• The past financial year saw solid to strong returns from most asset classes drive good returns from balanced and growth oriented investment strategies, including from super funds.
• Investors should expect returns to slow over the year ahead, but they are likely to remain solid as share valuations are still reasonable, the global economy continues to grow, the Australian growth outlook improves and monetary conditions remain easy.

Introduction

The past financial year saw another 12 months of strong returns. Returns of around 20% from shares, solid returns from property assets and good returns from bonds saw balanced growth superannuation funds return around 13% on average. This was the second year in a row of double digit gains. By contrast the return from cash was poor and average 12 month bank term deposits returned less than 4%.

As always there has been plenty to fret about, including:

• The mid 2013 “taper tantrum” in the US, with investors fearing the Fed’s decision to start winding down its quantitative easing program would threaten the US economy and shares;
• The US Government shutdown and debt default worries in October and the March quarter economic contraction;
• The slow recovery and deflation worries in Europe;
• Fears of a sales tax hike driven recession in Japan;
• Another bout of hard landing worries regarding China centred on the property and shadow banking sectors;
• Worries about the impact on emerging countries of Fed tapering;
• Geopolitical worries regarding Syria, Ukraine and Iraq;
• Ongoing worries as to how Australia will fare as the mining boom fades and whether the May Budget will worsen the economic outlook; and
• The last six months has seen intensifying concerns that share markets are set for a fall.

But these concerns were offset by a range of factors:

• A continuing improvement in the global economy;
• The Fed’s tapering has clearly been contingent on improving growth with a rate hike still a fair way off;
• Further easing measures by the European Central Bank;
• Little global economic damage from geopolitical risks;
• Continuing record monetary stimulus in Japan;
• A stabilisation in Chinese economic growth helped by various mini-stimulus measures;
• No sign of capital flight from emerging countries and election optimism regarding India and Indonesia; and
• Okay growth in Australia helped by low interest rates.

This has all seen growth assets boosted by a reasonable growth and profit outlook and bonds helped by continued easy monetary conditions. The latter has also seen an ongoing search for yield by investors. With shares no longer dirt cheap its likely returns will slow – indeed they have over the last six months. However, the cyclical bull market in shares likely has further to go. This along with reasonable returns from property assets should underpin further gains in diversified investment portfolios over the year ahead.

Equity valuations – ok

After strong gains through 2012 and 2013 shares are no longer dirt cheap. However, as can be seen in the next chart valuation measures (which are based on a range of measures including a comparison of the yield on shares with that on bonds) show shares are not expensive.

Cyclical bull markets in shares invariably see three phases. First an unwinding of cheap valuations helped by low interest rates. The second is driven by stronger profits. And the third phase is a blow off as investor confidence becomes excessive pushing shares into expensive territory. Our assessment is that we are still in the second phase and as such the cyclical/profit backdrop remains critically important.

The economic cycle – slow improvement

We are still in the sweet spot of the global economic cycle. Growth is on the mend but only gradually such that spare capacity and excess savings remains immense so inflation remains tame, monetary conditions easy and bond yields low. In fact the March quarter growth soft patch seen in the US, Europe and China was more positive than negative because it wasn’t threatening but further pushed out the timing of any monetary tightening. By region:

• After a contraction in the March quarter driven by mostly temporary factors, the US economy is continuing to improve and looks on track for circa 3% growth. The jobs market and business investment are improving and shale oil boom is providing a long term boost both directly and indirectly via cheap electricity costs for business.
• Growth has returned to Europe. Ireland and Portugal have emerged from their bailout programs and structural reform seems to be on track. But growth is far from robust, inflation too low and uncertainty around the banks is likely to linger till later this year after the completion of the ECB’s bank asset quality review. All of which means continuing recovery but ongoing need for ECB support.
• Japan appears to be weathering its sales tax hike well, with ultra easy money and economic reforms providing confidence growth will continue.
• Chinese growth looks to be on track for around 7.5% helped by various mini-stimulus measures.
• Emerging world growth generally isn’t as strong as it used to be but it looks to be stabilising around 5%.

Reflecting this, the global manufacturing conditions PMI is at levels consistent with good, but not booming global growth.

This suggests global growth is likely to pick up a notch which should underpin a modest improvement in profit growth.

In Australia, while the mining investment slowdown, the impact on confidence from the May Budget and the too high $A pose a short term threat, underlying growth is likely to have picked up to a 3% pace by year end and continue through next year helped by a housing construction boom, a Senate induced softening in some of the harsher aspects of the Budget and strength in resource export volumes.

Monetary conditions to remain easy

When the Fed will start to raise interest rates and reverse its QE program has been a constant source of speculation. While such speculation may intensify over the next six months – resulting in bouts of volatility for investment markets – global monetary conditions are set to remain easy:

• The tightening US jobs market indicates the first rate hike in the US is coming on to the horizon. But continuing high levels of excess capacity indicate it may still be 9-12 months away and will be a gradual process when it starts. In other words it will take a long time before US monetary policy is tight – with above “normal” interest rates and short term rates being above long term rates.
• The ECB has only just eased monetary policy and has signalled it stands ready to do more, including via a quantitative easing program, if deflation risks don’t recede. Rate hikes are well over the horizon.
• Unprecedented quantitative easing in Japan will continue until underlying inflation is firmly ensconced around 2% and there is still a way to go. Rate hikes are not in sight.
• In Australia, the RBA is not expected to start raising rates till sometime next year. And as the Fed is likely to go first, the Australian dollar is likely to resume its downtrend.

While there will be a few bumps regarding the Fed (just like last year’s taper tantrum) the monetary backdrop is set to remain supportive for investment markets.

Investor sentiment a long way from excessive

We remain a long way from the sort of investor exuberance seen at major share market tops. It seems everyone is talking about share market corrections and crashes and tail risk hedging seems all the rage. In the US the mountain of money built up in bond funds during the post GFC “irrational exuberance for safety” has yet to really reverse.

And in Australia, the amount of cash sitting in the superannuation system is still double average levels seen prior to the GFC and Australians continue to prefer bank deposits and paying down debt to shares and superannuation. There is still a lot of money that can come into equity markets as confidence improves.

Concluding comments

After a bout of relatively smooth sailing there will inevitably be a correction at some point. There are plenty of possible triggers: geopolitical risks, the risk of an inflation/Fed rate hike scare, deflation in Europe, the property slowdown in China and in Australia the transition to more broad based growth. However, while investment returns are likely to slow, still reasonable share valuations, gradually improving economic conditions, easy monetary conditions and a lack of excessive optimism suggest further decent investment returns ahead.

Dr Shane Oliver, Head of Investment Strategy and Chief Economist, AMP Capital

———–

Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

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The March 2013 Investor Intentions Index, released this week, is a monthly report that takes the pulse of Australian investors’ sentiment and investment intentions, and is based on the responses of over 800 investors per month.

“Investors are not back to panic stations yet by any means, but were feeling much more cautions in March than in February,” said Investment Trends Analyst Kristin Bjerregaard. “Investors expressed increased concern over last month’s volatility, Cyprus/Europe contagion and safety of their superannuation.”

Return expectations decreased
In March, the average investor expected the market to be 6% higher in next twelve months (excluding dividends), which is 2 percentage points lower than their expectations in February, but still 2 percentage points higher than the average for the last 12-months.

62% of investors expected the market to increase in the next month, which is 29% more than in December 2011, but down from 74% in February.

“We found more people intending to increase cash holdings in the short term in March,” said Bjerregaard. “However, there is still some willingness to move long term cash off the sidelines.”

“For the second time in the last 3 months, more people plan to sell down term deposits than increase their exposure. This did not happen at all last year.”

“Despite the increased fear level, views on the Australian economy are actually quite positive,” said Bjerregaard. “61% think the Australian economy will show healthy growth over the next 12 months, a 19 month high, and only 30% of investors think we are in a second wave of the GFC, a 19 month low.”

Low interest rates are prompting increased interest in property investment
“Two thirds (65%) of investors still expect the next interest rate movement to be downwards, though this is notably lower than last month’s four-in-five (79%) expecting a cut,” said Bjerregaard.

“Low interest rates and market uncertainty are also prompting a large rebound in interest in investment property with more planning to buy than sell, and by an increased ration versus February.”

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The January 2013 Investor Intentions Index, released last week, is a monthly report that takes the pulse of Australian investors’ sentiment and investment intentions, and is based on the responses of over 800 investors per month.

Australian investors’ concern level (with the situation in the financial markets) has fallen to a 40 month low. Investors’ fear levels have been dropping steadily since late 2011, when they at levels last seen during the depths of the financial crisis.

“Up until the end of 2012, this decline in fear levels had not translated to an increase in investors’ 12 month market return expectations, which have been hovering around the 3% to 4% mark (excluding dividends) since the beginning of 2012,” said Investment Trends Senior Analyst Recep Peker. “Now, for the first time, we have seen a big spike in investors’ market return expectations.”

In January, the average investor was expecting the Australian stock market to rise by 7% (excluding dividends), jumping up from 5% in December. This corresponds to a rapid improvement in the stock market.

“Return expectations don’t predict returns, but they do predict investment activity, therefore this is a huge development,” said Peker. “January is the most positive we have seen investor return expectations in the last 20 months.”

“Half (49%) of investors say they plan to increase their exposure to Australian shares in the next month, up from 37% in December 2012,” said Peker. “There is a significant jump in the appetite for direct shares, and for the first time since the inception of this study there are more investors who intend to reduce their exposure to term deposits than increase their exposure.”

Australian sharemarket expectations

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Sentiment towards equities has hit a five-year high as managers ditch their pessimistic outlook and turn to growth assets in Australia and offshore, according to the latest Investment Manager Outlook (IMO) from Russell Investments.

Results from the quarterly survey of 35 Australian managers showed that, on a net basis, 69% of managers are bullish towards the Australian sharemarket.

“One of the most interesting things this quarter is there was a dramatic drop off in pessimism, with only 5% of managers bearish towards shares, down from the 30% last quarter,” said Scott Bennett, portfolio manager at Russell Investments. “The bears seem to have gone into hibernation this quarter.”

Three-quarters of managers expect the Australian sharemarket to be higher over the next calendar year. Around a third were extremely bullish, predicting the market to rally by more than 10%. Consistent with this positive sentiment, not a single manager thought the Australian share market is overvalued.

One of the managers surveyed as part of Russell’s IMO commented: “We are positive on the outlook for the Australian equity market, based on a constructive economic backdrop and valuations that are supportive especially relative to bonds. Australian listed corporations are in general very well capitalised and have strong growth prospects. We think there are strong signs of increasing M&A activity which we expect to continue into 2011,” said Neil Boyd-Clark of Arnhem Investment Management.

International equities supported by QE2 and strong AUD

This quarter’s survey also saw a major shift in the sentiment towards international shares, which went from neutral to overwhelmingly positive.

“The US Fed’s continued support for monetary stimulus has helped remove some apprehension from the minds of Australian investment managers about international equities,” said Mr Bennett. “The strong Australian dollar is also helping international equities to look more appealing.”

More appetite for risk and growth

The positive sentiment was also reflected in managers’ appetite for riskier sectors of growth-oriented assets, with small cap Australian equities gaining new favour.

“Risk aversion has abated and managers appear more willing to increase their beta exposure,” said Mr Bennett. “We have seen a good reporting season from the US and a robust one here also. Stronger company earnings as well as the recent surge in M&A activity are adding to the appeal.”

Sector wise, resources and energy led the charge, as US quantitative easing and a stabilising outlook for China calmed investor concerns over both economies.

There was a slight increase in positivity towards cash following the RBA’s rate increase and the expectation of further monetary intervention. However the interest rate sensitive asset classes, namely REITs and local bonds, suffered slightly on the increase.

“It’s encouraging to see sentiment bouncing back,” said Mr Bennett. “There are good opportunities in the market and this turnaround should provide investors with some confidence heading into the New Year.”

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The survey of 418 investors who use financial advisers was undertaken in September by the University of Adelaide’s International Centre for Financial Services (ICFS) for Lifeplan, and sought feedback about the performance, trust and reliability, and technical ability of their financial adviser.

Mr Matt Walsh, head of Lifeplan, said that, despite continued negative reports about the financial planning profession, it is clear that investors who use an adviser value the relationship, and have a high level of trust in their adviser.

“The level of trust in advisers amongst clients is much higher than trust amongst non-clients, as shown by the recent Roy Morgan survey*.  It highlights the value of satisfied clients in promoting the value of financial advice, and also in generating new business development through referrals and word-of-mouth.

“This is particularly true of those aged over 60, who show the most favourable view of their adviser in the survey.

“This group have seen for themselves their adviser’s technical ability over time and in different market conditions, and believe that the strategies they have implemented since the financial crisis have weathered the last downturn well (since April 2010).

“It shows that advisers have succeeded in establishing strategies that are appropriate for this group’s needs, and these clients make up the bulk of the industry’s client base and are the ones most likely to provide word-of-mouth recommendations about their adviser,” he said.

The survey also showed that those who have had a relationship with their adviser for longer than five years are amongst the most satisfied.

“Despite having experienced the global financial crisis and subsequent market downturn, this group remains happy with their financial adviser, suggesting that they recognise the value of financial advice and the role it plays in developing long-term strategies to withstand economic and market cycles,” Mr Walsh said.

He pointed out that a possible sign of future problems could be seen in the survey’s results on investors’ satisfaction with the performance of their investments.

“In past surveys, the level of satisfaction with performance has often been a leading indicator for satisfaction with trust and reliability, and technical ability. Therefore there could potentially be a decline in these areas over the short-term.

“The findings suggest that some investors believe their advisers should be able to predict market movements and investment performance and, when things go badly, they blame their adviser.

“This kind of investor behaviour is unfortunately quite common, where people look for someone else to blame rather than accepting that they have made a mistake, or that they can’t control investment outcomes or market performance.

“However, it is clearly a concern for advisers, who need to ensure they are managing their clients’ expectations of how markets perform, and how far their own advice can go,” Mr Walsh said.

The survey was conducted in late September, when the Australian equity market had fallen after the highs of April. The long drawn-out results of the Australian Federal Election, housing market downturns, higher interest rates and lower equity markets, would also have had an impact on investors and how they viewed their investments.

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Investor sentiment in Australia is on the rise and there is a markedly more bullish attitude to Australian equities, according to the quarterly ING Investor Dashboard Sentiment Index released today. However, it seems investors are not acting on this more positive view, still favouring cash and gold deposits over shares.

The survey measures investor sentiment across 12 countries in the Asia Pacific region, focusing on changes in market sentiment, investment attitudes, investment performance and the financial situation of 3,755 investors. These factors are quantified and averaged resulting in a sentiment score. The Australian portion of the survey was conducted amongst 313 investors with liquid assets of US$100,000 or above.

Sentiment in Australia improved after plunging to a low in last quarter’s survey, scoring 135 out of 200 this quarter, well above the 113 of last quarter. However Australia is still lagging against its neighbours and was the third most negative country in the pan-Asian region behind Japan and Korea. Sentiment is also far behind some countries such as India, which was the most positive in the region with a score of 175, and financial centres like Hong Kong which scored 151.

Investors were also more bullish towards Australian equities with 84% thinking the market will either rise or remain stable. Last quarter 39% thought it would rise and 26% said it would stay the same. Investors also believe the stock market will increase by 6.42% over the next three months.

“It is encouraging that sentiment is picking up in Australia, albeit on a lag with Asia, particularly in the equity market where we are seeing an increasingly positive attitude,” said Jim McKay, head of sales for INGIM.

Cashing in

Yet despite this bullish view of equities, when it comes to deciding where to invest, cash and gold are still the favoured option. Gold scored 50 points when rated as an investment while cash deposits scored 31 and local stocks only 23.

Cash was also perceived as the best investment to take advantage of domestic interest rates and was chosen by 55% of respondents, compared to 27% selecting stocks. Similarly, cash and gold were considered the best investments to protect against the European debt crisis with 33% and 44% nominating them respectively.

When asked where they would invest on the risk/reward spectrum, there was a definite weighting towards the safer end. Low risk/return investments such as medium growth managed funds and cash were favourable for 64% of respondents and unfavourable for only 7%, compared to only 23% seeing merit in high/risk return investments like derivatives and 38% finding them unfavourable.

“It is interesting that there seems to be a disconnect between what investors are thinking and what they are doing,” said Mr McKay. “The fact that they expect the equity market to improve, yet prefer cash and gold, perhaps shows that continued volatility in the markets is still making them nervous.”

Australia robust while US economy casts shadow

Most Australians (79%) continue to predict that domestic inflation is on the rise, similar to 78% last quarter, reflecting the ongoing strength in the Australian economy.

Australians also found ways to take advantage of their strengthening currency, with many investors saying foreign currency is a good investment.

“As we all know the Australian dollar has continued strengthening, reaching almost unprecedented highs, and it is interesting to see Australians considering taking advantage of the rising Australian dollar by investing in foreign assets,” Mr McKay said.

When it comes to currency, Australians were also sceptical on the US dollar, with only 10% expecting it to appreciate and 49% expecting it to depreciate further.

In fact Australia had one of the most negative views on the US economic situation of the countries surveyed across pan-Asia, with only 27% thinking it will improve this quarter, compared to 31% last quarter. More than half, 62%, thought it would take three months or longer to recover. Thirty one percent thought US interest rates will rise and 55% thought they would stay the same next year
“With all these pressures it is not surprising investors are still attracted to safer assets, despite predicting increasing stock market strength. Yet this overly cautious attitude could cause them to miss out on opportunities. INGIM sees volatile markets creating good opportunities for quality active managers,” said Mr McKay.

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The Index, prepared by CoreData for the Financial Services Council, shows investor sentiment fell a further 0.5 points to -9.0 in quarter three 2010.

Sentiment is now more than 16 points lower than at the end of 2009 when investors were cautiously optimistic about the strength of the Australian economy and their own financial security.

John Brogden, CEO of the Financial Services Council, said: “While sentiment did not deteriorate significantly, it is clear investors remain uncertain about the future.

“Investor uncertainty is not surprising given the concerns about the European and US economies and the recent period of political upheaval resulting in Australia’s first minority Government in 70 years.

“The number of investors expecting economic growth to accelerate in Australia has declined over the last four quarters and now stands at 26.8 per cent, with half of the respondents expecting growth to slow next quarter.

“While the data suggests investors are reluctant to invest new money, their satisfaction with existing investments remains consistent with the last quarter at 37.7 per cent, with a further 37.6 per cent neutral.  Of those that make additional contributions to superannuation, 76.7 per cent expect to keep the level of their contributions the same over the next year while 16.9 per cent expect to increase their super contributions.”

Tracking investor sentiment Q4 2004 – Q3 2010

Kristen Paech, head of advice, wealth and superannuation at CoreData, said:  “The RBA’s decision to abstain from rate rises over the past three months has clearly provided a reprieve for mortgage owners, with the average household slightly better off this quarter.

“However, the expectations around future economic growth suggest Australians remain unconvinced that the future is bright, despite the market recovery.”

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David Harrison, Managing Director of Charter Hall, said the positive retail investor sentiment to commercial property shown in the survey was very encouraging, and called for investors to follow the lead of savvy institutional investors who are taking advantage of emerging opportunities in the listed sector (where REITs are trading at a discount to NTA) and also in the unlisted (direct) property sector.

The Charter Hall survey found 60% of those intending to invest in the next 12 months planned to invest sizable sums of more than $50,000. The survey showed 36% of respondents favoured listed property, another 11.71% favoured unlisted (direct) property while 6.35% favoured residential property.

“We believe the commercial property market has reached the bottom of the cycle post GFC and for investors considering their re-entry to this sector, now is the time to do it to take advantage of property values we expect will continue to rise.

“Charter Hall is hearing reports from our agencies that institutional investors such as superannuation funds, high net worth individuals and syndicators are in the market looking for homes for mandates up to and in some cases in excess of $1 billion as confidence returns,” Mr Harrison said.

Overall, investors surveyed had a conservative allocation to commercial property with 47% of those holding a less than 10% allocation in their portfolios. Respondents also showed a strong preference for office space, with one third of investors preferring this sector.

Mr Harrison said the strong preference for office space suggested retail investors may be overlooking opportunities available in the retail and industrial sectors which are also expected to perform strongly owing to attractive characteristics such as lower volatility and higher prospective returns.

“Institutional investors are returning to the market on the strength of excellent buying opportunities, in a climate of reduced competition and rising tenant demand in the industrial space. Retail investors should
take the lead set by institutional investors as a reference point for their own portfolio allocations,” Mr Harrison said.

The CEO of Charter Hall Direct Property, Richard Stacker echoed Mr Harrison’s comments saying successful capital raisings by Charter Hall this year confirmed investors’ return to the market.

“Since January this year, Charter Hall Direct Property has raised more than $110 million in capital for the since closed Macquarie Martin Place Trust; the open Stirling Street Trust; and the Charter Hall Direct Industrial Fund. The success of these raisings is confirmation of increasing investor appetite and our ability to offer retail investors access to institutional grade property at the right point in the cycle,” Mr
Stacker said.

The survey found that investors’ primary motivation for investing in real estate was regular income with 43% citing this as their number one driver. Mr Stacker said retail investor demand for income was a key
consideration in the development of Charter Hall Direct Property’s Direct Industrial Fund (DIF) launched in July this year.

“We developed DIF in response to demand from advisers, investors and in particular SMSFs, looking for simple products that deliver steady income over the long term.

“The survey results show the fundamental characteristics of unlisted property, which include reliable income and capital preservation on a long term basis, continue to be attractive to retail investors and
SMSFs,” said Mr Stacker.

Reflecting the defensive investment strategies taken by many investors during the downturn, investors also revealed significant holdings in cash and term deposits with nearly one third of respondents holding more than $200 000 in these assets. However, investors also signalled their rising confidence with 74% of those surveyed believing the Australian sharemarket would rise in the medium term.

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The S&P/ASX 200 VIX will be an end-of-day index that reflects investor sentiment about the expected volatility in the Australian benchmark equity index, the S&P/ASX 200.

A volatility index at a higher level generally implies a market expectation of large changes in the S&P/ASX 200 over the next 30 days, indicating that investor sentiment is uncertain. Conversely, a lower volatility index value generally implies a market expectation of little change, suggesting greater levels of investor confidence.

The S&P/ASX 200 VIX will reflect expected equity market volatility over the next 30 days by using settlement prices for S&P/ASX 200 put and call options to calculate a weighted average of the implied volatility incorporated into the options. The calculation will use proprietary methodology of the Chicago Board Options Exchange (CBOE).

Richard Murphy, ASX General Manager, Equity Markets, said: “The new volatility index will provide investors, financial media, researchers and economists with a means to gauge the level of volatility anticipated in the Australian equity market over the near-term. More specifically, because the S&P/ASX 200 VIX is a forward looking volatility measure, observers of the index will have insight into the degree of uncertainty among investors and their expectations regarding the magnitude of future movements in the local equity market. It is a valuable complement to the existing suite of S&P/ASX indices.”

Guy Maguire, Head of S&P Indices in Australia, said: “The introduction of a volatility index for the Australian equity market is a sign of Australia’s standing in the global investment community, and the requirement for a means by which Australian investment conditions and performance can be viewed in a manner that is distinct from other markets.”

“We are pleased to extend the use of the CBOE’s VIX methodology to the ASX through our partnership with S&P,” said CBOE Executive Vice President Richard DuFour. “The VIX methodology has become the recognised standard for measuring implied volatility, and we are confident that its use by ASX will add value for market participants.”

The S&P/ASX 200 VIX will initially be available as an end-of-day index from ASX, with back data published on the ASX website at www.asx.com.au/volatilityindex. ASX will consider making the index available in real- time and launching derivative products over the volatility index at a later date.

S&P Indices, the world’s leading index provider, maintains a wide variety of investable and benchmark indices to meet an array of investor needs. Over $1 trillion is directly indexed to Standard & Poor’s family of indices, which includes the S&P 500, the world’s most followed stock market index, the S&P Global 1200, a composite index comprised of seven regional and country headline indices, the S&P Global BMI, an index with approximately 11,000 constituents, and the S&P GSCI®, the industry’s most closely watched commodities index. For more information, please visit www.standardandpoors.com/indices.

About Standard & Poor’s

Standard & Poor’s, a subsidiary of The McGraw-Hill Companies (NYSE:MHP), is the world’s foremost provider of independent credit ratings, indices, risk evaluation, investment research and data. With offices in 23 countries and markets, Standard & Poor’s is an essential part of the world’s financial infrastructure and has played a leading role for 150 years in providing investors with the independent benchmarks they need to feel more confident about their investment and financial decisions. For more information, visit http://www.standardandpoors.com

About ASX

ASX Group is a multi-asset class, vertically integrated exchange group, and one of the world’s top-10 listed exchange groups measured by market capitalisation.

ASX’s activities span primary and secondary market services, central counterparty risk transfer, and securities settlement for both the equities and fixed income markets. It functions as a market operator, clearing house and payments system facilitator. It monitors and enforces compliance with its operating rules, promotes standards of corporate governance among Australia’s listed companies and helps to educate retail investors.

ASX’s diverse domestic and international customer base includes issuers of securities and financial products, investment and trading banks, fund managers, hedge funds, commodity trading advisers, brokers and proprietary traders, market data vendors and retail investors.

By providing its systems, processes and services reliably and fairly, ASX generates confidence in the markets that depend on its infrastructure. This is integral to ASX’s long-term commercial success.

More information on ASX can be found on our website www.asx.com.au

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What we are seeing at the moment are two very strong trends that are having opposing impacts on markets.  Low interest rates, low valuations and a lack of alternatives (as neither bonds nor property are seen as prospective) are key supports for equities and are helping to fuel brief periods of exuberance. However, the persistence of weak economic growth, fiscal deficits and high unemployment, are all contributing to subsequent despair and apathy which saps any market rally.

The result of such opposing forces is some unexpected outcomes.  Uniquely in a volatile market with a decidedly uncertain and negative bias, a number of small speculative companies are performing very strongly. Many small caps are at 52-week highs while quality blue chips languish at multi-year low valuations. Speculation in small caps is symptomatic of a low interest rate environment whilst at the same time investor disillusionment is keeping investors away from the big end of town. This market behaviour provides very little predictive value.

In addition to macro-economic uncertainty there have recently been attention-grabbing statements and sound bites from market commentators that seek to add insight but rather disclose a weakness of analysis.  Such statements only add to the confusion level for investors.  For example, following a 10 year period of flat equity markets, it is now often said that “buy and hold” is dead.

Bold, game-changing statements such as these are common after periods of above or below trend outcomes. Recall the tech boom of 1999-2000 and how investors scoffed at valuations and earnings. “Earnings don’t matter” they cried as they rushed to embrace the dotcom economy at all costs. That strength of conviction is back in force but this time in reverse. These days it’s “P/Es don’t matter” as the marginal buyer seems not to care about the long term given so much uncertainty.

Adopting this assumption fails to grasp the components of investment returns or, more specifically, that a share price is a function of valuation and earnings. Suggesting that stock prices will not rise over time is an explicit statement that earnings will stagnate or valuations will drift lower. But historical evidence is firmly against this assumption.

Over the past 10 years the average earnings growth of S&P 500 constituents was 3% per annum despite two severe recessions. It is prudent to assume that at least a similar rate of growth can be maintained over the next 10 years. With the addition of dividends, returns of 6-7% per annum are achievable in the medium term with no change in valuation.

On the valuation side, company earnings are currently valued very cheaply at around 12 times earnings. The reason share prices went nowhere over the past 10 years was exclusively due to valuations contracting from about 25 times earnings to close to 12 times today. The long term valuation range is between 10-25 times earnings with only brief periods above and below this range. Given corporate balance sheets are in great shape and investor sentiment is so poor, the risk to valuation is arguably to the upside. In this environment, rising valuations can easily lead to double digit returns even assuming weak earnings growth.

For these reasons, at Wingate we believe the bull case for equities has significant fundamental underpinnings. The negativity bubble engulfing investors has delivered this opportunity but investors need to get away from the immediate noise in the market and maintain their focus on fundamentals.

In addition, the strength of the Australian dollar, which for many reasons will likely revert lower over time, provides local investors an exceptionally strong currency. Using the strong currency to purchase international equities provides an additional investment benefit that is unavailable on domestic stocks.

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