2011 will be a catch up year for Australian equity markets as several factors start to work in favour of investors.
Last year, a number of headwinds held back the local sharemarket, such as the Reserve Bank of Australia’s (RBA) aggressive cash rate rises, the very strong Australian dollar and the shocks from international events such as the European sovereign debt crisis.
As a result, the Australian market has underperformed other global indices during calendar year 2010 and this was a constant source of frustration for domestic investors. Overall, however, at Platypus we are positive about the Australian market for 2011 from a bottom-up perspective, in part because the domestic economy will start to gain some momentum.
This doesn’t mean that the headwinds aren’t still apparent.
There is no doubt that international investors will continue to have an influence on the direction of the Australian equity market. Many international investors are still benchmarked in US dollars; therefore, as the Australian dollar has appreciated from 89c to $1.00 over the course of the last 12 months, these international investors have made excellent returns just from the currency trade alone.
In other words, due to currency movements, our domestic market is currently internationally “more expensive” to buy into than it was 6 or 12 months ago, despite share price movements being largely sideways. The chart below shows the performance of the All Ordinaries Index verses other global indices in 2010. The All Ordinaries Index is priced in both Australian dollars and US dollars. The return of our domestic market when priced in US dollars is more in-line with the performance of other global markets, yet we underperformed when benchmarked in local currency terms.
But such factors will start to be outweighed by more positive drivers during the course of the year.
The best results in 2011 could well come from domestic cyclical stocks, such as retailers and industrials, which didn’t perform well in 2010 because of the four official cash rate rises. In particular, the last rate rise in November, accompanied with additional rises by banks above the cash rate increase, created a negative lead-in to the Christmas retail spending period.
Anecdotally, many fund managers trimmed their holdings of consumer discretionary stocks and short positions were increased towards the end of the year based on the view that Christmas retail spending would be weak. Product price deflation – caused by the strong appreciation of the Australian dollar and glut of product in the consumer electronics sector – was another factor having a negative influence on retail sales growth, particularly for companies such as JB
Hi-Fi.
We believe the RBA will be much less aggressive in raising the official cash rate, with our forecast that interest rates will remain on hold until at least mid-year. The slowdown in gross domestic product growth, stemming from the Queensland floods and early signs of benign inflation data, reinforce our view.
We also think there is the opportunity for credit growth to accelerate from the current low levels. The economy is continuing to add both full-time and part-time jobs, and combined with a modest level of wages growth will be positive for retail spending.
Despite poor retail sales growth over the past 12 months, consumer sentiment remains at reasonable levels. We feel that this has not translated into strong retail sales growth because consumers have been encouraged to save more in the aftermath of the global financial crisis – and certainly there are attractive interest rates on offer by banks for savers.
However we still believe that the strong economic conditions and positive consumer sentiment will inevitably rub off on better retail sales growth in 2011. From an investment perspective, the consumer discretionary sector is currently unloved but has the opportunity to provide good returns for shareholders as the Australian economy picks up later in the year. On a micro level, many stocks offer the opportunity for solid earnings and dividend growth combined with the possibility for capital management.
Our favoured consumer discretionary stocks include Super Retail Group and David Jones. JB Hi-Fi is our favoured contrarian play. Each of these three companies has strong management capabilities, a good balance sheet and leverage to an improvement in domestic retail sales growth.
The short-term outlook for the market is perhaps best described as muted. We believe that the February reporting season will be patchy and company outlook comment likely to be conservative. This reflects the domestic economic conditions in Australia since last June and the impact of the recent natural disasters, in particular the Queensland floods.
Nonetheless, the mining boom will continue and the floods have demonstrated just how sensitive commodity prices are to unexpected set-backs.
In our view, commodities prices will remain high for the next few years, fuelled by demand from China and other emerging countries, although eventually supply will meet demand and prices will start to fall for goods such as iron ore, copper and coal.
Once reporting season is out of the way, the market should continue its upwards trajectory, particularly in the new financial year when earnings forecast are likely to be raised. If this occurs, the market could well start to outperform, with the S&P/ASX 300 index reaching 5,500 and perhaps higher.
In the US, the Federal Reserve seems solely focussed on employment figures at the moment. We therefore expect the Fed to keep the stimulus package at full throttle, which could cause some volatility for the more risky assets during the year; however as a general theme the US market will continue to trend higher.
This continues the pattern set late last year, with markets performing strongly in December even as macro concerns such as sovereign debt issues in Europe and the Chinese monetary tightening lingered in the background. There was a noticeable lack of liquidity particularly towards the month end. The month also saw a flurry of corporate activity including Rio Tinto’s bid for Riversdale Mining, Seek’s purchase of Asian employment classifieds business and the trade sale of Valemus to Lend Lease.
We expect that the high levels of corporate activity seen towards the end of 2010 will continue well into 2011.
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* Simon Bonouvrie is portfolio manager 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.
