The Market Wrap 17-2-2012

By Jason Fittler

At present the average investor has three major fears.

  1. European Debt Crisis
  2. Australian Dollar
  3. Interest Rates

Will the European debt crisis send the world into another GFC as credit tightens? 

This seems unlikely. 

The issue is understood and measures are being put in place to control the fall out of this crisis. By no means will this be fixed overnight and it will have an effect on the people living in that region of the world but I do not expect to see another GFC type event. 

To put it in prospective the GDP of Greece, Spain and Italy together adds up to $4.2 Trillion the USA has a GDP of $14.5 Trillion, it would take all of the countries in Europe to falter before it became a GFC size problem. 

Is the Australian dollar too high?

Yes, the Australian dollar is simply too high and is now starting to come off the boil. Chris Caton from Westpac is expecting to see the Australian dollar back below $0.90 by the end of the year.  

This is positive for our export industry, which at this time is mainly iron ore to China. This will bring more stability back into our domestic markets. 

Will interest rate go lower? 

I expect that monetary policy be almost used up, as such I do not expect interest rates to go below 3.75%. 

The Reserve Bank has kept these on hold for now; the big four have increased their rates to counter the increase cost of capital. There is a lot of pressure from the Government to keep rates low. At present, the rate is 4.25%, during the GFC the rate went as low as 3%, we are limited to the amount, which the rate can be reduced. 

Further falls in the interest rates will not see the housing market recover. The housing market is driven mainly by employment and availability to repay loans. 

At present the rules around lending have tightened and clearly unemployment will increase over the coming twelve months… as such I do not expect to see the housing market improve in the near future. 

Lowering interest rates will also see foreign investment slow as they seek better return elsewhere, this again will reduce the funds available to the banks. 

Is our market is cheap?

This year the Australian share markets had a good start with a 5% gain in January, statically this points to an up year for Australia.  

When we take a long-term view it is clear that our market is the cheapest it has been since the late eighties and early nineties with PE’s trading around 10.8 times. The average historic PE for the market is 15 times.  

Fair value for our market is around 5000 points; it is currently trading at 4300.  Although we cannot say when the market will recover what we can say is that now is a good time to start buying with a long-term view. 

Australian companies have gone through the re-capitalization process; they have reduced debt and dividends and are now looking to improve productivity. The first step towards better productivity is to reduce the work force; we have already seen announcements across all industries in Australia in the next 12 months. 

This in my book is a positive for the investor, it will make companies more profitable; provide better cash flows and higher dividends. 

At present our model portfolio is returning a gross income of 7.5%. 

High dividend provides two benefits.

  1. The price of the stock will increase over time as investors look for a better return than with term deposits.
  2. Your investment is paying a far better return than similar cash type investment, while waiting for the capital growth to kick in.  

The chart (below) highlights the market over the past 6 years. 

The market as made a significant recovery from the lows of 2009. Over the last 6 months you will have noticed less volatility and slower growth then seen in previous periods. The market is moving up at a slower rate, which indicates that investors are moving out of cash and slowly back into Australian shares. 

As interest continues to fall over the coming year I expect more investors will leave the safety of cash in search of a better return pushing the market back towards fair value.

I expect to see the market back above 4500 points in the coming 12 months.  

There is strong support for the market around the 4000 points mark as such any downside would be short lived.