02 9683 5999OVERVIEW: THE WORLD ECONOMY
Information that has become available since December confirms that economic conditions in Europe were weakening late last year, with risks still skewed to the downside.
Reflecting this, most forecasters have lowered their forecasts for world GDP growth this year to a below trend pace. That said, recent data from the United States suggest a continuing moderate expansion after a soft patch in mid-2011.
Growth in China has moderated as was intended, however most indicators remained quite robust through the second half of last year. China’s GDP growth figures continue to outperform other economies (see Table 1). Australia’s resources sector is highly leveraged to China’s growth and therefore the resources industry is still expected to outperform over the next few years.
EUROPE
The acute financial pressures on banks in Europe were alleviated considerably late in 2011 by the actions of policymakers. Financial market sentiment, though remaining skittish, has generally improved since early December.
Share markets have risen and term funding markets have reopened (including for Australian banks), albeit at an increased cost compared with the situation prevailing in mid-2011. However, the situation in Europe is a long way from being resolved.
GREECE HEADING TOWARD A TECHNICAL FAULT?
The current issue for Greece is whether private lenders are willing to take write-downs on their Greek debt.
If private lenders are unwilling to take write-downs on their debt, the Greek government will have to change the terms of its loans in order to force those lenders who are holding out to take mandatory write-downs. However, that would cause credit rating agencies to declare an event of default on Greek debt, which would trigger credit default swaps – which are a form of insurance on Greek bonds. At the same time, bond yields for other debt-laden Eurozone countries are likely to soar, as panicked investors dump their bonds, fearing that they may also end up defaulting.
WHY HAS THE ALL ORDS RALLIED IN EARLY 2012?
If Europe is in such a dire state, then why have equities had a small rally since the beginning of 2012?
It appears that improving US economic data, in particular the improvement in Quarter-to-Quarter Growth in Real GDP (see Table 2) is the driver for this performance.
US QUARTER TO QUARTER GROWTH IN READ GDP
However analysts suggest that the appetite for stocks could weaken when news of a resurgent US fades, and headlines of unresolved structural European banking and credit issues return to prominence.
SO THE QUESTION IS, HOW DO YOU INVEST AMID TROUBLE IN EUROPE
Apart from the option of fleeing into cash and therefore being at the mercy of falling interest rates, the key to remaining invested in equities is to identify those companies with considerable dividend yields that are expected to grow year-on-year.
For investors facing a falling market, stocks with a high dividend yield can be a strong investment to cushion the blow and maintain a solid income stream. However, caveat emptor – not all highdividend- yield stocks are quality stocks. It is important before making any financial decision to examine the fundamentals of those companies that you are looking to invest in.
EXAMPLE: CAP
If you invested in CAP in 2002, your dividend yield would have been 4.6% at the time (share price: $32.61 and dividend: $1.50). If you had held the equity until 2011, your dividend yield would have increased to 9.81% (purchase price $32.61 and dividend yield $3.20). The dividends are also 100% fully franked, so the actual yield may be close to 12.75%. Not a bad return considering current economic circumstances. Referring to the chart below, notice that post-Global Financial Crisis (GFC) in 2008, the dividends dropped to $2.28. Although the drop is substantial (from $2.66 pre-GFC to $2.28 post-GFC), the dividend post GFC is still 52% above the ’02 dividend.
WHAT NEXT?
It is fair to say that no-one really knows what will unfold in the short-term in Europe and, more importantly, what reaction global financial markets will have to these outcomes. On the positive side, Chris Caton (BT’s chief economist) believes Australia is expected to outgrow every developed country over the next decade. In a recent report Blackrock also stated that the Australian equity market is undervalued by global investors and is likely to trade at a premium over the next year. It singles out five economies – Australia, Canada, Singapore, Switzerland and Hong Kong – that it says have strong economic “fundamentals” not fully reflected in their equity prices. The problem is knowing when the world will see through the gloom and realise this!
CAP SHARE PRICE (GREY) & DIVIDEND CHART (LIGHT GREY)
