The recent pullbacks in the US and Australian share market are a reminder of the inherent risk associated with equities. With the US market bursting through its record high levels (and then suffering as the tapering of QE and uncertainty around the strength of the US recovery resurfaced), and the Aussie market still trading below its pre GFC peak, many investors returning to the markets remain less than convinced about the durability of stock returns. The key is to focus on fundamentals – and measured through this prism, careful investing in quality Australian stocks is looking like a good proposition. Australian corporate profits support this analysis, with record profits recently driving share prices to new highs.
So what are investors worried about?
The shock of the GFC forced many investors to question the sources they use to make investment decisions. Many professional analysts didn’t see the GFC coming and many brokers and advisers were recommending investing in the share market, right up until the collapse of Lehman Brothers.
So now, for those once “all trusting” but now “all skeptical” investors, any sign of economic weakness can trigger significant concerns – and charts like Figure 1 below are now doing the rounds, to the anxiety of nervous investors!
Source: MarketWatch, Wall Street Journal, February 11, 2014
This chart supposedly shows the parallels between the US stockmarket in the run up to the 1929 crash, compared to today – with the implication that we may be headed for another bout of market disruption, possibly worse than the GFC.
Of course, while we can’t ever rule this out, improving economic fundamentals in the US suggest this is unlikely. Consensus economic forecasts for the US economy show a GDP growth of 2.9% for the coming year, with some analysts forecasting even higher growth of around 3.3%. That’s why the US Federal Reserve is starting to taper its QE program – albeit slowly and cautiously.
What about Australian stocks?
The annual corporate reporting season in Australia is led by the banks, with ANZ and CBA releasing interim results in February 2014. Significantly, both bank CEOs have noted that economic stability continues to improve, with ANZ CEO Mike Smith stating that although global challenges persist, the economic environment is becoming more predictable. Smith announced a significant improvement in profitability, most notably a 13% year-on-year increase in the bank’s unaudited cash profit for the final quarter of 2013, which he attributed to growth in both the retail and corporate businesses and a fall in bad debts.
The CBA result was also outstanding, with all key measures ahead of market consensus expectations. The bank’s cash profit rose 14% over the six months to December to a record $4.27 billion, ahead of market estimates of $4.1 billion, while its earnings per share were also 10 cents above market expectations. While CEO Ian Narev said that market volatility was still suppressing business confidence, he did note several positive economic influences, including higher consumer confidence and housing market growth.
Banking results so far are a clear illustration that quality Australian stocks continue to grow their earnings and reward shareholders. By focusing on fundamentals – for instance, a company’s revenue, cash flow and the value of dividends paid to shareholders – investors can access these stocks at appropriate prices, and position themselves for future upside.
For those investors that are seeking Australian equities exposure with a ‘fundamentals bias’, the BetaShares FTSE RAFI Australia 200 ETF (ASX code: QOZ) provides exposure to the broad Australian sharemarket using fundamental analysis to construct its portfolio, all in a single trade. You can find out more about the theory of fundamental indexing here.
While investors certainly need to maintain vigilance when determining whether to invest in or add to investments in the equity markets, recent economic and corporate developments indicate that equities investments, carefully analysed on their fundamentals, may well merit further consideration as potential additions to investment portfolios.