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Growth assets for the new financial year

Anthony Fensom  |  12 Jul 2016Text size  Decrease  Increase  |  

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Fiscal 2016 was not especially prosperous for Australian investors, with the share market and Aussie dollar falling along with bond yields, and the residential property boom largely benefitting only Sydney and Melbourne.

So, which asset classes might perform better in the new financial year?

Small was beautiful in the year to 30 June, with the S&P/ASX 200 Index posting its first fall in four years, dropping by 4.1 per cent to finish at 5,233.

However, this was largely due to poor performance from the ASX 50 (down 7.4 per cent) and top 100 (down 5.1 per cent), with the MidCap 50 gaining 13.4 per cent and the Small Ordinaries posting a 10.4 per cent gain.

Total returns on Australian shares (as measured by the All Ordinaries Accumulation Index) still eked out a 2 per cent rise, which was dwarfed by the 13.9 per cent increase for property and the 7.9 per cent return for government bonds.

Cash investors, however, suffered as the Reserve Bank of Australia slashed its official rate to a record low of 1.75 per cent, with yields on the 10-year government bond hitting record lows below 2 per cent.

Australians also saw their collective wealth shrink as the local currency dropped by 3.3 per cent against the US dollar during fiscal 2016, weighed down by a 15 per cent fall in commodities prices.

Despite the market challenges of fiscal 2016 having included rising US interest rates, worries over China's economic transition and the recent "Brexit," the Australian economy still managed to continue its record winning streak with GDP growth of around 3 per cent, a rate which it is expected to maintain into 2017.

Volatility to continue

Yet with uncertainties over Australia's election aftermath and credit rating agencies signalling an end to the nation's triple A credit rating, volatility appears set to continue in fiscal 2017.

"We had a pretty good run since 2010 with four years of double-digit returns, but 2016 was abnormal," says Morningstar's head of equities research, Peter Warnes.

"This was driven by the underperformance of the major banks due to increased regulatory pressure and the requirement for them to raise new capital."

Warnes suggests smaller companies could perform well again in fiscal 2017, with the banks and insurers still under pressure, particularly in the event of a credit rating downgrade.

"Interest rates are going to remain low in historic terms, and investors are being forced further out the risk curve to shore up income levels ... I'd have quite a bit of defence in my portfolio," he says.

Warnes points to healthcare stocks like CSL (CSL) and ResMed (RMD), telecommunications company Telstra (TLS) and potentially gold stocks such as Newcrest Mining (NCM) given the rising Australian dollar gold price.

Warnes also suggests Australian investors gain some international exposure to aid diversification both in asset class and geography, particularly into US-dollar-denominated assets, such as US-facing stocks or US exchange-traded funds.

He warns against bonds, saying "they're overvalued versus equities at this point in time," although "that does not mean yields will not stop falling".

"Overleveraged property and utilities stocks would suffer if bond yields start rising," he says.

Warnes expects the S&P/ASX 200 to stay within a trading range in the year ahead at between 4,900 and 5,500, without a major boost to economic activity.

AMP Capital's chief economist Shane Oliver has warned against cash and bonds, instead pointing to real estate investment trusts and dividend-paying Australian shares, and also international shares.

He cautions against investing in residential property in Sydney and Melbourne, saying they had done "spectacularly well" over the past four years, but Brisbane could be a better bet in future after having lagged its southern rivals.

Lower returns?

Meanwhile, Glenn Rushton, executive director of Rushton Financial Services, suggests investors should prepare for a world of lower returns and higher volatility.

"In the past year we have entered an environment of lower returns, with record low official interest rates here in Australia, and low, or even negative rates, overseas," he says.

"We have also seen government bond yields hit a record low in Australia, and with little expectation of higher interest rates, they could fall even further.
 
"Meanwhile, stock markets internationally have risen strongly post the global financial crisis, as investors chase higher returns at the cost of increased risk.

"But with 'Brexit' and concerns about a hard landing in China hitting the resources sector, and worries over the US Federal Reserve's moves on interest rates, there appears little prospect of a sharp upturn in the Australian stock market.
 
"In such an environment, investors should consider alternative investment strategies, such as market neutral, which are not reliant on constantly rising asset prices, are lowly correlated to returns from shares, and can actually benefit from increased volatility."

With low returns seen from cash and bonds, a volatile share market and an uncertain outlook for residential property, a safety first approach could prove beneficial in the year ahead--backed by the confidence of Morningstar's economic moat ratings.

"Uncertainty will mean markets will remain volatile and investors have got to make sure they're comfortable with the risks they're taking," Warnes says.

"We've had some pretty good times from 2010 to 2014, but caution is to the fore in 2017--we've got to make sure we don't lose any money going forward."

More from Morningstar

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Anthony Fensom is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind.

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