Danger: don’t be fooled by global share rallies
Investors who like being close to the action may be wondering if Morgan Stanley was right to this week issue a ‘full house’ alert to buy European shares.
‘Full house’ is the investment bank’s way of saying all of the indicators it uses to assess shares as a ‘buy’, ‘hold’ or ‘sell’ are now aligned, and that European shares overall have passed their low-point – we shall see.
On this side of the world, the big question for investors is whether the bank’s pronouncement has anything to say about Australia’s volatile equities markets. If Europe has reached a low point, surely we’ll do the same soon?
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Not quite. Whatever happens on the European bourses, Australian stocks face very different challenges in the months ahead.
This is important because while Australian share prices jump and dive like a school of playful dolphins, many spooked investors are sitting on large piles of cash and wondering when to jump back in.
Talking about shares in aggregate is always dangerous, because while some stocks – such as banks and miners – face long-term structural problems, others are on the cusp of big opportunities.
The Australian economy is hurting as the mining and housing-credit booms abate, but it is still well placed to profit from the emergence of a large, more affluent consumer society across Asia.
The collapse in China’s share markets, and mixed commentary on that economy’s many structural problems, can lead to the false view that Asian economies won’t have any money to spend on Australian exports.
Well they won’t have as much, perhaps, but they’ll still have plenty.
Let’s take one example – agricultural exports have been growing strongly, with Agriculture Minister Barnaby Joyce this week celebrating “a 7 per cent increase in the value of rural exports in 2014-15, on the back of a 9.7 per cent increase in 2013-14”.
If more of the value-adding in food exports is retained onshore – beef exporters, for instance, moving into portioning and packaging beef here rather than sending carcasses or live cattle abroad – the companies in those supply chains can experience strong earnings growth, even if the ASX is sagging.
Roger Montgomery, founder and chief investment officer at Montgomery Investment Management, says this is the key to understanding Australian equities.
He argues that Australian investors have developed a culture of yield-chasing, almost heedless of the capital value of the shares they buy.
Thus it was that ANZ CEO Mike Smith was last week promoting buying opportunities in Australia, telling journalists: “… if you look at the fundamentals (in Australia), you look at some of the yields that are being offered now in terms of Australian stocks, frankly it’s a no brainer what you’d do.”
That prompted a swift reply from economics commentator David Llewellyn-Smith, who while agreeing that true yield stocks are a good thing, argued: “Banks are not yield stocks … A yield stock is a boring, utility-like, low leverage, low risk, plodding return on equity …”
That’s the point Montgomery makes too: if you want to buy Australian equities, do your research. Buying ‘plodding return’ yield stocks is a good idea if that’s what you’re looking for, but with higher yields come higher risks that you will lose, or at least not grow, your capital.
As an example, Montgomery cites Telstra 10 years ago, when it was returning a gross yield of 5.9 per cent. An investor who invested $100,000 back then would now own shares worth $111,400.
Over the same period, investors who did their research and looked for companies with real income-growth potential, might have resisted Telstra’s high yield.
Had you put the same $100,000 into the start-up telco M2 Group back then, when it was only yielding about 3.5 per cent, you’d now be sitting on $2.4 million worth of shares.
The point here is that while Australian yields can look attractive, their allure is greatly reduced by the huge structural shifts underway in the economy – away from the mining and housing-credit booms, and into the new growth industries.
If European shares rebound, or US shares for that matter, it will say very little about shares listed on the ASX, which is so heavily dominated by banking and mining shares.
Individual stock-pickers like Montgomery will continue to find shares with real upside, but mum-and-dad investors feeling an exuberant urge to follow the European and American bourses higher, had better do a bit more homework.
A global rebound may be just around the corner, but an Australian rebound – if we can pull it off at all – is a much longer term prospect.