The future looks well-valued

At school and university my favourite day was always the first day of the academic year. The first day was filled with possibilities, excitement and plans for the year ahead. The only thing better than the first day of a new year is the first day of a new decade! I look forward to the anticipation of what’s going to happen over the next ten years and what I can set in motion at the start of the decade to make sure it is a great one…

There is a modern maxim generally attributed to Bill Gates that states that most people overestimate what they can do in one year and underestimate what they can get done in ten years. I think this is also true of investments and markets. The Australian stock market is likely to close out the year with close to a 20 percent return which is a great result by any measure. In reality we all know it takes much longer than a year to make a significant difference to someone’s financial life, but this type of return isn’t a one-off. Research by the London Business School demonstrates the Australian equity market has delivered approximately 12 percent per year for the last 120 years. That’s some serious compounding!

"While conditions remain constructive for the Australian equity market it’s certainly not without risk.”

The Fidelity Australian Equities Fund, while not quite at the 120-year mark yet, is now 16 and a half years old and has delivered an annual net return of 12.1% against a market return of 9.8% p.a. To demonstrate the power of these returns, if you’d invested $10,000 at the Fund’s inception it would today be worth $65,487, that’s six and a half times your initial investment despite enduring one of the most severe global market crises Australia has ever seen!  These figures serve as a powerful reminder for us to ignore short-term distractions, weather the ups and downs and stay focused on our long-term investment objectives.

2020: A New Year and a new decade

Today, thinking about equity returns for 2020 and the decade to come, I remain surprisingly positive on both. The Australian equity market not only remains good absolute value but great relative value. Market valuation levels, at 17x price earnings ratio, are above long run averages of around 15x but earnings quality is much better than average, corporate balance sheets are strong, and with very low interest rates today’s valuation multiples are more than justified. A fully franked dividend yield of around four percent also makes it a very hard asset class to ignore.

 We’re in the unusual position heading into 2020 of having tailwinds from both monetary and fiscal policy. Having pretty much used up all monetary policy ammunition, governments are now being asked to step up with fiscal policy to help economies break free of this very low growth world. This will likely come via significant infrastructure development which should be good news as low interest rates combined with fiscal stimulus is normally a positive environment for equity returns.

While conditions remain constructive for the Australian equity market it’s certainly not without risk.  For lack of a better word the ‘populism’ based politics that seems to be sweeping the world is very anti-growth in its approach. Populist policies like protectionism (trade wars), anti-immigration and government intervention are all anti-growth in nature and are likely to continue to put downward pressure on the already sluggish one to two percent economic growth range in most developed economies.

While I’m positive on the overall Australian equity market, stock selection as always will be crucial.  I continue to look for great companies at reasonable prices and tend to have less sector over-weights and under-weights preferring to back the best companies in each sector. Companies such as Suncorp, Seek, Dominos, Ramsay Healthcare, Oil Search and Goodman Group remain major over-weights in the portfolio as we believe these companies have strong fundamentals, good balance sheets and management teams, and importantly attractive valuations for the dividends and growth they’re able to achieve.

2020 has always been a year trend-watchers looked ahead to try and identify some future trend or new phenomenon. Equity market trends seem to be in our favour and while there are still risks around, policy alignment should see tailwinds win out. To echo Bill Gates however, I’d encourage investors to focus more on the next decade than the next year, even though I think both look positive.

Paul Taylor, Portfolio Manager, Fidelity Australian Equities Fund