Market Outlook - Spring 2009

Spring in Australia (autumn in the Northern Hemisphere) is often a very volatile season for investment markets.  On average it has been a time of market weakness, although this is not always the case.  Generally, there is hope for continued economic recovery as the ‘green shoots’ of renewed prosperity appear to be sprouting. Since market lows in March, significant recoveries globally in investor confidence and share and credit markets demonstrate how quickly markets move and can overreact on both the upside and the downside. Broad economic indicators that are watched with interest are adding to confidence.

In June, house prices in the US recorded their first monthly gain for three years and recovery seems to be continuing. Share market volatility has reduced significantly, although dramatic price movements may continue as the market settles following the crisis. Commodity prices have recovered in line with economic prospects, with Chinese demand remaining strong and stockpiles being replenished. Industrial production levels are beginning to increase following a period of inventory run-down. Production is picking up to align with stronger than expected demand. Unemployment internationally is yet to fall but the rate of new unemployment is reducing and generally lags a pickup in profits and sales.

Both business and consumer sentiment continue to strengthen as an increasing volume of news suggests the major industrialised countries are at or close to the end of their recessions, China and India’s already strong growth rates are lifting and Australia, with two consecutive quarters of growth, has missed an official recession. Markets have been led by this more positive economic data along with better than expected company reports.  With a mixture of good management and luck, the worst of the Global Financial Crisis may be in the history books, but even if this is the case, the road to recovery is expected to be a long and bumpy one.

It now appears investment markets were broadly oversold as investors reacted to the daily flood of bad news. Investors are now proceeding with far more confidence and the subsequent recovery in share prices of 40 to 50% has been the strongest since the 1930s in the US and the 1970s in Australia.

In Australia, the recent company reporting season saw profits down by approximately a third from the highs of 2007/08. Company guidance for the year ahead has been restrained and we continue to re-iterate a long-term focus on fundamentals. There are still investment opportunities. Globally, there is a similar story with company profit expectations low compared with last year. However, most companies’ profits were better than expected.

Companies that were in the news for the wrong reasons through the downturn have so far rebounded strongest. Diversified financials and the banks have been supported strongly after the introduction of government guarantees and appreciation of the profit to be made if the world isn’t ending. Industrial companies that are highly exposed to economic conditions have also provided strong returns based on the broad realisation that the downturn isn’t as bad as markets were expecting.

Reducing debt to improve balance sheets is likely to continue for some time. Previously cheap and easy credit has all but dried up, and businesses and individuals are moving to more conservative financing structures as a result. Individuals are now beginning to save more and spend less, a positive for the future even if it may slow the immediate recovery in retail sales. At the same time, companies have had large capital raisings through rights issues and share purchase plans.

Listed Property and Infrastructure investments suffered badly during the credit crunch due to their generally high levels of debt. Most property funds have now recapitalised and infrastructure managers are experiencing little difficulty in refinancing. They have all written down the value of their assets to reflect weaker markets, but this is of little concern if they aren’t forced to sell. Asset values will improve as the world returns to normal. During this period they have also prudently reduced the distributions paid to investors and distributions are likely to be restored in future as the crisis passes.

With the better outlook, the Reserve Bank is warning that the very low level of interest rates is close to ending and announced a 0.25% lift in the cash rate following their October meeting, to what is still a low 3.25% by Australian standards. A move to a more ’neutral’ policy position, if the recovery remains on course, would have cash rates in the order of 5%, or around 2% higher than current levels. Professional fixed interest investors are already anticipating rate rises and longer-term fixed interest investments are providing higher yields. This is good news for those invested in cash and fixed interest term investments where rates are currently at historically low levels.

Given the issues we have navigated and the response from policy makers and governments, the immediate future seems likely to remain difficult, however we believe there are strengthening indications we are past the worst. Again, we re-iterate that it remains a time to proceed with caution and retain an investment focus on quality managers and quality companies while conservative cash and fixed interest investments should be held to provide a buffer against any further market uncertainty.