You can read the full version of the February fund manager's commentary on www.btim.com.au/Fund Commentaries

Australian Shares

• The rally in equity markets off their recent lows has reinforced our view that we remain in a consolidation phase. In Australia, we are currently transitioning from stimulus-driven consumer growth towards more investment and corporate spend growth.
• The market has re-rated back to its long-term valuation, contingent on a recovery in earnings of 20% in the 2011 financial year. It is the confidence in this earnings recovery which will drive the markets from here.
• The threat to the downside comes from the world economy and specifically the US, where the recovery has lost some of its momentum.
• The upside opportunity is born from the lagged effects of the substantial policy stimulus kicking in and triggering an improvement in business confidence driving a recovery.
• In addition we believe the Chinese economy will remain strong, with recent policy actions more focussed on controlling growth rather than slowing it markedly.
• The economy is leveraged to the Asian growth story. We are now beginning to see the next wave of positive effects of China’s recovery through the annual reset of bulk commodity prices, the increasing investment spend on mining and energy projects and the related infrastructure investment which will pick up to facilitate the movement of these materials.
• We are likely to see a growth pause for a few months as the consumer eases off, while the investment spend is still ramping up. However, strong growth should resume later in the year so long as the US does not deteriorate.
• This development in the domestic economy also shapes the positioning of the portfolio with our favoured positions being in stocks benefiting from this shift in growth, notably engineering stocks such as UGL and Worley.
• The February reporting season provided a direct insight into corporate performance. The sharp reactions to announcements, in both directions, highlight that at the current time the market is close to fair value and relying on a strong earnings recovery.
• Reporting season confirmed that the recovery in the domestic economy is flowing through, with the banks in particular benefiting from a drop off in loan losses. Overall the continued improvement in balance sheets helps to reduce the risks from any future economic shocks and would suggest that M&A will become a bigger theme in months to come.
• The portfolio is positioned to benefit from the continued growth in China via the large bulk commodity stocks as well as through engineering companies. It is also exposed to an improvement in the back end of the economy, which has lagged up to now as corporates were tight on costs and cut inventories.
• Finally, we are cautious for the near term on consumer-sensitive stocks as we see the effects of rising interest rates kick in.

Fixed Income & Cash

• The RBA surprised the market in February by deciding not to raise the base rate. However at the time of writing the Reserve Bank increased the cash rate by 25 basis points to 4% at its March meeting.
• The pace of further tightening will remain the focus of the market, dictated by Australian economic growth, growth in Australia’s export trading partners and in particular China, where recent policy measures have aimed at controlling domestic growth .
• The Reserve Bank will also review sovereign risk in Europe. If this risk continues to rise and starts to affect the outlook for global growth, it is likely that the Reserve Bank will slow the pace of further monetary policy tightening.
• The fixed income portfolio remains defensively positioned as we believe bond yields do not offer good value relative to cash rates.
• We are aggressively overweight bonds with an explicit Government guarantee and we expect this sector to continue performing well as the Government has withdrawn its guarantee to the banks and states. The lack of supply should cause spreads to continue to narrow relative to Commonwealth Government bonds.

Listed Property

• At current prices, the sector is delivering a 6.2% distribution yield and 0 to 2% p.a. medium-term growth. Although earnings and balance sheets are stable, there appears limited catalyst near term for further upside price performance.