|Summary: The outlook for the year ahead looks encouraging, but portfolio management as always will be the key to success. Here’s our key rules for 2014.|
|Key take-out: There will be big returns again next year, but asset allocation is key and you may need to look into some different areas to get the best results.|
|Key beneficiaries: General investors. Category: Shares.|
Strap on your safety belts! It’s looking like 2014 is going to be lucrative, volatile and ultimately rewarding … very much like 2012 and 2013 when you stand back and review them.
In setting some ground rules for the next 12 months I don’t for a moment claim to know what’s going to happen next year. Rather, the objective here is to give a clear summary of some consensus forecasts that are in the market and then to make recommendations around those predictions.
Exactly a year ago, in the final edition of the year for Eureka Report, I presented the inaugural list of 10 things you must do in the year ahead. Thankfully, most of those guidelines proved to be accurate and any subscriber who followed the guidance of that piece should have done very well indeed. Perhaps the best advice of all was to prepare for upside surprises, and to believe in the power of our local banks stocks. (To read last year’s recommendations click here).
In hindsight, last year the primary concern was the risk of being too negative. If anything, this year the risk is that we may become complacent because, after two years of very handsome returns from stocks and one year of strong returns from property, the temptation is to become too bullish. Anyway, here we go...
1. Make yourself buy foreign equities.
The forecast outlook for overseas equities market is strong again in 2014, especially in the US and Europe. Indeed global GDP estimates, even Euro zone estimates, are considerably stronger that what has been pencilled in for the Australian economy. Until very recently most local investors entrusted non-ASX equity investments to fund managers. Now there is no need to do that; you can directly buy overseas from any broker online.
There is also an increasingly expansive list of overseas-focussed exchange-traded funds specialising in key overseas indices. Australian investors who placed money in US markets unhedged over 2013 made an average of 40%, says AMP (Yes, that’s 40% … in fact, if you just bought the US S&P 500 in $A you would be up 48%).
2. Get some takeover targets.
Cashed up global conglomerates are facing modest GDP growth, but when they look at Australia they see a bridge to China coupled with the tantalising prospect of a weakening local currency. Spurred initially by North American money from Saputo of Canada, the spectacular battle over Warrnambool Cheese and Butter this year saw a sleepy regional food stock move from $3 to $9 as a long-held theory that Australian food companies would become a ‘China play’ turned into reality. In selecting a shortlist of takeover targets, Tom Elliott at ER handpicked Warrnambool, GrainCorp and Envestra earlier this year. Among his favourites for the year ahead are Santos, Brambles, Mortgage Choice and Treasury Wine Estates.
3. Accumulate big miners at value levels.
Two of the world’s greatest mining companies, BHP and Rio, are listed on the ASX, paying improved dividends and trading at multiples that are clearly relative value to the broader market. Moreover, a consensus is growing that 2014 should see the beginning of a cyclical recovery for resources stocks – led initially by zinc, tin and diamonds. As Australia becomes what US broker Morgan Stanley calls “a gas super-power”, the comparative advantage of many local resource stocks should shine. One outstanding example: With the ASX on a forward P/E of 14.9, Rio is on just 11.5 .
4. Yield hunting? Consider residential property.
Slowly but inevitably the powerful yields we saw from leading stocks, especially banks, are shrinking as the markets normalise. Take NAB for example: 12 months ago it was yielding 7.2% and by the end of 2013 that dividend yield had shrunk to 5.7%. The pattern is repeated across other top yielders of recent times. In this context, residential property is now returning close to long-term annual average price appreciation.
In fact, in its final analysis for the year, property researcher RP Data said we are now looking at an 8% house price rise on average nationwide over the last 12 months. This price appreciation can be coupled with reliable gross yields of about 4% for houses. Overall then, as an alternative to cash and as a diversification from shares, property looks a lot better than it did a year ago. Doug Turek calls property a ‘bond substitute’, and with some bonds currently returning worse than cash the appeal of well-located rentable property is unquestioned.
5. Assume the $A moves lower against the $US.
The fate of the dollar is always relevant to local investors, but in the year ahead it will be crucial to investing strategy.
We know two things for sure: the US recovery and the ‘tapering’ of (QE) quantitative easing must inevitably create upward pressure on the $US, and our own Reserve Bank wants to see the $A below 90c.
There is every chance that our $A could occasionally spike against a broader downward trend in the months ahead (as it did in mid-2013) but investors can be comfortable the consensus for 2014 is that the $A will be lower than we have seen in recent years. In turn, that means money invested in the US through ETFs or direct investments should be lucrative. Separately, Australian listed stocks with strong US operations – such as James Hardie, ResMed, Westfield – are set to benefit.
6. Consider the cycle – Swap some defensives for cyclicals.
Don’t miss this trend – the Australian sharemarket has been totally characterised by the so-called ‘hunt for yield’ over the last 18 months. Our banks, aREITs and infrastructure stocks have rafted on higher P/Es as a legion of investors bought these stocks primarily for yield – this was the high point of defensive investing and the tide is turning. A-REITs and infrastructure stocks may not fare as well in the year ahead; banks, however, are expected to return solid, if not spectacular, returns thanks to their pivotal role in the local market.
If history and economic theory are any guide, then the year ahead investors will swing to cyclical stocks – that is stocks where growth is more important than dividend yield.
Cyclical stocks might include conglomerates such as Coca Cola Amatil or Crown Resorts, they might arguably include the magnificently diversified BHP.
7. Always rotate your small caps.
As we say here at ER, when it comes to small caps forget about the index –the small cap index that is, because in a market where we are only expecting modest economic growth of less than 3%, then it’s all about stock selection.
Earlier this year Brendon Lau handpicked eBet, which has turned out to be one of the best stocks on the entire ASX over the year. More recently, Simon Dumaresq has chosen CTI Logistics. Everyone has their own rules on small caps – mine is that if you double your money it’s time to cash out. Losing later profits rarely hurts as much as watching a former winner wane as too many investors rush into a small cap play.
At ER we cannot guarantee that every small cap will be a winner, but we aim that our small caps selection will beat the All Ords – we did that in 2013 and we aim to do it again in 2014. Keep up to date and rotate.
8. Fix into low interest rates.
Interest rates are at 50-year lows – the cash rate is at 2.5% and the majority of indicators suggest that rates may stay little changed for most of 2014. At the very least you can assume interest rates are not going to fly upward in the coming months, and in turn that means you can borrow at very reasonable levels.
Anyone brave enough to borrow against the sharemarket over the last two years – when margin loan volumes were at record lows – will most likely have done very well. In the less risky zone of residential property, investing gearing is also offering the sort of rewards investors have come to expect – mortgage rates are at about 5%, rental yields (gross) are at about 4% and the price appreciation over the 12 months to December was a tad more than 8% nationwide.
If you are going to borrow, make sure to actively consider fixing at least half of the loan.
9. Shift substantially Out Of Cash (your final warning).
According to the latest available ATO statistics (i.e. the 12 months to June 2012. Yes, they are 18 months’ old) the level of cash being held by SMSFs in Australia was running at a massive 32.5%. No doubt that figure has dropped in the intervening period but the chances are it has not dropped enough. Indeed, the rising level of deposits at some leading banks through calendar 2013 suggests private investors are still heavily skewed towards cash.
The problem is that from an allocation level if you have, say, 25% in cash, that’s a quarter of your investment portfolio most likely returning less than 4%, and that in turn will be a desperate drag on your overall returns.
10. Be in it to win.
One last thing: We say it time and again in Eureka Report, and it’s probably the very best message to finish our list of things to do for 2014. If you’re not in, you can’t win … it’s time to start investing again; don’t miss any of the money to be made in the year ahead.