Asset allocation: Mark Story Take advantage of opportunities

Value investors should be quick to take advantage of the opportunities provided by volatile markets

If you want to know the difference a year makes when investing, just look at the gulf in the average super fund balance, which dived from around 10% in 2017 to between -1% and -2% a year later. By all accounts, 2019 appears to be threatening even greater trepidation than last year, when the S&P/ASX 200 fell 6.9% (excluding dividends), which marked the biggest loss for the local sharemarket since 2011.

However, despite smouldering big-ticket macro issues – including the late-cycle stock sell-off, trade wars, falling GDP growth in China and, closer to home, tightening credit conditions, along with declining house prices – investors shouldn’t take overly pessimistic market commentary too seriously. That’s the view of Paul Moore, chief investment officer of PM Capital, who reminds investors how irrelevant these events can be – and with Australian shares up over 4% in January alone he’s got a point.

Moore says there’s never been a more urgent need for investors to understand that future returns will come from avoiding the continuum of negative news and focusing on how their capital is deployed over a longterm horizon. “In reality, one only needs a few good investments in their lifetime to produce attractive returns, and they tend to come around every 10 or so years.”

New way of thinking

What’s needed now, says Moore, is a fresh approach to looking at where future returns are more likely to come from. In 2019, he urges investors to recognise a tectonic-like shift playing out in the structural drivers of markets. It’s because of this structural shift that he expects the next 10 years to be more determined by the “serious investor” and less by the momentum and hype that have dominated the market and accentuated volatility over the past decade.

With stocks having been driven by anomalies (such as monetary stimulus) for the past 10 years, he says it’s understandable that investors have been trapped into an old way of thinking about markets. “But instead of being process-driven, what we’re seeing now is a return to fundamentals, and the types of investments you want to be involved with will have this wind at their back.”

With “real-world” issues re-emerging – such as fundamentals and the underlying economy, rather than momentum and quant strategies that distort market movements – Moore advises investors to seriously reconsider what assets they want to be invested in. Given that it invariably behaves like the Texas Two-Step – one jive forward and two backwards – he says we’re now entering an environment where investors really don’t want to be too diversified.

In Moore’s view, there’s currently no place for property or defensive stocks. The only

two places to be are in cash and owning businesses offering satisfactory rates of return. By all means have some money in cash but Moore says the notion that 2019 is first and foremost about capital preservation is dangerous, and having too much in cash only consigns investors to locking in losses.

Tighter focus

Rather than hoarding cash, Moore recommends holding it as sufficient “dry powder” to capitalise on value opportunities that sharemarkets regularly throw up. In simple terms, a value approach is all about buying a share, for argument's sake, at 70 cents when it might be worth $1. He favours these value stocks over growth stocks that have become increasingly more expensive. “There’s got to be a much tighter focus on valuation relative to growth, and within this environment good, solid companies, fundamentally mispriced and selling on low price to earnings ratios, will again receive the coverage they deserve.” Admittedly, most investors don’t have the skill to recognise genuine buying opportunities when they arise. That’s why Moore recommends seeking the expertise of fund managers with high degrees of conviction and a greater contrarian approach to market opportunities.

He urges investors to work with their advisers to find value fund managers who remain true to label and have done well over a longer period of time and in different market environments. “Remember, the more you diversify, the lower the outcome becomes, and the harder it is to identify where the upside came from, so don’t just diversify for the sake of it.”

He also reminds investors that the best results come when they’re highly focused, with opportunities becoming greater in magnitude the longer they’re invested. While wanting to preserve capital is a given, the longer you plan to invest the more willing you should be to endure short-term volatility.

Ripe pickings for contrarians

While volatile markets like these are stressful, Shane Oliver, head of investment strategy and chief economist at AMP Capital, reminds investors that despite a fragile outlook for global growth, and with long-term return trends likely to be lower, they still remain considerably higher than more stable assets. For example, while Australian shares could fall further in the short term, following the 8% rally since Christmas, a grossed-up dividend yield of around 6% , still makes them infinitely more attractive than deposit rates at around 2%, and possibly falling.

If investors want to bring a fresh look at markets in 2019,

Oliver also suggests taking a more con- trarian approach to buying stocks direct. For example, at times like these, when shares often bottom at the point of maximum bearishness, when everyone is negative and cautious, he says it’s often time to buy. “Remember, shares may have fallen in value but the dividends from the market haven’t, and the income flow you are receiving from a diversified portfolio of shares remains attractive.”

Despite myriad uncertainties that could unhinge markets over the near term, including Brexit, trade wars, another possible US government shutdown and the Australian election, Oliver’s outlook for shares over 2019 remains upbeat, due somewhat to signs of more supportive policy shifts globally. “Volatility is likely to remain high in 2019 but, ultimately, reasonable global growth and still easy global monetary policy should drive better overall returns than in 2018 as investors realise that recession is not imminent.”

Oliver expects Australian shares to deliver constrained returns of around 8%, with moderate earnings growth. While low yields are also likely to see low returns from bonds, he says they continue to provide an excellent portfolio diversifier.

Narrowing gulf

Based on a similarly positive medium-term outlook for the Australian economy, Stephen Bruce, director of portfolio management at Perennial Value, also sees a greater role for value this year, with Woodside Petroleum (ASX: WPL), Tabcorp (TAH), Amcor (AMC), Ausdrill (ASL), Nufarm (NUF), Aristocrat Leisure (ALL), Graincorp (GNC), Downer EDI (DOW), Macquarie Group (MQG) and Suncorp (SUN) currently on attractive multiples and enticing yields.

In an environment where market conditions are finally becoming more normalised (based more on fundamentals such as capacity, reinvestment and more normal interest rates), Bruce expects the gulf between value and growth to continue narrowing. For example, the 13 times forecast earnings per share (EPS) for growth stocks is only marginally higher than the 12 times EPS growth forecast for value stocks.

Having had a fabulous time with growth and momentum, Bruce suggests investors consider some profit taking. “The gap between value and growth can close fast, so now’s the time to be rotating into these sorts of (value) opportunities,” he says. “Within a more normalised underlying environment, growth will be available within a broader part of the market, and another sector to benefit will be resources due to supply/demand dynamics and reinvestment now at a tipping point.”