Nicholas Grove: In their recently published biannual forecast, Morningstar's equities research team provided their outlook for the Australian share market over the next year. Today I'm joined by Morningstar's Peter Warnes, who is here to discuss some of the opportunities and risks that lie ahead.
Peter Warnes: Nick thanks. It's lovely to be here.
Grove: First of all, Peter, in the forecast you say that the remainder of 2014 will not be plain sailing. What are some of the headwinds that investors are going to have to confront over the next six months?
Warnes: Nick, basically, a combination of international and domestic issues -- the international ones being the end of the taper. That's really not a headwind, but coming up we've got tightening in monetary policy that's going to start certainly some time in 2015, but really depending on how quickly the labour market recovers. And so the timing of the tightening will be important and how that is communicated to the investing public and the markets. And so that's one issue.
Secondly, in the eurozone, there are still some problems there as you have just seen recently in Portugal -- and that economy is very, very sluggish, and deflation is an issue there.
And then China, on our doorstep, will it achieve the GDP growth numbers that are out there in the marketplace with a 7, 7.5-ish number? And will property issues surface and put that economy under some pressure and the monetary policy also under some pressure? So they are the international headwinds, if you like.
Domestically, it's this impasse we have in fiscal policy, where we've got an arm wrestle between parties and it's not in the national interest. So we have got to look at that. It's denting consumer confidence, business confidence, business investment plans are in limbo, and so they're issues that we have to face domestically. And that's not good for the total demand situation, but I think we'll muddle through and I don't think there are any problems on the horizon in terms of inflation at this point in time domestically, and the Reserve Bank is likely to keep interest rates low through the best part of 2015 I would think.
Grove: Peter, should investors still maintain a strong weighting towards income stocks and moat stocks for the remainder of the year and beyond?
Warnes: Nick, in these kinds of relatively uncertain times, certainly domestically, I would think so. I mean despite the fact that lot of the price appreciation in some the income stocks has come from yield compression, offsetting that is that some of those sustainable stocks or sustainable income stocks, they'll be able to kind of eke out positive growth in terms of earnings and increasing their dividends. So the dividends are increasing as well as the earnings and so the investor is getting a little bit of cream on the cake, if you like, of that yield.
In addition to that, again, this is political but the PLL is still there. Will the corporate rate be cut from 30 per cent to 28.5 per cent? And if that happens, will companies try to push more of the 30 per cent franked credits to investors before July 2015. Now that is a possibility.
So, look, we are always looking for sustainability and that sustainability comes from moats. And so, at this point in time, given the uncertainty out there, I would say, yes, you'll be taking a lower yield, but the certainty that you are going to get that yield is very, very important. And so, I would still have my portfolio certainly very, very biased towards income, sustainability of income, and moat stocks.
Grove: Peter, in the forecast, you also say that investors should entertain some exposure to those stocks that benefit from a lower currency. Can you briefly give us a couple of your preferred examples of such companies?
Warnes: Nick, I mean again there is an arm wrestle whether the Australian dollar is coming down or not and of course our relatively attractive AAA-rated bonds are a source of capital inflow, if you like, and that's keeping the Australian dollar where it is and that is unlikely to change in the near term. Having said that, if the Australian dollar did decline against the US dollar, which is possible if in fact that tightening occurs in the US and the interest-rate differential moves against the Australian dollar, then yes, you should be looking for stocks or have exposure to stocks that have a lot of income being generated from offshore operations. And those ones really are in the healthcare space -- CSL, Cochlear, ResMed, Sonic, and companies like Amcor, Brambles, James Hardie, even Domino's Pizza, Breville. So they are the companies that have got a lot of operations, I am sure, and a lot of foreign income.
In addition to that, you look for companies who have their revenue and profits being earned, if you like, in US dollars, reported in US dollars, paying dividends in US dollars, but predominantly their costs are in Australian dollars. So they are getting a little bit of a second bite at the cherry. And those companies would be BHP and Rio's iron-ore and coal operations in Australia, which make up a significant part of their bottom line, and Woodside and Santos. So, they are the companies that you should be looking at to give you some protection against a falling Australian dollar.
Grove: Peter thank you very much for your time today.
Warnes: Good to be here, Nick, as always.