carry through some of the critical themes from last year.
But it’s certainly not all doom and gloom. Things have improved quite a bit from the start of the third quarter of 2011, when the outlook looked really grim. At the time, the United States economy was weakening to the point that the media was full of double-dip recession predictions for the US; the European sovereign debt issue was seemingly out of control; global financial crisis (GFC) mark II was referred to by some; China appeared to be headed for a hard landing; and the Reserve Bank of Australia (RBA) was keeping its foot firmly on the brake.
We know the US economy is regaining momentum and all those calling a double dip are back in their respective boxes. Chinese authorities have shown pragmatism in signalling an easier stance on the economy. Inflation in China is coming back to acceptable levels, allowing Beijing to support growth. The RBA has done an about-turn and cut rates by 50 basis points.
While the European issue is far from being resolved, the pathway to a lasting solution seems clearer today than it did a few months ago. Enforceable fiscal integration will occur and that will be the price ‘periphery’ countries will have to pay for the bailout by the ‘core’.
We should not forget the new head of the European Central Bank has acted decisively in cutting rates, easing the funding squeeze on the banks by providing in excess of $600 billion in three-year loans while easing their collateral requirements. These measures are likely to be helpful in restoring
calm and allaying fears of contagion spreading through the financial system.
If the European threat to the financial system is taken out of the picture – and it may well have been by the second half of this year – investors can start focusing on the fundamentals, which don’t look that bad.
In a global world, the Australian economy will be affected indirectly by the impact of European issues on China, but the extra degree of separation helps.
Europe will need to fall off the cliff and Chinese authorities will need to be powerless to neutralise the effect of this event on their exports before there will
be an impact on Australia.
The chances of this occurring are not particularly high. Aside from a GFC-like event that engulfs the entire world in a short span of time, via a freeze in credit markets, China is likely to feel a relatively small impact from a recession in Europe, and there is ample ammunition for authorities in China to be able to respond. In a realistic scenario, the influence on Australia will be relatively small.
On the other side of the equation, China’s transition from an investmentand exports-dominated economy to a consumer economy is likely to benefit
Europe tremendously over the next 10 to 20 years.
The question for Australia is: how do we position ourselves to benefit from this transition in China and India? It’s a question that will need to be answered soon so we are not left behind when throngs of Chinese and Indian consumers are ready, willing and able to spend their new-found wealth on things we have taken for granted over the past 60 years.
For investors in the Australian market, there are a few sectors that hold promise. In the absence of a collapse of commodity prices, mining and oil and gas services companies appear set to do well. Exploration, production and testing of minerals and drilling for oil and gas appear to be in top gear with no sign of letting up as the producers of these commodities achieve record cash flow.
Mining and oil and gas companies may be trickier. Although there is clear value in these names, the catalyst of a sharp rally in commodity prices from current levels may be missing. Banks at 7 per cent to 8 per cent yield and 1.6 times book value are priced attractively and, if risk appetite improves, can give investors a liquid means of strapping on some market exposure quickly.
It’s likely the domestic market will continue to trade within a range around 3800 to 4400 for the first half of the year at least, until we get comfort on European issues. A worst-case scenario would be if the eurozone collapses, in which case our market could test the GFC low of 3200. But a best-case scenario – where investors are comfortable that GFC mark II is definitely off the list of concerns and they can start to price stocks based on fundamentals – could see the market trading over that critical 5000 mark.
Source: IFA magazine, Page 20, Issue 583, 23 January 2012.
