The three largest funds managers – Colonial First State, MLC and AMP Capital Investors – have issued generally positive reports about the outlook for markets this calendar year, with Colonial and AMP the most bullish on Australian shares.

But each warned investors not to expect the same level of returns as the past two years – above 20 per cent – and suggested the risks which were evident at the start of 2005 remained still 12 months later. The three factors most likely to impact on both global and Australian shares are: continued growth of the Chinese economy, continued recovery in Japan and the state of interest rates in the US – whether or not the Federal Reserve over-reacts to wages and other inflationary pressures. Hans Kunnen, head of investment markets research for Colonial, said: “It might be too much to expect another year of returns in excess of 20 per cent but in buoyant economic times there is money to be made. Australia is well placed to benefit from current global trends but we cannot take sharemarket returns for granted. Companies have a lot to do this year if they are to maintain earnings, lift productivity and meet competition.” Shane Oliver, head of investment strategy and chief economist for AMP, predicted that the Australian sharemarket was on track to move beyond the 5000 mark (ASX 200) by the end of the year, which would be a 10 per cent gain. And if the market rose to match its previous peak in average PE ratio, of 18.3 times earnings in 1999, the index would hit 6100. Oliver argued that the recent rise in the average PE for Australian shares, to match that of global shares, was justified and did not indicate that the local market was over-valued. “Our assessment remains that Australian shares will continue to outperform mainstream global shares (as they have for five years) thanks to a combination of higher dividend yields, slightly stronger earnings growth, helped, of course, by the resources sector, and franking credits, which add 1 to 1.5 percentage points to the after-tax return for Australian shares. The performance differential is likely to be narrower than it has been over the last few years, though.” In its January investment briefing on the year ahead, MLC appeared a little more cautious, particularly for global bonds, weighing up the various scenarios which could lead investors to be either bullish or bearish. Susan Gosling, general manager of MLC Implemented Consulting, said: “What the future holds for investment markets depends on two things: the course of the fundamental drivers of returns – the economy – and what is currently factored into markets. Even a lacklustre investment environment can generate a reasonable return outcome if the market is currently pricing in a more pessimistic outcome. This might be the case for some global sharemarkets, but it is certainly not for bonds. Bond markets appear to have factored in a highly positive environment from their point of view, which implies a significant slowing in economic growth.” According to Gosling, the range of possibilities which could produce surprises for markets include: . The Chinese economy slows down, leading to unexpected declines in commodity prices, possibly caused by a more market-orientated banking system leading to less excessive lending; . The US Federal Reserve raises rates by much more than expected to slow down a resilient economy; . A serious outbreak of bird flu triggers a generalised rise in risk premiums; . The global imbalance starts to correct with no adverse market adjustments, as US consumers curtail their spending, Japanese consumers regain their confidence, Asian spending picks up and the Eurozone economy starts to improve. “Whatever happens, more volatility may be in prospect,” Gosling said. Colonial’s Kunnen also mentioned bird flu as a possible risk to markets, as well as China’s potential to “unsettle markets as it finds its way in the world of trade and policy making”. AMP’s Oliver said that despite the gains of recent years, Aussie shares were still trading on a forward PE ratio below the 10-year average – 14.5 times against 15.1 times. He said a discount to other markets was no longer justified because the reasons for it existing in the past were no longer valid. These included: no longer more volatile because of a high exposure to resources; no longer the governance concerns of the late 1980s when entrepreneurs drove the market; Australia being no longer a laggard in keeping a lid on inflation; and no IT bubble to widen the gap between Australia’s relatively low-tech market and others.

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