June 2014 Review & Comments
Written by TONY GRAY   
Friday, 11 July 2014 15:50

International Shares

Whilst generating the highest total return for the financial year, virtually all of this was achieved
in the first half – the second half return was a miserly 0.9% - partly due to a modestly higher $A.
Asia and emerging markets underperformed developed economy markets.
We still see decent long-term value from international shares, but have some reservations about
the higher premiums in US stocks (especially smaller companies). 
Some Asian stocks appear quite cheap by comparison.
The Australian dollar does appear to be swinging upwards again, so we are biding our time in terms
of directing significant new funds to the international sector.

Australian Shares

A similar story to international shares – most of the circa 17% total return was generated
in the first half. 
In fact, half of the capital rise occurred in the first 5 weeks of the financial year. 
Whilst a good start to the year, that rise was only making up for weakness in May/June 2013
– another reason why the financial year numbers seem high.
The market has essentially moved sideways for the 2014 year thus far –
with income responsible for most of the 3% return in the second half.
In terms of value, while the total market price-earnings multiple for the year ended June 2014
sits at around 16.5 times (only an estimate until results come through next month),
this is a weighted average dragged down by the very large weighting of banks and
materials in the index. 
There are in fact plenty of sectors priced quite highly. 
We have generated the table below using Morningstar estimates to highlight this:


Highly Rated Sectors

Weighted Avge Price-Earnings Multiple 2014FY




e.g. Transurban



e.g. Ramsay Healthcare

Pharmaceuticals & Biotech


e.g. CSL



e.g. REA Group

Software & Services


e.g. Computershare



e.g. Duet Group

Consumer Durables


e.g. Fleetwood

Food & Beverage


e.g. Coca Cola Amatil

Consumer Services


e.g. Flight Centre

Food & Staples Retailers


e.g. Woolworths

Commercial & Prof. Services


e.g. Brambles

Diversified Financials


e.g. ASX Limited



e.g. Woodside Petroleum

One practical way to look at a price to earnings (pe) multiple is to take it as the number
of years of earnings per share to equal the share price. 
For example, for the average transportation stock it will take 23.56 years of expected 2014
financial year earnings to ‘pay’ for the stock. 
In this case the figure is high due to distortion from one very large asset – Transurban Group
– as reported earnings for that company are quite low due to depreciation benefits.
It’s not necessarily ‘bad’ to buy high pe multiple stocks or sectors – it comes back to
growth expectations. 
Investors will pay more for a company where growth in earnings is expected
and a lot less for stocks where earnings are declining.
We can see this discount factor at work for the Capital Goods sector 
        - where suppliers to the miners have suffered from falling profitability. 
The table below outlines the pe multiples for some other market sectors.

Rest of the market

Weighted Avge Price-Earnings Multiple 2014FY




e.g. Telstra



e.g. Myer



e.g. BHP

Real Estate


e.g. Westfield Corp



e.g. ANZ



e.g. QBE Insurance

Capital Goods


e.g. Bradken

Interestingly, we are seeing plenty of stocks that have in fact weakened in price over the
last 9 months or so and do represent worthwhile value. 
These are typically smaller and medium sized businesses, rather than the large blue chips. 
Examples include ARB Corp, Iress Limited and Ainsworth Gaming Technology.
The share market has generated two consecutive years of double-digit returns and we have
reservations about the likelihood of a third (historically this is quite rare). 
Ideally a mild correction occurs and presents some safer buying opportunities.

Listed Property (Australian Real Estate Investment Trusts)

In contrast to Australian and international shares, listed property generated most
of their return in the second half as bond yields fell and overseas demand for
Australian property was sustained.
We see the sector as representing reasonable, if uninspiring value. 
The income yields and modest growth potential will struggle to sustainably generate
a double-digit return, but is acceptable in comparison to at-call and fixed interest returns.
One leading manager in the sector feels that actual commercial property values
could be re-rated higher by 10% to 15% based on market prices compared
to book valuations.

At-Call & Fixed Interest

Bonds rose in the second half, resulting in a circa 6% total return for the year. 
We had feared rising bond yields (falling bond prices) as the US slowed the
printing presses, but thus far this has not emerged.
Presently bond yields continue to soften – which actually generates outperformance
(since existing bonds on issue rise in value). 
While this continues bonds will generate modestly higher returns than deposits. 
In the absence of further falls in bond yields, we see low return potential/higher
risks from bonds, as at some point the global interest rate cycle will swing higher. 
If this occurs rapidly, then bond returns could be negative.
10 year Commonwealth Government Bonds presently yield just 3.46%. 
If buying a bond today and holding to maturity, this will be the annualised return
and represents less than can be achieved from a 6 month term deposit! 
In fact bond market pricing indicates a 50% chance of another interest rate cut
by Christmas and a 70% chance of a cut by early 2015.
Personally I think the low bond yields have a lot to do with money flows –
while the US, UK, Japan and Europe use unconventional monetary policies
to artificially repress interest rates, then it makes sense for investors to buy
Australian debt for the higher yield. 
The problem is that the longer rates are held down, the greater the risk
that future rises will be rapid and sizeable.
There are a few floating rate notes generating a worthwhile return –
but we are not attracted by the risk/return equation for the newer and
longer-dated bank notes being issued.
Term deposit yields are softening as overseas funding is available at cheap rates
to Australian banks. 
At-call returns are low, but not much of a discount to deposit rates –
so the penalty for holding opportunity money is not overly high at present.
We are finding the defensive fixed interest class the most difficult to generate
an acceptable return at this time.


Returns for the 2013/14 financial year were above average and dominated by
the growth asset classes  (in order) of international shares, Australian shares
and listed property.
We are struggling to generate acceptable returns from fixed interest and the long-term
interest rate risk from bond investment is high – leaving us little choice but to stick
with deposits.
We have reservations about the risk/return trade-off in relation to all asset classes at this time.
These comments are general in nature and we need to tailor the actual approach to your position. 
As always, please contact me with any questions about your portfolio or any planning queries.

Best wishes

A.W. (Tony) Gray BCom, LLB, Dip FP, GDipAppFin, CFP, FFin
Principal, TG Financial
Please treat the above comments as General Advice or general information, with no action to occur until we have considered with reference to your financial position, needs and goals.
Last Updated on Wednesday, 06 August 2014 11:11

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