Australian stock investors face some difficult choices in the coming years. The never-ending search for returns is on everyone’s mind. Employing the right strategies to maximise returns is of immediate concern.
But what is the right way to approach stock investments? Specifically, what kind of outlook will Aussie investors need to grow their portfolios? Should they stick with the ASX, or look abroad for opportunities? These questions are difficult to answer. It depends on a series of conditions that won’t apply to every investor.
What we do know, however, is that Aussies are increasingly global in their outlook.
The fraught nature of the ASX is pushing investors towards international markets. The reason for this is relatively straight forward. Investors are spooked by the issues facing the Aussie economy.
What issues? Take your pick: weakening commodity prices, diverging interest rate movements, or slower domestic growth. These are just three issues weighing on investors’ minds.
Their pressure they exert on the economy suggests the next few years could be troublesome for the ASX. In a ‘best case’ scenario, they suggest the ASX could hold firm, showing relatively weak growth.
Amid this raft of issues plaguing the Aussie economy, diversifying overseas might seem like a no-brainer.
It’s for that reason that investors are looking towards global markets to boost their portfolio. That applies to funds as much as it does to retail investors. Tempo Asset Management’s Joe Bracken explains:
‘A lot of the super fund are getting quite large, ending up with capacity constraints with a lot of capital to deploy. Our domestic [stock] market’s range of large companies is quite narrow. We’re definitely beginning to see a trend of moving into more overweight overseas allocations, and increasingly into emerging markets’.
With super funds moving further into global markets, it reinforces the poor outlook for the ASX. Then again, it might merely tell us that these funds are outgrowing the domestic market. That’s certainly true, but it sends mixed messages about the state of the ASX.
It doesn’t help that market surveys are supporting the argument to look abroad.
A recent survey of fund and asset managers actually ranked Aussie stocks as the least profitable over the next three years. In contrast, the most attractive markets were the likes of the US, China, and India.
But how attractive are these international markets really? The trade-off between risk and reward is not altogether clear.
Domestic economic conditions may be pushing investors’ assets out of the ASX. But the pull factors drawing them towards international markets come with their own challenges.
For one, there’s the issue of Greece and China. However you feel about them, the dangers they present to the global economy haven’t disappeared. They’ve merely been shoved aside.
You could argue the fear of contagion, in particular from China, is easing. But China didn’t fix its economy overnight. It put in place stop-gap measures to prevent further market selloffs. While Chinese stocks have little exposure to the ASX, the same can’t be said about the Chinese economy. And whichever way the Chinese economy goes, so too will its stock market.
On that front, the situation isn’t promising. China remains plagued by toxic local government debt, poor manufacturing output, and slowing construction. Only aggressive government intervention stopped the stockmarket rot.
At the same time, Chinese stocks remain massively overvalued. The share prices for a large number of companies is far in excess of their P/E ratios. And as long as fears over China’s economy remain, a larger crash can’t be ruled out.
In the right circumstances, there’s no telling how far the market could decline. Chinese markets will soon open up to Aussie investors. But investors would be wise to approach Chinese stocks with wariness.
Commodity prices forcing unwanted interest rate movements
Falling commodity prices are a serious cause for concern among investors. There’s a good reason for this too.
As you’re no doubt aware by now, commodity prices are trending at historic lows. Supply is abundant, and prices will fall further if demand doesn’t pick up.
A thriving materials sector, as you might expect, reflects on sharemarkets too. The materials sector currently makes up 15% of the ASX200 index. It’s second only to banks in its share of the total index.
Australia is in a select basket of countries that derives its prosperity from commodity exports. Materials make up a significant chunk of the national income. When the industry suffers, as it’s doing now, the rest of the economy feels the effects of this. Naturally, this has a knock-on effect on every sector of the ASX, not just materials.
It’s for this reason that resource-dependent economies make for a risker bet for investors.
Governments and central banks try to redress the issues with falling commodity revenues. One of the ways they’ve done this is to lower interest rates. Canada and Australia, for example, have both cut rates in the last few months.
In an era of strong commodity prices, rate cuts are positive for stockmarkets. The influx of new credit eventually finds its way towards stocks, pushing up prices in the process. But with slow economic growth, interest rate cuts leave investors with diminishing returns.
However, not every central bank has rate cuts on their mind. The exception here is the US Federal Reserve. Economists now strongly believe the Fed will buck the trend and raise rates in due course. The growing consensus is that it’ll take place sometime this September.
This matters to investors because investors perceive rising interest rates as a boon to stocks.
Whether economists are right is debatable. The Fed is just as likely to hold off on raising rates until late-2016. That’s because the US economy isn’t really improving. Month to month, official data sends out mixed signals about the state of the US economy. There isn’t the kind of sustained stability that would suggest rates will rise again soon.
What’s more, how certain can we be that higher rates will result in larger returns for investors? There’s enough historical evidence to show that US stocks actually struggle to keep up with inflation once the Fed tightens credit.
The excitement about US markets, in the event of a rate rise, might be overblown then.
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The opposite view: Aussie stocks a good bet
Not everyone is concerned about the future of the Australian stock market.
Kate Howitt, of Fidelity Australia, thinks ASX listed stocks will remain competitive for some time yet. She explains:
‘Australia’s economy swaps between being mining-led, and otherwise, regularly. It’s true we’re at the harder part of the transition, going from relying on mining to the wider economy, rather than the other way round. But it’s a fairly normal thing in our economy’.
Another thing investors are underestimating is the ‘power’ of franking credits. In Howitt’s view, this gives the ASX an advantage.
‘[Dividend tax breaks do] create a way of cash being recycle through the economy. [It does this] without the government taking a clip on the way through.
‘Our London-based global equities income fund manager’s target is a 3.5% dividend yield, without franking. You can buy most stocks in our market and get a dividend north of that.
What’s more, she adds that ASX-listed companies already have significant exposure to global markets.
‘If you look at our top 100 or so, about 30–40% of their sales are done overseas, especially in the health care sector. And there are at least 10 that are among the global top three for its industry’.
The arguments in favour of the ASX do tell us one thing. There is no black and white approach to investing. As with any good investment strategy, a sound strategy may involve diversification. There is no reason why investors can’t benefit from a dual approach to investing. As with any investment strategy, the key is to pick the right stocks. Whether they’re in Australia or not matters less.
Contributor, Markets and Money
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