Reconsidering the position of equities

Paul Taylor points to several positives that have been overlooked amidst the nervousness surrounding the equity market volatility.

It’s a bit of an understatement that equity markets are nervous at the moment.

Investors are nervous, sceptical, cautious and scared – and for very good reasons: there has been a lot of negative macro-economic news lately. 

However, there are also several positives that have been overshadowed.

For example, even if the global economy slows, some Australian companies will still be in a comparatively good position. 

Some macro-economic conditions could change over the next year and potentially have a different impact on the market.

Concern around Chinese economic growth, for example, is one that could change through the year. The worse conditions are for global economic growth, the higher the likelihood Chinese authorities will stop tightening monetary conditions and seek to resume growth.

At the moment, the Chinese authorities are trying to bring growth down to more sustainable levels by increasing interest rates and tightening lending standards.

Should global economic growth get worse, the Chinese authorities are more likely to reverse this policy stance as they did moving from 2007 into 2008 and 2009.

This would see the government in Beijing try to boost growth, which would maintain if not increase Chinese demand for Australian commodities, which would in turn buoy our resources and associated stocks.

This highlights how while macro-economic concerns continue to overshadow the market and impact sentiment, it’s key to talk to companies to see how they are actually being impacted by these factors.

Some are being impacted much less than others.

The Australian market remains attractively valued at well below long-term average levels. The earnings and dividend yield of the market also indicates attractive valuation levels.

Over the past year, the macro-economic concerns have dominated bottom-up fundamentals and company valuations.

At individual company levels, you are now able to buy great quality Australian companies with strong balance sheets and good long-term growth prospects for very attractive long-term valuations.

I believe the bottom up fundamentals and attractive market valuations will win out over the long-term, but it’s always difficult to pick the exact timing.

With these macro concerns now very well priced into the market, and some improvement likely over the next 12 months combined with very attractive valuation levels means that the likelihood of getting better returns from the Australian market over the next year is much improved.

Two-speed opportunities

Australia’s two-speed economy is creating divisions within the sharemarket. Some sectors – such as those reliant on consumers – were depressed, as households remained concerned about further increases to interest rates.

At the moment, we have overweight positions in the industrial, healthcare and energy sectors. 

Within the mining sector, we still see opportunities to invest in the larger diversified miners over the smaller miners.

The miners – big and small – are trading on similar multiples, which is unusual. One reason is when commodity prices are rising, the market generally gets excited about small-cap miners and bids them up.

The fact that all miners are trading on similar valuations presents a fantastic opportunity to invest in the big miners at good prices, as that’s where the long-term value is.

The larger miners tend to own the best quality assets, such as the low cost, long life mines.

They also have strong operational and management teams – and they are currently trading on the most attractive valuations.

Australia’s banks are also attractively priced, but are facing some headwinds in slowing lending growth and higher interest rates.

Investors also have to take into account what the high Australian dollar means for each company, and this could well be a feature during the reporting season.

While the strength of the Australian economy relative to other parts of the world, health of commodity markets, and yield on the Australian dollar probably mean the Australian dollar will  continue its strength against other major currencies, exchange rates – especially in the short term – are notoriously difficult to predict.  

Some of the macro-economic concerns, like sovereign debt issues and US economic growth, are likely to remain with us through at least this financial year.

But with the Australian market very attractively priced and with good quality companies with strong balance sheets and solid long-term growth opportunities combined with potential improvement in some macro-economic issues, the probability of achieving good returns in the Australian market for the next 12 months is much improved.

Paul Taylor is the head of Australian equities at Fidelity and portfolio manager of the Fidelity Australian Equities Fund.