What now for stock selection?

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Long term SMSF investors probably knew instinctively the recent downdraught in world stock markets caused by the overdone reaction to news on the US Federal Reserve’s plans, was almost certainly a buying, not a selling, signal. This was accentuated by some market commentators’ doubts about China’s economy.

There were some subtle differences, however, in the market climate: the upward pressure on the US dollar and the downturn in the Australian currency. This may mean some changes in local investors’ strategy if, as many suspect, the exchange rate shift temporarily makes overseas investors sellers rather than buyers of Australian stocks. In addition, the China factor has cast a temporary pall over major resource stocks.

Focus on stock picking

For long-term investors, the new circumstances merely reinforce the need to concentrate on selecting local stocks, which provide safe, growing income. In short, this is a time to look again at selecting the right stocks, rather than an asset allocation decision to reduce exposure to the stock market.

The changes in markets, however, do underline how new conditions can alter the emphasis on stock selection. In the changed circumstances, companies exposed to the world markets (especially the US) now have an extra attraction. Companies earning a large part of their income from the US, like the now separate News Corp stocks, insurer QBE, share registry and corporate servicer Computershare, and blood serum group CSL, all look more interesting if the $A continues to weaken against the $US.

There is still the need for income stocks, so the usual stalwarts – the banks, Telstra, Wesfarmers, Woolworths – will remain in favour, since the overseas worries don’t appear to alter their appeal. In fact, if bond interest rates keep rising as a result of the potential change in the Fed’s approach, this merely reinforces the need to seek good yields on shares.

While these stocks have retreated sharply since May, the banks are still between 25% (NAB) and 36% (Westpac) above their financial year lows at recent prices, while Telstra is still about 25% above its low a year ago. The banks are now yielding between 5.2% and 6.5% and Telstra 6.0% – without the gains from dividend imputation.

Value proposition

Among stocks re-emerging because of the US recovery and exchange rates, Amcor is still about 45% above its year low and CSL and QBE are now selling at around 60% and 50% respectively above their lows. All this demonstrates the benefits of buying good stocks when they are temporarily out of favour.

Investors also shouldn’t overlook the attractions of leading property stocks, with most of the major REITs forecast to edge up distributions to maintain yields of 5% to 6%, albeit without the advantages of imputation credits.

The scares over China are spooking some investors in resource stocks and leaders BHP and Rio Tinto were pushed back to around their 2012-13 low points. This mood change may be more permanent but both companies have strong financial resources and buying such leading low-cost producers should pay off, long-term.

In general, investors with a long-term portfolio can ignore the wild swings in the market’s mood to concentrate on blue chips, which still offer after-tax returns twice that of bank term deposits – plus the ability to provide a hedge against rising inflation.

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.

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