Nicholas Grove: I'm Nick Grove for Morningstar, and today I'm joined by head of equities research, Peter Warnes, who is here to discuss his FY17 forecasts.
Peter, thanks for your time today.
Peter Warnes: Always good to be here, Nick.
Grove: First of all, Peter, in your forecast you said that the year just gone was not a very productive year for investors and one of the most volatile years in your memory. Now, given the Brexit vote, our own election, the upcoming US election, sluggish GDP growth around the world, what's the best piece of advice you can give investors at this point in time?
Warnes: Nick, I think caution and prudence. This is a volatile and uncertain environment which we're embarking upon and I think it's going to be a difficult year again. I'm not suggesting that the markets will go into negative territory, but there's always a chance that will happen. The year just passed, the ASX 200 was down 4.1 per cent, but the Accumulation Index is just up a touch and that's way, way down from what we've had in the past three or four years.
Going forward, look, those situations you mentioned are going to be evident right throughout this financial year and markets will have to deal with a lot of changing situations. Undercurrents are going to be very, very strong and therefore, we have to make sure that capital preservation is the number one target and therefore, be very, very cautious. Make sure that the margin of safety is there for you. So, when you make an investment or choose a risk profile that the margin of safety is there that compensates for the risks you're taking. That's the advice I'm giving to our clients.
Grove: Where do you see the ASX 200 in six months' time?
Warnes: Nick, given the volatility we've seen over the past 12 months that is the $64 question, where will it be in six months' time? I've reduced my top-end estimate for the ASX 200 and pulled that back from 5800 to 5500. I just don't see where these markets are going to gain the momentum that's required to get it to 5800. The banks in particular, being 30 per cent of the market, to get to about 5800, the banks will have to participate and I do believe that they are going to be under some pressure, not under some pressure from an earnings point of view but from a sentiment point of view and I think it will be--they are good income-producing investments, but I just think that the sentiment's going to be still a little bit negative towards in both domestically and internationally and that's one of the reasons why I'm more subdued about the outlook for the market.
There will still be sectors in the market that will outperform as they always do. I mean, last year, you saw REITs and utilities driven by falling bond yields and lower discount rates--outstanding performance, up over 20 per cent over the year. That space can still work for you, but you've just got to realise that they are tied to these falling bond yields and bond yields will not fall forever. However, having said that, interest rates aren't going up for quite a while. So, I think between now and the end of the year the market has a good chance of getting to 5500, but beyond that I'd be very doubtful.
Grove: Peter, in your forecast, you recommend that investors increase their US$ earnings exposure. Why do you think they should do this and can you just talk us through a couple of recommendations?
Warnes: I think the A$ is--and I've been an A$ kind of supporter. What's supporting the A$ at the moment is yield and that yield is still going to be evident for quite a while. I mean, we are a high-yielding country, if you like. Our two-year bonds and 10-year bonds, the yields on those are way, way higher than anywhere else in the developed world and we will still get yield money being attracted to Australia and that will support the A$.
But this situation we have now with the election, albeit now it looks like the Coalition will rule in its own right, but still in all, it's not a decisive situation. We have to get this budget deficit under control and I don't believe that the senate will allow that to happen. So, there is a very good chance--S&P are saying one in three chance of a downgrade in two years' time. I think it's going to be earlier than that and therefore, I think that you have to position yourself for a weaker A$ and I do think that the Fed is likely to move before the end of the year. So the interest rate differential will widen and put the A$ under some pressure.
So that's why I'm saying get some more US$-facing assets in your portfolio. It also gives you diversification as well which I think provides you with some safety in terms of caution and prudence and what have you. So that's where I'd be looking to do that and you can do that at a macro level, if you like, by investing in US$ funds or even a US$ ETF, even the Morningstar Wide Moat ETF, which is listed on the Australian Stock Exchange, you can have a look at something like that. It becomes more difficult if you are selecting an individual or direct investment into US companies because then you have to do some research and what have you. But those more passive vehicles give you an opportunity to get your US$-facing exposure higher.
Now, in terms of Australian-listed companies with major exposure to the US$, I would again tend to look at the healthcare space. CSL and Resmed are our two picks in the space in terms of US$ facing. They are both, I think, nearly 50 per cent of their revenue and income is derived in US$. These two companies have 30 per cent to 40 per cent of the global market in which they participate, good balance sheets, good management, et cetera. So, those two would be higher on my list.
In the financial services space, we have Computershare, we have Macquarie Group and QBE, but people might shy away from those because of the volatility in the financial services or finance space because of undercurrents, as I say, bond yields moving, currencies moving and what have you, so they might be a bit tentative there. Elsewhere, we like News Corp, again a major US$ exposure and a big discount to our fair value, nearly over 30 per cent; Ardent Leisure through their main event operations in the US; and if I'm right on the A$ falling then tourism obviously becomes a focus and they have got tourism-facing assets in Australia. We also like Westfield Corporation, but that's about just a little bit above our fair value but we still like the stock. Those other stocks that I did mention they are up to 20 per cent to 25 per cent below our fair value and I think that's where you could certainly find some profitable and relatively safe investments with their higher US$ exposure.
Grove: Peter, thanks for your time today.
Warnes: Pleasure, Nick. Always a pleasure.
Grove: I'm Nick Grove for Morningstar. Thanks for watching.