NAOS Recaps 2014 & Insights for 2015…

NAOS Recaps 2014

• Concerns over global economic health overshadowed investor sentiment and low interest rates,
• Fund Managers have had a tough year overall especially domestic focused funds,
• Investors looked towards large caps for investing, where there was greater opportunity for yield,
• Company themes included cost-cutting and margin management with little revenue growth,
• Continued fall in the Australian dollar and domestic/global interest rates.

2014 began with the worst start to the Australian market since 2009. “Concerns over global economic health overshadowed sentiment, with a slow rate of growth out of China and Europe. Whilst the outlook for growth out of the US looked strong, the figures were supported by a build-up in inventory, which was soon rewound.

The market environment in 2014 was characterised by benign global inflation and subdued outlook for growth. Investors continued to drive growth in the larger capitalisation sector of the Australian equity market, in particular in REITs and Utilities, where investors saw the greatest opportunity for enhanced yield.

A fall in the Australian dollar over 2014 also lent its hand to an increase in earnings for those companies with offshore earnings, leading to supporting overall revenue growth for the broader market even as Australian exporters struggled.

Insights for 2015…

• US market retains a positive outlook, although key risk still exists
• The outlook for Europe remains tenuous
• Growth in China remains largely dependent on government fiscal initiatives
• Australian economy looks set for further interest rate cuts while the dollar is put under pressure
• Support for valuations in domestic equity market remains as long as investors seek yield

The US market looks positive, although we need to watch the falling price of oil. Energy debt now accounts for 16 per cent of the US $1.3tn junk bond market, up from a share of 4% a decade ago. While the outlook in the US remains broadly supportive of a stronger equity market, the European outlook is more tenuous. Some aspects of the European market look stronger, for example mergers and acquisitions have picked up, which has been fuelled by cheap financing as well as plump cash balances.

With regards to China, Beijing has, in recent years, sought to move from its investment-heavy, credit-dependent growth model to one that relies more on consumption and services. Despite this, slipping growth rates this year have seen the Beijing economy fall back on loose credit and government-mandated infrastructure investment to prop up the economy and ensure steadily rising employment.

Looking domestically, we predict there will be further cuts to interest rates, which will go a long way to support existing and future growth in the industrials sector. This support will be the key to market performance over the first half of the year, at least. A further cut in interest rates will also go a long way to support a rise in inflation which will ultimately result in an increase in value of real assets and will place continued downward pressure on the Australian dollar, which we believe may drop as low as 70c against the US dollar. A lower dollar will impact positively on Australian exporters and further gains in GDP (excluding mining) as household income increases marginally. This being so, employment security will remain a key factor for predicting consumer confidence and consumption trends into anything positively significant for the domestic economy over the longer term.

We see significant evidence to suggest that valuation levels in certain sectors will remain expensive across the large and small ends of the market. With valuations remaining currently where they are makes the opportunity set for investment very much derived from the stock/company specific story. If current market conditions persist and growth stagnates, compelling investment opportunities will only be found by digging deep and identifying /exploring industries where significant tailwinds exist. An example of one such industry us battery technology/development. The key output we are looking for here is how manufacturers can harness development in technology to result is a product that meets innovations at the end user, such as hybrid (electric) cars. As always, the key to investing in successful businesses will be the strength of the management teams as they are the ones to drive business management and growth.