Steps to recovery

After years of volatility, there are sure signs some stocks are worth investing in, writes John Collett.

After years of volatility, there are sure signs some stocks are worth investing in, writes John Collett.

It's not surprising that investors are confused - so are the experts. Many called the recovery in Australian shares at the start of last year, only to see markets dip lower. They're reluctant to call it again, even though there has been a good start to the year on world sharemarkets.

The woeful performance of most sharemarkets last year and the trials and tribulations of Europe's debt crisis suggest investors should stick with the capital security of cash.

On the other hand, Australia's economy is growing at close to its trend of a little more than 3 per cent. And economists expect that rate of growth to be maintained, even if there is a recession in Europe this year.

Forecasts of lower global growth by the World Bank and International Monetary Fund should not affect the outlook for Australia, according to most economists.

If anything, the risk is that we talk ourselves into lower growth by focusing too much on the negatives.

The outlook for the world overall is slower growth but not recession, though recession is expected in Europe.

Chinese authorities seem to be engineering a soft landing for the economy, which has slowed to just under 9 per cent, down from about 11 per cent.

Our big miners are certainly showing confidence in China by continuing to make big investments in new mines. And the economic data on the US suggests the country is not about to slip back into a "double dip" recession.

The big question for investors, though, is whether we have been through the worst of it.

Is it time to start moving out of cash and into shares? Term deposits have been a rock for worried investors for the past three years but cash is not a long-term solution for wealth accumulation. Interest rates are on their way down. After paying tax on the interest at the investor's marginal income tax rate, term deposits are only just beating inflation.

AUSTRALIAN SHARES

"The improved global economic outlook and reduced risks regarding Europe suggest 2012 should be a better year for shares and other risk assets," the chief economist at AMP Capital Investors, Shane Oliver, says. "This is also supported by the fact that shares are starting the year on sharemarket valuations well below year-ago levels.

"Sharemarket price-to-earnings multiples remain low."

It's been a good start to the year on world sharemarkets, as it was last year, before markets turned down once again. Australian share prices are almost 6 per cent higher since the start of this year.

US share prices are more than 4 per cent higher and even European shares are more than 5 per cent higher.

The Australian sharemarket underperformed other sharemarkets quite badly last year, with share prices down more than 14 per cent. But the fundamentals of our economy did not justify that, an analyst at Fat Prophets sharemarket research, Greg Fraser, says.

Australian shares could end this year between 15 per cent and 20 per cent higher than they started the year, he says. Fraser favours the diversified miners such as BHP Billiton and Rio Tinto and gold miner Newcrest Mining.

In the energy sector, he likes Woodside Petroleum. Among the industrials, he likes packaging company Amcor, which bought the Alcan packaging assets cheaply.

DEFENSIVE STANCE

The editor of FNArena financial news and analysis service, Rudi Filapek-Vandyck, says long-term investors should continue to have a "big chunk" of defensive stocks in their portfolios. But he can see the logic of taking a bit more risk in portfolios as sentiment could turn positive very quickly.

One of the problems for investors is that many of the defensive stocks are, if not overvalued, fully valued. "People who want to add to the defensive part of their portfolios have to be careful not to pay too much," he says. Among the defensive stocks, he likes Blackmores. The food supplements and vitamins maker is a "dream stock" to have in a portfolio but is normally too expensive.

"Its share price has come down over the past month, as the market has been selling out of stocks like Blackmores and buying miners and biotechs," Filapek-Vandyck says. He also likes Fleetwood Corporation. Its original business is making caravans but it also builds and operates mobile accommodation for the mining industry. Its shares are on a fully franked dividend yield of 7 per cent.

For investors with an appetite for risk, he likes iron-ore miner Fortescue Metals Group. "If sentiment turns positive and world growth this year, including China, surprises on the upside, then Fortescue is definitely among the stocks you want to have."

For those who can take on more risks, substantial rewards could be on offer from international shares.

INTERNATIONAL SHARES

The US is still home to many of the most profitable companies in the world.

"Corporate balance sheets are arguably in the best shape we have ever seen, with very low levels of debt and mountains of cash," says Jonathan Pain, a former fund manager and author of the investment newsletter The Pain Report.

He says in his latest report: "Apple has $US97.6 billion of cash, enough to cover Greece's debt payments due in the next two years." During 2011, Apple's sales rose to $US127.8 billion, "bigger than the size of the New Zealand economy", while more iPhones were sold each day in the final three months of last year than babies were born in the world, according to data compiled by Bloomberg and the United Nations.

Greg Fraser says of the overseas sharemarkets, the US could do best given the emerging economic recovery there.

Fraser regards European shares as a "no-go zone", as there are just too many unknowns. Pain says the world's most populous nations will continue to produce the lion's share of global growth.

He regards Indonesia, the world's fourth-most populous nation, as "one of the most exciting prospects on planet Earth". India should grow about 7 per cent and China should should slow to about 7 per cent, Pain says. Japan will "bumble more than muddle along", he says. "Their demographics are truly horrifying, as soon more adult diapers will be sold than those for children."

For most investors, the best way to own shares listed on overseas sharemarkets is to invest through a fund manager. Andrew Clifford, the deputy chief investment officer at fund manager Platinum Asset Management, says the manager owns many strong and growing businesses trading at attractive prices.

BMW, Microsoft, Samsung Electronics, China Mobile and Royal Dutch Shell are trading on low price-to-earnings multiples of between eight and 11 times. "Each of these businesses will face challenges in the current economic environment but our assessment is that they are well-placed to grow their businesses over the next five years or so," Clifford says.

The fund manager also has investments in companies on "distressed" valuations such as Bank of America and Allianz Insurance. "On any given company, we will clearly make errors but with a portfolio of companies on starting valuations such as these, it is difficult to see how they will not provide investors with good returns over the next three to five years," Clifford says.

WHAT TO DO?

Investors have to think about capital preservation first, then income and, last, about the opportunities for capital gains, says Satyajit Das, a former banker and author of Extreme Money: The Masters of the Universe and the Cult of Risk. It is the reserve order of how investors have thought about investing for the past 20 years.

In Das's opinion, there is almost a bubble in high-dividend stocks and a bubble in high-yield corporate debt, including non-investment grade debt.

"You want a core portfolio that is throwing off income and is capital-secure but you want to capture some growth," he says. Investors need to be mindful of the elevated risks - there will be bubbles and busts and the recovery could be a very long one.

"People forget it took 25 years for US stocks to recover to the level of 1929," Das says. "People also forget that even if Australian share prices rose by 10 per cent, prices would still be 30 per cent below their high."

Pain continues to favour global companies, regardless of their domicile, that have the reach and scale to benefit from the emergence of the Asian middle class.

He also favours a core exposure to energy-related assets and an exposure to gold, as it should provide some security against some of the more nasty risks. The chief geo-political risk, as Pain sees it, is conflict in the Persian Gulf over Iran's nuclear ambitions.

Three reasons to be cautious

Satyajit Das says there are still significant risks for investors: "Europe is going to be trapped in, at best, a long period of low growth and at worst, a deep recession."

He identifies at least three channels of possible contagion of the "train wreck" in Europe to Australia.

Slowing European demand for Chinese exports and imbalances in the Chinese economy could lead to China's growth rates falling from less than 9 per cent now to between 5 per cent and 7 per cent and it could happen quite quickly, Das says.

And, with all the new mines opening there could be an oversupply of some commodities at the same time as demand weakens.

That would have a big impact on the profitability of Australian mining companies.

There is another way the woes in Europe could affect Australia. Its current account deficit has to be funded from overseas markets, including Europe. Das says Australian banks might have to start rationing credit if their costs of borrowing from overseas increase.

He says a third danger is the emerging "currency wars". Europe, the US and Japan are trying to devalue their currencies to increase the competitiveness of their exports.

The problem with that is the Australian dollar could be pushed higher, reducing Australia's competitiveness with exports.

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