Two big takeouts for investors from 2016

ST Wong, 12 Dec 2016

Another eventful year ends, and the Australian equities market is still growing. But there have been some big challenges in 2016, and some issues still playing out. For investors, there are two big take outs to consider:

1. Macro fears can be destructive

2016 is a reminder that macro forecasts are often an investor’s worst best friend, given the Brexit victory and Trump presidency came as a surprise. The problem is, focussing too much on macro forecasts has the potential to cost investors valuable returns by frightening them into inactivity.

The macro environment has been hard to call this year, which means becoming too attached to a forecast is potentially dangerous. On issues like Brexit you may have had more luck flipping a coin to predict the result.

Yet a proliferation of media and social media has made macro forecasting more prominent. Naturally, investors are often interested in macro outlooks, but there is potential to scare investors off.

For example, if investors had listened to the forecasts and over-allocated to cash during the last five years they would be poorer today. Fear and greed are widely accepted as two of the most destructive investment emotions. Fear is destructive because it causes investors to retreat from markets when they should be participating.

We saw much fear generated around Brexit and Trump, but the market is yet to justify that fear.

Despite all the doom and gloom and mixed messages on the market, the Australian market is still growing. For the first time in a long while we have three pillars of the market, industrials, banks and resources, expected to grow simultaneously.

Rather than be rattled by the endless macro forecasts, investors should focus on what they can control. We still have a macro view, but it is flexible and doesn’t govern everything that we do. The most important things as investors is to analyse opportunities on their own merits from a bottom up perspective.

For example, is this company well-run? Does it have good cash flows? This is far more useful to investors than worrying about distant macro events.

Of course, one should always invest with an eye on capital protection for when things do go south, but few macro forecasts will ever accurately predict a downturn.

2. Quality can be sold down, but bounces back eventually

Investors could be forgiven for wondering why so many quality stocks on the ASX have been sold down during late 2016. Many quality small and mid-cap stocks have under-performed since September as large investors have rotated out from quality smaller stocks to increase resources exposure.

Defensive growth, high PE stocks and yield plays have all been sold-off.

But depending on your time horizon some good opportunities are emerging among these stocks. For example, we are seeing some good potential in sold-off sectors like tourism and aged care.

Times like these can test investors, who may need to be patient. But quality tends to bounce back eventually. The important thing is understanding your investment time horizon.

Quality remains a key mantra for mid to long-term investors. Valuations will vary but experience shows that quality companies come out on top in the end.

The first thing we ask with any potential investment, is: what is the potential of this company? A strong balance sheet is a starting point. From there, the quality of the people is important.

We also consider the quality of the assets, and management’s ability to drive those assets over time. Generally, valuations are becoming more attractive, with good buying opportunities going into 2017.