Four dynamics that could shape returns from Australian equities through 2021 - Hello Wealth

Four dynamics that could shape returns from Australian equities through 2021

Four dynamics that could shape returns from Australian equities through 2021

February’s reporting season set a strong benchmark for Australian equities for the rest of 2021, with conditions arguably more conducive to earnings growth now than they have been for many years. We think those gains will fall unevenly, however, and there are a number of unfolding dynamics that will shape the destiny of small-cap stocks in particular. Considered, active portfolio management will be key to extracting the maximum value from positive market conditions through 2021 – here are four factors which we believe will need to be taken into account:

1. An uptick in mergers and acquisitions

Extensive capital raising has left many companies with strong balance sheets heading into 2021, and in combination with ultra-low corporate borrowing rates has created optimal conditions for a surge in mergers and acquisitions over the year ahead.

To this point, M&A activity has been confined to the value end of the market, notably in relation to consolidation of Australian entities by overseas related parties with access to very cheap debt. But as the economy effectively returns to steady state conditions, cashed-up corporates will look for the next set of growth opportunities and buying growth is an easy way to achieve that.

Besides capital raising, 2020 was also a busy year for IPOs, with 54 in the December quarter alone, and there is a large pipeline of companies looking to list in 2021 if market conditions remain conducive.1 While quality has been mixed, there are good deals out there and the door is open for active managers who can secure preferential access and discounts to add value through this period.

2. A rebalancing of the value vs growth equation

Growth stocks have generally outperformed value stocks for a number of years, but value has come back to the fore in recent times. Many growth companies are starting to underperform on earnings delivery, and are struggling to justify high valuations. As a result, we’ve seen a number of quite aggressive sell-offs over the past few months.

On the other hand, earnings for a number of value stocks are bottoming out and even looking up for the first time in some years. A good example can be found in certain legacy media stocks, where booming retail ad spends are flowing through at a time where cost-cutting and asset sales are eliminating debt and sending equity value through the roof.

There are still good structural growth stories that will continue to climb despite the increasing effects of gravity on their peers. In our view, investors should be happy to hold high-value growth stocks as long as these companies continue to deliver on earnings expectations but should be prepared to exit as soon as earnings look like missing lofty estimates.

3. A supportive macro environment

On the macroeconomic front, we can in all likelihood expect a year of extremely positive data. The continued rollout of vaccines will increasingly provide insurance against the possibility of renewed lockdowns, and we’ve seen the value of having people out and about – and spending on services in particular – both in our own experience and in other countries ahead of the curve, such as New Zealand. As a result, the overall economic environment should be very supportive of earnings and consequently of equity markets.

One area of concern is rising bond yields. Markets are a little jittery around inflation, the amount of liquidity being pumped into markets and the potential for overstimulus. To this point those nerves have predominantly been confined to bond markets, but if yields keep running up equity markets will come under pressure as well.

4. Evolving business conditions

The February reporting season has defined the trend for 2021, and we’re likely in for a strong period of earnings. There will be exceptions, however, and some stocks that performed well last year, such as online retailers, are going to have trouble keeping pace with previous earnings growth.

Costs will also become more of an issue over the course of the year, as businesses ramp up their activity again and spare capacity begins to be taken up in the economy. Cash flows may also come under pressure if there is a general reinvestment of working capital back into businesses towards the end of the year.

1Source: ASX

 

Author: Matt Griffin, Co-portfolio Manager, Small Caps Sydney, Australia  

Source: AMP Capital 16 March 2021

Reproduced with the permission of the AMP Capital. This article was originally published at AMP Capital

Important notes: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

 

This article is not intended for distribution or use in any jurisdiction where it would be contrary to applicable laws, regulations or directives and does not constitute a recommendation, offer, solicitation or invitation to invest.

 

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