The recent strong reporting season is expected to further shift investors to allocate away from bonds into equities, according to independent Australian investment management firm Dalton Nicol Reid.
The company has also emphasised the strong link between a quality equities portfolio and good returns.
Jamie Nicol, Dalton Nicol Reid chief investment officer, says equities look more attractive than bonds when compared with the price-to-earnings ratio (PE) of the market or dividend yields.
“The market is trading at 13.8 times PE, which looks about average and not particularly cheap on an absolute basis. However, once we compare the market to low interest rates, which look like they are here to stay, the story is very different,” he says.
Since the global financial crisis, investors have valued the security of bonds regardless of the fact that fixed income is expensive, relative to historical valuations. Nicol points out investors need to be prepared for the potential of another bond crisis if inflation spikes in the US.
“Given risks now seem to be easing and interest rates are low, we expect flows to be supportive of equities. Additionally, any pullback in the market is likely to be well supported by the amount of money sitting on the sidelines,” he says.
Research from Dalton Nicol Reid, which uses a five-point quality matrix to identify relative quality of listed companies, has shown a strong linkage between the quality of equities portfolios and performance over the medium and long term.
To achieve investment success, Nicol says it is crucial for investors to distinguish between equities that have genuine operating upside as the cycle turns, as opposed to a simple short covering rally.
Growth companies, which have enjoyed a strong run, are starting to be sold off where the results did not meet expectations.
In the meantime, there are signs of a pickup in housing – and to a lesser extent, media and retail – with leading companies reporting lifted earnings providing a further boost. Good results from some local banks also highlight easing funding conditions, driving stronger profits and market confidence.
“Expected profit growth for the major banks has been lifted a couple of per cent. Strong capital position increases the likelihood of future buy-backs and bad loans are easing as interest rates decline. This increases market confidence regarding FY14. The trends are particularly favourable for the domestic retail banks,” Nicol adds.
