“A fully-valued market and uncertain macroeconomic environment means that individual stock performances are likely to be more volatile, and returns less closely correlated, than they were in the past year,” said Morningstar Australasia's head of equities, Andrew Doherty. “This means that stock selection is more important than ever.”
Morningstar believes this volatility is being fed into the market due to uncertainty around the timing and impact of stimulus tapering in the United States, more modest growth in China and the continuing danger surrounding the European sovereign debt crisis.
The research firm advocates strategies that focus on stock selection to find value, finding companies that have a competitive advantage, durable earnings streams and above-average yields.
“Investors therefore need to adopt three key strategies: First, look for companies with economic moats able to withstand competition and earn excess returns for many years, as these stocks offer the best promise of healthy and reliable long-term returns. Second, invest in businesses with low correlations to the rest of the market. And third, consider lower-return options that protect on the downside,” Mr Doherty said.
Morningstar sees most value in the resources sector, but cautions investors against dipping their toes in this sector, encouraging them to instead pick more “globally diversified, cost advantaged firms” as “conditions could easily worsen”.
Outside equities, Morningstar sees opportunities in fixed income assets, particularly with the recent introduction of more investment options through exchange traded Australian government bonds.
However, the company warns investors to “beware of the impact of global quantitative easing” and to educate themselves “on interest rate risks”. For this reason, analysts believe investors should have access to a short-term exit strategy if needed.
“The market continues to price in a best case scenario for the majority of securities....[the] market does not differentiate particularly well across bank tier-1 securities, hence we currently prefer the securities with a shorter term to maturity,” Morningstar credit analyst Nicholas Yaxley stated.
