Changing investment climate

If local economists’ predictions stand, Australia’s share market will take a nasty knock in the not-too-distant future.

As oil prices show signs of dipping and interest rates hold steady, the Australian share market looks set for a slowdown, leaving planners on tenterhooks. Though, according to economists, such a reaction is hardly surprising.

“People forget how volatile the stock market is, and in history, over long periods of time, Australian stocks have given very good returns. But roughly one year in four, it’s a negative return,” director of Access Economics David Chessell says.

In Chessell’s view, the predicted slowdown has been on the cards for some time.

He says over the past few months the market has been pretty flat. And while there has been some activity, the market is still roughly where it was in May.

Tyndall economist Roger Bridges says while the share market may be experiencing a slowdown, he prefers to label it as sustainable rather than heading into a recessionary-type situation.

“Our view at the moment is that monetary policy remains relatively accommodative. It’s not as accommodative as it was before, it’s probably around neutral. It’s not tight in any way, so the economy, rather than going at full pelt, is more likely to be growing at the sustainable rate or slightly below it,” he says.

“Though, in terms of a slowdown, it would be positive for bonds and probably should be fairly negative for equities at the same time because it pressures the revenue side of funds, if you believe that the economy is going through a slow down,” Bridges says.

However, while the events of the share market downturn in 2001 and 2002 created chaos across local and international financial sectors, ahead of recent industry predictions, fund managers are confident this time they are prepared.

MLC investment strategist Brian Parker is well aware the local market could turn sour. Though for him, timing is the key.

“It’s important to realise that over a year ago there were credible voices expressing concerns about the Australian share market, and over a year later, we’re not all that far from our record highs.

“Getting the timing right on these calls is tough even for professional, full-time investment managers, let alone individual advisers and investors,” Parker says.

“I think the safest assumption to make is that we’ve had a brilliant run, and that when we’re doing our planning, we shouldn’t be banking on double-digit returns persisting. Longer-term, markets just don’t work that way.”

Echoing Parker’s comments is Macquarie’s division director, research strategy Tanya Branwhite, who also believes while a slowdown is inevitable, many have predicted it would occur for the past two years.

“The share market fall in 2000 came off the back of the speculative bubble in tech stocks globally. The value of tech stocks globally now is much stronger than it was in 2000. There were many factors that affected the share market fall in 2000. The 1988-89 and 2000 share market falls saw the rate of bad debts rise substantially, and credit spreads widen from their lows,” Branwhite says.

“In this cycle the process is repeating itself. Credit spreads have moved off their lows and the global monetary tightening cycle and its lagged effects are still underway. We are seeing a similar rise in interest rates and the beginning of some nervousness as the economy shows signs of slowing.”

So, with a market slowdown looming, how do fund managers respond?

Parker says MLC does not try to catch shorter-term market movements by adjusting the asset allocation for most of its funds.

“For our long-term absolute return portfolio (LTAR), we have reduced our exposure to commodities, and reduced our equity exposure, but that’s really not based on any short-term concerns,” he says.

“Rather, it’s an acknowledgement that these kinds of metal prices don’t typically last long-term, and with profits as a share of the economy at an all-time high in Australia, it’s hard to see the profit environment getting much better from here.

“In a number of key global markets, the profit environment has also been brilliant, and again it begs the question, how much better can things get?”

Macquarie, on the other hand, believes responding to the market in such an event is out of fund managers’ hands.

“Fund managers don’t have control over asset allocations any more — it is the asset consultants that control the allocation,” Branwhite says.

“The fact is that it’s not all that particularly dynamic any more.”

Weighing into the debate, Chessell says amid such market uncertainty, he advises clients to put up to 45 per cent of their portfolios into alternative assets, such as infrastructure, direct property, and private equity.

“So that when the share market does go down, as it inevitably will, the whole funds returns aren’t dragged down with it.

“Our clients can cope with an equity market downturn, because they have this large allocation of 45 per cent to non-equity assets that, basically, have proven to be largely independent of the market, so they will keep giving you returns when the market has turned sour,” Chessell says.

In the event of a share market dip, what asset classes would fair well?

According to Bridges, a dip in the share market might become a positive for Australian equities if the slow- down doesn’t put too much pressure on resources.

“It might actually be a positive for equities than anything else because monetary policy — if it’s at a sustainable rate and the economy can carry on without putting undue pressure on resources and remains at fairly tight levels — will remain on hold and therefore it’s probably a good environment for equities. Though, you won’t get the growth that you’ve probably seen in the past, but it’s still a good environment to be in,” he says.

This view is shared by Branwhite.

She says, traditionally, a dip in the share market paves the path to cash or property, or if there is a rally in the bond market, investors look to bonds.

However, it could be different this time around.

“This time could be different because the projected slowdown coincides at a time of rising interest rates and declining property market investment.

“Given this is the case, most investors might this time elect to stay with equities offsetting some of the effects of an economic slowing.

“If they don’t feel they are in quality companies with good management, the sectors that will do best will be the defensive sectors such as infrastructure, utilities and consumer staple stocks.”

And on the flip side, which asset classes would be hardest hit by a slow down?

In Branwhite’s view, cyclicals would be worst hit.

“If the slowdown happens the sectors to be hardest hit would be cyclicals — resources, basic materials, consumer cyclicals,” she says.

However, Bridges believes the bond market would feel the brunt.

“The bond market at the moment is pricing in a dire position, particularly in the US with inverse curves,” he says.

“They’re talking a recessionary situation, so given what their pricing is, it’s probably not a good environment for bonds at the same time.”

Parker agrees, although he also adds cash to his list of possible asset classes heading for an unfavourable turn.

“Cash and bonds would tend to perform better, but even then, bond rates don’t look all that attractive right now,” he says.

“You could also make a case that if the market were to decline, resources would likely bear the brunt of that given the magnitude of gains in recent years. Other sectors could end up performing quite well.”