Market Update March 2014

Despite a continuation of good returns for growth asset classes, farrelly’s consider that markets are back around normal levels, which means that most assets are still around fair value except for the US which is close to fully-priced as S&P500 approaches the 1900 level.  However, this means that we should expect much greater volatility this year, despite shares looking by far the most attractive asset class for this year.

Correlations between asset classes are widening again, which is more common as the GFC crisis fades, when all asset classes moved together and fell across the board as they tend to during extreme events.

Best value currently appears to be in Australian equities and emerging markets outside the so-called “Fragile Five” of Brazil, India, Indonesia, South Africa and Turkey.  In particular, Asia ex-Japan is looking more attractive after last year’s emerging market falls, for both equity and debt investments.

Rather than placing too much reliance on short-term forecast and trying to pick next year’s top-performing asset class we recommend rather diversifying across a range of asset classes, in line with your risk tolerances and desired outcomes, seeking to avoid buying assets when they are fully valued and trying to top up on assets while they are cheap to fairly valued.

Australian shares

Australian shares gained nearly 5% in February after the January falls, lifting 12 month returns to 10.6%.

IMR_2014-03-5The market was boosted by improved company earnings, the release of reasonable economic data and interest rate sensitive sectors (retail and housing) continuing their recovery from the second half of 2013.

Stronger earnings from mining and building materials particularly supported market performance.

With the ASX-200 level index around the 5350 level the Australian market is at the low end of ‘fair value’ (with expected 10-year returns around 9.7%pa) at that level on a ten-year view.

The Small Cap accumulation index also gained just under 5% in the month, taking returns to -3.62% for the last 12 months.  The small and mid-cap areas are where better growth prospects are expected by several value-based fund managers.

International shares

International shares bounced back strongly in February after a weak January, buoyed by broad economic recovery and extremely low interest rates, rising around 4% in the US, UK, and Hong Kong.  Besides the US, developed markets still appear to offer fair value and still worth investing in at these levels.

The US market reached new highs despite ongoing uncertainty about the timing of the Fed’s tapering and growth momentum in 2014 and concerns about the impact of the Crimean dispute.IMR_2014-03-7

The world ex-Australia is now up 22% over the last year in local currency but up 40% in Australian dollars due to a 13% depreciating of our currency against the US dollar and $21% against the UK pound.

Emerging Markets also rose in February, by 2% after falling 4.5% in January overall taking 12 month returns to only 7.5% in Australian dollars, but country returns have wide differences resulting from  relative exposures to the US Fed tapering effects and different prospects for growth, profit margins and return on equity.  Emerging Asia, for example, was up 10% in February while Greece was up 17% for the month and up 45% for the last year.

Opportunities are beginning to look more favourable for investing in northern Asia (ex-Japan) after last year’s corrections, but despite cheap prices it is generally considered too early to invest in the “Fragile Five”.

Listed Property and Infrastructure

The S&P 200 Australian listed property index rose 3.3% in February but was down -1.9% for the year due to the sector’s sensitivity it interest rates.

Signs of improvements to the domestic economy should flow through to better earnings for the sector.   The expected return differential compared to Australian equities has now narrowed, so it probably makes sense slightly increasing allocation to this sector.IMR_2014-03-9

Global property trusts rose 4.75% in February on top of 2.45% rises in January lifting f year annualised returns to 26.94%.  Global property now has yields of only around 3% and PE multiples of around 30x, so looks very unattractive compared to Australian trusts or listed infrastructure.

Global infrastructure rose 4.38% in February lifting returns to 18.5% for the last 12 month s and sector favoured by large Australian super funds seeking inflation-linked income to meet future pension liabilities.

Fixed interest and Cash

The RBA held cash rates at 2.5% again in March as is expected to remain at that level for the rest of the year with Australian Fixed Interest returns overall returning around 2.7% for the financial year to date, only slightly above cash at 1.8%IMR_2014-03-8

Bonds were steady in general with US 10 year bonds at 2.6% and Australian 10-year bonds at 3.95%, with some commentators quipping that these traditionally risk-free asset have now switched to become return-free risks.

The UBS composite bond index, covering both government and corporate bonds in Australia, fell a marginal 0.34% in February after rising 1% in January to lift year on year returns to 3%.

One year Term Deposits remained unchanged below 4%, while three to five year deposits are still an attractive place to invest the secure-debt part of portfolios and remain at premium to bank bills when they were at a discount pre-GFC.

For those investors remembering the recent past with rates of more than 6% should take heart they are not facing the sub 1% rate for investors in places like the US.  While cash rates are more likely to rise in future, TD rates are expected to still reduce further, so it may still be worthwhile locking in 5 year TDs that will hopefully mature once rates have started rising again.

Alternatives

We are now beginning to start looking at alternative assets again for when the time is right: over the last 5 years equities markets have been cheap and performed strongly to move up to around fair value.  That means we may soon be in a market environment where traditional assets are fully priced or even expensive.  If that happens, alternatives like hedge funds, direct property (commercial) gold and other commodities may have a more useful role to play.

 

However, diversification benefits only come where the addition of an asset to a portfolio gives higher than expected returns for the same level of risk or the same returns with less risk.  Past returns are usually an extremely poor guide to the future, but understanding where past returns have come from is extremely useful for developing an expectation about future returns and risks.  In particular, we need to be wary of assets classes that have been subject to a substantial increase in new money.

 

For more specific help and guidance with your own investment strategy or asset selection, please don’t hesitate to contact Michael Rees-Evans CFP® in our office on 02 9299 7044 or by email at michael.rees-evans@lockwood.com.au

 

Important note: this information is based on opinions and information obtained from various sources deemed reliable, especially 1AMP Capital, farrelly’s, the Pain Report and van Eyk Research, with graphs sourced from Bloomberg and van Eyk.  However, it is of a general nature and has been prepared without taking account of anyone’s financial situation, objectives or needs. Before making any investment decisions based on the contents you should obtain professional advice. 

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