The 2010 Investors Mutual Advisor Briefing was held nationally in all mainland state capital cities in March and April 2010 and addressed the theme:
“Has the storm passed? Challenges and opportunities for investors in 2010.”
In the sessions IML investment director Anton Tagliaferro, senior portfolio manager and head of research Hugh Giddy and equities strategist Paul Winter mounted a case that the worst of the Global Financial Crisis storm has passed – but that the recovery will be both long and slow.
Clearly, the mood is much more optimistic than it was at the same time last year in 2009, when the global financial system seemed almost broken. Back then, with credit markets frozen, many major financial industry names either having collapsed or poised on the brink and most of the sharemarkets having halved as investors rushed for the exits, optimism was in short supply. But with global governments and central banks having mounted massive rescue missions through co-ordinated programs of monetary and fiscal stimulus, 2010 has dawned with the global economy picking up, although plenty of risks remain.
Stimulus has driven much of the recent economic strength
In IML’s view, much of the recent level of economic activity has been driven by government stimulus, which cannot go on indefinitely. At some point, the real economy must show that it can rebound without government assistance. Although this recovery is happening, it is in its infancy, and moving to more sustainable economic resurgence is likely to prove both a slow and protracted process.
In a similar vein, the pronounced recoveries in equity and credit markets seen in the developed world over 2009 and into 2010 have been helped by huge fiscal spending, global interest rate cuts and guarantees of trading banks by governments and central banks. While markets have stabilised and investor confidence has recovered, a climate of slower growth and still-present uncertainty prevails, in which investors face both lower returns and higher volatility.
In searching out companies that can lead the recovery, IML believes that good-quality small-capitalisation stocks with attractive valuations – classic “value”-style investment candidates with pricing power, healthy balance sheets and a policy of paying out profits to shareholders – will prove the most rewarding investments as markets slowly consolidate their recovery.
IML believes this is not some kind of new paradigm: it was in fact the way things were before the great credit bubble of the 2000s loosened investors’ reliance on fundamentals.
Dividends likely to be a bigger part of total returns
Over very long periods of time, dividends have generated just over half of investors’ total return: this proportion fell to less than one-third over the last 25 years, but IML believes dividends will return to their usual importance from this point. The beauty of focusing on strong dividend-paying companies is that they usually exhibit far less volatility – an attribute even more attractive than usual in the current market environment.
Globally, investor concerns are focused on the weak “jobless recovery” in the USA, the fragility of the European recovery – not helped by the budget deficits and consequent sovereign debt market slumps in several European nations – and the sustainability of the 8 per cent-plus economic growth reported by China.
In Australia, investors have to deal with fading fiscal stimulus and rising interest rates, but they do so from a standpoint of still-strong employment and a relatively resilient economy.
While the impact of the GFC was still evident in the recently completed Australian half-year earnings season, results were generally well-received, although companies were greatly assisted by fiscal stimulus, which is progressively being would back. Not surprisingly, companies were notably conservative in their guidance and cautious in their outlook statements.
Australia is well placed but not without some risks
* Australian banks generally showed an improving picture in bad and doubtful debts, a slowing in credit growth and the effect of heavy dilution because of the equity issues they undertook to shore up their balance sheets. Funding issues remain for the banks, and regulatory risk is also increasing.
* Despite the seeming strength of Chinese demand, IML is still cautious on resources stocks, in the belief that commodity prices are in many cases not driven by fundamentals, and have more to do with speculative activity. IML continues to hold its resources exposure through high-quality, diversified bulk-commodity producers and selected energy stocks.
* Telstra disappointed in its first-half revenue, and has also been hit by uncertainty surrounding the government’s NBN plan. But while the regulatory framework is uncertain, the company’s huge cash flow is on track and its dividend is sustainable.
While many financial stocks appear fully priced at present and many cyclical stocks look over-valued, there is value present in many high-quality industrial stocks. Hugh Giddy made the important point that it is quite meaningless to only look at the price of a stock without an understanding of its underlying quality. Consequently, IML is seeking stocks with the following characteristics:
* high free cash flow; * strong financial position; * high returns on equity and funds employed; * high-quality management; * sustainable industry and competitive position; and * reasonable valuation.
IML’s current focus is on companies that can grow their earnings without relying on either government stimulus or a free spending consumer. We believe the best places to look are in the healthcare, consumer staples and small-cap areas of the market.
