Australian Sharemarket Update - Early 2016

There is a substantial amount of financial material available online regarding Australian equities and sharemarket performance. We don't intend to compete in that regard, but we have had a long term relationship with John Goodlad of Hartleys sharebrokers, who has many expat clients, and include his monthly briefing as a short, sharp briefing for Australian expats. You can make contact with John through our Inquiry Form.

Well, 2015 was not much of a year for the Australian Stock Market. Even with a modest “Santa Clause Rally” the ASX finished 2% lower for the year – although dividends pushed the total return back in to positive territory. 2016 is off to a dismal start as concerns about the Chinese economy reverberate around capital markets.

2015 The Year That Was

2015 was marked by geopolitical tensions that inevitably found their way into investor decision making. The year began with the Charlie Hebdo killings and further attacks, the Syrian refugee crisis, and gains by Islamic State making the Middle East situation even more unpredictable. In economic terms we saw the US Federal Reserve finally raising interest rates, a Chinese Stock Market plunge, and a savage fall in commodity prices for base materials and oil and gas. Many of these are now trading at pre GFC levels – as supply overruns demand.

In broad terms, however, the global economy continued to expand – and we avoided many of the apparent pitfalls that we faced the previous year. Remember the Greek Crisis?

In stock market terms it was a case of “good in parts”. Industrials – especially mid-caps – performed well. Financials pulled back as the search for yield met the headwinds of constraints on growth. Property/Infrastructure and Utilities performed well.
But the fabric of most portfolios was damaged by a surprisingly strong pullback in commodity prices. Again, some of these companies, like BHP and Santos (STO), are selling at well below GFC levels.

Portfolios with international exposure through Australia’s global stocks (like CSL, Ramsay Healthcare and Domino’s) or Exchange Traded Funds or Listed Investment Companies were able to perform better with a combination of foreign currency upside and stronger global earnings. This trend looks set to continue.

2016?

What lies ahead? Well, first we know that the Australian stock market averages a total return of 11-12% p.a. (4% yield plus capital growth). A couple of years of underperformance augers well for an eventual return to the mean.

Secondly, the market still provides better yield than cash and fixed interest – although sometimes it feels like this premium does not justify the volatility in the underlying share price. Indeed at current levels the ASX provides the highest relative yield (approx. 5%) of all major stock markets.

Along with property, shares will continue to be one of the two primary asset classes for the accumulation of long term wealth.
Finally, a diversified portfolio continues to be the key to minimising downside risk and capturing upside. Not many pundits predicted that it would be Industrials that would outperform over the last 2 years. In the same way some commentators now argue that, after the last several months of market savagery, resources and energy stocks could be the sectors to outperform in 2016.
There is plenty of material on the Bear case for commodities. Some commentators are now saying that this downside has been overdone. Most commodities are now trading well below their 40 year averages and, a return to the norm (US$55 per tonne iron ore and US$55 per barrel oil) is more likely than not.

Deutsche Bank recently concluded that we are now “into ridiculous territory” when it comes to the Mining sector. Supply cuts are accelerating which should lead to a rebalancing in most commodities in 2016. “In addition, any small take up in demand (likely China-driven) would likely see a price rally in our view.”

So hold on to large caps like BHP and nibble away at a few more at these levels. If that rallies, a host of other small and mid-cap opportunities will arise in companies that are trading well below replacement value.

Oil & Gas

Much the same may be in store for the oil and gas stocks. There is an extraordinary juxtaposition of supply side pressures – but the consensus now is that, while the price could slide further, much of the downside has occurred and there is light at the end of the tunnel given current prices do not allow for the necessary replacement energy capacity. Woodside (WPL) and Santos are our large cap recommendations.

Our Energy analyst summed it up this way “Nobody has a clue where the oil price is going in the short term. The geniuses at the large investment banks (I was one of those once) are fighting to see who can put out the lowest forecast. As they did with higher forecasts at the peak of the market. What we do know is that longer term, the aggressive cuts to capex currently occurring will impact future production. Demand will continue to grow, requiring 1 to 2mm b/d of additional supply. The Saudi budget is in trouble, and announcing plans to sell Aramco provides further evidence of this. Reduced supply, OPEC budget stress, and demand growth all add to a longer term bullish outlook.”

The Banks

My favourite aphorism is ‘Don’t bet against the Australian Banks’. We have Accumulate recommendations on the Big Four Banks noting yields in excess of 5-6% as well. CBA is the Rolls Royce play in terms of quality. And I am attracted to Westpac (WBC) and the new CEO’s predilection for cost-cutting and revenue increases (e.g. Westpac, was the first to increase interest rates). Business 101!

Industrials

As mentioned earlier a combination of global earnings and exposure to lower AUD benefits Australian International companies like CSL, Social Healthcare, Crown, Resmed, Amcor, Flight Centre, Invocare, Domino’s, Ramsay Healthcare are all on my preferred list – with Sonic Healthcare (SHL) an Accumulate at current levels.

Property Infrastructure and Utilities

I continue to accumulate SLF (the Exchange Traded Index Fund) which reflects all the players in the Property Index. Sydney Airport (SYD) and Transurban (TCL) are preferred infrastructure plays. And I am interested to see whether Auckland International Airport (AIA) can mirror our SYD’s success with Air New Zealand’s new routes to the Americas (and targeting Australian passengers).

AGL is the Australian Energy/Utility company that continues to defy gravity. A core company in any portfolio.

Conclusion

2016 will contain the usual surprises – good and bad – as markets continue their daily gyrations. Remember, despite the day to day depredations, the market is a weighing machine. Good companies with solid earnings will always perform over time and the solid yield on offer in the Australian market continues to attract investors. And the global economy is still growing.