Market Update

Wednesday, December 17 2014

Grinch has arrived this Christmas from a market perspective. We examine the recent weakness and share our thoughts going into the New Year.

The main concern of the market has been the oil price, which we have discussed in detail. The impact of the lower oil price is being felt across the globe. There is a massive transfer of wealth occurring, from oil producers (such as Russia) to oil consumers (the developed world). This is occurring through currency moves with the Russian ruble falling and the US$ rising, and through relative stock market moves.

At present the volatility caused by the above has increased the risk premium demanded by the market to invest. There is an understandable fear that there will be defaults among some oil producers and large capital flows out of certain emerging markets, such as Russia. We continue to note that for the developed world the lower oil price will be very positive for growth given it is an input cost for so many manufacturers or transport companies.

In Australia consumer confidence remains subdued. We have been expecting the lower oil price to provide some relief into Christmas however following the events in Sydney, we expect the consumer to remain subdued this Christmas. Our largest consumer exposure is JB Hi-Fi. We now think there is some downside risk to earnings for JB Hi-Fi, however we note the following factors to support retaining the position:

  • The RBA will likely lower interest rates next year.
  • The oil price will eventually provide some relief for the consumer.
  • They will be cycling a very soft year next year so should start to enjoy some growth.
  • The stock is already factoring in a soft environment with the stock trading on 11x earnings and offers a 7.85% grossed up yield.
  • The company has little debt and remains well run.

While volatility in global oil markets and a softer consumer environment has caused markets to retreat, we finish the year with some reasons for joy. We see the following factors contributing to a better outcome next year:

  • US growth rates remain very strong.
  • China is very active in terms of reforming their economy.
  • Lower interest rates and lower oil price will provide stimulus for the economy.
  • Lower currency will provide a further benefit to a range of sectors including tourism, education and other exporters.
  • Markets will be starting the year at a lower level. The price earnings of the industrials index (excluding resources) is 13.9x. This represents an earnings yield of 7.2% which is at a large premium to cash rates of 2.5% (and falling) and bond yields of 2.8%. In other words, investors in equities are being offered a nice premium at present to compensate for potential risks and given current uncertainties, the market is unwilling to pay too much of a premium for growth. We would expect this to change as the year progresses.

Of course in the near term the risks might well remain on the top of the mind for investors for a while but we see the positioning of the portfolios as well placed to weather the current volatility:

  • We have significant exposure to companies with offshore earnings which benefit from the lower A$ (Brambles, Sonic Healthcare, IRESS, Henderson’s, QBE, Treasury Wines, Macquarie Bank, Resmed, Macquarie Atlas).
  • We are positioned in high quality companies with good balance sheets and sustainable earnings.
  • Our exposure to resources is at the higher quality end (BHP and RIO) which can ride out the cycle and end in a stronger position with greater market share.



IMPORTANT NOTE: This information has been prepared by DNR AFSL Pty Ltd ABN 39 118 946 400, an Australian Financial Services Licensee, Licence Number 301658. Whilst, Dalton Nicol Reid has used its best endeavours to ensure the information within this document is accurate it cannot be relied upon in any way and recipients must make their own enquiries concerning the accuracy of the information within. This document is not intended to provide you with personal advice and in providing this information, Dalton Nicol Reid has not taken into account your particular investment objectives, financial situation or needs. You should assess whether this information is appropriate for your particular needs, either by yourself or with your adviser. Dalton Nicol Reid expressly disclaims any responsibility or liability to anyone who acts or relies upon anything contained in, or omitted from, this document. Past performance is not indicative of future performance. Total returns shown are based on Dalton Nicol Reid’s model portfolio and have been calculated before taking Dalton Nicol Reid’s fees into account. No allowance has been made for taxation.

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