Feature: Australian equities in 2016

11-Jan-2016

By Sarah Kendell

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There are bright spots on the local market for 2016, although spectacular falls in commodity prices in 2015 combined with the market’s gloomy start to this year have significantly dampened the 12-month outlook for Australian equities.

Despite significant falls in mining stocks in the past few months, these have not necessarily bottomed out, IOOF chief investment officer Steve Merlicek says.

“Further drops cannot be ruled out if commodity prices fall further, though on a number of metrics they are starting to look cheap,” Merlicek says.

China’s economic troubles may not be quite as severe as some predict, but its economy is still expected to transition away from commodities, which will affect the long-term outlook for Australian blue-chip miners.

“Even though our outlook for [China] is less pessimistic than consensus, our expectations of a cyclical recovery in the country’s demand for commodities are modest at best,” AllianceBernstein Australian equities chief investment officer Roy Maslen says.

“This is because China’s economic rebalancing could lead to a structural decline in such demand in future.”

With China’s commodity demand stabilising at a lower long-term level, local mining companies still have some serious work to do when it comes to trimming back capital expenditure and staff headcount,  Australian Unity Investments chief investment officer David Bryant says.

“Even though commodity prices are at the bottom, the full pain is not yet priced in,” Bryant explains.

“One of the world’s largest mining companies, Anglo American, recently announced it was cutting major assets and reducing employee numbers from 135,000 to 50,000 over the next few years.

“It begs the question – how much will Rio and BHP need to do?”

Merlicek adds that the outlook for financial stocks is rosier than some analysts have implied, with issues like increased capital requirements and tighter regulation unlikely to have a huge effect on earnings.

“On all these fronts there are headwinds, but no significant collapses are expected and the current dividend yield is expected to be maintained,” he says.

T Rowe Price head of Australian equities Randal Jenneke says that over the longer term, in contrast to many other industries, the banks’ oligopoly status is unlikely to be under serious threat.

“If you look at the other oligopolies in Australia – supermarkets, general insurance, telecoms – they are all breaking down,” Jenneke says.

“Banks remain the last strong oligopoly, which is a main reason why we have been allocating capital to the sector recently.

“With the capital requirement issue largely completed, and given the reasonable-looking credit cycle, we think this is the most attractive the banks have looked in years.”

He points out yields are less sustainable in property and infrastructure stocks, which have taken advantage of credit conditions following the financial crisis to increase their debt levels.

“We have seen 20 to 30 per cent returns from infrastructure and property in recent years, but how long can that continue?” he says.

“Infrastructure companies, for example, are doing exactly what we saw in the lead-up to the financial crisis – gearing up significantly in a very low-rate environment.”

Vanguard Australia economist Alexis Gray notes that while commodities and the banks are continuing to be a drag on growth, there are signs other sectors are picking up.

“The most positive indicators are those associated with international trade, the labour market and sentiment,” Gray says.

“This suggests that the lower Australian dollar is indeed boosting exports, and that business and consumer sentiment has improved, perhaps due to a mix of factors including the strong housing market, stable unemployment rate, lower currency, which improves business competitiveness, and the change of prime minister.”

Colonial First State Global Asset Management head of economics Stephen Halmarick agrees that despite market pessimism, the Australian economy is shaping up better than expected for the coming year.

“The economy proved itself to be more resilient and more flexible than most people imagined through 2015,” Halmarick says.

“This should further help the economy through 2016.”

 Jenneke predicts that services sectors in particular will deliver valuable earnings growth heading into 2016.

“The best growth is expected to come from more traditional long-term growth areas like healthcare, which our analysis forecasts earnings to grow by around 15 to 20 per cent,” he says.

Despite these encouraging signs, investor and planner sentiment for the year ahead is lacklustre for domestic equity returns, according to Investment Trends data.

The firm’s "2015 Adviser Product Needs Report", which surveyed 676 financial planners and investors, revealed the average investor predicted a return of between 2 per cent and 3 per cent for the market this year, while financial planners predicted around 6 per cent.

“This is down from 8 per cent last year and very bearish by historic standards,” Investment Trends head of wealth management research Recep Peker says.

While Merlicek is slightly more optimistic and predicts annual returns could reach as high as the low double digits, Gray thinks the full recovery of the market is still a way off.

“A cyclical economic recovery is likely to emerge over the coming years as the drag from mining investment fades,” she says.

“However, in our view this is unlikely until late 2016 at the earliest.”

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