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Shane Oliver, Head of Investment Strategy
  & Chief Economist


  Where are we in the
  Heading 1 or 2 shares?
  investment cycle for                                                                                                               EDITION	4	–	16	FEBRUARY	2011


                                                                                 So	far,	so	good	with	the	correction	in	share	markets	last	year	being	
                                                                                 consistent	with	this	pattern.	Of	course,	markets	don’t	always	
                                                                                 follow	a	precise	12-month	pattern,	but	if	history	is	any	guide	this	
                                                                                 would	suggest	strong	returns	over	the	next	six	to	12	months.	More	
                                                                                 fundamentally,	the broad cyclical backdrop for shares and other
                                                                                 growth trades remains fundamentally positive.	
  Key points
                                                                                 Firstly, share valuations are still attractive. The	forward	price	to	
  •	 Bullets
     While	mainstream	global	shares	may	be	due	for	a		
                                                                                 earnings	(PE)	multiple	for	global	shares	is	12.9	times	which	is	well	
    short-term	correction,	the	cyclical	recovery	still	has	further	
                                                                                 below	longer-term	averages	for	the	low	inflation	period.	Similarly,	
    to	go.	Shares	are	still	cheap,	confidence	in	the	sustainability	
                                                                                 the	forward	PE	ratio	for	Australian	shares	is	13	times	compared	to	
    of	the	global	recovery	is	continuing	and	share	market	
                                                                                 a	longer-term	average	of	14.6	times.	Emerging	market	and	Asian	
    liquidity	remains	favourable.	                                               shares	are	only	trading	on	11	to	12	times	forward	PEs.
  •	 US	shares	are	in	the	‘sweet	spot’	of	the	investment		
                                                                                 Shares are still attractive
    cycle	and	are	likely	to	outperform	for	a	while.
                                                                                 25        Forward PE, times
                                                                                 23                                                                  World (current = 12.9 times
                                                                                 21                                                                 15-year average = 16.7 times)
Introduction                                                                     19
                                                                                 17
Improving	confidence	in	the	global	recovery	has	seen	mainstream	                 15
global	share	markets	post	strong	gains	since	mid	last	year.	However,	            13
many	fret	that	it	is	unsustainable	with	high	unemployment,	high	                 11                                        Australia (current 13 times,
                                                                                  9                                       15-year average = 14.6 times)
public	debt	and	unsustainably	easy	monetary	policy	hanging	over	                  7
advanced	countries	and	emerging	markets	increasingly	subject	to	                  5
                                                                                      88       90     92       94     96       98        00    02        04   06        08   10
inflationary	pressures.	
                                                                                 Source:	Thomson	Financial,	AMP	Capital	Investors
Cyclical recovery has further to go                                              Secondly,	while	some	of	the	heat	is	starting	to	come	out	of	
While,	as	always,	there	is	lots	to	worry	about,	our	assessment	is	               emerging	countries,	leading indicators for the US, Europe and to
the	cyclical	recovery	in	shares	is	panning	out	broadly	as	expected	              a lesser degree Japan have moved back up after a soft patch mid
and	has	much	further	to	run.	After	a	major	bear	market	ends	the	                 last year.	This	is	evident	in	business	conditions	indicators	as	shown	
recovery	in	shares	often	goes	through	several	stages:	an	initial	                in	the	next	chart.	
rebound	during	the	first	year,	a	period	of	correction	or	consolidation	
                                                                                 Business conditions in the US, Europe & Japan are up
in	the	second	year	and	then	a	continuation.	This	is	illustrated	in	the	
                                                                                 70                                                                                           100
table	below	for	Australian	shares	which	shows	strong	average	gains	                                        US ISM (LHS)
                                                                                 60                                                                                           90
in	the	first	year,	typically	poorer	performance	in	the	second	year	and	
                                                                                 50                                                                                           80
then	strong	gains	in	the	third	year.		                                                                              European PMI (LHS)
                                                                                 40                                                                                           70
Post bear market recoveries, Australian shares                                                                                   China PMI (RHS)
                                                                                 30                                                                                           60
                                                                                 20                                                                                           50
 Bear	market         %	decline	in	    %	gain	in	     %	gain	in	    %	gain	in	
                       All	Ords       first	year	   second	year	   third	year	   10                                                      Japan PMI (RHS)                      40
                                      from	low       after	low     after	low      0                                                                                           30
                                                                                      00             02             04              06              08             10
 May	51-Dec	52           -34               8            13             5
                                                                                 Source:	Bloomberg,	AMP	Capital	Investors
 Sep	60-Nov	60           -23               12           -2            18
                                                                                 In	fact,	the	US	is	leading	the	charge	on	this	front.	The	US	Institute	
 Feb	64-Jun	65           -20               8            11            67
                                                                                 for	Supply	Management	business	conditions	indicators	are	about	
 Jan	70-Nov	71           -39               49           -25           -33        as	strong	as	they	ever	get.	Corporate	profits	are	up	strongly	and	this	
 Jan	73-Oct	74           -59               54           16             -4        is	boosting	business	investment.	Various	labour	market	indicators	
 Aug	76-Nov	76           -23               6            21            27         point	to	a	big	resurgence	in	jobs	growth	and	unemployment	is	
                                                                                 already	falling.	Finally,	US	consumers	are	starting	to	feel	more	
 Nov	80-Jul	82           -41               39            9            36
                                                                                 confident	again	and	this	is	boosting	retail	sales.	Similarly	in	Europe,	
 Sep	87-Nov	87           -50               35            5            -19
                                                                                 strength	in	Germany	is	more	than	offsetting	weakness	in	peripheral	
 Sep	89-Jan	91           -32               39           -9            46         debt-troubled	countries.	So	there	is	good	reason	for	confidence	in	
 Jan	94-Feb	95           -22               25            8            10         the	sustainability	of	the	global	recovery.
 Mar	02-Mar	03           -22               28           24            16         Thirdly, the liquidity backdrop for shares is very positive	with:
 Average                 -33               28            6            15         easy	money	in	the	US,	Europe	and	Japan;	cashed-up	corporates	
 Nov	07-Mar	09           -55               53            ?             ?         starting	to	undertake	takeovers	and	share	buybacks	and	boost	
                                                                                 dividends;	and	individual	investors	starting	to	switch	back	from	
Source:	Bloomberg,	AMP	Capital	Investors                                         bonds	to	shares.	At	the	moment	the	latter	is	particularly	noticeable
in	the	US	with	the	record	inflows	into	bond	mutual	funds	of	recent	                    •	 Household	balance	sheets	in	the	US	remain	worrying	but	rising	
years	now	starting	to	flow	back	out	into	equity	mutual	funds.	Given	                      share	prices	and	the	fall	in	household	debt	ratios	mean	they	are	
the	size	of	the	bond	inflows	in	recent	years	this	might	have	a	way	to	                    becoming	less	fragile.		
go	before	it	is	complete.	If	history	is	any	guide	and	share	markets	do	
                                                                                       •	 While	the	US	housing	market	is	still	a	threat,	rising	home	sales	
continue	to	rise,	then	the	same	is	likely	to	become	evident	amongst	
                                                                                          suggest	it	has	found	a	floor,	and	in	any	case	the	significance	of	
Australian	individual	investors.
                                                                                          housing	activity	in	the	US	economy	is	half	what	it	used	to	be.
In	fact,	the	US	and	northern	Europe	are	arguably	in	the	classic	‘sweet	                •	 Finally,	demographics	are	certainly	poor	and	will	be	a	long-term	
spot’	in	the	investment	cycle	–	with	rebounding	growth	and	surging	                       constraint	in	major	advanced	countries,	but	this	is	a	very	slow	
profits	but	plenty	of	spare	capacity	such	that	inflation	is	not	really	a	
                                                                                          moving	event.		
problem	and	central	banks	can	keep	interest	rates	low	and	money	
easy.	This	period	in	the	cycle	is	usually	very	positive	for	shares.                    Thirdly, worries about inflation and growth in emerging countries
                                                                                       could start to weigh on major share markets. Asian	and	emerging	
The US is in the ‘sweet spot’ in the investment cycle                                  market	shares	generally	have	had	a	bad	start	to	the	year	reflecting	
    Economic                                     Inflation rises,                      the	need	for	monetary	tightening	in	response	to	inflationary	
    Slowdown                                        rate fears Non-residential
                                                                property does well     pressures.	Basically	Asia	and	other	emerging	countries	are	further	
                                                                                       advanced	in	their	economic	cycle	(see	earlier	chart)	and	so	have	
                                                                                       less	spare	capacity	and	less	justification	for	very	easy	monetary	
                                 Economic    Equities
                                  Recovery   do well                                   conditions.	As	a	result,	monetary	tightening	is	required	to	take	
                                                                 Emerging
                                                                 countries             monetary	conditions	back	to	neutral	–	as	has	already	occurred	in	
  Government
  bonds do well                                                                        Australia	-	and	this	is	seeing	emerging	markets	go	through	a	period	
                                               US, core
                                                                                       of	underperformance	relative	to	the	US	and	Europe.	This	is	likely	
                                               Europe                                  to	continue	for	the	next	six	months	or	so,	but	with	underlying	
Source:	AMP	Capital	Investors                                                          inflation	in	these	countries	a	long	way	from	getting	out	of	control	
Finally, there are no signs of the excesses that normally mark                         and	policy	makers	already	responding,	a	hard	landing	is	unlikely	in	
                                                                                       the	emerging	world.	Nor	does	it	change	the	favourable	strategic	
the end of cyclical recoveries in shares.	Inflation	is	still	benign
                                                                                       outlook	for	Asian/emerging	share	markets.
in	advanced	countries	and	even	in	emerging	countries	it	is		
mainly	reflective	of	higher	food	prices,	not	excessive	demand.		                       Finally, the eventual reversal of easy money policies in the US,
Prices	for	assets	such	as	shares	and	property	are	still	far	from		                     Europe and Japan and easy fiscal policy in the US will likely
being	overvalued.	                                                                     cause gyrations in share markets.	However,	this	is	unlikely	to	be	a	
                                                                                       major	issue	for	markets	until	later	this	year	at	the	earliest	or	more	
But what could go wrong?                                                               likely	through	next	year.	Excess	capacity	in	the	US,	Europe	and	
Essentially,	there	are	four	main	areas	of	concern:                                     Japan	suggests	underlying	inflation	is	likely	to	remain	benign	for	
                                                                                       some	time	heading	off	the	need	for	a	quick	return	to	more	normal	
Firstly, there is a risk of a short-term pull back in shares.
                                                                                       monetary	conditions	in	these	countries.	
Many	technical	indicators	suggest	US	shares	are	overbought	
and	measures	of	short-term	investor	optimism	are	at	levels	that	
                                                                                       Concluding comments
often	precede	corrections.	However,	while	there	is	the	risk	of	a	
consolidation	or	a	5%	pullback,	the	positive	fundamental	outlook	                      The	cyclical	recovery	in	global	shares	has	further	to	run,	but	with	
outlined	above	suggests	any	short-term	dip	should	be	seen	as	a	                        Asian	and	emerging	markets	further	advanced	in	their	economic	
buying	opportunity.	                                                                   cycles	and	US	shares	still	in	the	‘sweet	spot’	in	the	investment	
                                                                                       cycle,	the	next	six	months	or	so	may	see	further	short-term	
Secondly, longer-term structural issues clearly remain in major                        outperformance	by	US	shares.	Australian	shares	are	likely	to	be	
advanced countries. The	threat	remains	from	very	high	public	                          in	between:	monetary	tightening	in	Asia	may	act	as	a	short-term	
debt	levels,	still	fragile	household	balance	sheets,	ongoing	issues	                   constraint	on	Australian	shares	but	with	monetary	conditions	
in	the	US	housing	market	and	poor	demographics.	However,	our	                          already	normalised	in	Australia	and	the	Reserve	Bank	of	Australia	
assessment	is	that	while	these	are	likely	to	be	medium-term	                           ahead	of	the	curve,	Australian	shares	are	likely	to	continue	to	
constraints	for	major	advanced	countries,	they	are	unlikely	to		                       benefit	from	the	positive	lead	flowing	from	US	shares.
cause	a	blow	up	in	the	next	year	or	two:
                                                                                       Dr Shane Oliver
•	 Europe	seems	prepared	to	do	whatever	it	can	to	stop	its	debt	                       Head of Investment Strategy and Chief Economist
  problems	from	spreading.	And	the	US	is	having	no	trouble	                            AMP Capital Investors
  financing	its	budget	deficit.	




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Shane Oliver's Insights Where are we in the Investment Cycle for Shares

  • 1. Shane Oliver, Head of Investment Strategy & Chief Economist Where are we in the Heading 1 or 2 shares? investment cycle for EDITION 4 – 16 FEBRUARY 2011 So far, so good with the correction in share markets last year being consistent with this pattern. Of course, markets don’t always follow a precise 12-month pattern, but if history is any guide this would suggest strong returns over the next six to 12 months. More fundamentally, the broad cyclical backdrop for shares and other growth trades remains fundamentally positive. Key points Firstly, share valuations are still attractive. The forward price to • Bullets While mainstream global shares may be due for a earnings (PE) multiple for global shares is 12.9 times which is well short-term correction, the cyclical recovery still has further below longer-term averages for the low inflation period. Similarly, to go. Shares are still cheap, confidence in the sustainability the forward PE ratio for Australian shares is 13 times compared to of the global recovery is continuing and share market a longer-term average of 14.6 times. Emerging market and Asian liquidity remains favourable. shares are only trading on 11 to 12 times forward PEs. • US shares are in the ‘sweet spot’ of the investment Shares are still attractive cycle and are likely to outperform for a while. 25 Forward PE, times 23 World (current = 12.9 times 21 15-year average = 16.7 times) Introduction 19 17 Improving confidence in the global recovery has seen mainstream 15 global share markets post strong gains since mid last year. However, 13 many fret that it is unsustainable with high unemployment, high 11 Australia (current 13 times, 9 15-year average = 14.6 times) public debt and unsustainably easy monetary policy hanging over 7 advanced countries and emerging markets increasingly subject to 5 88 90 92 94 96 98 00 02 04 06 08 10 inflationary pressures. Source: Thomson Financial, AMP Capital Investors Cyclical recovery has further to go Secondly, while some of the heat is starting to come out of While, as always, there is lots to worry about, our assessment is emerging countries, leading indicators for the US, Europe and to the cyclical recovery in shares is panning out broadly as expected a lesser degree Japan have moved back up after a soft patch mid and has much further to run. After a major bear market ends the last year. This is evident in business conditions indicators as shown recovery in shares often goes through several stages: an initial in the next chart. rebound during the first year, a period of correction or consolidation Business conditions in the US, Europe & Japan are up in the second year and then a continuation. This is illustrated in the 70 100 table below for Australian shares which shows strong average gains US ISM (LHS) 60 90 in the first year, typically poorer performance in the second year and 50 80 then strong gains in the third year. European PMI (LHS) 40 70 Post bear market recoveries, Australian shares China PMI (RHS) 30 60 20 50 Bear market % decline in % gain in % gain in % gain in All Ords first year second year third year 10 Japan PMI (RHS) 40 from low after low after low 0 30 00 02 04 06 08 10 May 51-Dec 52 -34 8 13 5 Source: Bloomberg, AMP Capital Investors Sep 60-Nov 60 -23 12 -2 18 In fact, the US is leading the charge on this front. The US Institute Feb 64-Jun 65 -20 8 11 67 for Supply Management business conditions indicators are about Jan 70-Nov 71 -39 49 -25 -33 as strong as they ever get. Corporate profits are up strongly and this Jan 73-Oct 74 -59 54 16 -4 is boosting business investment. Various labour market indicators Aug 76-Nov 76 -23 6 21 27 point to a big resurgence in jobs growth and unemployment is already falling. Finally, US consumers are starting to feel more Nov 80-Jul 82 -41 39 9 36 confident again and this is boosting retail sales. Similarly in Europe, Sep 87-Nov 87 -50 35 5 -19 strength in Germany is more than offsetting weakness in peripheral Sep 89-Jan 91 -32 39 -9 46 debt-troubled countries. So there is good reason for confidence in Jan 94-Feb 95 -22 25 8 10 the sustainability of the global recovery. Mar 02-Mar 03 -22 28 24 16 Thirdly, the liquidity backdrop for shares is very positive with: Average -33 28 6 15 easy money in the US, Europe and Japan; cashed-up corporates Nov 07-Mar 09 -55 53 ? ? starting to undertake takeovers and share buybacks and boost dividends; and individual investors starting to switch back from Source: Bloomberg, AMP Capital Investors bonds to shares. At the moment the latter is particularly noticeable
  • 2. in the US with the record inflows into bond mutual funds of recent • Household balance sheets in the US remain worrying but rising years now starting to flow back out into equity mutual funds. Given share prices and the fall in household debt ratios mean they are the size of the bond inflows in recent years this might have a way to becoming less fragile. go before it is complete. If history is any guide and share markets do • While the US housing market is still a threat, rising home sales continue to rise, then the same is likely to become evident amongst suggest it has found a floor, and in any case the significance of Australian individual investors. housing activity in the US economy is half what it used to be. In fact, the US and northern Europe are arguably in the classic ‘sweet • Finally, demographics are certainly poor and will be a long-term spot’ in the investment cycle – with rebounding growth and surging constraint in major advanced countries, but this is a very slow profits but plenty of spare capacity such that inflation is not really a moving event. problem and central banks can keep interest rates low and money easy. This period in the cycle is usually very positive for shares. Thirdly, worries about inflation and growth in emerging countries could start to weigh on major share markets. Asian and emerging The US is in the ‘sweet spot’ in the investment cycle market shares generally have had a bad start to the year reflecting Economic Inflation rises, the need for monetary tightening in response to inflationary Slowdown rate fears Non-residential property does well pressures. Basically Asia and other emerging countries are further advanced in their economic cycle (see earlier chart) and so have less spare capacity and less justification for very easy monetary Economic Equities Recovery do well conditions. As a result, monetary tightening is required to take Emerging countries monetary conditions back to neutral – as has already occurred in Government bonds do well Australia - and this is seeing emerging markets go through a period US, core of underperformance relative to the US and Europe. This is likely Europe to continue for the next six months or so, but with underlying Source: AMP Capital Investors inflation in these countries a long way from getting out of control Finally, there are no signs of the excesses that normally mark and policy makers already responding, a hard landing is unlikely in the emerging world. Nor does it change the favourable strategic the end of cyclical recoveries in shares. Inflation is still benign outlook for Asian/emerging share markets. in advanced countries and even in emerging countries it is mainly reflective of higher food prices, not excessive demand. Finally, the eventual reversal of easy money policies in the US, Prices for assets such as shares and property are still far from Europe and Japan and easy fiscal policy in the US will likely being overvalued. cause gyrations in share markets. However, this is unlikely to be a major issue for markets until later this year at the earliest or more But what could go wrong? likely through next year. Excess capacity in the US, Europe and Essentially, there are four main areas of concern: Japan suggests underlying inflation is likely to remain benign for some time heading off the need for a quick return to more normal Firstly, there is a risk of a short-term pull back in shares. monetary conditions in these countries. Many technical indicators suggest US shares are overbought and measures of short-term investor optimism are at levels that Concluding comments often precede corrections. However, while there is the risk of a consolidation or a 5% pullback, the positive fundamental outlook The cyclical recovery in global shares has further to run, but with outlined above suggests any short-term dip should be seen as a Asian and emerging markets further advanced in their economic buying opportunity. cycles and US shares still in the ‘sweet spot’ in the investment cycle, the next six months or so may see further short-term Secondly, longer-term structural issues clearly remain in major outperformance by US shares. Australian shares are likely to be advanced countries. The threat remains from very high public in between: monetary tightening in Asia may act as a short-term debt levels, still fragile household balance sheets, ongoing issues constraint on Australian shares but with monetary conditions in the US housing market and poor demographics. However, our already normalised in Australia and the Reserve Bank of Australia assessment is that while these are likely to be medium-term ahead of the curve, Australian shares are likely to continue to constraints for major advanced countries, they are unlikely to benefit from the positive lead flowing from US shares. cause a blow up in the next year or two: Dr Shane Oliver • Europe seems prepared to do whatever it can to stop its debt Head of Investment Strategy and Chief Economist problems from spreading. And the US is having no trouble AMP Capital Investors financing its budget deficit. Contact us If you would like to know more about how AMP Capital can help you, please visit ampcapital.com.au, or contact one of the following: Financial Advisers Your Business Development Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591) (AFSL 232497) makes no Manager or call 1300 139 267 representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator Personal Investors Your Financial Adviser or call of future performance. This document has been prepared for the purpose of providing us on 1800 188 013 general information, without taking account of any particular investor’s objectives, OI_160211 financial situation or needs. 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