Banks back at value

After a very strong run from mid 2012, global equity markets peaked in May and have corrected over the last month. The old adage of “sell in May and go away” came true yet again. The following table shows market returns since the peak in May 2013 to their recent low, on June 13, in the case of Australia.

We cannot be certain, of course, that the recent low was the ultimate low for this correction, but for a number of reasons I believe that we have seen the worst of the correction.

In the case of the Australian market most of the damage appears to have been done by offshore selling, and the decline in the market has corresponded with the fall in the Australia dollar as funds left the country. Overseas ownership of our market has risen to a relatively high level so the selling has been understandable as a more negative view on the Australian dollar emerged. The currency plays a significant part of the potential return for overseas investors.

The fall in the Australian market has, however, brought many shares back to a level where the dividend yield has again become very attractive to domestic investors. Balancing this, however, has been the release of March quarter GDP data showing that the domestic economy is very close to stalling. This has been confirmed by soft data for retail sales and auto sales.

We have also seen a number of earnings downgrades announced by domestic companies, mainly in the mining services and cyclicals space (media, transport, building materials).

However, the non-mining Australian economy has been flat for some time and I believe that with the interest rate cuts that have taken place and with further potential cuts, the economy is moving along the bottom with an improved outlook for 2014. Getting the federal election out of the way should be a further positive.

The US economy appears to be continuing to strengthen despite some variation in monthly numbers. Whilst the Federal Reserve announcement for plans to wind back monetary stimulus has led to increased market volatility it clearly signals that they expect improvement in the economy to continue, which is in a fact a very real long term positive. We do, however, need to get through the transition from powerful stimulus driving the economy to sustainable underlying growth.

As with the US there has been mixed signals out of China and the economy has been softer than expected which has led to a continuing wind back in growth expectations for our resources sector. However, China appears capable of sustaining growth of over 7% pa which, whilst well below its boom years, will provide a solid base to world growth.

Portfolio positioning

With the Australian market coming back by over 10% I see good value having emerged again and remain positive on the outlook. A further positive sign for markets is that in the US cash flows into mutual funds have remained at a historically high level since the start of 2013.

With the correction in our market I recommend reducing the cash weighting from the previous 20% back down to 10%.

I suggest remaining relatively conservative and I have increased the weighting to banks by 5% to 35%, and to property / Infrastructure by 5% to 10%. I feel that at this point in time portfolios should remain balanced across sectors with a good weighting to both high yielders as well as leading industrial and resource stocks.

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John Axsentieff is a senior client advisor with wealth advisory firm Phillip Capital. www.phillipcapital.com.au. This research note was first published on June 18.