SSgA Australian Equity Market Outlook

By Olivia Engel, Head of Australian Active Equities

MARCH 2012

SSgA Australian Equity Market Outlook

Executive Summary
The time is right for institutional investors to consider adding more risk to their portfolios. Market conditions look set to reward investment in attractively valued companies with higher risk characteristics. Todays prices are some of the cheapest we have seen since the early 1990s and volatility has now fallen, after spiking in Q3 2011. SSgAs dynamic equity model favors retaining exposure to cheap stocks with attractive fundamentals (such as steel and iron ore, some consumer discretionary and media companies) while increasing exposure to higher risk stocks, such as those with high volatility, high beta, smaller capitalisation and higher leverage.

Reviewing Q4 2011
At the beginning Q4 2011, our research showed aggregate market valuations in the Asia Pacific region were lower than they had been in 90 per cent of periods since the early nineties. At the same time market volatility was elevated, driven by events surrounding the European debt crisis and uncertainty about global growth. In addition, commodity prices had seen a substantial drop. The Australian equity market had seen a fall of around 20 per cent in just six months. At that time, our research indicated the market would reward companies exhibiting good value, and companies with higher risk. The previous themes that had performed well during much of 2011 such as high quality would no longer be rewarded. With market volatility so high at that time, we preferred positioning away from recent trends. In fact, our models suggested we position into companies that had experienced recent poor performance (forecasting reversal). Q4 did indeed provide a recovery environment where the market rose around 2 per cent.

Looking ahead
Now, market volatility has fallen as the equity market has recovered. Despite this, the aggregate market remains cheap, and commodity prices are still weak. Foreign investment funds flow into Asia is currently very high relative to history. In this environment, we dont expect price reversal to be such a strong influence as it was last quarter, but we do still believe that cheap stocks will be rewarded those appearing attractive on fundamentals such as dividend yield, forward earnings yield and price-to-book. In addition to this our research suggests the time is right to increase exposure to equities with higher risk characteristics, such as highly volatile stocks and those with high beta, smaller capitalisation, and higher leverage. SSgAs Australian Dynamic Equity portfolio has been positioned since the beginning of 2012 for a rebound in attractively valued companies with higher levels of risk. This theme has played out so far. We have witnessed strong returns this year in high beta companies, small caps, higher volatility and undervalued companies. There has also been a great deal of dispersion in the stock returns, exacerbated by high levels of surprise around company reporting season. The Australian equity market has now seen a recovery since the market low at the start of Q4 2011 of around 10 per cent. The sectors that are most attractive on our preferred fundamental characteristics are, for example, steel and iron ore, industrial cyclicals, and some consumer discretionary stocks, and our portfolio has greater exposure to these sectors.

SSGA AUSTRALIAN EQUITY MARKET OUTLOOK

Disclaimer State Street Global Advisors, Australia, Limited (ABN 42 003 914 225) (SSgA Australia) is the holder of an Australian Financial Services Licence (AFSL Number 238276). Registered office: Level 17, 420 George Street, Sydney, NSW 2000, Australia Telephone: +612 9240-7600 Facsimile: +612 9240-7611 Web: www.ssga.com. Investing involves risk including the risk of loss of principal. Risks associated with equity investing include stock values which may fluctuate in response to the activities of individual companies and general market and economic conditions. Investments in small-sized companies may involve greater risks than in those of larger, better known companies. The views expressed in this material are the views of the SSgA Active Australian Equity Team through the period ended 15 March 2012 and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected Past performance is not a guarantee of future results. This material is for your private information. The information we provide does not constitute investment advice and it should not be relied on as such It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. We encourage you to consult your tax or financial advisor. There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information. Past performance is not a reliable guide of future results. This communication is directed at professional clients who are deemed both knowledgeable and experienced in matters relating to investments. The products and services to which this communication relates are only available to such persons and persons of any other description (including retail clients) should not rely on this communication. The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSgA Australias express written consent. 2012 State Street Corporation - All Rights Reserved prohibited.

AUSMKT-0221