PORTFOLIO POINT: The Australian stockmarket will likely offer good returns over the long term, but a painful structural revolution for companies will create uncertainties over the next five years.
This week I had breakfast with some 150 suburban accountants and I was asked a question that rarely comes up at functions like this – what do you think the sharemarket will be like in five years’ time?
Normally you are asked about the likely sharemarket trend in the next six to 12 months, yet for most superannuation holders the five- and 10-year outlook is far more important.
It’s not surprising that a suburban accountant would ask such a sensible question, and before trying to answer it let me put on the record the magnificent achievement of the accounting profession, particularly the smaller firms.
A decade or two ago, Australian superannuation was dominated by bloated, badly managed institutions charging very high fees to manage the savings of those who invested in superannuation. Self-managed funds were a relative rarity.
But the accounting profession, led by the smaller accountants, devised a way to set up self-managed funds at low cost and run them for incredibly low annual fees.
As a result, the self-managed fund movement has absolutely exploded and now represents over 30 per cent of superannuation management. My guess is that, in another five to 10 years, it will rise to around 50 per cent and dominate the management of superannuation in Australia.
The rise of self-managed funds is one of the most productive exercises we have seen in the land, because not only has it lowered the cost of running superannuation, but it has empowered people to manage their own savings. That doesn’t mean that self-managed funds will not use professional funds and managers. But these clients do have the power to choose which area a professional manager works with a portion of their savings, and if the fees are too high, they can simply go elsewhere.
In very few places in the world can a person with, say, $100,000 or $200,000 in superannuation justify the establishment of a self-managed fund. But here in Australia, it makes a lot of sense and increasingly that’s how superannuation is being managed in this country. So it is not surprising that an accountant who has a great many clients with their superannuation money in their own fund asks such a fundamental question.
For the most part, institutions concentrate on performance over a six- to 12-month period and do very little work on the long-term fundamentals of companies. That’s why when somebody lobs a bid that’s at a premium to the market, the institutions can’t wait to take it and simply don’t have the talent or inclination to look more carefully at what is behind the bid and what is inside the company.
We saw that graphically in the takeovers of AXA and ConnectEast, which were disasters for long-term shareholders.
So, back to the question of what will the sharemarket look like in five years’ time? First, a confession: anyone that has knowledge of sharemarkets will know that predicting long-term trends raises very difficult issues and no one can be certain of the outcome. But let’s look at what might happen. The local sharemarket will, of course, continue to be affected by events that go beyond our domestic economy. In particular, the problems of Europe, the change in leadership in China and the instability of the Middle East are potential nasties that no one can really predict. At the moment, the sharemarket believes we will sail through all three successfully. But sentiment can change quite quickly, as we have seen so often.
Looking forward, I think that at some point in the next five years we are going to see a period of oversupply of commodities. There are a large number of new projects in the pipeline and they will come on-stream and create surpluses. In addition, somewhere along the line we will have a set of tough times globally and commodity prices will slip. I can’t tell you whether that will be in 2012, 2013 or 2014. But at some point, a setback is likely to take place within our five-year timespan.
Also, during that time we are going to reengineer our local companies due to the following: the mining investment boom, which has boosted the Australian dollar; our increasingly inflexible workforce and the Fair Work industrial relations laws; overseas outsourcing of services and manufacturing, which will rise dramatically because of these first two trends; high interest rates in Australia, which will curb demand and underpin the Australian dollar; and an explosion in internet usage, both through conventional computers and mobile phones, which will cause business – including supply chains and consumer marketing – to be redesigned.
At the same time, governments have no idea how to increase their productivity and they are going to struggle in the provision of services. But all of that will trigger an enormous momentum within business, as these re-engineered operations become highly-profitable powerhouses.
We are seeing the start of this in America at the moment. The American economy is sluggish. It is possible it will have a banking backlash as a result of silly deals that have been done by Wall Street bankers in Europe. But despite this, the fundamentals of American companies have been greatly improved. Where Australian companies have tended to sit back and enjoy the money falling from the sky via the post-GFC measures undertaken by Kevin Rudd and Julia Gillard – and the big rise in demand in China – America has set about reorganising its corporate base.
So we are seeing some really good profit signs among many US companies and that is underpinning Wall Street. I think a similar reorganisation will take place in Australia, but we are about two or three years behind. Because of our bad industrial relations laws, it will be tougher here and more brutal, so companies will have to take drastic action or risk obliteration. But we will do what has to be done and out of it will come a much stronger business community. Also, during that five-year period there will be a European “nasty”. I believe Greece will pull out of the euro and maybe take one or two others with it, creating nasty banking repercussions. There is a risk that the current money-printing to solve banking problems in Europe and the US will create inflation, so it is dangerous to have all your money in interest-bearing securities. But out of this turmoil will emerge a much stronger European community. And so I would expect in five years’ time, both Europe and the US are going to be much stronger than they are today.
But of course, it is the 'Asian century’ and China will have had some four years under a new leader by the end of our timespan. The 'hiccup’ dangers that a leadership change brings will have passed by then and I would expect the China growth path to continue, but with much greater emphasis on the consumer. Remember, because China is now so much bigger, even if the percentage growth falls the amount generated continues to be very large.
Meanwhile, the globe is in need of infrastructure and must improve the standard of living of large areas of population, so we are going to need investment and commodities. So, all in all, I think in five years’ time we will have an attractive sharemarket, which will provide good long-term returns. But during those five years, we are going to have a few bumpy rides and there will be great variations in the performance of different companies in the same industry. It is this long-term optimism that makes me confident that it is worth having a significant part of your portfolio in equity securities. Australia has a wonderful opportunity to not only benefit from what is taking place in Asia, but to link into the better economies of Europe and the US. But we will have to go through a revolution, which will be painful and have an impact on the sharemarket. In other words, I am a long-term bull, but I see forces in the shorter term that I have not seen before and I worry about just what impact they will have.