As most developed market economies work towards a recovery, Australia continues to outperform them in terms of growth rates. Paul Taylor, portfolio manager of the Fidelity Australian Equities Fund looks at the state of local equities and outlines the key drivers of the Australian economy.
What’s your outlook for Australia’s economy?
The Australian economy has seen uninterrupted growth for more than 20 years and its economic fundamentals remain strong, which is why Australia is one of the few triple-A-rated countries in the world. I see this positive trend continuing for the next five years.
Consumption, which comprises about two-thirds of GDP, is poised to drive the economy in coming years for three reasons. The first is that Australia’s population growth is among the fastest in the world. It is expected to outpace the OECD average growth rate by four to five times over the next decade. This will be the most important consumption driver for Australia.
Second, cuts to interest rates are helping spur spending. The Reserve Bank of Australia cut the cash rate five times in 2012 and once so far in 2013. There is a likelihood of one more rate cut in 2013. Lastly, despite falls in commodity prices, mining activity should hold up, and income from this sector supports the economy. Australia is a low-cost producer, giving miners strong incentive to expand production even when commodity prices are low.
Australia is a small open economy that would be hampered if the world economy were to experience another economic shock stemming from the debt crisis in Europe or something else. However, I believe Australia would still fare better than most countries because interest rates in Australia are significantly higher than other developed countries. This gives the RBA enough room for further easing relative to other countries. In addition, the government has low debt levels and could undertake a large stimulus program to assist economic growth, if required.
The Australian dollar has been strong in recent years. Where is it headed?
The Australian dollar has been strong in recent times due to a number of reasons such as overseas investor appetite, strong commodity prices, attractive interest rates and high dividend yields as well as due to Australia’s stronger economic fundamentals compared with other countries.
The future direction of the Australian dollar might be more about what other countries do with their monetary policies than with anything that happens here. The interplay of these factors is hard to predict and is likely to result in volatile shifts in sentiment.
The strong currency has been a headwind for miners, other exporters and tourism. Any decline will help these sectors while hampering the importing sectors.
What’s the outlook for commodities given that Chinese demand could slow?
Slower growth in China would reduce demand for Australian commodities and, to an extent, such fears are reflected in the share prices and capital expenditure plans of the miners. However, the longer-term impact on Australian commodity producers is likely to be limited.
The amount mined from Australia should still grow. Arguably, in many cases, a drop in commodity prices would help Australian low-cost miners because their higher-cost competitors could become unprofitable.
It is important to note that Australia is undergoing a significant shift in the composition of its exports. In coming years, energy exports, led by LNG gas and thermal coal, are expected to rise as large investment projects are completed.
Demand for energy from Asia is expected to grow at a robust pace, fuelled by the needs of a rising middle class there. In addition, services exports, particularly in education, should provide additional support for the economy.
How is the fund positioned in the natural-resources space?
Since the portfolio is built stock by stock, the positioning at the sector level is an outcome of a bottom-up approach. At the moment, the fund is underweight in the materials sector. However, in April I reduced the underweight position in view of an improving environment and pricing outlook for mining companies.
In particular, I raised the allocation to BHP Billiton because valuations became attractive. I maintain the high-conviction allocation to Rio Tinto and James Hardie Industries due to their strong positions within their industries.
With energy stocks, I am optimistic about the prospects for Oil Search and Origin Energy, given strong potential exploration upside and good growth visibility; progress on key projects has been encouraging, despite the cost overruns that were reported recently.
What is your view on the financials sector, particularly on banks?
Australia’s banking sector is among the strongest in the world. The big four banks are among those few that can boast of a double-A or above rating from Standard and Poor’s. Their shares prices have done well over the past year or so as investors found safety in their robust balance sheets and stronger dividend yields.
As a result, I maintain a cautious-to-neutral view towards the sector and own those banks with strong capital ratios, favourable funding positions and attractive dividend yields. Commonwealth Bank and ANZ Banking are my favourites.
The Australian residential property market has been subdued for several years and now seems reasonably valued. There is an increasing expectation that property prices could rise in 2013 due to lower interest rates. Given that, I hold a substantial stake in globally integrated industrial property owner and fund manager Goodman for its strong business model and excellent access to capital.
What are the other overweights in the fund?
The largest overweight in the fund is the online employment search provider, Seek. I hold this stock for its strong structural growth driven by a shift from print to online media. The company has a natural edge in the marketplace as its growth creates high entry barriers.
Additionally, Seek holds a majority stake in a China-based Zhaopin, which is the second-largest online job portal in China. An attractive yield and strong balance sheet with its low debt are other reasons for holding the stock.
Domino’s Pizza Enterprises in another overweight position. The multinational food retailer offers strong growth prospects, particularly due to promising demand and store roll-outs. A strong brand franchise and an excellent management team have been the firm’s key growth drivers.
Another key holding is the private hospital operator Ramsay Health Care. The firm has a significant presence in the UK, France and Indonesia, and it is the largest owner of hospitals in Australia. The stock benefits from favourable demographics and an advantageous pricing environment, while operating costs have a fixed structure.
Paul Taylor, is country head of equities and manager of the Fidelity Australian Equities Fund
