Although it seems there is currently quite a pessimistic mood in the market, investors should see excellent returns this financial year as changing conditions give companies a better opportunity to increase their earnings.
The confidence in the market has fallen significantly since May, with tightening liquidity in China and signs that the US Federal Reserve may begin to taper off its bond buying program. These circumstances have seen the S&P/ASX 200 (^AXJO) (XJO.AX) fall significantly, after having soared for the 12 months beforehand.
After being driven by high-yielding defensive stocks such as the banks – particularly Westpac (WBC.AX) and Commonwealth Bank (CBA.AX) – and Telstra (TLS.AX), it seems as though the market will soon be driven by earnings and growth by companies again. Lower interest rates and a lower Australian dollar, as well as an almost certain change in government later in the year, should help companies to increase their earnings.
Meanwhile, the banks could also increase their earnings and fully franked dividends by up to 5% this financial year, according to The Australian Financial Review, as a lower dollar would decrease funding costs. Currently, the interest rates handed down by the banks are still significantly higher than the official 2.75% cash rate, as funding costs remain quite high for the corporations. Should the banks lower their interest rates as their costs decrease, we could see an increase in loans taken out which would also drive their earnings.
Whilst the banks and mining heavyweights BHP Billiton (BHP.AX) and Rio Tinto (RIO.AX) make up an enormous portion of the index, the confidence in the market relies heavily upon their profitability and growth. A lower Australian dollar would likely benefit both sectors, which would give the market a strong core on which to build earnings growth.
Companies that could be enormous beneficiaries of this are gaming machines manufacturers Aristocrat Leisure (ALL.AX) and Jumbo Interactive (JIN.AX), as well as medical group ResMed (RMD.AX). With a falling Aussie dollar, international demand would likely pick up which would increase profitability for each of these companies.
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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned in this article.