Paul Taylor, Head of Australian Equities at Fidelity and Portfolio Manager of the Fidelity Australian Equities Fund, provides his outlook for the Australian stock market and why the market is presenting so many opportunities for stock pickers.
It could be a good time to buy Australian equities, according to one of the country’s best performing fund managers.
x
Where do you see the Australian market heading for the rest of 2011?
x
“While we are positive on the outlook for the Australian market in 2011, there are some black macro clouds hanging about. One is the European sovereign debt crisis, which began as concerns around Greece, spread to Ireland and could engulf Portugal and Spain. Another is the instability or geopolitical risk in the Middle East and north Africa that is boosting oil prices. A third is that the Chinese government is trying to slow the country’s economic growth to control inflation. Then there are the repercussions from Japan’s earthquake. Lastly, there is still a question mark over the US economy even though many economic indicators, from retail sales to production, are improving.
x
“But when we look through these clouds we see a lot of positive signs within the Australia stock market. The market is trading cheaply on a 12-times price-to-earnings ratio, which is below the historical average of over 16-times. It is offering a dividend yield of about 4% to 5%, which is historically attractive. Australian companies are in good shape. They have repaired their balance sheets; in fact, some have built up such large cash reserves you could say they have lazy balance sheets. The Australian economy is in relatively good shape.
x
“At a stock level, we are seeing some exciting opportunities – some great companies are trading at cheap prices.”
x
What do you see as the main themes that will surface in the market in the next 12 months?
x
“Over the next 12 months we are likely to see the continuing theme of a two-speed economy; a strong resources sector but also a strong Australian dollar and higher interest rates with their negative consequences for other segments of the economy. We could also see further merger and acquisition activity as companies with strong cash flows and balance sheets identify value in the market and potentially look for more growth opportunities. This could be both onshore and offshore activity.
x
“The significant growth in smart phones, tablets, mobile telecommunications, online retailing and online media distribution is also likely to be a growing theme in the market over the next year and beyond with implications across multiple sectors.”
x
What are your top overweight holdings and why?
x
“Key sector overweights for the portfolio are the industrials, healthcare, materials and energy sector but these outcomes are built from the bottom up. So what we’re seeing in those different sectors are good companies at bargain prices. We think in this environment you want to be focused on pricing power; you want to be focused on the growth of the company.
x
“What we’ve seen generally is that the valuation of the whole market has gone down based on these big macro fears, but the market is not discriminating between companies. That’s why we are seeing great stock-selection opportunities. When the whole market is priced at a lower level, there’s a great opportunity to pick up high-quality, high-growth companies on cheap valuations. And that’s what we have been doing across sectors.
x
“In terms of sectors, mining services and engineering firms should benefit from the significant investment planned in major resource and infrastructure projects. This strong demand should lead to an improvement in contract terms like a move to a cost-plus basis and higher charge-out rates. Healthcare should see strong structural growth and should be relatively unaffected by the rising interest-rate environment. Within healthcare, I like the industry leaders and those stocks benefiting from structural growth themes.
x
“If I look at some of the key overweight stocks positions in the Fund – Rio Tinto, Wesfarmers, MAp, Commonwealth Bank, ANZ and Oil Search – they are there because we think they are good companies with solid balance sheets and strong growth opportunities that are attractively valued.”
x
What are your views on material stocks?
x
“Within the mining sector, we prefer the big-cap miners over the smaller miners. We see the big miners as great investment opportunities at the moment.
x
“Right now all the miners – big and small – are trading on similar multiples, which is unusual. History tells us that the big miners such as Rio Tinto and BHP Billiton should trade at significant premiums to the small-cap miners because they have diversified earnings streams and quality management, are proven operators and own the tier-one assets – the low-cost, long-life mines.
x
They should trade at a premium to the small-cap miners. But when commodity prices are rising, the market generally gets excited about small-cap miners.
x
“The fact that all miners are trading on similar valuations opens up a fantastic opportunity to invest in the big miners because that’s where the value is. To us, the great opportunity is Rio Tinto. On top of having the low-cost, long-life mines, Rio Tinto is trading at a valuation discount to BHP Billiton. So within the mining sector, Rio Tinto to us is the standout investment.”
x
What are your views on the banks?
x
“Australian banks are reasonably valued at the moment. They are offering a good dividend yield. While their lending growth is slowing, their margins are improving. So from a sector point of view, I think banks are reasonable investments at the moment.
x
“Within the banking sector, our preferences are for Commonwealth Bank and ANZ. We think these two banks are the best positioned because they have the best growth opportunities and have the lowest-cost funding.”
x
What do you think are the key risks for the next 12 months?
x
“There are probably a few key risks for the Australian market over the next 12 months, the first of which is interest rates. The market still expects the Reserve Bank to boost interest rates in the second half of 2011. A cash rate at 5.25% from 4.75% now could add to pressure in the consumer-discretionary, in the household-spending, sector.
x
“The second key risk is China. Chinese authorities are trying to slow economic growth to about 7% to 8% a year, which is still high by world standards. The question if they succeed is: are the Chinese still going to buy commodities at the same rate?
x
“Another risk is whether a destabilising macro issue eventuates. In Europe, people are nervous about Portugal and they’re saying if there’s an issue with Portugal it could spread to Spain. These risks are likely to hang over the market at least for 2011.”