As the new decade begins, we can reflect on the chaos that heralded the last. Who can forget the hype that was sold to business about the dangers of not upgrading software to shield it from the Y2k bug? Of course it didn’t exist, any more than we were facing double dips and a W-shaped recovery (although, by chance, 2010 caused some computer-related grief for credit card providers this New Year!). All were fantasies to focus the spotlight. Of course, terrorists or some other evil can unexpectedly change the world, but the global policies in place and the inherent strength of the Australian economy now, a year ago and two years ago makes anything other than a bright economic future for Australia as remote as it usually is.
I tested for a Y2k bug a few months before the new millennium by moving forward my computer clock to greet the new year nice and early. I saw no impact on my software, which added to my feelings that the fear was indeed not much more than a hoax. I can’t move the economy forward a few months but I can turn my attention straight past 2010 to 2011 and beyond to form my view for this year. By some time in 2011, the doomsayers will have been cast aside, along with flared trousers and platform shoes. Company earnings will be strong, as will be China. The USA economy might not be great, but recovering nonetheless. This scenario means demand for Australian resources will be strong. There will be no one talking about parity for the Australian dollar (just as it went away during 2008-09). The official interest rates will have climbed to 5 per cent, and maybe more. I don’t hear anyone mainstream – other than those with vested interests – saying anything significantly different.
The only question is, “How does our market get from here to there in 12 to 24 months?” The real keys for the Australian market lie in what transpires during the two major reporting seasons in February and August. If February is not strong, August should be very robust. If February is strong, August should simply reinforce the February growth. The impact on the market is obvious – the market starts growing again soon or jumps up sharply later in the year when companies upgrade not just profits but their clarity about future trends. Based on 2009 data, my analysis at the end of 2009 of broker forecasts for earnings and dividends sourced from Reuters Knowledge, shows only a modest improvement in 2010 – around 10 per cent, including dividends.
However, more emphasis on 2011 broker forecasts points to an average growth over 2010 and 2011 of about 25 per cent to 30 per cent a year. The only way to reconcile these starkly different estimates is to expect a massive 2011 in the market – unlikely. Rather, I suspect companies and analysts are not yet ready to upgrade 2010 forecasts: nobody wants to be first. So I see 2010 expectations evolving through clearer company guidance and clearer macro signals (and quieter doomsayers!). 2010 looks to me more like a 20 per cent to 25 per cent total return (including dividends) with the same or better for 2011. The really important point for any investor who agrees with this assessment is that it shouldn’t really matter when market expectations and stock prices start to improve. Trying to time market entry to getting set just before the next rush is a waste of nervous energy.
Dividends are likely to match or exceed the return from waiting on the sidelines in cash. Waiting for a correction before a take-off could prove frustrating. Sitting in the market like a coiled spring waiting for the take-off might feel like being a small child again, waiting for Christmas, and the presents might be just as exciting. With such strong expectations starting sometime soon, it might take some effort to beat the index. Nevertheless, there are a few observations worth making. Big companies’ returns may well better those of small caps. Many small caps are dependent on big caps taking off first. This growth is different from the sprint from the bottom last March, when small caps won through, having been oversold – not on producing a more dependable future earnings stream. I have never been a fan of bleating parity for the dollar.
To me it is a meaningless concept, used to fill another paragraph of an economic report with catchphrases. With the dollar at just under $US0.90 at the time of writing (start of January), and a long-run average in the mid to low 80-cent mark, companies dependent on US-denominated sales (such as some of the major healthcare stocks) should come back in favour when the dust settles. This should happen as soon as US interest rates make a move up – or are reasonably expected to. Where the dollar gyrates to in the short run is anybody’s guess. The opposing influences of potentially rising US and Australian interest rates – and their timing – might make the short-run dollar even more volatile than normal. Resource-related industrials-sector companies should follow the resurgence of the China “supercycle” onwards and upwards.
Growth in banking stock prices are likely to be limited by their impact on dividend yields, relative to term-deposit rates, to maintain yield-seeking investor appetite. While this analysis outlines my “best-efforts” view on how our market will pan out, there is one almost certainty to hold on to. Markets, in particular resources, are volatile. Just like the big corrections in the wonderful growth years of 2005 and 2006, there are corrections – almost unpredictable – ahead of us. The next is more likely after mid-2010 than before. But the one lesson to learn from the GFC is to be ready for them. A long-term strategy should be able to withstand a correction or two. If a new Grinch arrives to try and steal next Christmas’s fun, either get out early or ride the wave. Bailing out at the bottom is the worst thing to do. So, if the market hasn’t increased too much by the time you read this article, getting in the market and waiting patiently for strong gains could prove to be a virtue.