What’s driving our equity markets and where to next?

The Australian large cap equities market is in the doldrums. Not that that’s necessarily a bad thing, unless you’re a broker requiring volume to pay your bills, or a day trader looking to make your daily bread between the ticks on the tickertape (for the youngsters that’s another way of saying looking to buy on the low of the day and selling on the high).

But the market keeps on chugging along. Rates of volatility on a six-month rolling basis are low, returns for the general investor are good.

Happy with that – returns good, risk low

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Capital value

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6 month volatility

Local equities are to a large extent mirroring their offshore brethren. Current international markets are characterised by extremely low volumes and levels of turnover, even by the usually quiet standards of the northern hemisphere during summer.

The domestic drivers aren’t lighting any fires either. On the economic front, while signs of further investment are emerging, these plans remain tentative as firms wait for signs of improvement before committing more to expansion.

On the labour front, growth in wages has fallen and though there have been some progress in the jobs market it’s expected to be some time before unemployment declines materially.

On present indications the Reserve Bank is likely to retain a holding pattern on interest rates as well.

On the market front, the local “confession” period has been surprisingly muted – especially given marked weakness in the Retail sector – with few companies looking to downgrade their earnings expectations. This might just bode well for the formal reporting season, with the market’s increasingly less optimistic – but more realistic – expectations not as likely to be disappointed.

The stocks to watch are those delivering strong free cash flow (EBITDA), that are benefiting from low-capital intensity growth, or are set to do well at this point in the business cycle.

Small cap concentration

There’s been a marked divergence within the small cap market as investors have flocked to a relatively narrow set of growth stocks, driving them to elevated valuations. This has created opportunities elsewhere in the market where good quality companies with strong management and cash flow are available. Factors such as niche products, robust franchises or compelling “turnaround” stories are catching the eye.

Opportunities seem to be more abundant in the Consumer Discretionary stocks and Diversified Industrials – particularly Diversified Industrials not totally reliant on the mining industry.

In the property sector of the market, earnings and balance sheets are stable with sector gearing currently standing at about 29%. Look at supportive funding costs, positive spread investing and cost cutting when considering if the performance of the sector can be sustained.

Read more about our Australian equities investment approach.

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The views expressed in this article are the author’s alone. They should not be otherwise attributed. BT Investment Management may hold securities mentioned. This is general investment information and does not take into account your objectives, financial situation or needs. Before acting on the information or advice, you should consider the appropriateness of the information or advice in relation to your objectives, financial situation or needs.

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