Quarterly Review – January 2013

Posted in Wealth
18/01/2013 Level One

Market Review

The final quarter of 2012 calendar year was again positive for the Australian Share market. The ASX/200 rose 261.9 points or 5.97% from 1st October 2012 – 31st December 2012.

For the 2012 calendar year the ASX/200 rose 592.3 points to finish at 4,648.9 points. This delivered a total return of 14.6% for the twelve month period. This is the growth return for the Share market, dividends paid on top of this increase the return further.

On the interest rate front, The Reserve Bank of Australia cut interest rates from 4.5% at the start of 2012 to 3% at the end of 2012.

The drop in interest rates has seen more investors moving money out of term deposits and into the Australian Share market. While high yielding stocks were the most appealing acquisitions in 2012 out of favour resource stocks have had a late resurgence in December.

We see good value within the resource sector at present. BHP is currently paying a fully franked dividend of 4.01%. When compared to Term Deposit rates of 4.3% we see BHP as an attractive investment as we see upside in the share price. Albeit investors need to be prepared to accept volatility. On the flip side the banks continue to offer a high yield with a lower level of growth potential.

At this stage it looks like the looming “fiscal cliff” in the USA has been averted, however negative comments from the Federal Reserve’s minutes in relation to concerns over current bond purchasing measures and comments that the stimulus program may be withdrawn earlier than expected, have had some negative impact on share markets.

There are some positive signs coming out of America; housing markets look to have bottomed out and the unemployment rate continues to tread lower. However, the prospects for a long-term sustainable recovery will depend on policy makers implementing the required reforms to reduce debt.

We continue to expect volatility within the market but given the current valuations and income supporting Australian Shares we expect a solid return for 2013.

Economic Update

2013 has a few obstacles lined up for our economy: further declining terms of trade, the winding down of the mining investment boom, the stubbornly strong Australian dollar, and substantial fiscal tightening by both state and federal Governments (it is an election year after all). There are a few positives to soften the blow expected however, with these being the influence of monetary easing by the RBA so far (and possibly more to come) and the potential for mining exports to lift as new capacity comes online and China makes a modest recovery.

Real GDP has slowed further coming out of the last quarter of 2012 and, although economists predicted growth to be around 3%, this has been downgraded to a more realistic figure of 2% – 2.5% in 2013. This is largely due to the belief that the impending obstacles having a more significant impact on our economy than first expected.

Terms of trade have fallen 14% over the last year and are likely to decline further.

Previously, increasing incomes fuelled by the commodity boom were being supported by the increase in prices; however this is now being reversed and is shown by declining nominal GDP – an increase of only 1.9% in 2012 to September after growth of 8.1% in 2010 and 6.6% in 2011.

The Australian Government is unlikely to achieve its desired fiscal surplus this year but nonetheless is implementing the largest fiscal tightening since at least 1970.

Interest rates are expected to decline further – we believe down to an all-time low of 2.5%. However, households in deleveraging mode will more than likely save these rate cuts instead of spending them which is another adverse economic effect, especially for the non-mining sector. Thus this rate reduction strategy has not had the desired effect of previous attempts, but time will tell if things can be turned around as consumer confidence grows.

While massive cash and fixed interest holdings are being held by super funds, corporate Australia and “mum and dad” investors, the reduction in interest rates have already seen some long term conservative investors moving their monies into the sharemarket – seeking out the high yielding stocks such as the big four banks and Telstra. Further reductions could see more money move into shares and push the market higher over the next year or so.

The Australian dollar is still high despite falling commodity prices, the China slowdown, risk aversion around Europe and RBA rate cuts. The AUD has remained stubbornly resilient, predominantly due to global investors seeing it as a safe haven and the stability within the resources sector as mining and infrastructure spending is largely locked in. Currency models suggest that the AUD should lower to parity with the USD, however if global investor sentiment becomes aggressive this could fall towards USD0.90 in 2013.

In summary, the implications for financial markets seem to be: more RBA easing, subdued long-term interest rates, a weaker Australian dollar, and moderately higher share prices.

Spotlight on BHP & Rio Tinto

2012 was a tough year for BHP and Rio however a strong pick-up in December saw these stocks move out of the red and into positive territory.

BHP started the year at $34.42 and finished the year at $37.10, an increase of 7.79%. During the twelve month period BHP dropped to a low of $30.09 on 12th July 2012. It’s worth noting that BHP’s share price at 30th November was $34.39 so the capital increase for the twelve month period was all made in the month of December.

Similarly Rio Tinto started the year at $60.30 and finished the year at $66.01 an increase of 9.70%. During the twelve month period Rio dropped to a low of $48.37 on 30th August 2012. Rio’s share price at 30th November was $58.75 which was below the 2012 initial price. Again the capital increase for the twelve month period (as well as the regain of losses for the period) all occurred in the month of December.

On 12th December 2012 UBS reiterated their “Buy” rating for both BHP & Rio. They also updated their twelve month price targets: BHP $40 and Rio Tinto $86. If we see these prices achieved the growth return will be 7.82% for BHP and 30.28% for Rio when compared to the 31st December prices. Please note that dividend income is on top of these figures.

The outlook for commodity prices for 2013 is flat, thus BHP and Rio will need to reduce costs to drive earnings growth. The implementation of this strategy commenced last year with Rio announcing cost cuts of $5 billion of which UBS expects $3.3 billion to be sustainable in the long term.

2012 was the year for High Yielding Stocks such as the Banks and Telstra. What will be the top performer for 2013?


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