Despite the possibility for a rougher-than-expected US economic recovery and trouble in emerging markets, the 2014 outlook for Australian equities is good.
We can expect low interest rates, a lower dollar, continued revival of the housing and construction sectors and increasing confidence. However, a poor start to 2014 has some investors spooked and money has been quickly transferring out of the local economy.
So is the local market set for a bearish run in 2014, or can we expect a strong rally before the end of the year?
According to Charlie Green – founder and director of institutional broker Hunter Green – company "valuations, overall, have become stretched." He believes: "It's highly unlikely that we'll have another year of mid-teen returns. It will be the year for the pause that refreshes as company earnings grow into expanded multiples."
The current economic environment, which includes nervous investors and high earnings multiples in the share market, prompted the broker to change its portfolio of holdings towards "higher quality" companies rather than growth stories.
The broker's analysis resulted in 10 high-quality companies for 2014. They valued them on consistency of earnings, financial strength, management and a host of other metrics.
In the top five were two banks, Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd. (ASX: NAB), Telstra Corporation Ltd (ASX: TLS), BHP Billiton Limited (ASX: BHP) and biotech stock ResMed Inc (ASX: RMD).
Despite the high earnings multiples of a number of the companies on the broker's list, Hunter Green's model portfolio has risen 50% over the past two years. According to The Australian Financial Review, they sell nearly half of their holdings each year.
Foolish Takeaway
So what can we expect from the S&P/ASX 200 Index (ASX: XJO) (^AXJO) in the next 12 months?
Some fund managers and brokers are restricted to investing in blue-chip companies which have a larger market capitalisation. Unfortunately for new buyers, they had a great run in 2013 thus rendering many of them fully valued.
In my opinion, investors should look past the recent setback in share prices and focus on picking up stocks leveraged to an improving Australian economy over the long term. Investors shouldn't give up on finding rock solid growth stories in 2014, but perhaps look further down the market capitalisation ladder to find new ideas.
