Surely equities turned in another poor year? The European Union was on the verge of collapse with an imminent exit by Greece. The slowdown in China’s growth was a precursor to a hard landing. And to round it out, partisan politics in the US threatened to send its economy off the cliff, taking global markets with it.
Not quite. In spite of the headlines, the local market rose 11 out of 12 months and turned in its best performance since 2009. Perhaps it could’ve been a different outcome, but a little bit of commonsense in the US and policy response in Europe, combined with reasonable valuations, ultimately won the day. Besides, only a permabear would begrudge a return of 19.7 per cent.
However, not all boats rose with the tide. Materials suffered in the face of falling commodity prices. As too did related industries such as mining services. Not helping was talk of an earlier and lower peak in the mining boom, though it did prompt the Reserve Bank of Australia to cut rates further.
In light of lower cash rates, high-yielding shares were very popular with stocks such as Telstra enjoying strong support. REITs also enjoyed an outstanding year.
| Zurich Investments outlook for 2013 | |
| Europe | Effectiveness of stability mechanisms will be tested should Spain request a bailout. Elections may also feature. |
| USA | Debt ceiling 2.0. The energy revolution should not be underestimated in the US. |
| China | Growth reaccelerating. Overcapacity in many industries unresolved. |
| Australia | RBA to remain a ‘reluctant cutter’ as economy transitions from peak mining related activities. Australian dollar appears overvalued, though offsetting global forces such as money printing remain. Anticipate a strong focus on cost control by Australian companies. |
| Global or local? | Global over local equities. |
So where does this leave us for 2013?
With the exception of the smaller end of the market, Australian equity valuations are not as compelling as they were, and the earnings outlook remains rather subdued. Hopefully an improving global backdrop can alleviate some of the softness in the local market. But while it appears more stable than recent years, it is clearly not without risks.
For starters, it would be more of a surprise if Europe didn’t flare up some time over the next twelve months. In recent times, Greece has been the primary cause of headaches, though the main story for 2013 could well be Spain. Should Spain require a bailout, the effectiveness of mechanisms such as the Outright Monetary Transactions will dictate market sentiment.
The debt ceiling in the US is the other elephant in the room. With the president not willing to negotiate and Republicans agitating for cuts, it looks as though another showdown looms. Maybe it will come down to a loophole in the US constitution, otherwise the discussions could vary from disruptive to devastating. Perhaps a $1-trillion platinum coin isn’t as fanciful as it sounds.
After a year of slowing growth, the Chinese economy looks like it is set to reaccelerate. Recent surveys have suggested expansion, though investment-driven growth cannot last forever and overcapacity issues will need to be addressed.
A cue for cost control
Nevertheless, Chinese growth is a positive for Australia and should support the materials sector after a tough 2012. While the recent rally in the iron ore price may be seasonal, the majors look set to benefit from a renewed focus on productivity gains and cost control.
At their investor updates late last year, both BHP Billiton and Rio Tinto made specific mention of their decisions “in a challenging market”. Rio alone is targeting savings “of more than US$5 billion of operating and support costs by the end of 2014 compared with expected costs in 2012”, according to its website.
Cost control could well feature across the broader market in the coming year. Aside from resources, some cyclical sectors may also fare better as the RBA attempts to spur economic activity outside the mining sector.
While 2013 has commenced with relative calm, there will no doubt be headline shock along the way. On balance, equities have a fair chance to outpace more defensive asset classes again, though we’d anticipate more modest gains in lieu of earnings growth.
With the prospect of further rate cuts, the tussle between lower cash rates and investing in shares will continue to be an interesting deliberation.
Patrick Noble is a senior investment strategist at Zurich Investments.
