The Australian Share Market performed very strongly over the month of October, with the S&P/ASX200 benchmark index increasing 206.6 points or 3.96%.
The ASX/200 started the 2013/14 financial year at 4,802.59 and has now risen to 5,425.50; a gain of 622.91 or 12.97% over the four month period. This is an outstanding result so far.
Further this means that the ASX/200 has risen 32.5% since 1st July 2012, but remains even at these levels 21.06% below the market high of 6,873.20 on 1st November 2007.
The Financials (ex REIT’s) was the strongest performing sector for the month of October, posting gains of 5.9%. Of note within this sector was the performance of Macquarie Group which outperformed the index and returned 6.35% to close at $50.95 on 31st October 2013. Some of our portfolio management clients were fortunate enough to buy into this stock in the $36 – $40 price range earlier this year when it was initially added to our recommended model portfolio and have enjoyed the gains ever since.
The Healthcare sector also performed well increasing 4.5% in October. Within this sector one our portfolio darlings CSL Limited jumped 8.59% over the month to close at $69.50. Twelve to eighteen months ago the Healthcare sector was heavily out of favour, stock prices were low and we were recommending buys in stocks such as CSL and Primary Healthcare. The last twelve months has seen a surge in this sector due to the defensive and reoccurring nature of earnings. Most of our portfolio management clients would hold at least one healthcare stock and hence are currently enjoying the returns within this sector also.
The energy sector was the worst performing sector increasing only 0.2% for October.
The US shutdown failed to put a damper on equities, with initial weakness early in the month being shrugged off and producing a strong rally for the backend of October. The rally was broad based, with every major sector and almost every country’s stock market posting gains – Japan being the notable exception. The MSCI US index increased 4.4% in October not bad for a country who spent half the month in a Government Shutdown!
Spotlight on the Banks
As our portfolio management clients are well aware our portfolios have been heavily invested in the banking sector over the last few years. For regular readers you will know that we have also been highlighting the grossed up dividend paid by the “big 4” which has been roughly double term deposit rates for some time now. Below is a quick summary of how the shares have tracked and the current income:
|Share Price 31stOctober 2011
|Share Price 31stOctober 2012
|Share Price 31stOctober 2013
|Current Grossed Up Dividend Yield
Now the question we seem to be getting asked is are the banks over valued? Well there are arguments for both sides so here’s a quick summary.
Strong Capital Growth
Share price movement of the big four banks from 2009 to 2013 so far:
The “yield trade” or chase for yield has been a key reason why banks and high yielding assets have rallied over the last few years. With interest rates falling domestically and globally, investors have turned to assets with high yields.
As you can see from this chart of CBA (black line) and the cash rate (blue line), the two are inversely related. That is as cash rates have been falling, CBA’s share price (as well as many others) has been rising.
3 keys to potential negative reaction in bank share prices
- Bond prices fall, yields rise
- Domestic economy slows
- $A continues fall
Bond prices fall, yields rise
As interest rates rise, high yielding investments will be less attractive to investors. Our view is that interest rates will be on hold for the entire 2014 calendar year.
Domestic economy slows
The big four banks are still highly leveraged to the domestic economy. If we start to see the domestic economy struggling, especially the housing market, expect this to impact on banks bad debts and profitability. At the moment though, the opposite is true with relatively low unemployment rates, rising mortgage and construction approvals as well as record auction clearance rates particularly in Sydney and Melbourne.
$A continues to fall
If the $A falls significantly, that will discourage international investors from investing in the Australian market. International investors benefit from a rising $A while invested over here.
The yields on offer are far more attractive than the 3.5% being offered for term deposits and for long term investors, especially those requiring income from their investments the banks are still an attractive option if weighted correctly within your portfolio.
While bank valuations are rising, they can remain and rise above these levels for extended periods of time. A key reason why banks have performed so strongly is a relatively strong domestic economy (no recession in over 22 years) and falling interest rates.
While we continue to monitor economic conditions and the bank valuations may fluctuate we believe that they are an essential part of any long term portfolio. Trying to pick short term fluctuations more represents gambling than investing for the long term.