I expect the Australian equity market to be lower at the end of 2015 than at the start. My guess is that it will close the year down about 5%. Take this with a pinch of salt as always with the stock market, because – quoting from Ellie Goulding’s pop lyrics – “anything could happen”.
My expectation of slow Australian economic growth and inflated valuations due to excess global liquidity lies at the core of this prediction. In the last six years, a significant factor that has driven global equity markets has been the excessive liquidity injected in the system by world monetary authorities. Even though the US has halted its QE (Quantitative Easing) policy, excess liquidity is still being pumped into the system via Japan and Europe. My main concern is what will happen to equity markets when the easy money policy finishes. Given the high valuations that have resulted from the excessive global liquidity, I believe world equity markets are vulnerable.
Over the past few years, corporate Australia has significantly reduced its costs in an effort to boost profitability. Lower interest rates have not yet led to a pick-up in general economic activity, as shown by the recent release of third quarter domestic GDP. The growth figures released at the start of the month came in at 0.3%, well below expectations of 0.7% and down from 0.5% in the previous quarter. We are expecting that interest rates will be cut in the first half of calendar year 2015.
When the broader economy eventually delivers stronger growth from lower interest rates, the impact on corporate profitability is likely to be significant. Simply put, revenue growth of 5% would lead to a 25% increase in profitability for any company that can maintain costs with a 20% profit margin. The key remains the ability to predict when this will happen.
In the absence of strong economic growth in the near future, we look for stock picks that have their own growth drivers.
Intellectual property services firm, IPH Limited (ASX: IPH), better known as Spruson & Ferguson, listed on the ASX in November and has been a great performer. This company is one of the better quality IPOs we have seen in recent years with highly predictable revenue streams and strong cash flows emanating from its capital light structure. We like the longer-term fundamentals of IPH and think that it is well placed to grow through acquisitions in the coming years.
I also like to look at companies in the listed investment company sector trading at a discount to NTA (Net Tangible Assets). Hunter Hall Global Value (ASX: HHV) fits the bill. At the time of writing, it is trading at a 10% discount to its asset value. It has two main drivers of growth. First, it is exposed to international stocks, with 52% of its assets listed outside of Australia, where we see stronger drivers of economic growth in the main. Second, its largest holding, medical device group Sirtex (ASX: SRX) is currently undergoing trials for its major product, SIR-Sphere, to be used at an earlier stage of liver cancer upon diagnosis, with results expected mid-2015. This could provide a strong fillip for the shares, were the trials to come out with a positive result.