Author: Christine St Anne is Morningstar’s online funds and ETFs editor. This article appears in part from a Morningstar investment newsletter with comment from Harvest.

 

At the beginning of this year, AMP Capital investment strategist Shane Oliver said Australian shares will continue to lag global shares.
The high Australian dollar and monetary tightening, both domestically and in China, were the key factors behind the lacklustre performance of Australian shares.
Four months later and the environment remains the same. Oliver says the continued strength of the Australian dollar will further dampen the profit outlook for Australian companies.
“There is still a growing concern over the strong Australian dollar, which has proven to be a dampener on the profit outlook. China could still possibly have a hard landing. I believe Australian shares will continue to lag,” Oliver says.

The surging Australian dollar is also a concern for Playtpus Asset Management portfolio manager Prasad Patkar. In particular, Australian companies with offshore earnings are getting squeezed because of the high Australian dollar. Patkar also highlights the interest rate hikes by the Reserve Bank of Australia as further dampeners on consumer confidence.

Fidelity head of Australian equities Paul Taylor offers a slightly more optimistic view of the Australian market.
For Taylor, the outlook for the Australian market is clouded by global risks. These risks include the ongoing European sovereign debt crisis, the geopolitical risks in the Middle East, and China’s fight with inflation. However, he says Australian companies are now in good shape as they have repaired their balance sheets. Some companies are even holding large cash reserves.

Both Taylor and Patkar believe the market is presenting some valuable opportunities for stock pickers. Taylor says while the valuation of the whole market has gone down, the market is not discriminating between companies. “It is definitely a stock picker’s market at the moment,” Patkar says. “Just buying the market won’t give you the returns. Companies that deliver on their earnings expectations will see their PEs

[price-to-earnings ratios] expand. Investors will pick these companies up,” Patkar says. “That’s why we are seeing great stock-selection opportunities.”

The Platypus Australian Equities Fund gained 1.4 per cent in March, outperforming the S&P/ASX300 index by 0.7 per cent. The industrials sector was the biggest contributor to the performance of the fund, followed by the healthcare and consumer discretionary sectors. Industrial firm Campbell Brothers (CPB) was a strong performer for the fund. Healthcare stocks Cochlear (COH) and Ramsay Health Care (RHC) also generated positive returns in March. While Platypus Asset Management has as stakes in the banks, Patkar says he is underweight the financials sector because the loan growth for banks remains stagnant. “Because the demand for loans has not picked up, banks will struggle with their earnings,” he says. The manager is bullish on the materials sector, particularly steel, copper and oil. “We feel demand will remain strong for commodities, particularly from the emerging markets,” Patkar says.

The fund manager also took new positions in three mining services companies, including NRW Holdings (NWH), Decmil Group (DCG) and Maca Limited (MLD). Earnings of these companies are strongly leveraged to the capital expenditure boom in the iron ore and LNG [liquefied natural gas] sectors in Western Australia. Companies who have discovered a new mine or who have created a new invention are also best placed to deliver performance in the current environment, according to Patkar.

Fidelity’s Taylor has been picking up some “great companies at cheap prices” across a number of sectors. Sector overweights in the Fidelity Australian Equities Fund include the industrials, healthcare, materials and energy sectors. “What we are seeing in those different sectors are good companies at bargain prices. We think in this environment you want to be focused on pricing power, you want to be focused on the growth of the company,” Taylor says.

He says mining services and engineering firms should benefit from significant investment planned in major resource and infrastructure projects. “Healthcare should see strong structural growth and should be relatively unaffected by the rising interest rate environment,” Taylor says. Fidelity’s portfolio is overweight a number of stocks including Rio Tinto (RIO), Wesfarmers (WES), MAp Group (MAP), Commonwealth Bank of Australia (CBA), Australia & New Zealand Banking Group (ANZ) and Oil Search (OSH). “They are there because we think they are good companies with solid balance sheets and strong growth opportunities that are attractively valued,” Taylor says.

The strong Australian dollar, higher interest rates and China’s inflationary problems will continue to hamper the performance of the Australian market. For Taylor, this will only mean more buying opportunities. “When the whole market is priced at a lower level, there’s a great opportunity to pick up high-quality, high-growth companies on cheap valuations,” he says.