Commodities strength augurs well for Aussie shares

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Glenn Freeman: In this week's "How we Invest your Money?" I'm speaking to Randal Jenneke, Australian Equities Manager with T. Rowe Price. I'm speaking with Randal about the asset selection process that T. Rowe Price follows in putting together its funds, including what its outlook is for markets for 2018 and some of the sectors that they are particularly bullish about.

Randal, thanks for your time today.

Randal Jenneke: Thanks, Glenn.

Freeman: First up, can I get your thoughts on the Australian equities market for 2018?

Jenneke: We are quite positive for Australian equities for 2018. And the key reason is that we are seeing strong synchronised global growth across the world for the first time in a better part of a decade. So, that's a really positive backdrop for, you think about commodity markets and what that means for commodity prices. So, we think that the synchronised growth, clearly strength coming out of the U.S., coming out of Europe as well and China and emerging markets continue to be robust, it's going to translate into an earnings upgrade cycle.

And for Australian stocks, that's largely going to be driven by stronger commodity prices. So, we think we are in this environment where commodity prices are going to continue to be stronger than people think. That's going to mean an earnings upgrade cycle for those parts of the marketplace. So, that all goes very well for the overall Australian marketplace. So, last year, we got roughly 12 per cent total return out of Australian equities and we would expect we are going to get something similar in 2018.

Freeman: And Randal, with your funds made available to investors through platforms or through financial advisers, can you just talk us through the asset selection process that you follow in compiling these?

Jenneke: Sure. So, the key thing to note about how we do things at T. Rowe Price is that how we build our portfolios is all driven by a fundamental research and it's all bottom-up. We have extensive research coverage around the world. We have a big team in Australia, big research teams in the U.S. and Europe and Asia as well. And so, really our views are driven by those fundamentals views coming from our research analysts around the world. And they are collaborating and talking to each other as well. We think that's very powerful.

In terms of how we go about selecting stocks, we apply a quality growth process. And so, what that means for us is that we are looking to identify companies that can invest at attractive rates of return, rates of return above cost of capital, can continue to invest at those rates of return and grow their earnings faster and typically, faster than the marketplace. So, that's how we define quality. And we rank all of our universe on an A to F quality ranking scale with A being the highest ranking that a company can get and that's a business that generates well above cost of capital, can reinvest at those high rates of return and it's growing fast in the market.

And then we apply valuation as well, because we want to own quality companies when they are cheap versus our longer-term expectations of what these businesses can deliver. So, those are the two critical factors that go into how we choose stocks for our portfolios.

Freeman: And some of the favorite sectors of Australian investors, financial services and the materials sectors, can you just give us your view on these and how it's reflected within your portfolio?

Jenneke: I think when you look at materials, there's a few different areas where we expect that you are going to generate strong returns. The first is the mining areas, I just touched on before, where we think commodity prices are going to surprise people on the upside. But it's probably going to be more in the base metals areas than the bulk areas of iron ore and coking coal or in thermal coal.

So, we think that base metals really on the strength of economies, U.S. and Europe in, particular, doing better is going to be a positive place to be. But also, there are areas within materials such as the building materials names that are directly exposed to a stronger economy like we are seeing in the U.S. and also Europe. So, we think that those parts of the materials space will also do well.

When I think of financial services, obviously, banks are the big sector there. We think that the banks will have a better year in 2018 than 2017. 2017, really the banks were challenged by the bank levy, a lot of the political and regulatory issues and the dynamic in the royal commission. And that led to the banks actually declining by 3 per cent to 4 per cent in the market that gave you a 12 per  cent return.

This year, we think that it's going to be better environment. A lot of the bad news is out there. We think the underlying fundamentals look fairly robust. So, we think this year you will probably a 6 per cent or 7 per cent dividend yield that of a bank and 2 per cent or 3 per cent earnings growth or capital return.

So, we think overall, our view is that you'll probably get around a 10 per cent return out of banks this year. So, definitely, better than 2017.

Freeman: Thanks for your time today, Randal.

Jenneke: Thanks, Glenn.

Freeman: I'm Glenn Freeman for Morningstar. Thanks for watching.

This report appeared on 2022 Morningstar Australasia Pty Limited

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