Head of Portfolio Management
When investing for the long-term, it is important to be aware of the macro-economic backdrop and its implications on investment performance. However, those investors who are able to assess these events in the context of their long-term investment goals, and who can remain focussed on the important investment fundamentals, will ultimately win out.
Investors who stayed invested during the March quarter were once again rewarded as global shares hit highs not seen since 2007. Although the continued upward market trend has brought shares closer to ‘fair value’ we believe there is still scope for further upside as we enter a more normal and constructive investment environment. As economic growth begins to stabilise and valuations remain attractive, a baseline for better times is slowly being created.
Markets are no longer fixated on headlines
In our last update in January we noted that the economic backdrop had become ‘less risky’, leaving room for the market to focus on fundamentals.
We predicted that headline news would have less of a stronghold over financial markets, and global growth in 2013 should be positive, though lower than that experienced prior to the Global Financial Crisis.
As we move further into 2013, the investor confidence we saw emerging in late 2012 has continued. There seems to be a consensus building that economic growth is stabilising, that inflation is not much of a concern, and that the risk of a meltdown in Europe is gradually receding. Markets no longer appear to be fixated on daily headlines and global macro developments. Indeed, the relatively muted reaction by markets to the messy bailout of Cyprus is evidence of this.
While the risk of another flare-up in Europe hasn’t disappeared, it does appear to have diminished. However, there are concerns that the Eurozone and the region’s weak economic profile will continue to be a drag on global growth in 2013, and from time to time problems will likely resurface creating angst in markets. In the US, the pace of economic growth remains moderate, but there have been encouraging signs that the recovery has become more self-sustaining. Trends in employment, manufacturing, consumer spending and housing have generally been favourable.
Have share markets plateaued?
The strong bounce in share markets for the past two quarters has left some commentators asking whether the market has run its course. Although valuations are closer to ‘fair value’, we believe there is scope for further upside in Australian and global shares. The forward price to earnings multiple, as shown in the chart below, has only increased to around its long term average, indicating that shares remain attractive. (The forward price to earnings multiple is a measure of how cheap or expensive shares are. It uses forecast corporate earnings to measure the market’s valuation of a company compared to the income the company is expected to generate.)
Also, we shouldn’t forget that, prior to the market rally, markets were fully reflecting the prevailing macro-economic anxiety. Consequently, markets were positioned to rise if developments did not turn out to be as bad as anticipated. One example of a stock that has risen particularly well is JB Hi-Fi. Investors had previously mis-judged the threat to retail sales. The share price rose more than 40% during the first quarter of the year reflecting the fact that sales prospects were nowhere near as bad as people had come to fear.
Active management will remain important While the mending economy should result in better returns for
While the mending economy should result in better returns for investors, active management will remain critical as these returns are likely to be constrained, volatile and lowly correlated.
The tendency for all shares to move in lockstep with each other, regardless of company fundamentals, has diminished. As a result, this should afford greater opportunities for active managers to outperform the broader market. The chart below reflects the average correlation across sectors of the S&P/ASX 200 Index, and shows that correlations have fallen in recent months. Within the share segment of the diversified portfolios, we have increased our allocation to active management strategies. Strategies such as ‘long-short’ fully enable a manager to express their views on individual stocks; they can benefit from rising and falling markets by sourcing profits from both positive and negative share price movements.
We remain in an environment of historically low bond yields, but it is important to remember that a well-diversified, actively managed bond fund continues to play an important role in a client’s overall investment strategy. Not only can exposure to bonds help protect a client’s investments from the risk of capital loss, but bonds act as an important diversifier for investors who also have an allocation to shares. The need for an actively managed bond strategy will remain key, and different market conditions will favour different types of investment strategies. For example, the diversified portfolios have added a ‘floating rate’ investment within the Australian bond segment in order to limit interest rate risk.
Exposure to the Australian dollar and foreign currencies also acts as an important diversifier. The Australian dollar tends to trade on global growth, so foreign currency exposure can provide a hedge when markets weaken on global growth worries. Although quantitative easing has been positive for the Australian dollar, as the mining boom within Australia fades, and higher rates in the US become an increased focus, there will likely be less support for the Australian dollar going forward.
Stay focused on achieving your long-term goals
The market continues to show us that it is difficult to accurately forecast short-term market movements. For investors who need growth over the long-term, they should remain invested in growth investments, and be prepared to ride the ups and downs that naturally happen over short time horizons. The diversified portfolios continue to be fully invested in shares, and we see no obvious red flags in terms of our expectations of share market performance. Investors who are prepared to stay invested in their actively managed balanced fund can expect to achieve high single digit returns over a medium-term horizon, with the strongest contributions presently sourced from the domestic and international share portfolios.
1 Compendium of Workers Compensation Statistics, Australia 2010-11 (SafeWorkAustralia.gov.au)
2 Compendium of Workers’ Compensation Statistics, Australia 2010-11 (SafeWorkAustralia.gov.au)
3 ABS, August 2011 – 6310.0 – Employee Earnings, Benefits and Trade Union Membership Australia
Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.