June 2012
Over the Horizon Market Commentary by David Offer
Continuing the negative sentiment of May, the S&P/ASX 200 struggled through June to an insipid close at 4094, an increase of only
18 points or 0.4% for the month. This performance capped a very disappointing year for the Australian share market with the ASX
S&P 200 losing 11.1% for 2012/13. In overseas markets, the performance over the year was a mixed bag with the Dow Jones rising 3.8%, but the London FTSE and German DAX falling 6.3% and 13.0% respectively. China faired particularly poorly, off 19.4% for
the year.
The Australian markets poor performance over the 2013 financial year was the result of its high weighting to cyclical sectors, such
as the materials (resources), media and retail. The significant retracement of shares in these sectors when compared to defensives, such as Telstra or even the banks which, whilst broadly flat as a sector, did show some pleasing resilience against a backdrop
of European financial turmoil, certainly dragged the market down.
In this regard, Telstra was the standout performer for the year, finally returning to investor favour with a 28% increase in share
price to $3.69 at year end. As confirmation that defensives are still the preferred flavour, Telstra has risen an additional 5% over
the past week and yet even with this price appreciation, is still providing a fully franked yield of 7.2%.
Compare Telstra’s performance with some of our cyclical stocks such as Rio and BHP (down 32.3% and 27.1% respectively), David
Jones and Myer (down 43.4% and 37.7% respectively) and Fairfax and Seven West Media (down 39.8% and 55.9% respectively)
and the clear pattern in our market emerges – that of a flight to an assured earnings stream rather than capital growth opportunities.
While financial news headlines have been dominated by global events such as the European malaise, political turmoil in the Middle East, concerns over US growth and natural disasters such as the Japanese Tsunami, the reality is that our share market has
also had a number of domestic issues to absorb over the year. This has included the challenges of our changing ‘two speed’
economy, a Federal government that has lost the support of the Australian people and a slowing and a more uncertain Chinese
economy impacting on our export sector. This unattractive investment picture has corresponded with equally unattractive investment returns.
Whilst many of these issues remain unresolved and are prominent in determining investor sentiment, the reality is that the share
market appears to have already priced in a situation far worse than the various economic realities suggest could occur. It would
seem that we are presently in a period where the share market has overshot on the downside, much as it overshoots on the upside when it gets overly bullish and assumes that the good times will never end.
Despite the current negative sentiment towards the market, many Australian companies are actually well cashed up and performing as well as could be expected in difficult economic conditions. Broadly speaking, corporate profits have been maintained over
the year and the S&P ASX 200 is now yielding 5.4%, following an 8% rise in dividends.
In these kinds of markets any predictions on the market direction are fraught with peril as fundamentals rarely dominate over sentiment. This is probably best illustrated by the number of market analysts sitting on their hands in many of the recent newspaper
articles summarising the year just gone and outlook for the year ahead. While tempting to do the same, we see a range of factors
in play that are actually supportive of our market and could provide the catalyst for a potential rally over the coming 6-12 months.
The most obvious is the attractiveness of share market valuations. The following table shows institutional broker estimates for the
price earnings (PE) ratio, average earnings per share (EPS) growth and average dividend yield for each of the major market sectors
over the coming two years.
It is also worth noting that the historical average PE across the S&P/ASX 200 is around 14 times. With the market’s current PE 12.6
times and forecast in 12 months time to be 11.1 times, this implies that the market is currently 10% undervalued but rising to being
27% undervalued one year out.
It is important to note that analysts’ projections can be notoriously inaccurate. However, for our market to reflect its historical
averages we need earnings to fall 10% from current levels and this is extremely unlikely.
Another equally compelling market value argument is that the dividend yield across the majority of sectors is now well above the
cash rate – even before taking into account franking credits.
Also cause for some cautious optimism is Westpac’s recent survey showing consumer sentiment in Australia is now rising. This has
been undoubtedly fuelled by the recent rate cuts and, while still in the fledgling stage, is nevertheless a step in the right direction. With the Reserve Bank in an easing mode, any additional rate cuts this year could see a further boost to improving consumer
sentiment. Any change in our Federal political landscape also provides scope to improve general confidence in the economy.
A key theme for investment choices and selections over the coming 12 months will be the structural change that will occur across
parts of corporate Australia. These structural changes can be as mundane as keeping costs in check and protecting margins to
wholesale changes to the way the business is conducted.
In terms of rising costs and reducing margins, every business in Australia faces those twin impositions with the high Australian dollar making Australian products relatively more expensive and the low unemployment rate placing pressure on employment
costs. One way this can be addressed is for businesses to move some of their cost bases through ‘off-shoring’ to lower cost countries such as India, China and the Philippines.
In terms of structural change, no sectors are under greater threat than retail and media. Traditionally both of these sectors have
lead historic rallies as they are the most cyclical to consumer sentiment. This time around they could still be expected to attract
investor interest but that interest will be tinged with caution as both sectors face considerable difficulties in their traditional business mix.
To date, a clear loser in our new internet age has been Fairfax which is currently undergoing its biggest transformation in its history
as it downsizes to try and survive. Conversely, entities such as Newscorp that own vast amounts of content that can be more readily accessed through the internet are prospering.
In the retail sector internet sales have operated in tandem with lower consumer confidence to reduce sales and keep margins under pressure for the past two years. Somewhat belatedly our major retailers are responding to these challenges but the continuing
high Australian dollar resulting in price deflation makes at least part of the challenge difficult to overcome in the short term. Nevertheless it remains a sector to watch over the coming months, especially the results from David Jones and Myer for the 2012/13
year.
The key challenge for retailers is to make the internet work to their advantage. Myer has invested heavily in this area and will
shortly have a fully-fledged and functioning E-commerce platform. Given 70% of Myer sales are derived from the Myer One loyalty
program, it already has a readymade market to access and stream specialised offers based on comprehensive client profiling. JB Hi
Fi is another retailer looking to develop an internet business and retails the products and has a target market well suited to internet sales.
Other sectors doing it tough include residential construction with shares in Boral and CSR in particular being sold down significantly
over the past year. The construction sector is a victim of the reduction in housing starts across Australia and with no change in sight
could languish for a while longer. However, with the sector trading at near basement levels and with Australia short of housing in
most states it could see a rebound fairly quickly as consumer sentiment improves.
While these are some of the factors weighing on the market into 2013, undoubtedly the most critical factor will be China.
As reported last month, the latest economic data suggests China now has its inflation under control and, with a tradition of surpassing official growth projections, could be ready for a renewal of economic growth. The recent move by the Central Bank to further reduce interest rates shows a desire to accelerate the economy and that can only be good for Australia and our beleaguered
resources sector.
In the short term, do not expect much for this month in terms of market activity. July is a notoriously slow month for market volumes and share price appreciation, the result of the northern hemisphere summer holidays, school holidays in Australia and the
reporting season commencing in early August.
With continuous disclosure we hope that most bad news is already in the market. Accordingly, even a benign reporting season through August and September provides scope for a recovery rally through those months and beyond.
If you have any queries with respect to any of the above or your investment portfolio in general, please do not hesitate to
contact this office. We would welcome the opportunity to be of assistance.
Sincerely
HORIZON INVESTMENT SOLUTIONS PTY LTD
DAVID OFFER
Authorised Representative 259188
Financial Planner & Investment Manager
ABN 79 668 035 212
Australian Financial Services Licensee (AFSL 405897)
HORIZON INVESTMENT SOLUTIONS PTY LTD
SUITE 1, POST OFFICE PLAZA, 153 VICTORIA STREET, BUNBURY WA 6230
T. 08 9791 9188 F. 08 9791 9187
[email protected] www.horizoninvestmentsolutions.com.au
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