It seems fitting to end the year with an outlook and some investment ideas for 2011. One of the major themes for 2011 will be the sustainability of the US recovery. Recent data suggests the US economy is improving although it is yet to show up significantly in the employment data. The good news for equity markets is that despite the recovery, US monetary policy will remain on hold for a prolonged period as inflation is low and the Federal Reserve openly wants US growth to accelerate above trend in order to lower the unemployment rate. This should provide a favourable environment for earnings growth. In terms of US investment themes, don’t underestimate how much higher US bond yields can rise as investors become more confident and re-allocate funds back into the equity market.
Against this backdrop, the Australian equity market remains attractively valued. The overall market is trading on a price earnings ratio of around 12.7 times. This compares to an historical average ratio of closer to 14 times. As the chart below illustrates, the performance of the Australian equity market is highly correlated with earnings growth. In 2010 this relationship diverged, with the market lagging the improvement in earnings. This suggests some catch up is due in 2011, particularly given our expectation of continued solid earnings growth in Australia.
In terms of stocks, we continue to see value in cyclical sectors given the potential for an improvement in global growth next year, particularly if the US economy improves. Many cyclical companies are trading on modest multiples and earnings levels are lower than they should be on a long term view. Examples of the cyclical stocks that we favour include BlueScope Steel, Brambles, Billabong and News Corporation. These companies are particularly leveraged to an improvement in the US economy.
Whilst we have taken profit on some resource positions, selected stocks in this sector remain attractive given their leverage to stronger commodity prices and Chinese industrialisation. We particularly like BHP as it has significantly lagged its peers in the recent rally. BHP is trading around nine times next year’s earnings whilst many of the smaller, one commodity stocks are trading on 12 to 15 times.
The other sector of the market that could do well in 2011 is the banks. Much of the negative news that plagued this sector in 2010 is fully price in to current share prices and recent developments suggest regulatory risks may be abating.
The above information is of a general nature and has been prepared without taking account of your individual investment objectives, financial situation or particular investment needs. It is not intended as financial advice to retail clients. Before making an investment decision, you should consider the appropriateness of the information, having regard to your objectives, financial situation and needs. We recommend you consult with your financial adviser, who can help you determine how best to achieve your financial goals and whether investing in a fund is appropriate for you.
Global markets
Equities advanced for a second consecutive week as Barack Obama agreed to extend Bush-era tax cuts, which are widely expected to boost US growth, and the S&P 500 closed up 1.2% at 1,240 – a level last seen in September 2008. However, the cost of this fiscal stimulus, which is likely to run to trillions of dollars in years to come, caused a sustained sell off of US and other ‘core’ government bonds: with the yield on US ten-year bonds, or treasuries, spiking as high as 3.33% midweek.
Macroeconomic data also supported equities. UK industrial output rose 5.8% in the year to October, Japanese growth statistics were revised upwards, and the Nikkei 225 surged to a seven-month high. China’s November exports increased 35% over a year ago – but this and stubbornly rising prices are stocking expectations that the government will tighten the money supply by raising interest rates before the end of the year.
Higher US bond yields generally support the greenback, and the US dollar rose 1.5% against the yen and the euro. Silver, increasingly seen as an inflation-hedge by investors, hit an all time high of over $30 an ounce – while gold, copper and oil also remained in demand, before falling back slightly from cyclical peaks seen midweek.
Global equities
The FTSE 100 rose 1.2%, driven in part by the prospect of acquisition activity. Smith & Nephew spiked over nine per cent on conjecture that private equity outfits are eyeing the artificial-joint maker. Anglo-Danish security firm G4S rose on similar speculation, while shares in Cobham – which have fallen 20% this year – rebounded on rumours that US defence conglomerate Northrop Grumman is considering a bid. Burberry rose 6.5% on talk of a Far Eastern bid for the luxury goods retailer. Meanwhile, FTSE 250 stalwart De La Rue surged 25% as it emerged French rival Oberthur Technologies had twice
offered to buy the 200-year old bank-note printer in the last two months.
The US Treasury, which has spent $45bn shoring up Citibank, sold its remaining shares in the country’s third largest lender at an estimated $12bn profit – it is now looking to accelerate the disposal of its holding in insurance giant AIG. Diageo, formerly known as Guinness, emerged as a possible bidder for US consumer products specialist Fortune Brands’ drinks portfolio, including Jim Beam and Courvoisier brandy.
European carmakers BMW and Volkswagen rose strongly on the back of well-received Chinese economic data – both are major exporters to the country – while privately held Swiss-based commodity trading giant Glencore is apparently mulling a $31bn London listing.
Global bonds
US government bonds prices plummeted midweek on concern that renewing the previous Administration’s tax breaks will result in higher levels of borrowing. Although prices rebounded on a well-received auction of 30-year securities, the closing yield of 3.30% on ten-year debt was 30 basis points up on the week, and nearly one per cent higher than mid-October. Despite positively interpreted economic data, UK ten-year government bonds yields were higher at 3.52 as against 3.40% a week ago – nonetheless, the differential between UK and US borrowing costs has narrowed to a low of around 20 basis points – a spread
of 50 basis points has been typical of recent months. German government bond yields rose by 12 basis points to 2.97%, having at one stage breached three per cent. Less in the news, Japanese ten-year yields are also sharply up – and at 1.20% are around 25% higher than a month ago.
It was a mixed week for peripherals. A meeting of EU finance ministers could not agree measures – such as a European-wide sovereign bond, or ‘E-bond’ – to contain the crisis in weaker members’ finances – a failure widely blamed on German government intransigence – and Spanish and Portuguese yields moved up around 20 basis points in thin trading. The Irish parliament narrowly approved the government’s austerity budget – and Irish bond yields dipped slightly on Friday, shrugging off a two-notch downgrade from ratings agency Fitch.
