Money
Issue No. 33 - February/March 2007
On the Money
Key issues for the share market in 2007
The performance of the Australian equity market since the start of the year offers some insight into how we see 2007 unfolding. In particular some of the key trends we have already seen are: possible significant M&A transactions, a proposed leveraged buy out with private equity, increasing speculation on a number of 'potential' private equity candidates, increasing volatility in commodity prices, strong investor preference for fully franked dividends and the risk of increasing interest rates.
We believe the market in 2007 will continue to be liquidity driven: significant inflows into superannuation funds are expected heading into 30 June (one-off opportunity to invest up to $1m), the Future Fund (currently with an estimated $40 billion in cash), combined with ongoing M&A activity and strong corporate profitability. Another key issue facing investors will be increasing volatility, particularly in commodity prices. This reflects changing expectations on global growth and interest rate assumptions - US and China will remain the keys - combined with increasing speculative activity in these markets.
While the liquidity outlook and corporate activity suggest another bumper year for our equity markets, valuation risks are increasing. In particular, the ratio of the bond yield to equity earnings yield reverting back to long term averages is reducing the clear incentive of equities over bonds. Real interest rates are at the highest level in six years, the period of 'free money' appears to be over, and valuations are reaching historically high levels on a PE ratio basis (see chart below).
Following the strong pull back in commodity prices since mid-2006 the major resource stocks have underperformed the market significantly. Sentiment towards the sector, particularly to stocks exposed to copper and ...
