Promising outlook for long-term investors, says Russell strategist
Global equities show exceptional value
SYDNEY, 16 July 2008 – Amid the current market turmoil, investors with longer time horizons should recognise the value currently on offer. Investors are being offered the opportunity to buy future growth and profits at significantly discounted prices according to the latest quarterly Russell Investments Market Barometer. The report found that while more volatility seems likely in the near future, investors with long-term investment horizons can now maximise returns and take advantage of discounted prices.
Global developed equity markets continue to show exceptional value, according to the July Barometer, with the forward price to earning (P/E) ratio hovering near 18-year lows at 12.5 times. Stockbroking analysts forecast that earnings-per-share (EPS) for global equities will grow by 12 per cent over the next 12 months.
Meanwhile, Australian shares continue to face more headwinds than their global counterparts. Over the first half of the year, the S&P/ASX 300 has fallen 18 per cent compared to the 13 per cent in the S&P500 and the 12% fall in the MCSI World ex US share price index. Despite the local market facing market volatility in the near future, the long-term valuation characteristics are sound. The one-year forward PE ratio, at 12 times for local equities is lower than when the bull market kicked off at the end of 2002.
Senior Investment Strategist at Russell Investments and author of the Barometer, Andrew Pease said: “Investors should step back now and ask the two fundamental questions: “what is the long-term outlook for profits?” and “what price am I paying for these profits?””, he said.
“Investors with a long term investment outlook beyond the next 6 months should take note of the low PE ratios on offer for global equities combined with resilient profit expectations. In the long-run local equities should also move higher by the end of the year but are likely to lag global share-market returns”, he said.
Global stagflation fears are misguided according to Mr. Pease and energy price rises will ultimately be deflationary rather than inflationary. Headline inflation rates have soared around the globe recently reaching 4.1 per cent in the United States, 3.3 per cent in Europe, 3.0 per cent in the United Kingdom and 4.2 per cent in Australia. However unlike the 1970s, wages are not surging in response to the higher cost of living. In the rest of the world, inflation is rising mainly because of energy costs and when these are taken out of the equation, inflation is still low. However, by contrast, Australia’s core inflation is rising at the same rate as headline inflation.
“Australia’s inflation problems are more widespread than the rest of the world. Australia’s economy has hit capacity limits producing ‘demand-pull’ in addition to ‘cost-push’ inflation pressures and the Reserve Back faces a difficult balancing act over the remainder of 2008.” Mr Pease said.
Oil prices have more than doubled over the past 12 months, rising to a peak of US$145 per barrel in early July, however oil consumption in the developed countries has been falling for the last year and this trend should continue. Demand growth is likely to start to cool in the developing economies as countries like China slow their economies in response to inflation pressures and as consumers across Asia and the Middle East cut back on demand in response to higher prices from reductions in oil price subsidies.
Sector Overview
Australian fixed interest is beginning to show signs of good value. The 10-year government bond yield is currently at 6.5 per cent and looks more attractive than several years ago. Non-government securities make up close to half of the UBS Composite Bond Index and the overall yield on the index is close to 8 per cent. From 2002 to 2007 when Australian shares were returning 21 per cent per annum, the UBS Composite Bond Index delivered just 4.5 per cent per annum making fixed interest an unloved asset class. With higher yields and the prospects for capital gains if bond yields decline as the economy slows, fixed interest now looks more attractive than for many years according to Mr Pease.
The LPT sector has moved from being dangerously overvalued at the beginning of 2007 to more reasonable valuation levels. Over the June quarter, LPTs lost another 20 per cent to take the total fall since February 2007 to 46 per cent. The LPT sector is now on a forward PE ratio of 11 times, compared with the PE ratio for the equity market of just over 12 times.
Small-caps have underperformed large caps by 4 per cent over the past year. Small-caps are trading at a PE ratio discount to large caps for the first time since late 2005. The forward PE ratio for the ASX100, providing no strong signal about relative performance prospects.
Australian dollar
The Australian dollar has been stuck in the 94 – 97 cents for the past couple of months, threatening on occasion to push through to parity. The main factor behind the Australian dollar strength over the past five years has been US dollar weakness rather than commodity prices or interest rate differentials. It would be hard to imagine a more bullish A$ environment than that of the past few months with widening interest rate differentials, soaring commodity prices and entrenched US economic pessimism, yet the A$ has been rangebound. This hints that the A$ upswing may be running out of steam.
“Furthermore, market expectations are shifting towards a Fed tightening late in 2008 and away from further RBA tightening. This suggests that interest rate differentials may not place much more upward pressure on the Australian dollar and may soon be a factor that favours US dollar strength and Australian dollar weakness,” Mr Pease said.
Conclusion
“The current investment backdrop is challenging and Australian investors can be forgiven for feeling a little shell-shocked when surveying the local market carnage. The turning point is likely to come when global investors shift focus from downside risks to the 2008 outlook to the upside potential to 2009 US economic growth and corporate profits,” Mr Pease said.
“However it is difficult to be overly pessimistic about the local market. Valuations, although high relative to other markets, look attractive in absolute terms. Compulsory superannuation contributions are likely to pour up to $30 billion into the equity market this year and the Future Fund is still building up local equity market exposure in its $60 billion plus portfolio,” Mr Pease concluded.
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