As we come to the close of the second week of the second month of 2013, it is clear that the media speculation last year about the end of the world, for reasons ranging from the US Fiscal Cliff to the perilous state of the Eurozone, did not pan out.
However it is fair to say that the US has not solved its problems and Greece is still broke; and that the high Australian dollar, lack lustre business sentiment, and the added uncertainties of an election year are impacting the Australian economy.
What to expect in 2013
The events of the past two years have set up the current market conditions: In mid-2011 significant amounts of money were sold out of equities globally and put into the bond markets, resulting in a rally in bond markets and a decline in stock markets. The ASX200 share price index dropped in Australia from near 5,000 to below 4,000. Global and Australian interest rates are at record lows; with current interest rates on term deposits sitting at less than 4% (compared to 8% three years ago). In the US, long term Government bonds are offering less than 2%, which is below inflation.
Global economic conditions are improving (despite what the media would have us believe), and with the record low interest rates, we are now seeing money moving from interest bearing investments like bonds and cash to chasing returns in the stock market, globally and in Australia. Notably, the ASX has risen to just below 5,000 over the last six months.
The key issue is: Will this rise in the stock market continue? Is it sustainable? In the long run company values are based on profits: share prices rise with company profits, and conversely fall with falling profits. One way to answer these questions is look at the valuation of the stock market.
While it is not possible to pick the top or bottom of markets, it is possible to determine valuation. I attach our current view of the Australian Share Market (Graph 1 below).
Graph 1. ASX 200 Share Price Valuation
Source: Equitas Wealth, 2013
As you can see, the share market has moved from being cheap to fair value, and I consider it to be “well priced”. This doesn’t mean it will not correct over the next weeks or months, but it does mean that right now the share market is priced well. Of course some of the global drivers for Australia are the price and volume of iron ore and coal, which seem to be improving, and also cost management as a way to improve profitability by companies with limited short-term growth opportunities.
The other key issue to look out for in 2013 is rising interest rates. For those of us with long memories, you will recall a similar period in the early 90s, characterised by a global downturn, falling interest rates and rising unemployment. In 1994 interest rates started to rise prematurely and that caused a share market downturn and a bond market crash. Just as falling rates can help the economy, rising rates are designed to slow the economy.
If interest rates remain low then those in interest generating investments will hurt, yet it is an environment for economic growth. When interest rates dropped dramatically in the 1990s most of us used the interest savings to pay our mortgage off; and it was only after a collective sense that the economy was OK was achieved and the fear of high interest rates subsided did we start spending and thereby stimulating economic growth. I think the same is occurring now.
Graph 2. Reserve Bank of Australia Interest Rates 1985 – 2013
Source: RBA, 2013
In summary, my perspective on 2013 looks like this:
- Interest rates will remain at current low levels for the foreseeable future.
- The Australian Share Market is still fair value but cannot grow dramatically without company profits growing.
- The Government will be looking for ways to raise taxes, so be sure you have a tax efficient financial plan.
- The residential property market will be lumpy, meaning well priced properties in good locations will do OK, and properties that are below par in term of condition and location will fare poorly.
Our outlook remains positive, Australia is in good shape, there are good investments and good companies reporting good profits, however I expect that the media speculation about the end of the world as we know it will continue through 2013. By the end of the year I hope we see a better political environment which should give business more confidence to invest.
As always if you want to discuss this or any other matter, please call me on (02) 9492 0444.