End of bull run, 1H18 earnings expectations

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<p><strong>Glenn Freeman</strong>: In this edition of Morningstar's "Ask the Expert" I'm joined by AMP Capital's Shane Oliver. He is speaking about global credit markets and what this means for locally-based fixed income investors and also his outlook ahead of the half-yearly company earnings season which is just about to kick off.</p> <p>Shane, thank you very much for your time today.</p> <p><strong>Shane Oliver</strong>: It's a pleasure to be here, Glenn.</p> <p><strong>Freeman</strong>: First up, we hear a lot about the rising bond yields in the global credit markets. How the Australian fixed income space holds up for investors?</p> <p><strong>Oliver</strong>: There's certainly a risk there. We've had something like a 35-year bull market in fixed income investments as interest rates fell from where they were in the early 1980s to the lows they have gotten to in the last couple of years. That's seen a massive decline in bond yields, a massive decline in corporate borrowing costs and therefore, rates of interest on credit products.</p> <p>All the way down, that's been great for investors, because as the bond yield comes down, you get capital growth. The only problem is that we are probably either at or near &ndash; that they are probably at &ndash; I have seen in fact the very end of that bull market &ndash; we are starting to see stronger growth globally. The IMF and other forecaster revising their forecasts up. So, we have gone through a cycle of a few years where year-after-year forecasts would be revised down, inflation kept surprising on the downside, interest rates had to be cut further. I think all that has come to an end now. So, we are moving into a stronger growth phase. As we say that, we'll see more upside surprise on inflation eventually. And of course, that will feed through to eventual tightening in monetary policy around the world.</p> <p>At the moment, that's mainly contained to the U.S. But the reality is, U.S. bond market leads the world and so far, this year, we have seen quite sharp rises in bond yields which has flown through to Australia. And obviously, as bond yields go up, the bond price goes down. That's just the maths of bonds. So, we are looking at an environment where you are going to see much lower returns out of bonds. That was the case last year and the year before. So, we have seen a few years now where it's starting to turn higher.</p> <p>What does that mean for Australian-based investors? I would tend to favor Australian bonds over global bonds because I think the U.S. bond market is far more at risk than our market is simply because the U.S. Federal Reserve is raising rates, the Reserve Bank of Australia is not.</p> <p><strong>Freeman</strong>: And within local equity markets, we are right on the cusp of the half-yearly earnings season. What are your expectations?</p> <p><strong>Oliver</strong>: I'm reasonably positive about company profits in Australia. But there's a couple of qualifications to that. First one is that earnings growth will slow down. This financial year, we are looking at earnings growth in Australia of around 7%. That's down from about 15% last financial year. The main reason for the slowdown is because a year or so ago, commodity prices took off, fantastic news for the resources. Stocks, they saw their profits rise close 130% through the 2016-2017 financial year. Their profit growth is going to slow down to around 14% for this financial year. So, we are seeing a bit of a slowing in profit growth coming through.</p> <p>The other thing is that even though profit growth is sort of okay in Australia &ndash; it's reasonably good in fact, profit growth globally is actually stronger than it is in Australia. So, in aggregate, we are looking at 7% profit growth in Australia at a time when global profit growth is running around 14% or so. So, we are seeing aggregate profit growth for our market. About half of that that we are getting out of global shares, out of the U.S., Europe, Japan and so on.</p> <p>So, they are the two qualifications to it. Yes, profit growth will still be good but not as good as it has been and global markets offer higher profit growth.</p> <p><strong>Freeman</strong>: Now, Shane, specifically, within the area of dividends, we have seen historically higher dividend payouts from companies last year. Do you expect this is something that will continue this year and is it actually sustainable?</p> <p><strong>Oliver</strong>: There's a lot of talk about dividends in Australia. By and large, I think that's actually a good thing. I think that the fact that Australian companies pay decent dividends and raise those dividends over time, tells me that they are not subject to the hubris that many overseas companies are. But they think if they make a good profit, time to return that to the shareholder. If they want the capital, they just have the dividend reinvestment plan and ask the shareholder to tick the box to get the money back. I think that's quite healthy rather than a company retaining the earnings on the basis that they know best and oftentimes when they do that, they step it up.</p> <p>So, I think, good dividends are a healthy phenomenon in Australia. I also think when you invest in shares, it's a bit like the old saying, 'a bird in the hand is worth two in the bush.' At least you've got part of your return. It's pretty certain you're going to get at least half of your return out of dividends and you've already got that. So, that's a good thing.</p> <p>Question mark is, is it sustainable? I think it is. When I look at the payout ratios across the market as a whole, they are not out of line with the historic averages. What has surprised many, I guess, in the last few years has been the resources sector. Traditionally, resources stocks didn't pay much in the way of dividends. They increased their dividends dramatically about 4 or 5 years ago only having to slash them again when the iron ore price collapsed. But recently, they have been able to increase them again. And I think the reality is that that's healthy. The resources sector when it realizes that it doesn't need to make more investment, it's good that they give that capital back to their investors.</p> <p>So, I think, that's one of the big changes occurring in our market. The resources stocks have gone from very low-paying in terms of dividends to now paying decent dividends and I think that's a good thing. But it doesn't mean that Australian companies are overpaying on dividends. I would stress, if a company needs the money, if it thinks there's good opportunities for investment, all they have got to do is put out a dividend reinvestment plan, ask people to tick the box, now get the money back. In most cases, they will. So, I think it's actually quite healthy. The Australian companies pay decent dividends, but I certainly don't think it's unsustainable.</p> <p><strong>Freeman</strong>: Thanks for your time today, Shane.</p> <p><strong>Oliver</strong>: It's been my pleasure. Thanks for having me.</p> <p><strong>Freeman</strong>: I'm Glenn Freeman for Morningstar. Thanks for watching.</p>

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