A run to profit

While the Australian share market pushed through the magical barrier of 5000 in February, March was seen as a month of consolidation rather than growth.

The month was relatively flat for the S&P/ASX 200, which finished off roughly where it had started and marginally above where it sat at the start of the year.

“There has been consolidating this month, and some concern around Cyprus,” said Andrew Doherty, head of equities, Australia at Morningstar, adding that “many stocks seem expensive – there are now clearly less under-valued opportunities in the market.”

According to financial services company Van Eyk, this correction was long overdue.

“Let’s not forget we have had a super run since October, November,” van Eyk’s senior portfolio manager, Otto Rieth, told ifa – “[the market] was really due for a pull-back.”

However, Rieth cautioned investors against being too pessimistic. “On the one hand, quantitative easing and the liquidity is pumping the markets up,” he said, but at the same time (referring particularly to corporate and housing data coming out of the United States), there are “improving fundamentals”.

Also driving investors to the Aussie market are the low bond yields and cash rates in much of the developed world.

“You have seen a lot of global markets in negative real return, so you are getting essentially forced to go to equities or, rather, higher risk assets,” he said.

In their search for return, investors’ appetite for risk seems to be changing.

“The yields available on term deposits and bonds have gone down,” Shane Oliver, chief economist at AMP Capital told ifa. “At the same time, the perceived riskiness around equities has diminished.”

Oliver also suggested that investors have now “become conditioned” to the negative news which continues to come out of the European markets, and which is part of the reason why they are willing to invest in what is “traditionally seen as a riskier asset class”.

Pointing to the fundamentals, Oliver noted that, “The two drivers are return and risk [and] the perceived return you can get from equity in the global and Australian market has picked up.

“Investors are inclined to see better return prospects in equities than in the other asset classes,” he said.

Rieth added that in the long run, inflationary dangers might drive investors to equities. “When inflation does take off, bonds could be in trouble – big trouble,” he said.

But that doesn’t mean that higher equity prices are expected to cause the bond market to crash. Bond markets are at the moment “trading within a very narrowly defined range”, Anne Anderson, UBS Global Asset Management’s head of fixed income for the Asia Pacific told ifa.

“The so-called ‘great rotation’ has not actually happened; we are still not seeing people switch from bonds into equities,” Anderson said. “Certainly, people are switching into equities, but more over from cash.”

She also points out that a higher risk appetite is not something just confined to equities. Referring to the lower credit quality and lower investment grade bonds, Anderson said this sector “has been performing very well as people have been reaching for yield, and as they have had greater conviction [about] taking more risk.”

But with bond markets trading within a fixed spectrum and the equity bull taking a breather, investors are having to be more discerning in their strategies – and in getting value.

“The easy money has been harvested,” Morningstar stated in the group’s Australia and New Zealand Share Market and Credit Outlook report. “We can envision a continued asset allocation shift to equities, pushing the market into more clearly overvalued territory,” the report said.

This view, however, is not shared universally.

“[At] face value the market looks a little expensive – the consensus is a bit reactive rather than proactive,” Otto Rieth pointed out, adding that “if you do see earning expectations continue, then that seemingly expensive forward price to earning can look fairly cheap in a couple of quarters.”

So, how should investors navigate these relatively risky waters?

Morningstar in its report called for investors to have “a diversified portfolio [that] should generate total returns greater than interest on cash”.

That sentiment was echoed by Jim Parker, regional communication manager at Dimensional. “We are very diversified. Some of those stocks will be bad, some of those will be stars, but over time you will get the capital market rate of return,” Parker said, arguing that his firm was able to reduce “idiosyncratic risk” by not taking specific bets on stocks.

This strategy, however, does have some drawbacks.

“If you over-diversify, you are going to get an index outcome; if you mix too much together you will dilute any chance of any excess returns,” Otto Rieth said.

While he did not see too much danger in the market, he added that stock selection is key. “I don’t think there is much down-size risk, but to add value you have to be looking outside the box,” Rieth said.

One area in which he sees opportunities is the consumer sector, where he believes there have been “a few bets taken on a domestic revival” and “the effect of the RBA rate cut is starting to flow through”.

Beyond equities, other asset classes are also performing well. According to RP Data, property values posted a solid rise during the month of March, increasing by 1.3 percent across the combined capital city index, with the highest growth rate in Perth and among middle income-priced properties.

And even if the appetite for equity exposure has not caused bond prices to fall through the floor, as Anne Anderson from UBS tells her investors, “By all means invest in equity, but it does not mean that bonds are turning into a bear market.”