The 12 months ahead will be characterised by plenty of investment opportunities and pitfalls. A key message is to watch for investment openings while remaining highly wary.
Most investment sectors are sending conflicting messages, leaving investors with the tough task of sorting out the potential winners from the potential losers. It won’t be an easy year for investors.
Investors should take a medium- to long-term perspective rather than chase rapid sharemarket profits over just 12 months. The sharemarket this year will be marked by its high volatility and short-term corrections.
In short, 2011 is shaping up as a year when investors can expect to make higher, perhaps significantly higher, returns from the sharemarket than from bank savings accounts, debentures and bonds.
And shares should be clear winners over residential property investments. Investors should steel themselves for the expectation of falling housing values in most states as higher interest rates and the exit of first homebuyers take their toll.
Overall, selective risk-takers should be rewarded in 2011 while those who continue to shelter excessive amounts in interest-bearing investments could pay the price of forfeited returns elsewhere.
Opportunities: The year ahead should provide plenty of buying opportunities for cashed-up investors. While the S&P/ASX200 only managed to produce positive returns in 2010 once dividends were counted, investors can expect solid returns from Australian shares in 2011.
Despite concern about the impact for Australia of China’s attempts to control its rising inflation, the horrific flood damage, European sovereign debt and the slowness of the US recovery, leading equity strategists interviewed by SmartCompany give forecasts for total returns this year, including dividends, ranging from 8-20%.
From a price-earnings perspective, shares appear cheap to some equity analysts – trading on a multiple of 12.7 times, down from a long-time average of 14.5 times. Corporate balance sheets are much leaner. And GFC-stung investors are now showing a greater appetite for risk.
As Andrew Pease, chief investment strategist for Asia Pacific with Russell Investments, emphasises, one of the most positive aspects of the Australian market is its dividend yield and franking credits. (A fully franked 4% dividend – the current average dividend – is equivalent to a 5.7% yield on an income investment – plus there is, of course, the potential for capital gains.)
As the first month of 2011 already suggests, the market is likely to remain highly volatile this year. And from a positive perspective, such a volatile market provides excellent buying opportunities for cashed-up investors.
Despite the affect of the floods on production, the big diversified resource companies and mining service companies appear among the standout buys on the back of strong Asian demand. This is with the main caveat that much will depend on the strength of the continued demand from China. (See next Pitfalls section.)
In December, SmartCompany quoted Prasad Patkar, portfolio manager for Platypus Asset Management, as saying a “blow-off” in commodity prices, delayed by the GFC, may occur in 2011. And Patkar said commodity prices may go “ballistic”. (See //coreuat-cdn.smartcompany.com.au/wealth/20101214-money-making-share-strategies-for-2011.html).
Pitfalls: There are plenty of potential pitfalls for local equities that investors should watch, ranging from small caps to factors that could affect the Chinese demand for Australia’s resources.
Investors should be wary of small-cap, non-mining stocks this year after their powerful gains in 2010. The S&P/ASX Small Ordinaries Index rose by 13.1% in 2011 as larger stocks struggled. The run on small caps could be over and these stocks could be particularly susceptible to losing value.
Another potential pitfall for share investors could be most non-discretionary retail stocks, given the prospect of further rate rises and the reluctance of consumers to spend.
Andrew Pease raises the key question for resource stocks of whether commodity prices will keep rising. Russell Investments is a “little bit sceptical” about further rises. He emphasises how China’s efforts to control rising inflation and slow its economic growth would affect its demand for Australian commodities.
Further, Pease questions how much of the rise in commodity prices has been driven by commodities trading rather than by underlying demand.
Pease doesn’t accept that the Australian equity market is cheap based on the market’s price-earnings multiple being significantly below its long-term average. But at the same time, Pease is not pessimistic about the outlook for local shares in 2011, but stresses his belief that international developed markets have more potential for 2011.
“Eighteen months ago, [Australian] markets were undeniably cheap,” he says. “At the bottom of the crisis, people were then obviously very scared.”
“Where we are now, it is very hard to make the case that markets are particularly cheap any more. But most of the valuation metrics, they don’t appear to be particularly expensive either.”
Pease’s view is that “the simplest and cleanest” way to value Australian shares is on their dividend yields. And at 4%, yields are at their long-term average.
Historically, Pease says that investors who bought on a dividend yield of 4% typically had a “pretty normal experience – 8-10% returns, which I would think would be more than acceptable”.
Opportunities: A big decision for Australian investors in 2011 is whether to increase their exposure to developed offshore markets. Some investment strategists believe that these will produce higher returns than the local market over the 12 months ahead.
Pease expects developed offshore markets to outperform the local market, partly on the basis that these countries suffered much harder than us through the GFC and now provide more opportunities for gains.
“Our markets performed terribly last year,” says Pease. “One of the mistakes that [Australian] investors made post the financial crisis was in thinking that if Australia didn’t have a recession, they should basically have this huge home-country bias.”
Pease says such investors viewed equity markets outside Australia as being “dangerous places to be”.
In short, he describes that Australian bias a “bad investment choice”.
Pease says that because Australia wasn’t as hard hit during the GFC, its valuations are not as attractive for investors. And he expects developed international markets to outperform the Australian markets “despite all of the bad news that’s around them”.
His favoured international developed market is the US on the basis of its stock valuations. And the US economy is looking stronger than that of most European countries.
Pitfalls: An obvious pitfall for developed international markets is the European sovereign debt crisis. “No one can predict how the sovereign debt crisis is going to end,” says Pease.
“One thing we know with a lot of confidence is that it’s going to take a long time to work out and in between there’s going to be a lot of drama. There’s no happy ending in store for Europe.”
“It could be just a hard grind of poor growth of poor growth, and crisis after crisis along the way.”
Smart Company is the leading online publication in Australia for free news, information and resources catering to Australia’s entrepreneurs, small and medium business owners and business managers.
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