There’s one thing about the markets that strikes me a few weeks after Christmas, year after year.
As investors get back to work, they ponder the ways to beat the investment returns they achieved in the previous twelve months. They skim through the yearly outlook pieces that large brokerage firms and investment banks love to produce.
And they notice something. It’s the same thing they notice every year.
The authors of these yearly outlooks almost invariably predict that the Australian share market will move in the same direction as it did the previous year. And almost every time they predict the same returns ; somewhere in the region of 5 -10%.
Why is that?
It’s probably because that’s about the average return for stocks. If there’s one thing mainstream analysts want to avoid, it’s being an outlier. So it’s no surprise that the crystal balls the pin-striped analysts peer into always seem to tell such similar stories.
That was clear to me in the wake of the global financial crisis, when I worked on the London equity desk of an international investment bank. And it’s clear to me now as I cast my eye across Australia’s mainstream financial press.
You need look no further than the chart below. It’s a survey of five strategists from five of the world’s highest-profile investment banks. Their consensus: a 10% gain for the index in 2014.
Here’s some food for thought. When polled at the end of 2012, the strategists from the five banks listed above forecast 2013 stock market returns averaging -3.2%. The analysts underestimated then, as they do now, the powerful effect of globally coordinated quantitative easing.
So much for the markets being forward-looking.
Let me tell you what’s also highly predictable. The factors that drive any year’s stock returns will be different from the factors that drove the previous year’s market.
That means the sectors, styles and stocks that outperform in 2014 are most likely poles apart from what worked well in 2013.
What do these two highly predictable outcomes tell us?
And how can they help keep your investment growth humming along after a successful year in the markets, like the one we’ve just witnessed?
The moral of the story is this…you can’t just set it and forget it.
Your portfolio, that is. That approach might work for your home air conditioning, but don’t try it here.
The secret to improving your returns is as simple as this: Take control. Get active. And when the facts change, so too should your investment strategy.
An Upturn in Profits?
Taking control is particularly important now that the S&P/ASX 200, at 14.9 times future earnings, is trading above its long-run average.
The easiest gains may have already been made.
There are still plenty of potential winners trading on the stock market. You just have to look harder to find them.
So, what’s changing, and how should you respond?
Let’s take a quick look at two important data points.
First, let’s look at employment. The ANZ index of monthly job ads for December was released last week. It showed that the number of jobs advertised online – which covers more than 95% of all jobs advertised – fell 0.7% month-on-month. That means this series has fallen by 9% over the course of 2013.
At face value, fewer job ad listings is bad news. You might argue that this points to rising unemployment in coming months. But it’s important to look behind the headlines.
Job ads in certain markets have been rising for months now. There’s been a real pick-up in the non-mining sectors of the economy. And it’s companies in New South Wales that are leading the charge.
That 0.7% monthly decline is the smallest fall recorded in months. That means we’re looking at signs of a turnaround. And it means companies whose earnings are sensitive to employment trends could be set for an upturn in profits.
That’s a topic I covered in some detail in this month’s issue of Australian Small-Cap Investigator.
A Key Money-Multiplying Theme for 2014
Second, the valuations of the ‘Big Four’ banks look stretched. The banks have had a charmed run. If you’ve taken the view that the best time to sell Aussie bank stocks is ‘never’, then you have probably done well over the past year.
The banks have done so well, in fact, that their valuations have blown out to a historic premium against their peers.
Bloomberg data shows that the share prices of the Commonwealth Bank [ASX: CBA], Westpac [ASX: WBC], Australia & New Zealand Banking Group [ASX: ANZ] and National Australia Bank [ASX: NAB] are at their most expensive since before the global financial crisis.
The big banks now trade at 2.1 times the net value of their assets. They’re more expensive than they’ve been at any point since 2007. And as measured by the MSCI World Bank index, they’re 75% more expensive than their global peers!
Given the run they’ve had, the major banks will probably struggle to deliver the level of earnings in the future that’s implied by their share prices today. Although this group drove the S&P/ASX 200 in 2013 with a 22% stock price surge, you’ll have to dig a little deeper to find the sectors and stocks that will lead growth in 2014.
If you’re looking for growth in 2014, I prefer smaller financial firms that are flexible enough to embrace alternative lines of business. I’m talking about anything from purchasing non-performing debt, to short-term lending, to coming up with innovative structured transactions.
In other words: places where the big banks fear to tread.
These are the areas where nimble, aggressive firms can rack up amazing growth in a matter of months. The company I profiled in the latest issue of Australian Small-Cap Investigator fits into this mould. It grew revenues by 40% last year and has just expanded into a highly attractive complimentary business.
This will be a key theme for investors this year. And in a market where investors are eager to find value, opportunities like this tend to be short-lived.
Tim Dohrmann
Analyst, Australian Small-Cap Investigator
From the Port Phillip Publishing Library
Special Report: 2014 Predicted
