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Aussie investors need to cast a wider net

Glenn Freeman  |  06 Jul 2017Text size  Decrease  Increase  |  

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Where in the world should you look for growth, with the US market stretched and the Australian dollar trending down?

 

Emerging markets and Europe ex-Britain are increasingly attractive, says Kerry Craig, global market strategist at JP Morgan. While many Australian investors remain over-exposed domestically, "we think that investors have done quite a significant rotation away from domestic into international equities already, but not nearly as much as they need to," he says.

While it is well-known that Australian investors traditionally have a "huge home bias ... I think that's still really only starting to unwind, so there is definitely scope to move more aggressively into international markets."

"Yes, valuations in Australia have come down a little bit ... but they still are above average and the earnings outlook is softening," Craig says.

Looking to the US, "it's also looking pretty stretched ... we still like it, but we definitely don't love it. We're looking more towards Europe and emerging markets for growth potential."

He believes the Australian market will lag due to its huge over-weighting to banks and mining stocks, "the things that aren't going to do well". A softening housing market, the impending bank levy and declining demand for our resources as China levels out are key reasons for this.

"We've also got no IT sector here ... it's the composition of the market that's going to dictate the market performance," Craig says.

He points to earnings revisions in Australia, as expectations are dialled back amid a moderating growth outlook.

"Analysts are really resetting their expectations about what can be delivered in this market ... the rest of the world just offers such a better opportunity than what we're seeing in Australia right now," says Craig.

A strategy whose time has come and gone?

Doubling-down on domestic companies that have higher international currency exposure is a common way Australian investors seek to harness global markets in their portfolios.

"But those guys are no longer cheap, by any means ... and you're not getting the international diversification benefits either, by just buying those stocks in the Australian market that have international exposure. To get the true growth potential of international diversification, you really have to go into the foreign markets, rather than just trying to gain it through the local market," Craig says.

This contradicts a view recently shared by Morningstar's head of equity research Australasia, Peter Warnes, who suggests shifting market conditions favour US-linked stocks such as CSL (ASX: CSL), Cochlear (ASX: COH), Ramsay Health Care (ASX: RHC) and Healthscope (ASX: HSO). JP Morgan's Craig says the opportunity to buy such companies at attractive prices has largely passed.

Central bank tactics

Looking at the Reserve Bank of Australia's recent official interest rate announcement, which he says was widely anticipated, Craig highlights its backing away from earlier predictions of inflation hitting 3 per cent this year.

"Our labour market is slowly improving ... consumer confidence and retail sales, we have seen those bounce up over recent months, and that will be a major factor," he says.

"But a slowing in terms of the outlook for the Australian economy, we're not nearly as hopeful as at the start of the year, but still not as dire as many people have put out there. I don't think the RBA is going to be open to cutting rates, I still think the next move will be higher ... the idea they were going to be hawkish going into this week was a bit ridiculous.

"We do expect the currency in Australia to weaken ... and the iron ore price coming down will weigh on currency."

He sees good opportunities outside Australia, with "strong synchronicity and orchestrated growth ... the global economy is doing very well."

Though Craig concedes that global economic growth projections have reduced slightly since the start of the year, "the main areas that drive the global economy still look like they're going to be the main growth engines of the global economy for some time".

US a healthy tortoise

He uses the analogy of a tortoise to describe the US, which is growing slowly but steadily: "I think that growth path will continue, but along a very narrow path."

The biggest risk to the US outlook is of overheating rather than recession, which could be created through policy missteps from central banks and the Trump administration: "Because you've got these supply-side constraints, the more that things don't work [as the administration encounters ongoing difficulty getting policies through Congress] the more you'll see the easy decisions being made."

"The easiest answer is always to spend, whether on infrastructure, defence, tax cuts--we'll just throw money at the problem--and the risk there is that creates way too much stimulus. The supply-side constraints really start to bite and you get an overheating of the economy."

Craig believes other central banks will follow suit on tightening monetary policies. He points to the Chinese government as looking at ways to address its build-up in credit without harming economic growth, with its increasing transparency on this viewed as a good sign.

"They're trying to take out some of the speculation in commodity prices. For us it just means you are going to get slower growth out of China for the remainder of this year, but it's a very necessary process--it was a big risk for us, if they don't do it, but this is a good thing for lowering risk over the longer term," Craig says.

Where to from here?

He favours the emerging market economies--those covered in Morgan Stanley's definition--over the traditional developed market powerhouses. "We like them for diversification, with pretty decent sources of income--emerging market debt is a great performer," he says, and he expects this to continue.

"Fundamentals are still very supportive: the US dollar is reducing; interest rate differentials are narrowing. All that adds up to a US dollar that shouldn't be so strong, which is supportive of our emerging market outlook for equities and debt."

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Glenn Freeman is a Morningstar senior editor.

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