Quality Growth Investments Still Safe

Written By Russell Tym, Authorised Representative of MoneyLink Financial Planning, AFSL No 247360

After canvassing several areas not to invest last week we can look at some of the more attractive options in the current markets this week. The Reserve Bank raised interest rates recently saying the move was needed to dampen inflation and slow the economy.

It isn’t just a problem created by expensive petrol and bananas. The RBA also believes economic growth will accelerate to 3.5 per cent this financial year, and would increase further without the rate rise to keep it to a sustainable level.

The mining sector is certainly booming but many general businesses would report only moderate progress. Some manufacturers, wholesalers, retailers and primary producers would say times are quite tough.

The RBA does have to watch the forward indicators carefully and be proactive as the effects of interest rate changes take six to nine months to become evident.

Record low interest rates here and in the US have boosted economic growth in previous years. Now rates are retarding the economies rather than stimulating them. It is also clear rates may be raised further if higher inflation and strong growth persist.

The recent setback in global share markets occurred because investors realised the new US Federal Reserve Chairman is serious about raising rates more than previously expected.

US inflation is above the 1 to 2 per cent target range, though it has been boosted by housing costs which are starting to moderate.

Investors have been wary of US assets recently. The US dollar has slumped against most currencies, US bonds have been less popular and US shares, while performing positively, haven’t done as well as others. Many major US companies look cheap at present.

The possibility of further rate rises means it is a good time to be prudent, ‘to take some risk off the table’ in market jargon.

Mineral commodity markets are very strong assisted by high demand and hedge fund speculation. They should remain healthy, but most stocks are fully priced, especially small mining companies which speculators have bid up.

Small company shares in general have performed well and are expensive relative to profits in many cases. Emerging market shares have also risen strongly fuelled by ‘hot money’ seeking quick returns. These areas are best avoided.

Perpetual Funds Management’s Chief Economist spoke about markets last week. They believe the best indicator of future inflation is the US ten-year bond yield. The current rate of 4.95 per cent indicates investors do not expect inflation to continue to be a problem.

A rise to 5.25 per cent would not be a concern, and an increase to 5.5 per cent would be tolerable. However if long bond rates exceed 5.5 per cent institutional investors believe serious inflation problems lie ahead and small investors should move to defensive areas.

Perpetual expects global economic growth will moderate due to the higher interest rates but that inflation won’t be an ongoing problem. Therefore interest rates are unlikely to rise much further.

So it is still safe to choose growth oriented assets, but a more cautious selection is best. Markets will be choppy in the near term with worries about the Middle East conflicts, inflation and oil prices.

Perpetual says investors should cut back on commodities, energy stocks, emerging markets and small company shares. It recommends overexposure to major Australian company shares, commercial property and large companies overseas. It also recommends some interest bearing assets.

Perpetual says major US stocks were trading at 22 times annual profits in 2001 but due to profit increases are now at only 12 times profits. Overseas stocks Perpetual like include Johnson & Johnson, Nestle, Union Bank of Switzerland, BNP Paribas, Exxon Mobil and Canon.

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