Our outlook for the new financial year

Outlook from Paul Taylor, Portfolio Manager of the Fidelity Australian Equities Fund

While there are plenty of potential economic headwinds my belief is that the Australian stock market is well positioned for the 2016-17 financial year.

There are numerous economic transitions happening around the world that contribute to heightened risk concerns. China is transitioning from an infrastructure-led economy towards domestic consumption. In the US, the Federal Reserve is trying to bring in higher interest rates. In Europe, Britain has just voted to leave the EU. Even in Australia, we are moving from an economy focused on investing in resources towards domestic consumption and services. The Brexit vote as well as the rise of Donald Trump in the US point to the rise of protectionism. The close Australian federal election vote makes for nervous consumers and corporates due to the belief that it will be more difficult to achieve positive reform because sub-optimal deals with minority parties will be required to run government. On top of these, there is nervousness around significant industry disruption from technology advances like artificial intelligence, virtual reality, augmented reality, e-commerce and power storage. It is important to note that even with these transitions and disruptions the world generally seems to be heading in the right direction, albeit at a lower growth rate. While the world may be low growth for a prolonged period, it is also important to note that there will be significant winners and losers within this low-growth outcome. Companies and sectors could see significant growth or decline. Growth and sustainable yield will be sought-after attributes and will be bid up by the market.

The Australian stock market is trading at average long-term valuation multiples. The Australian market is trading on a forward price-earnings ratio of about 15.5 times and a dividend yield of close to 5%. While these valuation metrics are in line with long-run averages, I believe they should be higher given the current environment. I base this more optimistic premise on three key factors. The first is that cash rates are low. The second is the high quality of earnings. The last is that expectations are for 10% earnings-per-share growth for 2016-17. Low interest rates should mean high price-earnings ratios. The spread between the equity market yield and the cash yield is high and we should see further yield compression that should justify higher price-earnings ratios. I would argue that we have much higher quality of earnings these days. Debt levels are low, balance sheets are strong, boards and management teams are conservative – all of which means that you are getting high-quality earnings at average valuations. Finally, earnings-per-share growth expectations of about 10% in 2016-17 would point to attractive valuation levels. In the new fiscal year, while bank and property earnings are expected to be flat to low-single-digit growth rates, industrials should average around 10% with even better growth coming from the resources sector. While growth is expected to pick up in the resources sector, it will be cyclical rather than structural, so not have the same impact on share prices. Selected technology, services and industrials should do well in 2017 on good growth and sustainable yield performance should continue in 2017 as cash rates remain low. Some of the major overweights in the Fidelity Australia Equities Fund remain WiseTech, Suncorp, SEEK, Rio Tinto, Oil Search, Goodman Group, Sydney Airport, Domino’s Pizza Enterprises and the Commonwealth Bank of Australia.

Over the long term, the Australian stock market has been among the best-performing markets in the world. Some of the key drivers to this strong long-term performance have been factors like strong population growth, a low-cost natural-resource base, strong corporate governance and high dividend yields and high real dividend growth. These key long-term factors are still in place and should set a strong platform for good Australian stock-market performance over the next decade. There is no doubt that some of the headwinds discussed earlier will cause volatility in Australian and global markets during 2017 but, given underlying fundamentals, any volatility may be viewed generally as a good long-term buying opportunity.

Outlook from Amit Lodha, Portfolio Manager of the Fidelity Global Equities Fund

Investors begin Australia’s new financial year acknowledging that it is likely to be bedevilled by political risk and that they are less adept at assessing such dangers than they are at judging macro-economic and company fundamentals.

Political uncertainty means that the odds of a global recession have risen because doubts about government policy undermine business confidence. But policymakers will react. The Federal Reserve is likely to keep the US cash rate on hold until November’s election, an outlook that favours bond-like equities (utilities, consumer staples and real estate investment trusts). The other response will be more fiscal stimulus. China and Japan are likely to boost government spending, which would help sectors such as construction and commodities.

While the US economy appears sound and China muddling through remains the most-likely outcome, riskier assets such as equities are unlikely to be as sought after as they were in recent years.

In spite of the uncertainty, it’s possible to find companies that are undervalued because their ability to generate superior profits (due to their pricing power) is underappreciated. People will still consume Coca-Cola, need medication and use Facebook, Google and Microsoft products. There remain developments to play such as virtual reality, gaming and the changes to business models that machine learning is bringing. Due to underinvestment in energy, the next oil price surge is only a matter of time.

Overall, though, the message for the coming 12 months is that protecting capital should be the top priority. It’s mine anyway.

References to specific securities should not be taken as recommendations and may not represent actual holdings in the portfolio at this point in time.