Looking across the investment landscape for clear winners and losers is not a simple task, with more grey than black and white coming into view. While performances are better than recent years, Jason Spits writes that managers remain quietly confident that the low points of the past may be behind them.
International Equities – shooting the lights out?
To affirm that international equities had a solid 2013 would be an understatement, according to Mercer chief strategist David Stuart, who stated the sector “had shot the lights out for two years running”.
According to data gathered by Mercer international, equities returned above 32 per cent for the past two years on the MSCI World ex Australia index; however Stuart is cautious in his optimism regarding the sector.
“What took place in 2013 to push the markets to this level was actually a re-rating of the market which moved it ahead of actual earnings growth, which was not at 30 per cent.”
This re-rating was the result of growing confidence that the economic recovery in the United States would be robust and self-sustaining, according to Stuart, who said that fund managers believed the private sector was recovering while the government sector was less of a drag on the recovery.
“The current levels of growth in the US are the highest seen since the global financial crisis (GFC) and it is the leading global market. Europe, on the other hand, is recovering but at more modest levels of performance and returns,” he said.
Stuart said that international equities benefitted from continued low interest rates around the world, while many asset classes appeared to be close to fully valued, with bonds yields at close to peak.
Rather than looking at the past two years, Stuart said a longer-term view was required of the sector which was in negative territory as recently as 2011.
“The 10-year return was 8.6 per cent which is what you would expect from international equities, with the last two years being what could be considered as catching up on the losses stemming from the global financial crisis,” Stuart said.
“The starting points in these recoveries matter and 2012 was the year people started moving away from fear and back towards greed.”
Sector performance was also an important factor in the performance of international equities. Stuart cites the first discussions about tapering by the US Federal Reserve in May 2013 as the beginning of a shift away from defensive and yield stocks to cyclical stocks.
“At the time it ushered in a period of volatility but prior to that the focus had been on bonds, credit and high yield credit investments. Since May 2013 the focus has moved towards investments that are leveraged toward the economic recovery.”
While these have typically been cyclical stocks, Stuart said the switch had not happened across the board and there have been some laggards – particularly energy and commodity stocks.
“The commodity super-cycles of the past will not repeat as growth has stabilised in the developed world and growth in emerging markets has slowed, while more supply is coming in,” Stuart said.
Instead, he said attention had turned to technology sectors, particularly those associated with social media, which are starting to reach full valuation – resulting in fund managers pulling back from the sector.
“Valuations in the social media technology sector were getting ahead, but growth in that area cannot go on forever. Some stocks, such as Google, are diversifying into other areas, but valuations are fairly rich in a sector that can change quickly.”
Australian equities – local hero
Local investors who stayed onshore may be feeling pleased with the 13 per cent return the local index generated in 2013, but IOOF Australian Equities portfolio manager Daniel Farmer said that compared to international equities (see above) the local market missed out.
“The absolute numbers are good but not as good as other markets and when looking at valuations they are getting close to full, but not too overvalued,” Farmer said.
While the usual suspects of banks and resources stocks continued to provide returns, Farmer said it was the areas of consumer discretionary spending, construction and healthcare that have performed well in the past 12 months.
He said each of these three areas had grown since the GFC and will continue to grow due to demographic changes, increased demand and earnings potential.
Farmer said the growth of the healthcare sector came from utilities – beds, housing, etc – as well as innovations such as new treatments and methods, with some stocks reasonably priced.
“The demographic has and will continue to drive growth, with returns coming from traditional stocks which supply the sector as well as the specialised stocks within that space.”
On a wider basis, Farmer sees the local equities market as having moved through the recovery space and normalised away from post-GFC sentiments.
“Trading has normalised and active managers are again doing well, with the median manager above the benchmark. Volatility is also low and there is no expectation of shocks or the need to sell off in the near future,” Farmer said.
“However the large gains seen in recent years are not likely to be seen again. Defensive stocks have been the stars but they have been priced up and are starting to lag and the market has shifted to cyclical stocks again.”
T. Rowe Price Australian Equities head Randal Jenneke said while the usual large cap stocks such as banking and telcos did well, the small cap sector was hit hard and fell by 1.5 per cent in terms of absolute return.
Jenneke said this was the result of a number of smaller resources stocks in the small cap sector being hit harder by the slow-down in commodities compared with larger players.
At the same time he said that while retail stocks had bottomed out in some areas, their return had been strong, with some investors too negative on the state of the economy and the impact of interest rate rises.
“Retail stocks have come back by more than 50 per cent and we should continue to see retail, advertising and residential property continue to climb.”
Fixed income – staking a claim
The fixed income sector found new fans during the 2013 calendar year, with fixed income managers taking some of the limelight normally reserved for equities managers.
AMP Capital Global Fixed Income head of credit and core, David Carruthers, said that fixed income investments produced excess returns in 2013, due to ongoing ‘technical’ shifts in equities markets.
“Global central banks continued to flood the market with liquidity, via quantitative easing, and forced investors into the risk spectrum and areas of downside risk,” he said.
“As a result Australia was considered an attractive place to invest and domestic demand increased, with investors de-allocating funds to move them into fixed income investments.”
According to Carruthers the activity was not restricted to the top end of the market. Triple B-rated issuers did well during 2013 while the market for corporate issuances was strong.
“There was more openness to the raising credit in Australian dollar terms and the breadth of investors also widened with more local and offshore investors.”
Carruthers said the ongoing demand for high yield resulted in a rally of credit spreads and good total returns in the triple B-rated sector as the Reserve Bank of Australia (RBA) continued to manage the transition of the local economic recovery.
While the RBA steered support toward consumer and business growth, Carruthers said the market had priced in the likelihood of no further rate cuts for much of this year and was looking at how the interest rates cycle would finish.
“The aim at the end is to protect fixed income assets, and if growth is stable but not too fast then that is good for credit markets. The risk is that growth will move quickly and create volatility like that seen in the United States in May last year,” he said.
According to Carruthers, the initial talk about tapering caught markets offside – with an interest rate sell-off creating instability, pushing rates up, widening credit spreads and impacting capital flows.
“The US Federal Reserve had to monitor cash rates against its quantitative easing program and the market become comfortable with what was going on, but since then the demand side has not been as strong as the growth side.”
Carruthers said that Europe had yet to go through these issues as it still lagged behind across the board, but there were some strong growth opportunities in Italy, Greece and Spain.
“During May and June last year there was a shift of funds from emerging markets back into Europe at both the core and periphery, with funds moving into capital markets instead of the banking system,” he said.
“However Europe will remain stagnant for some time due to the differing government policies across the region.
“Yet it still remains a topical area to invest because central banks have begun to agree to adopt unconventional measures and introduce quantitative easing to promote growth and avoid deflation.”
Property – steady as she goes
Listed property also had a solid year in 2013 according to AMP Capital Head of Australian Listed Real Estate Mark Ferguson, with the residential and industrial sectors leading the commercial sector.
Ferguson said that while Australian Real Estate Investment Trusts (REIT) posted a total return of 7.1 per cent on the S&P/ASX Property 200 index, it was less than expected. It was also well below that of equities, with the S&P/ASX 200 index returning 20.2 per cent for the 2013 calendar year.
“REITs with strong industrial exposure did well and will continue to do so because of interest from overseas investors and particularly from those who wish to invest in Australia and cannot access direct property investments,” Ferguson said.
Overseas interest also boosted residential property markets. Ferguson said there had been an influx of Asian investors into the residential property sector, which had undergone a shift in focus during 2013.
“There has been a structural shift in the types of property on offer in the residential sector, particularly in Melbourne and Sydney, with a move to medium-density housing becoming more attractive,” he said.
“These properties have greater saleability and access to social amenities and are appealing to baby boomers who are downsizing, as well as to the influx of Asian investors who are keen on investing in this type of property as well.”
Ferguson said while the demand for medium-density housing close to city centres had seen some B-grade offices converted into housing, there was concern that development might flood the sector.
“There has been undersupply in this area for years, but we remain wary that the catch-up may in fact become an oversupply,” he said.
Increased levels of savings by those already invested directly in residential property – that is, mortgage holders paying off greater levels of their loans – has in turn led to people becoming more willing to increase their discretionary spending, according to Ferguson.
“House prices have been paid off but we are not yet seeing people redirect equity just yet with confidence related to employment security. We do expect retail [REITS] to push upward towards the end of this year after a large number of retail REITS under-performed last year,” Ferguson said.
At the same time non-discretionary retail has continued to do well – particularly in regional areas – as will industrial property investment related to retail growth, with warehouse and distribution spaces generating good rental growth, according to Ferguson.
Commercial property, however, will continue to remain out of favour for some time, according to Ferguson, who said any growth in returns would be further down the cycle.
While he admits property will be impacted by any possible future rate rises, Ferguson said it was well positioned for future changes.
“REITS underperformed equities last year due to the level of quantitative easing which took place around the world. However property is positioned to do well when the yield curve drops or flattens.”
