What will be the fate of the Australian stock market in 2015? What companies will grow and prosper, and which will fall away? What sectors will be boosted by macro economic factors, such as movements in official interest rates? And will the market behave rationally or lurch up and down on the twists and turns of the daily media cycle?
Let’s have a look at the sectors which are well placed to prosper in 2015.
Market earnings outlook has fallen away
Market estimates for corporate earnings in the 2015 financial year have been consistently and significantly revised down over the last six months (see Chart 1). In the chart you can also see the general trend for the 2014 financial year was down, but the angle of the decline was less severe.
Our view is that the Australian economy has lost momentum as it transitions away from what has been an extraordinary decade of mining investment-led boom. Revenue growth for Australian companies is insipid right across the board; it’s not just natural resource companies or retailers that are facing challenging conditions. In December 2014 the Government’s Mid-Year Economic and Fiscal Outlook (MYEFO) pointed to ballooning future Government deficits and Australian Bureau of Statistics reports showed Australia’s GDP growth had slowed. 1
Given such a backdrop, we believe it is unrealistic to expect large absolute returns from the Australian stock market as a whole.
There is solid market support at current levels
On the other hand, at the outset of 2015, the Australian share market presents favourably when compared to other asset classes. With the official interest rate at 2.5%, 10-Year Australian Government bonds yielding 2.8% and a market dividend yield of 4.2% plus franking, it is difficult to see material downside to the market.
Chart 2 compares the historical dividend yield of the Australian share market (S&P ASX300) to the RBA cash rate.Note that towards the end of 2011, when the market yield rose above the cash rate for the first time since the GFC, the market was trading about 20% lower than it is today.
Over the past year we believe the Reserve Bank of Australian (RBA) was overly hawkish, holding rates at2.5%. Although the weakening Australian dollar is starting to help, confidence is low amongst both businesses and consumers, and seems to be declining further.Unemployment, too, continues to climb and has remained above 6% for some time. This slack in labour markets has kept a lid on wage inflation.Consumer Price Inflation is benign, even at these levels of historic low interest rates, with no immediate catalyst to push it higher.
Interest rate cut likely in 2015
Unfortunately, it seems Canberra will struggle to boost the economy or confidence in the short term. Thus, our view is that the RBA will have to act.
Market indicators for such an action, such as the shape of the bond yield curve, which has flattened from a year ago, also suggest the need for easier monetary policy and a reduction in official interest rates. Our view is that the improved housing market was primarily responsible for the RBA holding rates during 2014. However, with the recent introduction of the 7% interest rate stress test for new borrowers, we believe that housing will no longer be such a barrier.
As a result, we expect the RBA to cut rates in the first half of calendar 2015, which should be positive for equities.
Diverging fortunes will require active management in 2015
Comparing the earnings forecasts of several market sectors in 2015 highlights the need for active management when it comes to investing in the Australian share market. Charts 3 and 4 contrast the outlook for the Energy and Material sectors with the Health Care, Consumer Discretionary, Financials and Telecommunication Services sectors.
The story for the Materials sector is one of strong supply and weakening demand, as nearly all commodities are well supplied. In this environment, stock prices for miners and those businesses that had previously benefitted strongly from the mining investment boom, could see their prices drift lower in 2015 even under stable demand conditions.However, we believe that the most violent phase of the correction has passed.The group in Chart 4 stand out for the stability of their expected earnings forecasts in 2015.
The Consumer Discretionary sector is generally supported by structural growth stories and gaming stocks which we expect to deliver good growth in 2015. As well, the Telecommunications sector has broad-based earnings stability with robust dividend yield. Looking ahead, we believe conditions exist where quality businesses that can sustainably grow their revenues and profits in a relatively tough economic environment will continue to be bid up.
Similarly, in 2015, those Australian businesses with offshore earnings should enjoy a continued earnings tailwind from exposure to economies that are outperforming the domestic economy. As well, these businesses should benefit from the expected ongoing weakening in the Australian dollar.
The US market to be strong in 2015
From a global perspective, we believe a divergence of economic performance and monetary policy will continue to play out in 2015. The US economy should continue its strong performance, and its Federal Reserve will continue to withdraw accommodative monetary conditions just as the European Central Bank, People’s Bank of China and Bank of Japan extend current programs. As a result, we expect the US dollar will continue to strengthen in 2015.
In summary, the Australian share market looks set to deliver a year where there will be clear winners and losers.
In this environment, where the market is likely to see a greater dispersion of share performances, we believe it will be more favourable for active, bottom-up stock pickers that are able to find gains, even if the overall Australian share market tracks sideways.