Two of the most experienced analysts in the Australian equities market have warned of some of the most challenging conditions for 20 years.
Martin Conlon, head of Australian equities at Schroders, who was speaking at the Frontier Advisors’ annual conference in Melbourne, sees a confluence of negative factors.
These include the increasing dominance of financial services companies in both the economy and stock market, slowing growth, the lack of price competitiveness for exports, inequity in generational wealth and above all increasingly unproductive use of debt.
“Australia’s position is worrying. Like an increasing majority of countries, we are using more and more debt to generate less and less growth.”
As interest rates remain extremely low and increasingly reach for yield, the risk of investors paying too much for company cash flows is rising. He gave the example of a takeover of a company relying primarily on income from regulated assets trading being taken over at a valuation well above the level of its regulated asset base.
The high value of Australian incomes to the rest of the world would continue to impact on exports. This he thought made a curb on income growth and ultimately the domestic economy more likely.
In contrast to other analysts, Conlon said the market sector he was most positive on was resources, but he pointed out this had slumped from 37 per cent of the ASX All Ordinaries Index in 1990 to only 19 per cent today.
Of the largest sector in Australian equities, Conlon saw growing risk for banks, firstly from a housing market that was at risk from over-heating and also from the higher risk of a recession.
Conlon advised investors to purchase companies that were as under-leveraged as possible, on the logic that the benefits from financial leverage are most powerful when rates are high and can move lower, not vice versa.
John O’Connell, global head of research for Macquarie Securities, highlighted the risk of international investors, who make the largest base of investors in Australian shares, moving money to more attractive markets.
“If we lag in performance that money will be pulled, especially if emerging markets become the flavour of the month,” he said, adding, “it will not be superannuation that is driving valuations.”