Global outlook

• As we head into 2011 Australian investors continue to be influenced by global themes which affect both domestic sentiment and domestic fundamentals. The Sovereign debt concerns that continue to play out in Europe continue to cast a shadow over the Eurozone and have sharpened the focus on the effectiveness of the single currency model. It is clear from recent deliberations in that region that there is no silver bullet to the issue and the process of paying back debt in peripheral Europe will be a slow and hard one. While Australian businesses are less exposed to Europe than Asia, these issues will continue to affect global market sentiment.
• We are more encouraged by developments in the US where the recovery continues to gather momentum. The strength and sustainability of this recovery will be a key theme that investors will focus on 2011. While the short term indicators continue to encourage, there are still significant headwinds in the economy. In particular, unemployment remains at around 10% and the housing sector remains in the doldrums.
• We remain focused on the ramifications of the domestic ‘two speed economy’. Pressures on the Chinese to tighten monetary policy to curb inflation may dampen the more cyclical parts of the Australian economy that are exposed to this region. Meanwhile the threat of higher interest rates at home may curb the already quite lacklustre performance of the domestic based economy.

Australian equities

• Many Australian companies continue to benefit from the structural growth in China which should benefit mining, engineering and service companies as well as some infrastructure companies.
• Conversely, the domestic-based economy is grappling with softer conditions, with retailers in particular facing headwinds in this tightening monetary environment. Outlook comments have been quite cautious and earnings expectations tempered in this sector.
• We continue to seek companies that generate strong levels of cash-flow and earnings and have clearly identifiable advantages with regard to their market position and pricing power. While the type of company that we like to invest in does not change, the environment in which these companies operate is shifting constantly, as is the price that you pay for them.

Cash and credit

• Australia has benefitted from the strong growth in South East Asian economies and the elevated terms of trade. This growth has led to an increase in planned investment in the mining sector and also a significant pipeline for other infrastructure investment. The Reserve Bank will be monitoring closely whether these investment intentions materialise as they will exert upward inflationary pressure should they occur, and likely result in the RBA tightening monetary policy. This is currently a medium term issue however and we view the Reserve Bank as unlikely to tighten monetary policy in the nearer term given the more nervous state of financial markets currently.
• On a broader fundamental view, we are positive on credit on a medium to long term view. Leading indicators are looking more positive, balance sheets are strong, earnings have improved, equity volatility is low, defaults are falling and valuations are appealing on a historical basis.

Fund Manager Commentary