By Don Williams, Platypus Asset Management, chief investment officer
While many things still remain uncertain in the financial and economic environment globally, at Platypus we are starting to feel slightly more definite about some aspects of financial markets.
Of course, it is always risky to get out the crystal ball, but below are some predictions for the next few years that we feel relatively comfortable with:
- The eurozone will stay intact, but growth will be anaemic – less than 1 per cent – while the United States will grow around 2 per cent. We see Europe and the US flat-lining at these respective growth rates for a number of years.
- China will continue to manage its growth rate at lower levels as it rebalances away from investment to consumption. We are not anticipating any major policy changes from the central government.
- In Australia, growth will accelerate to around 3.5 per cent, up from the post-global financial crisis average of 2.5 per cent, on the back of more benign interest rate settings and a gradual improvement in business and consumer confidence.
- We believe the easing cycle is over and the cash rate will remain at 3.5 per cent.
- At the same time, the Australian dollar will remain stubbornly high, supported by central banks and investors chasing yield.
- Average commodity prices will continue to decline, but overall will remain at relatively high levels. Based on these views, our outlook for the Australian index is that the two main sectors – resources and banks – will experience very different fortunes.
The recent rally in mining stocks has fallen away at the time of writing, due to a steep decline in the iron ore price. The rally was based on the view China will increase its stimulus measures, and the US and Europe will do something similar over coming weeks. We don’t support either of these assumptions and, as a result, if our view is correct, the performance of BHP and Rio Tinto will continue to be a drag on the index.
Banks are unlikely to deliver a spectacular performance in the next 12 months or so, but nor are they likely to be much of a drag on the index.
While they haven’t generated a capital return for investors since 2009, they could be close to a turning point. Australian bank yields remain well above the historic range, and with investors struggling to find reasonable and reasonably safe returns, Australian banks are likely to garner support.
Money is likely to flow into the banks for several reasons:
- they are a stable oligopoly that has pricing power,
- their balance sheets are in good shape compared to the vast majority of Northern Hemisphere banks,
- Australia is seen as safe relative to Europe and Asia,
- They seem to have the implicit support of the government and the Reserve Bank of Australia, and
- the current level of earnings and dividends seems, at worst, sustainable.
Our expectation is that, as a group, banks will deliver yields of about 7 per cent and capital return of between 3 per cent and 5 per cent in the next 12 months. Assuming the total return is 10 per cent (before franking), the banks will contribute about 3 per cent to the market return, thus offsetting the drag from the two mining majors.
As a result, we anticipate around 40 per cent of the index to generate close to zero return in the next year or so, leaving the remaining 60 per cent to generate performance.
In trying to predict a return for that 60 per cent, it is worth noting that:
- valuations are largely at or below historical medians,
- the consensus earnings numbers for fiscal 2013 are likely optimistic,
- throughout this reporting season, share prices moved higher almost regardless of the numbers delivered. This supports the point that valuations are genuinely low relative to the outlook and a lot of bad news is priced into stocks, and
- the outlook is gradually improving. Overall, for the 12 months ahead we are expecting 8 per cent earnings growth for the non-bank, non-mining part of the market, and some valuation expansion.
The market will continue to trade within the broad range it has been in since 2009, but we would expect it to make new recovery highs in the following 12 month period.
Source: IFA magazine, Page 7, Issue 607, 17 September 2012