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Six key investment themes for 2013
This article appeared in the February 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.
More strengths, not weaknesses, the optimistic view.
By Christine St Anne, Morningstar
In the Chinese calendar, 2013 marks the Year of the Snake. Chinese tradition expects the year to usher in a mix of traditional strengths and weaknesses.
Events around the world will no doubt also bring such a mix for global markets, hopefully more strengths than weaknesses as countries continue to tackle a plethora of economic and social issues.
For the humble Australian investor, a number of key themes are set to dominate the landscape this year. Here are six to watch:
(Editor's note: Do not read the ideas below as stock recommendations. Do further research of your own or talk to your financial adviser before acting on themes in this article.)
1. Chase for yield continues, but sustainability the key
The chase for yield characterised 2012. In an environment of falling interest rates, investors were attracted to Australian companies that offered relatively high dividends.
In a recent economic review, AMP Capital's head of investment strategy and chief economist, Shane Oliver, says global and Australian property securities had a very strong year as investors switched into high-yield assets. Unlisted commercial property and infrastructure performed well, as did Australian income stocks that also benefited from investor appetite for yield and were among the best performers in 2012.
With interest rates expected to fall further, the search for yield will only intensify, but investors will need to exercise greater caution.
"Investors will have to be careful when selecting high-dividend companies; these companies need to also pay sustainable dividends," says UBS wealth management associate director, Abby Macnish.
Companies with healthy balance sheets and strong cash flows will stay positioned to pay good dividends despite the challenges ahead. Those that can manage price pressures and sustain cash flows are better positioned to deliver consistent dividend growth, Macnish says. "Some of our clients have identified companies that have been paying higher dividends than a company like Wesfarmers (WES). The difference is that the dividends Wesfarmers pay are sustainable."
Among the darling dividend stocks, there will also be a focus on whether banks will be able to continue to deliver on dividend growth. Although domestic economic challenges remain, Morningstar's sector outlook says banks are still on track to deliver consistent dividend growth.
"We believe investors are overly pessimistic on the Australian economic outlook and the potential damage to bank profitability caused by higher bad debts. Most importantly, major negative earnings surprises are unlikely, due to the generally lower-risk domestic focus and conservative loan underwriting standards," the Morningstar report says.
Macnish of UBS says investors could also look outside traditional defensive stocks for lower-yielding companies expected to grow their dividends over time.
2. Cash rates lower for longer
The broad theme of 2012 was falling cash rates. Overall, there have been cumulative cuts of 175 basis points since November 2011. For Macnish, this will only continue and, in fact, cash rates will be lower for longer. She expects rates to fall to around 2.5 per cent.
Morningstar's Peter Warnes says the Australian interest rate cycle is almost complete, with official rates of 3 per cent equal to post-GFC lows. Despite the bottoming phase that is likely to continue through 2013, Warnes does not expect the Reserve Bank to move to negative real interest rate.
Similarly, CommSec chief economist Craig James says there are a number of factors that will prevent interest rates from falling too low. In his Economic Insights paper, James says unemployment is still low and underlying inflation is in the middle, not at the lower end, of the 2-3 per cent target band. At the same time, there are reasons for optimism on the Chinese and US economies.
"It is clear from recent moves that the economy is far less responsive to rate cuts than in the past. But that doesn't mean rates should be cut further, but rather a different mix of fiscal and monetary policies may need to be contemplated," James says.
The fall in cash rates will only intensify investors' search for yield and Macnish says defensive stocks will maintain their high share prices.
Morningstar also notes that lower interest rates in Australia are likely to boost bank share prices as demand for sustainable dividends escalates.
3. End of the commodity and China boom?
Investors were stunned in January when iron ore prices rose to around US$160 a tonne, but a number of commentators noted this could be a one-off increase and the price slipped to around US$145. Regardless of the debate on the likely direction of commodity prices, Macnish says we are not going to see the high prices of 2008. Although the period of high prices may have eased, Macnish says current price levels are better than the US$90 a tonne a year ago, which is important because price levels affect sentiment.
With China a key driver of Australia's mining boom, Macnish says a soft landing in China, as well as quantitative easing in Europe, should help support commodity prices.
James is a tad more optimistic on the outlook for China and its ability to sustain demand for the world's resources. "Quite simply, the world has never seen industrialisation and urbanisation on the scale currently under way in China," he says. "A nation of 1.3 billion people, especially people experiencing growing wealth and income, will continue to place significant demands on resources."
A survey consensus of 47 economists from Emerging Markets Economic Data believe the Chinese economy will grow by 8 per cent in 2013. The International Monetary Fund expects the Chinese economy to grow by 8.2 per cent in 2013 and by 8.5 per cent on average from 2014 to 2017.
James says: "While the Chinese economy will not replicate the 10.1 per cent average growth rate from 2004 to 2008, growth of around 8.5 per cent is still a sizeable contribution to the global economy."
The boom in China is not over, he says, "unless Chinese authorities want to prevent their people enjoying the same lifestyle that exists in Western nations".
Nevertheless, James says the first phase of the boom is over; that is, the early stage of industrialisation with the unsustainable lift in resource prices.
In a period of commodity price easing, Macnish of UBS says investors should look at the big diversified mining companies such as Rio Tinto (RIO) and BHP Billiton (BHP), which can both handle pricing pressures easing.
"We saw in the July (2012) pricing shocks that BHP and Rio handled it better than Fortescue Metals Group (FMG), which had to go back to the market to refinance its business," Macnish says.
4. How high can the Australian dollar rise?
Macnish expects the Australian dollar to remain around parity with the US dollar over the next six to 12 months, because of our high cash and bond rates compared to the rest of the world and our triple- AAA rating in a pool that contains other countries' diminishing credit ratings. Essentially, the dollar has become a yield play, Macnish says.
For James, there is a risk the Australian dollar could go higher, given China's continued industrialisation. "China has only started down the industrialisation road and it will increasingly step up its spending on Australian resources and services over time. When the Japanese economy was treading the same path of industrialisation over the 1970s, the Aussie dollar was regularly above parity against the US dollar," James says.
Although a revisit to highs near US$1.50 appears "fanciful," James echoes Macnish's views that interest rates are higher compared with other countries, particularly the US where they are expected to remain near zero at least through to 2015. This would only increase foreign demand for Australian assets. "While we are tipping the Aussie to rise to US$1.10, it certainly could get higher," James says.
5. Will Europe continue to dominate?
Europe remains a much longer-term problem, according to Macnish. Although the region has made some great progress in tackling its economic issues, Macnish says there are outstanding concerns about Spain and Italy.
Macnish expects overall world growth levels to be around 3 per cent for 2013 and 3.5 per cent for 2014.
James says although Europe's debt problems have not been solved, he likes the "do whatever it takes" attitude of European policymakers. Even though European risks remain, James says they will not have the same impact as in recent years, provided the US and Chinese economies gather pace over 2013.
Macnish says a number of European companies are leveraged to the growth parts of the world, mainly in the developing and emerging markets, but investors must ensure these have quality management and realistic revenue streams. "We would include exposure to European companies in the satellite portion of an investment portfolio. That will add to growth. The core part of a portfolio, however, should continue to include high-quality, defensive and cyclical Australian companies."
6. A shift in confidence?
The effect of the GFC nearly six years ago continues to be felt by consumers, investors and businesses. Consumers have shifted out of debt and remained selective in their buying habits, while investors have been overweight cash. Businesses have remained reluctant to hire more staff.
James says there are early signs of a thawing in community attitudes. Investors are starting to invest in property and savers are slowly shifting out of term deposits; consumers have bought a record number of cars; the sharemarket has lifted to 17-month highs.
He points out that, compared to a global scale, the budget deficit is low, interest rates are historically low, unemployment is not far from the longer-term averages, and inflation is still within the RBA's 2-3 per cent target band. "If the global gloom disappears from view, Australians will find out fairly quickly that there are few worries here at home," James says.
Oh, and the election!
It would, of course, be remiss not to mention the Australian federal election in September. An election brings uncertainty, and consumers and businesses tend not to act until that has passed.
About the author
Christine St Anne is Morningstar's online editor.
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