Despite ongoing global growth concerns and a wobbly local economy, the Australian share market managed to end last year surprisingly well. After a rocky first half of the year, the market overall was up 14.6%, and closer to 20%, once dividends are included.
What sector themes drove the market, and what’s the outlook for 2013?
On the downside, if there was one sector theme that most marked Australia’s 2012 performance, it was the relatively poor results from the resource sectors. The energy sector dropped back 2.6% last year, while the materials sector (which includes our major mining stocks) rose only 1%.
Clearly, the introduction of the carbon tax took its toll on the energy and material sectors, as did the slow down in China’s economy and weakening in commodity prices. America’s shale oil supply boom is also leading to fears about long-term global gas prices.
Poor sentiment for mining and energy stocks was also reflected in the third worst performing sector – industrials – which contains a lot of mining service firms hurt by rising project costs and a prospective slowdown in the mining investment boom. The industrials sector rose by only 6.4 % last year.
By contrast, with interest rates low and the domestic economy sluggish, nervous investors chased yield and relative earnings security.
Defensives such as health care and telecommunications did especially well, rising by around 45% and 30% respectively. Other defensives also did well, with consumer staples and utilities (despite the carbon tax) rising by 20% and 15% respectively.
Investors were also attracted by the relatively high dividend yields still available in the financials sector – which rose by 21% – along with listed property, which rose by 25%. But even non-resource related cyclical sectors, such as consumer discretionary and information technology, rose by 15% and 20% respectively.
The question for 2013 is whether we’ll get a switch back to resources and/or cyclicals, or the chase for yield and relative safety will continue.
In regards to resources, America’s shale oil boom is here to stay, which should continue to make investors nervous about growing the long-term energy sector outlook. On the positive side, China’s economy ended last year picking up speed, which together with supply-side disruption in India, saw iron ore prices rebound strongly. Following their investments in new capacity, our miners are also starting to boost export supply.
That said, some of the current disruptions to global iron ore supply appear temporary, and rising global supply should temper commodity prices as the year progresses, even if the Chinese economy remains strong.
All up, given China is looking perkier and the carbon tax is bedded down, the energy and materials sector should do better this year than last year – but due to long-term commodity price concerns, they might again struggle to be among the sector outperformers.
Given the likelihood of further cuts in official interest rates, an eventual pick up in credit growth should continue to favour the banks – as will the likely continued “chase for yield” given reduced returns from fixed income products and bank deposits. Note that the banking sector ended last year with a gross dividend yield at a still attractive 6%, and recently proposed new capital requirements don’t look like being as onerous as once feared.
More generally, with the Australian economy responding only sluggishly to interest rate cuts so far, a defensive high dividend producing sector like telecommunications (i.e. Telstra) seems well placed to keep doing well – even though on traditional price to earnings metrics the sector is starting to look expensive. Encouragingly, apart from telecommunications, other defensive sectors – along with cyclical sectors – ended last year not all that far from long-term average price-to-book or price-to forward-earnings valuations.
The market is no longer cheap, but not overly expensive either.
The telecommunications sector ended last year on a price to forward earnings ratio of 14.6 – relative to a decade average of 12.8. At 6.4%, the sector’s dividend yield was also a bit below its long-run average of 7%, but in today’s low interest rate environment and given sluggish local economic growth, the sector may well benefit from a yield based re-rating. What’s more, whoever wins the next Federal election, Telstra seems well placed to extract benefits from the new National Broadband Network (NBN).
By contrast, with household debt already high and new-found consumer caution, cyclicals might also do OK, but still struggle to outperform the market.
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