While people are concerned about Australia being a two speed economy that actually part of its strength.
So when eventually the strong contribution of growth coming from the mining sector starts to fade there are other sectors of the market that will start to do better. That’s a key positive for our market; a lot of flexibility and ammunition should we need a bit of policy response.
Valuations are also very reasonable right now. The market rarely gets to levels this cheap and almost always when you’re buying at levels like this you get a positive return, certainly on a multi-year view.
Will the Australian dollar remain strong and how will this affect our economy?
We’ve got a real tug of war going on right now with the Australian dollar. On purchasing power parity models, fair value for the dollar is around 70 cents, so it is trading far above its fundamental value. But on the other hand, one of the reasons that the Aussie dollar is strong is because the major central banks around the world are injecting huge sums of liquidity and debasing their own currencies and that’s keeping ours strong, because people want to be able to invest into a stronger fiscal situation. This is a real tension, which of those is going to prevail and over what timeframe.
Supporting the Australian dollar is also the mining boom. The Reserve Bank doesn’t want inflation so it wants to keep a lid on the household and the domestic side of the economy. It does that by higher interest rates, higher interest rates support the dollar and this is really putting a dampener on manufacturing, retail and tourism related sectors.
This becomes a problem if it lasts for long enough that you get structural changes and you start to lose that side of business, because then if you do get weakness on the mining side, the other sectors can no longer rebound to offset that slowing.
If China’s growth slows, will our economy still be able to grow?
It’s really natural for us to spend a lot of time thinking about China’s economy and the growth rate because of the very direct linkage we can see. We sell an extraordinary volume of iron ore and coal to our northern neighbour. But it’s important to realise that what’s more important for our economy is a stronger for longer scenario. China needs a sustainable growth rate and a mid-teens growth rate is not sustainable for any economy, for any sustained length of time. China’s growth slowing to a 7.5% and 8% rate, it probably means that that growth trajectory for China is sustainable for longer, which should allow our exports to China to continue unimpeded. Personally, I welcome a bit of a moderation in China’s growth. I think that puts our export business on a more sustainable footing.
Will it just be dividends and little capital growth for investors?
Over the last couple of years investors have received almost all of their return from the equity market in the form of dividends. Of course that means that the actual share prices have gone nowhere and in some years gone backwards. What does that mean looking forward? Well, the great thing about buying into cheap markets is you can buy in to stocks with high dividend yields. So in a lower growth world, all asset classes are struggling to deliver strong returns and actually equities look pretty good now.
The dividends that you can get in Australia in the market overall are about 6% and there are some quality companies that will yield 7% or more, sustainably. This is great because it means you can buy into those stocks, you can get that return year in year out and then actually you’ve got an upside option that markets do rerate upside at some point in the future.
What do you like at the moment and why?
This is a challenging environment for investing as the market seems to be lurching between risk-on and risk-off phases. So there’s always a temptation to chase each of those and that kind of trading mentality is not good for long-term investment returns.
We have a preference for companies that are running their own race and that can do well regardless of what the macro environment is doing. In the resources space we have a preference for Oil Search and for Iluka. These are companies that have the returns coming out of their current businesses to be able to self-fund their growth into the future. They have secure supply demand fundamentals that will support them.
In retailing, there is a lot of concerns about consumer discretionary retailing and the headwinds they’re facing. We like Wesfarmers because it can run its own race by reducing its costs and increasing sales per square metre and closing the gap with Woolworths a bit.
In terms of stocks offering a high yield we’re very comfortable with Commonwealth Bank and ANZ Bank. Yes, credit growth rates are slowing but these businesses still generate high levels of cash that can be returned as dividends, and we also like Sydney Airport, a great business that’s gone through a simplification process and now offering a terrific yield and access to a really great asset.
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