There is no doubt that 2011 was a tough year with many investors finding the heightened volatility challenging. Market volatility was driven by a number of events – the US debt debate, revolts in the Middle East, Greece’s near economic collapse, the European debt crisis, the threat of another recession in the US and fears of a Chinese slowdown. Or more correctly, the sensationalizing of these things.
This update is designed to
highlight some of the important themes at play for financial markets in 2012
and emphasise the importance of retaining a sound investment strategy during
uncertain times.
The market will continue to
focus on economic news…
Volatility over the past year
can be largely attributed to the market’s reaction to the daily economic news
flow out of Europe, the US and China. While we expect 2012 to be no different,
we do see tentative signs of improvement as we head into the New Year.
While the situation in Europe
could indeed worsen, should policymakers be able to avoid the worst case
scenario – that is, a complete collapse of the banking system – the rest
of the world should be able to continue its recovery and/or growth trajectory.
Importantly, global growth has
been less reliant on European economic growth over the last couple of decades.
Therefore, if the issues in
Europe can be contained and avoid a full blown recession, the US should be able
to resume its moderate recovery, and for emerging markets the process of
urbanisation and the growth of the middle class consumer.
In Europe, policymakers also
start the New Year with a greater willingness to acknowledge the core problems
facing the region. This follows the appointment of more
economically-disciplined leaders in Italy, Spain and Greece.
In Australia, while it is true
that the economy has slowed – particularly in the non-resource side of the
economy – policymakers have plenty of “ammunition” in the form of further
cuts to interest rates and increased government spending.
The medium and long-term drivers for the Australian economy also
remain firmly intact. These factors should see record levels of infrastructure
spending over the next decade. Deloitte-Access Economics puts the amount of
“mega-projects” at approximately $400bn as at October 2011 – equal to
approximately a third of total GDP!
Sharemarkets: some
attractive fundamental attributes
Global sharemarkets were mostly
lower over the year – but what may come as a surprise is that the US was one of the best performing
markets. The S&P500 ended the year flat, while the Dow Jones was up
more than 5%.
This was despite the extreme
levels of volatility and negative news flow from the media.
Over the same period, the
Aussie market recorded a decline of almost 15%. The weak relative performance
can be attributed to the poor performance of our two dominant sectors – resources
and financials. Most of these concerns reflected the potential impact from
a slowdown in the Chinese economy.
The divergence in performance
between the Australian and US markets highlights the importance of geographical
diversification in an investment portfolio.
Looking ahead, despite
expectations for continued high levels of volatility, we are comforted by a
number of attributes for the market both here and offshore – valuations,
dividend yields and corporate balance sheets.
Valuations are at levels that are
considered low on a historical basis, indicating that the market has factored
in some of the worst possible eventualities. This is despite the continued
moderate recovery in the US and recent European efforts to resolve the debt
crisis.
Dividend yields are also
attractive on many measures. The Australian market is trading on a grossed up
dividend yield of approximately 7% to 8%, which is attractive on a relative basis
to both cash and inflation.
Sustainability of these dividends should be well supported by
generally strong corporate balance sheets, low debt, high cash levels, and for
some sectors low historic percentage of earnings paid to shareholders in
dividends.
Performance of best
performing sectors unlikely to be repeated…
The best performing traditional
asset class over the past 12 months was the fixed interest sector on a “flight
to safety” as investors sold riskier assets such as equities (shares).
The extent of this risk
aversion was no clearer than in sovereign bond markets where the US 10-year
treasury yield sunk below 2.0%, while in Australia the equivalent touched 3.6%
- a record low.
Looking ahead, we would caution
against chasing last year’s winners. With treasury yields already at record low
levels it is very difficult to repeat last year’s gains – interest rates cannot
fall indefinitely!
Focus on your investment
strategy and long-term investment goals
While dealing with market
volatility is often difficult and investors with short term investment goals
may need to consider how market changes will affect them, it is during these
periods that the market provides a number of opportunities for patient and
disciplined investors with long term investment goals.
Altering a long-term investment
strategy should also be considered against the negative implications of
frequent and undisciplined changes. Missing just a few of the best months in
equity markets may substantially reduce your overall return.
Lastly, very few people have
increased their wealth by selling low and buying high. Unfortunately, this is a
typical response due to the psychology of investing. Markets reward those with
patience and discipline.
Hugh Kilpatrick
RI Advice Adviser *Authorised Representative
*Authorised Representative of
RI Advice Group Pty Limited ABN 23 001 774 125, AFSL 238 429. This information
does not consider your personal circumstances and is general advice only. You
should not act on this information without first obtaining professional
financial advice specific to your circumstances.
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