Outlook for Australian equities positive as corporate earnings growth justifies solid returns

Global research a key component of forecasting Australian equities growth drivers

Johan Carlberg

It’s time for the Australian share market to stand on its own two feet as tapering by the US Federal Reserve creates a mixed outlook for US equities, according to boutique Australian equities fund manager Alphinity Investment Management. After a few lean years, Alphinity’s research shows corporate earnings in Australia are growing again, and should be supportive of positive returns from Australian equity markets.

Alphinity’s Australian equities outlook for the remainder of 2014 highlights growth opportunities in the housing, consumer and energy sectors. The banking sector is still expected to provide decent returns, however these returns are likely to stabilise, while the housing sector gathers momentum. Conditions in retail and consumer goods are set to gradually improve while resources remain soft.

Alphinity Principal and Lead Portfolio Manager Johan Carlberg said: “Markets have had a good run, but we remain positive on Australian equities and see earnings growth spread out across sectors and stocks. The US economy is still improving with the soft patch earlier this year largely caused by a severe winter. This should be supportive of earnings for companies with international operations there and also in Europe. However, our largest export market China is winding back growth forecasts, with obvious implications for Australian resources and other export sectors.”

Alphinity regularly conducts international research trips to gather insights on local markets, providing it with deep insights which contribute to its fundamental investment approach. Using both quantitative and fundamental research, Alphinity aims to identify ‘earnings surprise’, investing in undervalued companies entering an earnings upgrade cycle.

“You can’t just rely on official data if you want to get the full story. For example, we monitor GDP forecasts for growth in China, but find that we learn more by speaking with Chinese businesses to gain insights into their forward orders.” Carlberg noted.

Alphinity 2014 Outlook

Housing and Property

Companies exposed to Australia’s housing market will continue to gather momentum, as effects of low interest rates, the pick-up in building approvals and net immigration are felt across the industry. Investors can expect activity in housing markets to continue to strengthen.

Principal and Lead Portfolio Manager Mr Carlberg said: “We are seeing strong signals of activity picking up in the housing sector, and we should see two to three years of strong construction activity. Getting pure exposure to housing construction activity in equity markets can be a challenge, so we find that a “basket approach” works best. We see further potential in companies like building materials supplier CSR, and property developer Lend Lease which holds a number of key redevelopment projects in its order book, including Barangaroo and the Sydney Entertainment Centre.”

Banking and Financial Services

Banks have been outstanding performers, returning approximately 20 per cent per annum since June 2009. The superior returns have not only been driven by attractive dividend yields but many other factors have come together to deliver attractive earnings growth. Some of those tailwinds are now easing.

Alphinity Principal and Portfolio Manager Andrew Martin said: “As the only sector to outperform the market in every financial year since the global financial crisis, it’s clear that banks no longer stand out as cheap. While a particular catalyst for a sell off is not immediately obvious, you no longer have the valuation safety net, and even dividend yields are back to relative normality. The real risk to bank stocks usually coincides with a strong downturn in the economy, which is something we are not currently predicting, however competition is increasing and banks’ future profitability will also be somewhat capped by the increased capital requirements being put in place by the regulator. At the same time, the relative earnings growth appeal of other sectors is growing.”

Resources and Energy

Alphinity Principal and Portfolio Manager Stephane Andre’s recent visit to China provided a consistent message of slower growth as new leadership focuses on its five-year plan to become less reliant on property and other infrastructure investments to drive growth.

Mr Andre said: “It’s becoming increasingly clear that we are in a transition period in China. Its government is rightly focused on shifting growth to become more consumer-led. China wants to clean up its environment and business practices in the process, and also address unsustainable losses in industries such as steel which faces significant over-capacity, by restricting lending and encouraging consolidation. All this will result in slower and less commodities-driven growth, unfortunately at the same time resource companies in Australia and elsewhere around the world are poised to deliver increased supply of raw materials. We therefore remain cautious on the resources sector. “

Consumer

The sourcing of goods from Asia has been an important theme for most retailers in recent years, particularly in apparel. While some companies do it better than others, all have experienced significant cost improvements by shifting production, first to China but more recently to other countries in the Asia-Pacific region. However the safety and conditions for workers in emerging economies is increasingly being scrutinised by investors. Alphinity Principal and Portfolio Manager Bruce Smith recently visited Asia to investigate the quality and sustainability of retailer supply chains and concluded that companies themselves are still on a steep learning curve.

Mr Smith said: “Vetting of supply chains will become increasingly important for both company management and investors. It’s a complex process, and some companies still deal with middle men rather than the actual manufacturer who itself will often be using multiple factories. Getting the sourcing process right is an important social issue as well as a critical business success factor.”