This article appeared in the July 2013 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
Geoff Wilson lists 10 key drivers, makes a call on how the market will fare and has a look at 4 stocks he likes.
By Geoff Wilson, Wam Capital
The start of the New Financial Year is a good time to focus on the market outlook, although it is always worthwhile to consider macro drivers (big-picture themes) and how they may influence stocks. The reality is that this process is dynamic and constant, and at Wilson Asset Management we re-evaluate our positions all the time.
My current thinking for 2013-14 is set out below, but remember to always be flexible and modify your view around new information.
My top 10 drivers for our sharemarket in the financial year ahead are:
- The Australian economy is slowing, and Western Australia is already in recession. Consumers are still deleveraging (paying off debt) in an environment where property prices are stable but not fuelling domestic spending increases by rising.
- The Australian dollar is continuing to fall; we have seen the peak for our dollar.
- Interest rates are expected to be cut further.
- Business investment remains soft but may improve after the election.
- There are risks that unemployment will rise, and this will temper consumer confidence.
- Ongoing cost cutting by the corporate sector in the absence of top-line sales growth.
- The yield bubble in dividend-paying shares will continue but getting ever closer to the top when interest rates reach their low. The banks and Telstra are being treated as yield plays by investors, not as equity investments. This will end when the market perceives that interest rates have bottomed. This yield bubble may well burst at the back end of next financial year but predicting timing is always difficult in markets.
- China remains unpredictable but the prices of our listed mining stocks suggest it will not be bouncing back to strong growth. The Chinese leadership has suggested growth around 7 per cent is satisfactory.
- The slow recovery in the US will continue as the Federal Reserve begins tapering quantitative easing (a form of monetary policy). Ironically, this may coincide with the sharemarket falling because of the US economy's recent dependence on zero interest rates. As always, the outcome is tough to predict.
- On a positive note, our sharemarket may have underestimated earnings improvements that can be generated through further cost cutting and lower interest rates. Combined with a weaker Australian dollar, some sectors will fair OK in 2013-14.
It should always be noted that often the driver that is least anticipated is that which has the largest influence - 'The Black Swan' or the 'X Factor'. Obviously I cannot predict what this may be, but being open to new influences and variables is critical.
How will those factors combine to influence our sharemarket?
I suspect it will be a difficult year, a mixed bag - weak until the end of the calendar year and a stronger first half of 2014. The slowdown in economic activity because of the uncertainty from the September federal election is having a negative effect, leading to a number of earnings downgrades from listed companies.
At some point, lower interest rates and the lower Australian dollar will boost economic activity and have a multiplier effect on corporate profitability.
Bull markets are fuelled by two distinct sources: First, earnings growth; second, positive sentiment that drives price/ earnings multiple expansion (that is, stocks are priced on a higher PE, which lifts their valuation). As it stands, we have neither, so to expect a raging bull market next year is optimistic.
However, falling interest rates and a continuing flight to stocks such as the big banks and Telstra may well see these share prices move higher and take the indices (such as the S&P/ASX 200) higher with them.
Given the lack of value in these stocks, we will not be playing the yield bubble game but there will be good value opportunities elsewhere for patient, savvy and hard-working investors. We expect to continue to deliver satisfactory returns to our shareholders along with much-loved fully franked dividends.
In terms of specific stocks I can see moving higher, we own the following:
(Editor's note: Do not read the following ideas as stock recommendations. Do further research of your own or talk to your financial adviser before acting on themes in this article).
CSG Limited is a print services company that provides managed print and document output solutions. Following the sale of its information technology business in 2012, CSG has a strong balance sheet with a net cash position of $36 million. At the half-yearly result in February, the board announced a policy to distribute nine cents per annum to shareholders, a yield of 10.5 per cent. The company is trading on a P/E ratio of 10.5 times, with earnings per share (EPS) growth of 20 per cent in the 2014 financial year. Catalysts that could lead to a re-rating of the company include further reductions in operating costs and growth in the recently launched printer leasing business.
Slater & Gordon (SGH)
Slater & Gordon is based in Australia and the UK and the law firm specialises in insurance litigation, commercial and family law. The company operates 69 offices in Australia and 10 in the UK. It trades on a 2014 financial year P/E of 11 times, with strong earnings per share growth of 24 per cent. Slater & Gordon's future growth will be driven by further expansion into the UK. In early May the company announced the acquisition of three leading UK personal injury litigation firms. A re-rating for the company depends on how successful it is in integrating these businesses.
Villa World Limited (VLW)
Villa World is a residential property developer with assets in Queensland and Victoria. The company is currently trading at $1.12, a 38 per cent discount to net tangible assets (NTA) of $1.82 per share. More than half Villa World assets (54 per cent) are in south-east Queensland, a market experiencing increased demand following three to four years of depressed house prices. The company recently confirmed the turnaround in market conditions, announcing a 14 per cent increase in underlying operating profit for the 2013 financial year.
GrainCorp, an integrated grains and malt business, is currently under a takeover offer from Archer Daniels Midland (ADM). After an unsuccessful offer of $11.75 in October 2012, ADM came back with a sweetened $13.20 offer in April 2013, comprised of $12.20 cash and $1.00 fully franked dividend. We believe there is a high probability of the transaction proceeding. At the current share price of $12.48, the annualised return, assuming February 2014 implementation, is more than 10 per cent before including franking credits.
About the author
Geoff Wilson is chairman of Wilson Asset Management, a leading investment company that manages the listed investment companies WAM Capital, WAM Research and WAM Active.
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