Investment Outlook January 2016

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Interesting (but unverifiable) fact 1: About one third of the people working on financial trading desks have never experienced a single interest rate hike in their careers.

Attributed to Benjamin Butler, Futurist and Writer

 

Interesting (but unverifiable) fact 2: Oil briefly traded at USD$25 per barrel in 2016. At that price, according to various reports, more than half the world’s oil producers are losing money and the oil is worth less than the barrel it comes in.

 

2015 was a fairly ordinary year for most investment markets. The ASX accumulation index returned just 2.6% for the year including dividends and was negative excluding dividends. Global shares in their local currencies fared no better, delivering just 2.1% for the year. The good news was that the falling Australian dollar did boost overseas returns for Australian investors to a much more respectable 11.8%. Within all markets, there were a very wide range of results for the year in differing stocks and sectors. We see no reason to think that 2016 will be any different in this regard. In this climate, rather than buying index funds or ETF’s, we believe it is advisable to invest with talented, active stock pickers.

Market sentiment remains awful at the moment, as demonstrated by the significant falls in most markets in early January. On a technical basis, this is somewhat of a worry, with many sectors now appearing to be in bear markets. Having said that, we believe value is emerging in the Australian market. In early January the ASX200 index fell to around 4,900, the same level it was at in early 2006 and over 25% below the pre-GFC high in 2007.

Many SMSF trustees we speak to are a little shell-shocked over what has occurred since the market high in April 2015. Quite simply, they are struggling to understand how they could have seen 20% plus falls in the value of many shares they hold, without any great damage to the Australian economy. The answer, it seems, is that the share market has gone from being a bit overvalued to a bit cheap. We have also seen large cap shares bear more than their share of market falls and smaller, higher growth stocks have proven to be more resilient. With many SMSFs being woefully under-diversified, only their substantial cash holdings (with accompanying dreadful returns) have saved them from a much worse result in the past 9 months. If you know anyone in this boat, send them our way. An investment in the Affluence Fund can provide them with two things they probably don’t already have – access to some fantastic boutique managers and some alternative strategies and assets which should help diversify returns.

A year ago we thought unlisted (non-residential) property was the cheapest asset class. Since then, property has delivered around a 15% capital gain, while Aussie shares have gone backwards by roughly the same amount since their highs in April 2015. Thus, the valuation preferences between these two asset classes are now reversed, particularly given property is less liquid. Recent property transactions have grown more and more out of whack, relying on a continuation of ultra-low interest rates and inflows of foreign capital to derive reasonable returns.

We will continue to hold our limited property fund investments with good rental growth, low rent levels and tenants who aren’t likely to go broke anytime soon. But it doesn’t feel like we’ll be making too many additional ones.

Many investors are trotting out a list of things that are uncertain as a reason to be worried about investing right now. Most of these guys were remarkably quiet earlier in 2015 when stocks were 15-20% more expensive than now. To us, that is completely the wrong way around. Just because we don’t know the answer, doesn’t mean we should not try to deduce it – my grade 8 accounting teacher taught me that. In fact, as value investors, uncertainty is our friend – the more of it about, the more likely we are to pick up a bargain. Besides, negative surprises don’t usually come from things we know about and anticipate – rather from those that blindside us. Thus complacency and overconfidence is usually more of a problem than uncertainty. We don’t see too much complacency and overconfidence from Australian investors right now.

We believe at current values, the Australian market offers reasonable value and presents a good opportunity to add slightly to existing investments, while retaining some cash in case even bigger bargains appear. As we noted in our recent article (8 contrarian investment ideas for 2016), we expect the Australian market to be one of the better performers in 2016, with impact of twin negatives from falling commodity prices and a lower AUD largely now priced in.

In particular, we see many opportunities in the Listed Investment Company space, as some fairly wide divergences arise between the trading value of LIC’s and the value of the underlying stocks they hold. As just one example, you can buy Platinum International’s LIC at the moment for around a 15% premium to the underlying value of its assets, or the PM Capital Global Growth Fund for a 15% discount. Both are exceptional fund managers with great records. We know which one we’d rather own at those prices though.

The LIC market is currently throwing up a number of quality opportunities at discounted prices and, though we only allocate around 15% of our portfolio to this area, we feel it provides one of our very best opportunities to add value in the coming year.

While there are a number of signs of stress in high yield bond markets, this seems confined to the commodities space, in particular loans to US based oil producers. While there will no doubt be pain for holders of these bonds, this doesn’t seem to reflect a wider contagion of the entire sector.

Having got the first interest rate rise out of the way in December, it seems the US Federal Reserve will now be holding fire for quite a while. We expect a similar result in Australia. We expect bond returns to remain dismal for the medium term, and currently have no allocation to this sector.

We expect to continue our approach of making small additions to the portfolio on the days, weeks or months when the market is feeling down. We will remain patient at other times.

 

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