Where to for Australian equities?
Paul Taylor, Portfolio Manager of the Fidelity Australian Equities Fund, talks about what the eurozone debt crisis might mean for Australian stocks.
How do you see the eurozone debt crisis?
I would place the European crisis into two different-though-related categories. First, it is a crisis of confidence associated with the possible breakup of the euro and the EU. The impacts from this crisis of confidence for Australia would primarily be focused on the dislocation of European and global debt markets. This could potentially hinder Australian companies with higher debt levels as well as Australian banks seeking wholesale funding. At the moment, Australian companies have low debt and Australian banks have reduced their dependence on wholesale funding due to the strong growth in term deposits and low levels of credit growth. The damage from a crisis of confidence would likely be fleeting. If anything, it might create a short-term buying opportunity.
The second and broader category that the European crisis fits within is a global sovereign debt crisis. The global sovereign debt crisis includes the significant debt burdens of many European countries but also the debt of many developed countries including the US. The debt levels of many developed markets are too high and need to be reduced to manageable levels over a prolonged period. This is a problem that will likely hobble global economic growth over a prolonged period. Due to the global sovereign debt crisis, we should plan for a low-growth world for at least the next several years. Australia is well positioned for this low-growth world. The federal government has low debt levels and its budget is projected to move back into a slight surplus as early as next year. Australian interest rates are high by global standards, giving the Reserve Bank of Australia room to further stimulate our economy should the world economy falter.
How is the Australian stock market placed amid such elevated global uncertainty?
The pattern for the Australian stock market this year is that after every few good weeks it gets knocked around by the same global macroeconomic issues that have worried investors for some time; the sovereign debt issues in Europe; the US economic recovery and the sustainability of Asia’s robust growth. Fundamentally, we believe that the Australian stock market is attractively valued. Investors are getting good valuations for the long term. Corporate balance sheets are in really good shape. Free-to-invest cash flow is strong. Dividends are flowing. The dividend yield in the Australian market is an attractive 5%.1
What do these global issues mean for Australian stock investors?
The big global economic issues we face today mean that we are in for a lower-growth world for a while. Interestingly, investors are pricing all companies, all sectors and all countries on this low-growth profile. Stock investors are in a sceptical frame of mind. Therefore, we have seen a compression of valuations across all stock markets, sectors and companies. Whether companies are good quality or poor quality, whether they have high-growth or low-growth outlooks, they are trading around similar ranges. That goes for countries and sectors as well.
That’s where we see great opportunities. We think that there are pockets of growth throughout the world. Because we identify better-quality companies, stronger companies, companies that have promising strategic outlooks, we think that there should be differentiation in valuations. We think there should be more discernment among stocks and the lack of this discernment is where the opportunities lie. In a low-growth world, companies that can deliver yield and growth or both will be bid up. They’re the ones that over the long term will deliver great returns. They are the ones we want to own.
Can you name some of these stocks?
Companies like Sydney Airport, Iluka Resources, Suncorp, Telstra, Goodman Group and Seek represent great value because they provide investors with attractive yields and promising growth opportunities.
What’s happening with the Australian economy?
We are going through this once-in-a-lifetime resources, infrastructure and production boom. That’s all positive for Australia though it throws up a concern called the Dutch Disease. That’s the term to describe the situation when some parts of the economy are thriving so much that they make it hard for other sectors of the economy because, say, interest rates or the exchange rate are set at higher levels than they would be otherwise. The issue that the government and the Reserve Bank are grappling with at the moment is that while mining is doing well the non-resources sectors are struggling.
The federal government is trying to get through this phase by ensuring that fiscal policy is tight enough to allow the Reserve Bank to reduce interest rates, which offers the added boost of lowering the Australian dollar, to help the sectors of the economy that are struggling. A tight fiscal policy that allows the Reserve Bank to loosen monetary policy could put us in the best possible position to enjoy the benefits of the resources boom while not hindering the rest of the economy.
What will lower interest rates do for the Australian stock market?
Typically, lower interest rates benefit banks, insurers, property developers and retailers, whether they sell staples or discretionary items.
While I think lower interest rates benefit consumers generally, I’m not sure that will translate into better conditions for Australia’s retailers. These companies face many headwinds that will dog them even if rates fall. The internet is changing the way people shop. Price discovery is easier so retail margins are under pressure. What people are buying has changed. People are a lot less interested in things as they’re much more interested in experiences. While times will be tough for consumer discretionary companies in 2012, even with lower interest rates, the companies that deliver the essentials of life will benefit from lower interest rates.
1 The dividend yield on the S&P/ASX 200 Index was 5% on 31 May 2012, according to Bloomberg.
Any references to specific securities should not be taken as recommendations and may not represent actual holdings in the portfolio at the time of this viewing.