The Aussie dollar is strong, our terms of trade are at unprecedented heights, and unemployment is at a two-year low. But what does the future hold for the Australian economy and our sharemarket?
In the past year, the mining sector has compensated for underperformance in other areas, such as construction. Of course, enthusiasm for the mining sector isn’t exactly shocking news. Indeed, it may seem lately that the job description of an Australian investment adviser reads something like: “Must be constantly able to find new and exciting ways to spruik mining shares.”
Yet how long and strong will this commodities boom go? Although most analysts express continued bullishness on resources, many are starting to encourage investors to diversify into other sectors with promising long-term horizons.
The coming year in shares
Shane Oliver, Head of Investment Strategy for AMP Capital, says, “After a major bear market ends the recovery in shares often goes through several stages: an initial rebound during the first year, a period of correction or consolidation in the second year and then a continuation.” This cyclical pattern would explain the “correction” in the charts that took place in the latter half of 2010. “Of course,” Oliver says, “markets don’t always follow a precise 12-month pattern, but if history is any guide this would suggest strong returns over the next six to 12 months.”
Craig James, Chief Economist at CommSec, echoes Oliver’s optimism. “Overall company profits are still outpacing share prices,” James said. “The gap should close by share prices lifting to meet the higher earnings, but of course the difficulty is working on when, and how quickly, this will occur. CommSec believes that a combination of solid earnings and a lower Aussie dollar will serve to drive the sharemarket higher in the second half of 2011. We are sticking to our view that the All Ordinaries/ASX 200 will be near 5,400 points by end year.”
Obligatory spruiking of miners
By taking a proactive approach to managing inflation, China may have sacrificed some of their projected growth. However, they have reduced the chances of a “hard landing” for the Chinese economy. With continuing demand expected from China and India for many years, and a watered-down proposed mining tax expected to have little impact, many analysts are picking resources stocks with confidence, particularly megaminers BHP Billiton and Rio Tinto. BT Investment Management portfolio manager Jim Taylor says, “We quite like the outlook for iron ore and coal at the moment and even the prospects for aluminium seem to be improving.’
Shane Oliver’s analysis of the latest profit reports confirms this good news. Oliver says, “The Australian December half-yearly profit reporting season was better than expected. Most importantly, profit momentum is still up to 67% of companies having reported a rise in profits for the year ago. Thanks to a huge surge in commodity prices which has boosted revenues even though overall mining production is subdued, resources companies have shot the lights out with 65% earnings growth over the year to 31 December. The mining boom remains alive and well and, if anything, strengthening with the terms of trade continuing to rise and set to further boost mining sector profits.”
Thinking outside the resources box
Ross Bird, head of equities strategy for Morningstar, identifies his preferred sectors for 2011 as energy, financials, materials, and information technology. Among his recommendations in these overweight sectors: Woodside Petroleum, ANZ, Westpac, National Australia Bank, BHP, Rio Tinto, Kingsgate Consolidated, Computershare, and Calesales.com.
Although information technology is forecast to experience limited earnings-per-share growth in 2011, EPS growth is expected to pick up significantly in 2012, exceeding 10%. Bird’s fellow Morningstar investment guru, portfolio manager Frank Gannon, provides this insight:
“Tech stocks in general have been very inexpensive for several years-they’ve essentially been in a 10-year bear market, which has allowed us to find what we think are extraordinary opportunities in companies across a variety of industries.
Many companies have deferred normal technology upgrades due to the difficult economy, but upgrades are inevitable because ultimately no business can afford to fall behind in technology. In addition, there is growing demand for all types of technology in emerging market countries that simply did not exist 10 years ago.”
Not all experts are buying into commodities for the long haul. Says Merrill Lynch Australia strategist Tim Rocks, ‘We are much more comfortable taking exposure to energy stocks as opposed to stocks with predominantly bulk commodities. If you look at the energy intensity you can see China’s energy intensity is very, very low by the standards of the developed world, so it has much more further to go. We think that steel intensity is not as strong. Even BHP are expecting growth of 2-5 per cent over the next 10-20 years in steel intensity and we think the upside to energy is much, much higher.’
Looking ahead, Bird also takes a broader perspective. “Healthcare is a strongly growing industry over the long term, allied with an ageing local population, increased community expectation of improving medical care standards, a sound economic footing to fund these requirements.” In addition, Bird says, “The Construction and Engineering sub-sector is expected to participate in the very large capital expenditure program forecast for 2011 and beyond.” Bird’s picks for healthcare: Ramsay, Sonic, and Cochlear.
However, Tim Baker, head of equity strategy for Deutsche Bank, says, ‘After many years of stellar growth, healthcare sector earnings have slowed substantially, due to the high Australian dollar, health funding cuts, and the maturation of some markets.’
Baker’s analysis underscores the “dark side” of the export-based mining boom: its effect on the domestic economy.
Oliver also notes, “Only 37% of companies have beaten expectations. Clearly the uncertainty over the domestic economic outlook has weighed on corporate confidence. Reflecting this, analyst revisions to earnings expectations have generally been negative in Australia.”
As Prime Minister Julia Gillard observed in a recent interview, “I’m very conscious that a strong Australian dollar has benefits and it has burdens.” In addition to healthcare, sectors burdened by the rise of the Aussie dollar include manufacturing and tourism.
Yet if Oliver’s historical analysis is correct, Aussie shares are due to climb soon. Whether you’re looking at reaping momentum profits in resources or taking a longer position in a defensive sector such as healthcare, staples or utilities, this might be as good time as any to invest in the stockies. Next week, we’ll focus on the Construction & Engineering subsector – a beneficiary of the mining boom.