A good year to embrace risk

16:00, Jan 12 2013
Good rally: Almost $A200 billion was added to the value of the shares of the 200 biggest Australian companies in 2012.

Investors are hoping a recovery in the US economy, lower interest rates and a rebound in earnings will help propel the Australian sharemarket to its second straight year of gains for the first time since 2006 and 2007.

After a solid 2012, analysts are still braced for another volatile year. But shares, underpinned by reasonable valuations, could make further gains if investors are encouraged to take more risks and switch from cash and bonds to growth assets such as shares.

The benchmark S&P/ASX 200 Index rose 13.4 per cent last year, driven by industrial stocks. The challenge for investors is the sustainability of the rally and the upcoming reporting season is seen by many specialists as the first major test of the market.

Perpetual head of equities Matt Williams said the industrial rally of the past year was largely driven by a re-rating of existing earnings and dividend expectations.

"We will need to see a lift in earnings expectations or prices to retreat for the market to start looking attractive again. The major risk is that the industrials cannot continue or sustain this rally and resources do not pick up the slack," Williams said.

Almost A$200 billion (NZ$250b) was added to the value of the shares of the 200 biggest companies in 2012, despite ongoing concerns about the European debt crisis, a slowdown in China and the fragile state of the United States economy.


But during the past few months there has been favourable news on the US housing market with construction up, more homes selling and prices turning positive.

"That's something investors haven't seen for quite some time and it will help the sharemarket," UBS Wealth Management investment analyst Abby Macnish said.

"Consumers, having paid down their debts and secure in their jobs, will start spending again and think about moving into a bigger home."

The recovery in the US housing sector is coming off such a low base that it has the ability to make a significant difference during the next few years, she said.

The US Federal Reserve is expected to keep rates at zero until 2015 and will not start raising them until it foresees the jobless rate falling to 6.6 per cent. It is now at 7.7 per cent.

The Fed expects the US economy will expand by 2.3 to 3 per cent in 2013, while estimates for 2014 range from 3 to 3.5 per cent.

The US is growing at a rate of close to 2.5 per cent.

The solid gains made by the Australian sharemarket in 2012 mirrored the gains made around the world. Globally, stocks rose an average of 12.8 per cent in 2012, said the MSCI World Index.

On the ASX, back-to-back years of earnings growth came to an end in financial year 2012, with average earnings per share declining by about 1 per cent.

Nomura forecasts market earnings per share growth to be flat for the 2012-13 financial year, while most strategists believe EPS growth will be about 10 per cent in 2014.

Valuation measures such as the forward price-earnings multiple show shares are not as cheap as a year ago but still offer value. The multiple has risen to 12.5 times from around 10.5 times. Compared with bonds, shares offer decent value as bond yields have fallen further and should stay low because of very loose monetary policy globally and anticipated stronger profit growth in 2013-14.

Nomura's Tim Rocks predicts the major S&P/ASX 200 index hitting 4200 by the end of this year. As investors continue to search out yield he thought the "safety trade" of 2012 would still be on as investors hunt out stocks with high dividends.

"We know there is a lot of money on the sidelines that is becoming dissatisfied with term deposit rates," he said.

Macnish thought the one positive for the sharemarket might be the switch from cash and bonds back into shares.

Cash weightings for Australia's A$1.3 trillion superannuation funds remain at historical highs, around 23 per cent compared with the long-run average of about 18 per cent. But with interest rates tipped to fall to record lows, Macnish said a 5 per cent allocation back into shares would see a flood of money help prop up the market.

UBS Wealth Management has an end-of-year S&P/ASX 200 target of 4950.

However, JPMorgan equity strategist Paul Brunker believed there was "limited potential" for the equities benchmark as the environment of low growth and ultra-low rates are a "reasonable though unexciting background for equities".

The broker has a June target of 4500 for the S&P/ASX 200 but thinks it will fall back to 4250 by the end of 2013.

He said the Australian economy was entering a riskier phase as the public and priate sectors closed their wallets and export earnings tumble.

"The Aussie growth parcel is being thrown to the households, but they are constrained by a softening labour market, low appetite for leverage and credit supply," Brunker said.

Some specialists said rate cuts may lead to the Australian dollar falling as many challenges sweep across the Australian economy, including the narrowing interest rate gap, slowing growth and a widening trade gap, offsetting the impact of more US quantitative easing taking its toll.