Equity dilemma? Local markets full to overflowing

Are domestic equities running out of puff? Well, if you listened to representatives of major fund managers during October you could have been forgiven for thinking this was the case.

Both Franklin Templeton Institutional and Fidelity last month seriously questioned whether Australian equities could continue to turn in the types of performances that helped drive two consecutive years of superannuation fund growth.

Both managers were suggesting that Australian equities had either reached value or were currently overvalued.

In fact, Templeton Investment Management said it was struggling to find attractive new investment opportunities in Australian shares and believed that the recent decline might be part of the Australian market adjusting to more realistic levels.

Significantly, both firms are suggesting that Australian institutional investors would be better served looking offshore.

Portfolio manager, global equities, with Fidelity Jorma Korhonen attributed the on-going strength of Australian equities to the flow of investment monies generated by superannuation guarantee charge.

“You have a share price driven by supply and demand and as the flow of money [comes] from what represents a Government-regulated savings scheme, it means that money has to go somewhere,” he said.

However, Korhonen believes that Australian equities have reached full value and that it is now a lot more attractive to invest elsewhere in the world.

“The US is looking attractive,” he said. “It has arguably under-performed in the last couple of years and that suggests some up-side.”

Korhonen also pointed to Japan as an increasing investment destination and suggested that some sectoral opportunities existed in Europe.

Senior vice president for the Templeton Global Equity Group Peter Wilmshurst said that for some time Templeton’s team of global sector analysts had found few attractive new opportunities in Australia.

“While the stockmarket as a whole does not seem a concern, investors should remember that Australia is heavily dominated by the low-valued financial and materials sectors, which comprise approximately 60 per cent of the stockmarket,” he said.

“In almost all sectors, Australian stocks are more expensive than their overseas equivalents,” Wilmshurst said. “As a result, Australian investors should be considering an increasing allocation to global equities.”

He said it was worth remembering that 98 per cent of equity investment opportunities were outside of Australia, creating a broader scope for locating undervalued stocks and diversification.

Templeton also outlined a number of warning signs for the Australian economy that could have negative implications for corporate earnings and therefore the Australian sharemarket.

It said these included the current account deficit, extended consumer spending and a reliance on housing to support the latter.

Templeton suggested that the housing bubble could still bring problems to Australia as house prices were high relative to incomes, and housing assets as a percentage of household assets were double what they were in the US.

It said a key issue was the exchange rate, with the Australian dollar having appreciated close to 50 per cent over the past three years relative to the US dollar.

“This rise has adversely impacted Australians investing overseas,” Templeton said. “Templeton believes the Australian dollar is currently 10 per cent overvalued compared with the US dollar on a purchasing power parity basis.”

For his part, Korhonen believes Australian institutional investors need to be selective with respect to pursuing alpha offshore and suggests that opportunities exist in sectors such as technology, European pharmaceuticals and in the energy space with respect to oil refining.