The Australian market retreated 15% in mid-2010 and 20% in mid-2011, predominantly on European issues. So far the Australian market is down 9% in May. Is this a case of here we go again?
Lonsec’s Head of Equity Research, Bill Keenan, commented, “While Australia has low direct exposure to Europe, it will still be indirectly impacted by financial markets in terms of the cost of wholesale bank funding (still about 40% of the banks’ funding), currency fluctuations and global investor sentiment.”
“In addition, a European recession could indirectly affect Australia via its impact on China.”
“While the European situation remains very uncertain and hard to predict, there are a number of reasons to expect the downside to be limited this time around.”
Lonsec believes there are a number of reasons for this, including:
- Market lower – the Australian sharemarket has retreated from the 4,500 level rather than the 5,000 level as in April 2010 and 2011, and accordingly, dividend yields are higher and PE ratios considerably lower.
- Yield curve lower – the RBA has cut the cash rate by 100bp since late 2011 and another 100bp in cuts is expected in the short term. The yield curve from cash to 10 year bonds is falling quite rapidly, which is supportive of economic growth and equity valuations.
- AUD lower – the AUD has weakened 8% this year, which is taking some of the pressure off Australian exporters and manufacturers.
- China easing policy – China is progressively easing monetary and fiscal policy to support growth, which is still expected to be around 8%. Back in 2011, it was tightening monetary policy to combat inflation.
- US economy robust – US retail sales and manufacturing have been solid, while the housing market is showing signs of bottoming out. The US also has a new-found supply of cheap energy in shale gas, which will prove to be important over the medium term. On the negative side, new payrolls have been weakening again in recent months and the US budget deficit is due to be reigned in after the US election in November 2012.
“European issues are complicated and will take time to resolve,” said Keenan.
“However, we remain positive on the medium to long term outlook for the US, Asia and Australia.”
“Given the local market is already low and company balance sheets are strong, we don’t see any reason to be overly negative towards Australian equities.”
Lonsec expects the market to rebound, but it is likely that the rate easing cycle will need to play out fully before the market starts to recover in the second half of the year.
“Stocks with good dividend yield and fairly secure earnings are likely to outperform in the short term,” said Keenan.
“Investors should also target high beta resource and cyclical stocks on market weakness, taking a long term view that global growth will recover, led by Asia.”
Lonsec believes the next positive catalysts for the sharemarket will be:
- RBA rate cuts
- Lower AUD
- China stimulus
- EU progress
- Change in Federal Government.