Readers of this column will know I have been bullish on equities since last year; first with a call to increase exposure to international shares in developed market; then by adding more local property and housing-related stocks to portfolios. Both themes have so far worked well.
My bullishness is based on two key drivers for equities: earnings and interest rates. The market is in the second of three stages of a bull market – rising corporate earnings, as seen in the latest interim corporate profit season – and still a long way from the final stage of investor euphoria.
On interest rates, I cannot see the Reserve Bank lifting the official cash rate this year. The stronger-than-expected gross domestic product reading of 3.5 per cent year-on-year growth belied a soft outlook for Australian households. Rates could be on hold well into 2015 if sentiment remains weak.
Offshore, the US Federal Reserve is likely to start hiking rates in 2015. History shows that equities returns are typically strong in the lead-up to the increase (when rates are super low) and start to taper as rates are gradually increased over the cycle.
Macquarie Equities Research in May found US stocks had posted an average return of nearly 20 per cent in the year leading up the first Fed rate hike, since 1954. “Cyclicals also tend to lead the market, and at this point in the cycle we favour financials, industrials and technology,” it wrote.
If this scenario pans out, there should be decent equity returns this year and solid, although lower, returns later in 2015 and 2016. By this time next year, savvy investors could start to trim equities exposure, or move from cyclical stocks to defensives such as healthcare and consumer staples.
Although the trend is up, short-term volatility in Australian shares over the next few months would not surprise. The tough Federal budget has clearly affected consumer sentiment and retail sales growth, judging by some recent profit downgrades in the sector.
As I have written before for The Bull, any sharemarket pullback or correction this year would be a buying opportunity to capitalise on expected double-digit equities returns in 2014-15. I still favour US equities, domestic housing stocks and, increasingly, financials.
Mid-cap wealth-management stocks such as Magellan Financial Group, BT Investment Management, Platinum Asset Management and Henderson Group Plc appeal. None of them are cheap, but recent price weakness after strong gains provides a better entry point for medium-term investors.
Another option, which I consider separately for The Bull this week, is listed investment companies that specialise in international equities. Some high-quality LICs are trading at small premiums or even discounts to their pre-tax Net Tangible Asset (NTA) and are worth watching.
The wealth managers have four main attractions. First, they have strong leverage to the trend I mapped out above – firmer equity markets in 2014 and 2015. Rising equity markets increase the size of their assets under management and typically lead to higher funds inflows.
The second reason is the nature of these wealth managers: Magellan and Platinum specialise in international equities. BT Investment Management has a mix of Australian and internationally focused investment products, and Henderson invests across a range of asset class. Those seeking higher exposure to international equities might find it easier to invest in prominent fund managers that manage these assets than owning shares or funds directly.
The third reason is performance. Magellan’s strong outperformance in recent years has attracted huge funds inflows, swelling its management fees. Although the portfolio has recently underperformed, Magellan is clearly a star international equities manager.
The doyen of international equities managers, Platinum, has improving portfolio performance after an average period by its standards over three years, and BT Investment Management is coming off a strong year.
The larger UK-based manager, Henderson Group, has also had strong fund outperformance, with 78 per cent of its funds beating their benchmark index over one year, and 82 per cent beating theirs over three years. Henderson is enjoying higher fund inflow as a result.
The fourth attraction of the wealth managers is recent price weakness. Magellan has fallen from a 52-week high of $14.38 to $11.59 after stunning gains in the past two years. Platinum has dipped from a yearly high of $7.75 to $6.49. BT and Henderson are slightly off their highs this year, after strong gains.
Value investors will find it hard to buy these stocks at these levels, particularly BT. Morningstar rates Magellan, BT and Henderson a hold, and has an accumulate recommendation on Platinum.
Macquarie has outperform recommendations on Magellan, Platinum and BT. It expects a 12-month total shareholder return of 23 per cent for Magellan, 19 per cent for Platinum, and 18 per cent for BT, based on its June 2 analysis. Magellan is Macquarie’s top pick.
Of those, I favour Magellan and Platinum. Both are “go-to” international equities managers for advisers (particularly Magellan in recent years) and have excellent leverage to continued gains in global markets in the next 18 months. Platinum offers the best value.
Both stocks should be on portfolio watchlists in anticipation of improving value in the next few months as local sharemarket volatility increases. Continued price weakness would provide a buying opportunity in both stocks for investors with a two-year outlook. Although the big gains in wealth managers are over for now, this trend still has further to run.
Tony Featherstone is a former managing editor of BRW and Shares magazines. The column does not imply any stock recommendations. Readers should do further research of their own or talk to their financial adviser before acting on themes in this article. All prices and analysis at June 11, 2014.
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