It’s that time of year again when I sit down with the Wilson Asset Management (WAM) team and reflect on the year that was but, more importantly, the year ahead. Of course, portfolio construction and maintenance is a constant and never-ending process, however, the end of the year is an appropriate time to take stock…no pun intended.
At the time of writing, the All Ords is at 5101 up from 4664 at the start of the year and therefore has delivered a 9.4% return, plus dividends. Of course, stock pickers probably did better or worse than that, depending on how well they assessed value. We are pleased with our 23.4% return, particularly given we have held varying levels of cash through the year.
The themes for 2013
The two biggest themes for the year have been: the pursuit of yield, which has driven many of our large blue chips, such as the banks and Telstra, to historically high valuations; and secondly, the expansion of P/E ratios across the board without earnings growth. There are exceptions, but the reason interest rates are so low is that economic (and corporate earnings) growth rates in the developed world are weak. We, in Australia, have been blessed and avoided the worst but we are experiencing economic and earnings challenges.
This has led to the market moving ahead of earnings, partly driven by the pursuit of yield, and partly in anticipation of a pick-up in earnings. This, by definition, has made many stocks far riskier than they were when trading on lower multiples. I have always been reluctant to pay a premium in a stock for potential future earnings, as it has always proved difficult to forecast the future (and remains so).
So at the end of 2013 (or close to it), we at WAM find ourselves looking for value, as always, but finding less of it and sitting on quite large cash reserves waiting patiently for value to emerge, as it will in time.
I should add that the party-like atmosphere in the new float space that has engulfed the market in the last couple of months, has delivered few stocks for us to buy. There have been many new floats but few have stacked up in terms of value and quality for us.
Themes for the year ahead
To use a cliché, 2014 will be a challenging year…as they all are in our business. The market starts the year with a fair bit of growth expectation, so the odds of volatility remain high. We have seen a number of profit downgrades recently (QBE, Oz Minerals, Forge Group, Qantas, and GUD Holdings) that have disappointed the market and led to big sell-offs. I would not be surprised if we saw more in early 2014.
Next, as I wrote several months ago, I remain of the view that the Australian dollar should fall further (see Gary Stone’s charts today [1]). This will be positive for some parts of our market, but many of the beneficiaries have already had a lower Australian dollar priced in to their share price.
Interest rates are very low by Australian standards, with the cash rate at 2.5%, five-year government bonds at around 3% and 10-year government bonds around 4%. You can see why Telstra, providing a grossed up yield around 8%, is attractive to many investors.
I don’t have a strong view on where rates are going, however, there are early signs of improvement emerging in consumer confidence and business investment. If this trend gathers steam, we may have seen the bottom for interest rates.
Finally, another significant driver to the market will be net flows, simply put: investors allocating more of their capital to equities. I suspect this trend will continue, with huge cash deposits still sitting in bank accounts around Australia. Effectively, many investors (hurt by the GFC) have remained underweight equities and, unfortunately, will become ever more confident to return to the market as it goes higher. The old adage of buy in gloom and sell in boom is not followed by the majority. I suspect there will be further allocation to equities in the year ahead.
And finally
Having said all that, after a difficult start to 2014, the odds favour the broadly recovering market to continue its trend at a slower pace, with plenty of volatility and as always, plenty of winners and losers.
We at WAM will continue to look for high quality small and mid-sized companies with growth, which are trading at attractive value.
Merry Christmas and Happy New Year.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
Also in the Switzer Super Report:
- Peter Switzer: The rules for making money in 2014 [2]
- James Dunn: Eight stocks to drop [3]
- Gary Stone: “Little Aussie Battler” no more [1]
- Rudi Filapek-Vandyck: Buy, Sell, Hold – what the brokers say [4]
- Paul Rickard: Investing for your kids or grandchildren – part 3 [5]
- Penny Pryor: Property – what the market did [6]