Why is the market overpaying for growth, but punishing proven long-term stocks like financials when we clearly remain in a low-growth global environment?
Recent economic numbers show the world’s economies are entrenched in a low-growth environment and is flowing through to Australia, which has major implications for investors. Pumped-up growth stocks are set to become increasingly risky.
Instead, investors should focus on stocks with lower but sustainable growth from their strong franchises and which pay reasonable dividends, such the major banks, retailers and telcos.
The good news is that the market has been selling those very stocks off, which is providing reasonable price entry points against value.
Figure 1. Market Value chart as of 19 August 2015
If you had followed the release of recent growth figures from around the world, you would have noticed growth is slowing in key regions like Asia and Europe.
The world’s third-largest economy and Australia’s second largest trading partner, Japan, saw its economy actually shrink in the second quarter. Its GDP was down 0.4 per cent after a slump in consumer spending and exports, which translates to an annualised fall of 1.6 per cent.
Europe also posted surprisingly poor second-quarter GDP growth from a number of countries, and the whole euro-zone is now likely to expand at an anaemic 1 per cent this year.
The French economy, particularly, has stagnated with no growth in the second-quarter after a sharp fall in investment and consumer spending growth.
Italian growth is negligible, and Germany, touted as Europe’s growth engine, is forecast to grow about 1.5 per cent this year.
These growth figures follow China’s earlier-than-expected devaluation of their currency, the yuan, which is a clear indication that growth is also slowing there.
A clear message
Meanwhile, the US economy will continue to grow at below long-term trends at around 2.5 per cent. That is hardly the dynamic growth required to lift the global economy. And US growth will be hit by accelerated revaluation of the $US, particularly after China’s move to weaken the yuan.
The message is clear: the global growth outlook is not improving and developed economies are being drained by unemployment, ageing demographics and zero interest rates on savings.
Indeed the so-called stimulus, through zero interest rates and quantitative easing, is actually holding Europe and Japan in a low growth cycle.
Zero interest rates are doing as much damage as good because investors, retirees and savers can’t get solid return on their capital.
Central banks will have to rethink their strategies.
Yes, they’ve averted a disaster, but they’ve moved us into a unique low-growth economic scenario that no one can understand or indeed predict its consequences.
Lower growth in Australia too
This low-growth outlook, of course, echoes the commentary of RBA Governor, Glenn Stevens, who said in July this year that lower below-trend growth is the ‘new normal for Australia’.
Stevens said that Australia has assumed trend growth of 3 per cent to 3.25 per cent. But the economy has been expanding at a lower rate. Stevens said that perhaps that lower growth is “closer to trend growth than we thought”.
Today it is hard to see what’s going to step growth up in Australia, apart from China; and, as mentioned, China’s growth has fallen a couple of notches.
A low-growth scenario has major implications for investors.
Interest rates will likely remain lower for longer, which will prop up equities. And importantly in Australia negative real rates may become an intransigent feature in 2016.
A lower growth rate with low bond yields also means lower returns can be expected across asset classes.
How should you react?
What should investors do?
Firstly, high-growth stocks in this environment are becoming more risky because their growth will inevitably peter out. High-growth and high ROE are not sustainable in this low-growth environment. There are very few unique growth opportunities and in the main these are excessively priced.
Companies can grow above broader economic growth for a period, but projecting out three to four years of 20 per cent-plus growth is extremely foolish.
We believe the best opportunities for real total investment returns (that include low capital gain and high income) in this low-growth environment will be low-but-sustainable-growth, high-yielding stocks.
That includes the major banks, CBA, Westpac, NAB and ANZ; the major retailers such as Woolworths and Wesfarmers; infrastructure companies; and the likes of Telstra.
They are all yielding over 5 per cent, and they will all be second order beneficiaries of the emergence of strong growth in inbound tourism. This economic growth shift to tourism will boost consumption, financial transactions and mobile communication usage. It is a dynamic that has not been seen before in Australia and it will stimulate activity across the economy and capture many by surprise. It is why employment in services industries is being seen to grow above trend at present.
However, the market’s stance is currently the opposite: it is overpaying for growth, and selling down stocks which are proven long term returners, such as financials.
But the current weakness in the Australian share market is providing an opportunity for investors to buy these high-yield stocks. The trick is: actively manage your portfolio; continue to refine your existing holdings to ensure they remain relevant and appropriate, be patient and invest for 5 year returns rather than 5 minutes of glory.
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