Paul Taylor, Head of Australian Equities and Portfolio Manager of the Fidelity Australian Equities Fund

“Markets are nervous, sceptical, cautious and scared and for very good reasons. We have a European sovereign debt crisis, a huge US debt issue, worrying US economic growth, slowing global growth and concerns that China may reign in growth too hard and go straight past the soft landing scenario and head directly into a hard landing. Further depressing the market is the thought that the sovereign debt issues in Europe and the US are likely to be with us for a prolonged period of time – major readjustments like these take a long time to play out.

“Having made all those depressing comments any potential bright spots or glimmers of hope tend to get drowned in the over riding gloom of the current market sentiment. There is some good news in the US reporting season which is generally better than expected on both revenues and costs and I believe that China is much better positioned than market fears would suggest. The simple fact that Chinese policy is trying to lower growth to a more sustainable level and control inflation already means that they are in a stronger position than the rest of the world which is struggling to achieve any growth. The worse the rest of the world gets the higher the likelihood that China will at least halt its monetary tightening policy. China demonstrated through the global financial crisis (GFC) that it will act very counter cyclically and step up and invest when the rest of the world is struggling and they may well take the same approach again as global growth slows.

“What does all this mean for Australia? It means that with the sovereign debt issues in Europe and the US we are in a lower growth world. As the world undertakes de-leveraging this will have a negative impact on global growth and Australia as a small open economy will be negatively impacted by lower world growth.

“However while we are in a lower growth world this does not mean everything is low growth, it means on average we are low growth but within this average we will see some real pockets of growth. These pockets of growth will include China and a range of emerging economies. Australia will continue to be a beneficiary of its complementary economy with other emerging economies like China.

“With investors so cautious and sceptical they are implying that not only are we in a low growth world but that every market and every company is low growth – and that is the real opportunity in the market at the moment.

“We have seen very significant compression of valuations between markets as well as stocks within markets as investors become very sceptical about growth for all markets and companies. The Australian market is currently very attractively valued at about 10-11x price to earnings ratio and a 5% dividend yield. This sort of valuation is very attractive from an absolute perspective as well as relative to Australia’s own history. The Australian market has historically traded at between 14-15x price to earnings ratio. It is hard to see the Australian market re-rating from 10-11x back to 14x-15x over the next 12 months while these macro black clouds remain, so the market’s performance will likely come from the market’s earnings growth and dividend yield. It is very realistic to expect Australian market returns of 10%-15% over the next 12 months from dividends and earnings growth even without a valuation uplift.

“I think the really interesting point over the next 12 months will be the differentiation at the individual stock level. The pockets of growth in the market will provide a real opportunity to differentiate those stocks with significant growth opportunities. In a low growth world those stocks with growth opportunities will likely be bid up by the market as they become rare assets.

“As valuations are compressed the market is not differentiating between those companies with growth and those without growth. When we look back through history these sort of periods prove to be great long-term investment opportunities into great quality companies, with strong balance sheets and management teams, excellent growth opportunities and attractive valuations.”

Martha Wang – Portfolio Manager of the Fidelity China Fund

“Although China is not insular from recent world events, the sustainable domestic demand fundamentals driving the long-term growth and given the current attractive valuations against regional peers and versus long-term historical averages should provide ample grounds for fund flows back into China. “Given the domestic focus of my portfolio the impact from this incident would be less than other export oriented portfolios.”

Trevor Greetham, Director of Asset Allocation at Fidelity

“I see the US credit rating downgrade as bad news, but not for the obvious reasons. To me the ratings agencies are inadvertently playing a pernicious role in worsening the global policy response to the private sector debt crisis.

“They, along with the IMF, are encouraging governments to tighten fiscal policy when it is very hard to ease monetary policy effectively as an offset due to the zero lower bound for interest rates in the case of the US and UK or the one-size-fits-all ECB rate in the case of peripheral Eurozone countries. In addition, with almost all developed economies now tightening, export growth cannot offer the cushion it might to a country embarking on cut backs in isolation.

“Fighting the current crisis with additional austerity measures could be self-defeating. If growth weakens there will be negative consequences for tax revenues, private sector debt dynamics and financial stability.

“The credit agencies might argue they are not responsible for the broader implications of their actions. It is widely accepted that they were instrumental in creating the financial crisis in the first place due to the AAA ratings they placed on flawed structured products. As much as they are able, governments should probably ignore them. US regulators have already issued guidance saying US banks should continue to treat Treasuries as AAA. Taking things a step further, governments should not abandon the option of short term fiscal stimulus. Cut backs that create recession serve no purpose – not even to reduce government debt.”

Nick Price, Portfolio Manager Emerging Markets

“Given the political and currency frictions, it is highly likely that governments may have to resort to inflating away their debt problems.

“This bodes well for resource stocks, and especially those with assets less exposed to the economic cycle. We are already seeing this, with a number of the gold stocks recently reporting significant improvements in cash-flow generation on the back of recent rises in the prices of precious metals. If there is further monetary stimulus, this effect may well become more pronounced.

“In stark contrast to the cash constrained economies of the West where state funding is under pressure, we are also seeing opportunities present themselves in the developing markets where money is actually flowing into public sector systems, such as healthcare and infrastructure.

“This is exhibiting itself in the form of superior earnings growth rates in these segments, where the recent market falls are presenting stocks with superior fundamentals at increasingly attractive valuations.

“Against the backdrop of the recent declines in equity markets over the last few days, we have been using the opportunity to increase our holdings in those high quality stocks that can continue to generate free cashflow and pay an increasingly attractive dividend yield. Even the stocks with the best fundamentals are being impacted on an intraday basis, despite the fact that many of their fundamentals are proving stronger than ever.

“We regard the current environment as a real opportunity to buy some really good businesses at some great prices. This is exactly what we have been doing over the last few days.”

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