January 28, 2006Opportunities abound amid market volatility,...

January 28, 2006

Opportunities abound amid market volatility, writes Peter Weekes.

Investors should steel themselves for a volatile year ahead. Experts predict the sharemarket will outperform other asset classes and return up to 12 per cent, but economists and analysts warn that last October's heart-thumping market correction may be just a taste of what's to come.

"In short, 2006 is likely to be a more volatile and constrained year for investment returns," said Shane Oliver, AMP Capital Investors' head of investment strategy. This isn't a bad thing, he says, but it does mean investors need to pay more attention to their portfolios than last year, when the S&P/ASX 200 returned 22.8 per cent.

"Timing will probably be more important this year," Oliver said. "In the last few years an investor could have bought shares at the beginning of the year and would have made money just by hanging on. This year investors need to pay more attention to market timing and use any corrections or volatility in the market to facilitate (outperformance)."

Much of the reason for last year's stellar returns was the booming resource sector, with commodity prices rising by nearly 30 per cent. Even so, there is a consensus that earnings growth by Australian companies will ease this year, largely due to a slowing economy. The United Nations' World Economic Situation and Prospects 2006 report this week tipped that growth could slow to 2.9 per cent, lagging the rest of the world. Challenger Financial Services predicts this, along with rising input costs, will crimp earnings growth.

"We expect the EPS growth will be less synchronised across sectors," it says, meaning that picking the right stock in the right sector at the right time will be crucial to boosting returns.

Fortunately for investors, any significant downside will be protected by a high dividend yield and strong cash flows. Still, it says investors should buy companies with earnings certainty, low debt levels, and pricing power. For high conviction investors, it recommends Rio Tinto and Alumina; for others it picks ABC Learning Centres, Brambles and Transurban. Challenger and Oliver say lower economic growth will also further reduce consumer spending, so investors should stay clear of discretionary consumer stocks, such as Harvey Norman.

CommSec senior economist Craig James says that while the Australian economy may slow, Europe and the United States should pick up pace this year — adding that the Federal Reserve is set to take its foot off the monetary pedal. "Once interest rates are on hold, investors will be more confident about going into the sharemarket," he said. "We are looking for solid returns from both US and European equity markets."

Oliver is not convinced about US stocks, but predicts Asian equities will return about 15 per cent, as does Goldman Sachs, which has put a range of 12-17 per cent on the region.

Oliver also likes the outlook of non-residential listed property trusts. He says with yields of about 7 per cent, all investors need is a bit of capital growth to provide a decent return.

One thing that all agree on is that bonds will underperform. They say five-year bonds are now yielding a lacklustre 5.2 per cent and unlikely to give any capital gain as local interest rates are tipped to stay on hold.