Friday, 07 November 2014 09:59

Nouriel Roubini on India, China, Japan and Europe

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Nouriel Roubini - famous for anticipating the GFC - talks here with Bloomberg TV about his views on India, China, Japan and Europe.

 

He is bearish on Chinese growth over the next few years.  This is likely to have major ramifications for China's major trading partners, which includes Australia, Canada and Brazil.

 

 Nouriel Roubini, the Chairman of Roubini Economics predicts India will fly whilst China hits a “bumpy” landing. Commenting on the state of the world economy Roubini says some countries like India are going to do better, while others “are going to have fragilities” like Japan, China and the Eurozone. “So I think you have to look at the world and see where things are going right, and where they are not. The next decade will be the first time in 30 years that India’s growing faster than China. Growth in China could go towards 5% in the next few years. While in India with the right reform it could go toward 7%. So for the first time ever the tortoise becomes the hare and the hare becomes the tortoise.” Roubini says his view is non-consensus and there’s no way commodities prices and equities are “pricing-in growth in China of 5.5% in the next two years.”

 

 

Thursday, 06 November 2014 19:35

Investing in the "Asian Century"

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This century has been labelled as the "Asian Century", as the Chinese economy seeks to become the largest in the world and other Asian economies continue to grow at a rapid clip.

 

We talk with Jacob Mitchell (Deputy Chief Investment Officer - Platinum Asset Management) about some of the structural changes taking place in many Asian economies that investors should be thinking about.

 

We have provided a transcript of the video below for ease of reference.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

This information is of a general nature only and neither represents nor is intended to be personal advice on any particular matter. We strongly suggest that no person should act specifically on the basis of the information contained herein, but should obtain appropriate professional advice based upon their own personal circumstances including personal financial advice from a licensed financial adviser and legal advice. Fortnum Private Wealth Pty Ltd ABN 54 139 889 535 AFSL 357306

Sunday, 26 October 2014 18:27

Medibank Private - please consider

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medibank-logo-headerSummary of the Medibank Offer

 

The privatisation of Medibank Private Limited (ASX: MPL), or Medibank, provides an opportunity to invest in Australia's largest private health insurer at a fair price or better, depending on the price set in the institutional bookbuild.

 

All considered, we recommend investors consider applying for shares in the initial public offer, or IPO, though it is not as attractively priced as we hoped. We are disappointed retail investors are only given a broad indicative pricing range before they are required to apply (which has been a feature of private-equity-sponsored issues), rather than a fixed price.

 

Operating in a heavily regulated industry, Australian health insurers typically produce defensive earnings. In our opinion, Medibank is well placed to produce solid long-term earnings growth from productivity improvements and industry-wide growth.

 

Key Takeaways

 

  • ×  We recommend investors apply for stock through the IPO. Based on Medibank's proforma accounts, guidance, business assumptions and our earnings forecasts, our fair value estimate is AUD 2.10 per share with a medium fair value uncertainty rating.

  • ×  The indicative price range of the IPO of AUD $1.55 to AUD $2.00 per share represents a discount to Morningstar's $2.10 fair value estimate of between 26% and 5%. Lonsec have announced a valuation of $2.33 per share.  We consider Medibank attractively priced in the bottom half of the price range and roughly fairly valued at the top.

  • ×  Medibank looks attractive because of its strong competitive advantages, the heavily regulated industry and high entry barriers, leading to returns comfortably exceeding the firm's 10% cost of capital.

  • ×  Our positive view is underpinned by solid prospects for long-term earnings growth (averaging 10% per year during the next five years), low capital requirements, high returns on equity (growing to 24% by fiscal 2019), high dividend payouts (target range 70% to 80%) and relatively attractive fully franked dividends (4.3% yield for fiscal 2016 based on our valuation).

  • ×  Government initiatives designed to support private health insurance are the Medicare levy surcharge, the private health insurance rebate and the lifetime heath cover policy. Solid demand for private health insurance and population growth underpin our forecast 3% annual increase in policyholder numbers across the industry, with Medibank expected to lag the average for at least the medium term. 

 

Here are a handful of useful charts that outline the attractiveness of Medibank for long term investors.

 

 

 

 

 

Clients of GEM Capital will receive a complete copy of this research.  If you would like to receive a copy of the complete research paper please either ring (08) 8273 3222 or email This email address is being protected from spambots. You need JavaScript enabled to view it.This email address is being protected from spambots. You need JavaScript enabled to view it.">

 

You can also obtain a PDF of the prospectus by clicking the following link Download Medibank Prospectus PDF

 

 

 

This information is of a general nature only and neither represents nor is intended to be personal advice on any particular matter. We strongly suggest that no person should act specifically on the basis of the information contained herein, but should obtain appropriate professional advice based upon their own personal circumstances including personal financial advice from a licensed financial adviser and legal advice. Fortnum Private Wealth Pty Ltd ABN 54 139 889 535 AFSL 357306

Tuesday, 21 October 2014 19:23

Global Market Outlook - October 2014

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The US Federal Reserve continued to taper its bond purchases during the third quarter of 2014, amid greater-than-anticipated improvement in the US labour market (and despite lingering concerns over stagnant wage growth). Meanwhile, Eurozone inflation slowed further. In response, the ECB has recently announced its intent to increase the size of its balance sheet by around €800bn through two mechanisms. First, it will provide ultra-cheap funding to banks to then on-lend to the private sector and, second, it will purchase private sector securities. As the latter will be financed by money creation, it essentially amounts to small-scale Quantitative Easing.

There has been a massive compression in risk premia across multiple asset classes over the last 18 months. Within equity markets, one manifestation of this has been the underperformance of lower-volatility, high-quality stocks. We consider this a warning sign and believe there is an elevated probability of the risk compression unwinding over the next year or so, as investors focus on normalising US interest rates. As such, we continue to consider the unwinding of Quantitative Easing as the single most important factor that will impact markets and economies over the next few years.

Furthermore, it remains possible that China’s economy could experience a significant slowdown as a combined result of market forces and the government’s continuing efforts to address the structural oversupply inherent within its housing market. The rapid rate of credit expansion experienced by China in recent years, and its role in funding fixed asset investment and property developers, adds further risk to the situation. 

To listen in more detail from Magellan CEO, Hamish Douglas about his view of the world and how his fund is positioned, watch the video below.

 

This has been extracted from a recent publication from Magellan Financial Group.

 

This information is of a general nature only and neither represents nor is intended to be personal advice on any particular matter. We strongly suggest that no person should act specifically on the basis of the information contained herein, but should obtain appropriate professional advice based upon their own personal circumstances including personal financial advice from a licensed financial adviser and legal advice. Fortnum Private Wealth Pty Ltd ABN 54 139 889 535 AFSL 357306

 

IntroductionInvestment research globe

The impending end of the US Federal Reserve’s quantitative easing (QE) program and when it will start to raise interest rates are looming large for investors. Very easy global monetary conditions, led by the Fed, have been a constant for the last six years helping the global recovery since the GFC. But with the US economy on the mend the Fed is edging towards returning monetary policy to more “normal” conditions and this was evident in the Fed’s September meeting. After gradually tapering its QE program all year it’s on track to end next month and attention is now shifting to the first interest rate hike. What will this mean for the US and global economy and for investment markets? This note takes a Q&A approach to the main issues.

How did we get here?

It’s worth putting things in context and recalling how we got to this period of extraordinary easy monetary conditions. At its simplest it was just part of the cycle: growth weakened and so monetary conditions were eased. But the GFC related slump was deeper than normal leaving households and businesses far more cautious. So once interest rates hit zero and it was apparent the recovery was still sub-par, the focus shifted to measures to boost the supply of money. This became known as quantitative easing and involved the Fed printing money and using this to buy government bonds and mortgage backed debt. It helped growth by cutting borrowing costs, injecting cash into the economy, forcing investors to take on more risks, and to the extent it drives shares higher, it helped build wealth that helped spending.

Has ultra-easy US money worked?

The short answer is yes. A range of indicators suggest the US economy is now on a sounder footing: bank lending is strengthening; the housing construction recovery is continuing; consumer spending growth is reasonable; business investment looks stronger; business conditions indicators are strong; employment is back above its early 2008 high and unemployment has fallen to 6.1%. In particular, after a contraction in GDP in the March quarter, US growth bounced back strongly in the June quarter and solid growth looks to be continuing in the current quarter.

 

US payroll employment above 2008 high

Source: Bloomberg, AMP Capital

How will the Fed tighten?

Reflecting the success of extraordinary monetary easing its little wonder the Fed is edging towards starting to return monetary conditions to “normal”. In the past doing this was easy as the Fed would just start raising interest rates. Now it’s more complicated. The first step was the tapering of its QE program. QE3 started at $US85bn a month in bond purchases in 2012 and following the start of tapering in December last year has now been cut to $US15bn a month. It’s now on track to end at the Fed’s late October meeting.

The second will be to actually tighten. This will come in the form of raising interest rates and reversing its QE program (ie unwinding the bonds it holds). Raising interest rates is simple, but unwinding its bond holding is a bit more complicated. At this stage it looks like it will primarily aim to do this by not replacing bonds as they mature.

How long till the first hike & what's "normal"?

For some time the Fed has said that it expects a “considerable time” between the end of QE and the first rate hike. This has been taken to mean around six months or more and so if QE ends in October this means the first hike will occur around the June quarter next year. While the Fed is still retaining the “considerable time” language its clear from Fed Chair Yellen’s comments that the timing of the first rate hike is conditional on how the economy is performing. Our best guess though remains that the first hike will come in the June quarter. While the economy is on the mend, there remain several reasons why the Fed is not in a great hurry:

 

US labour market slack

Source: Bloomberg, AMP Capital

Reflecting this, the Fed can afford to take its time and when it does start to hike next year the process is likely to be gradual. In the past the “normal” or neutral level for the Fed Funds rate was thought to be around 4.5%, but Fed officials now put it at around 3.75% reflecting a more constrained growth environment due to more cautious attitudes towards debt and slowing labour force growth. So the Fed Funds rate may not rise that much above 3.75% in the upcoming tightening cycle, but it will take several years to get there.

What about the impact on the US economy?

Just remember that the Fed is only edging towards rate hikes because the US economy is stronger and so it can now start to be taken off life support. After the efforts of the last few years the last thing the Fed wants to do is to knock the economy back down again. Historically, it is only when interest rates rise above neutral and above the level of long term bond yields (which are now 2.6%) that the US economy starts to slow. At present we are still a long way from that.

What about the impact on the end of QE?

The more immediate issue is the end of QE next month. A concern for investors is that when QE1 ended in March 2010 and when QE2 ended in June 2011 they were associated with 15 to 20% share market falls. See the next chart.

 

Fed quantitative easing and US shares

Source: Bloomberg, AMP Capital

However, while the ending of QE3 may add to volatility it’s very different to the abrupt and arbitrary ending of QE1 and QE2. Back then the US economy was much weaker and global confidence was hit by the Eurozone crisis. Now the US economy is on a sounder footing.

What about the impact of rate hikes?

Shares – just as talk of tapering upset shares around the middle of last year (with a 5-10% correction), so too talk and then the initial reality of rising US interest rates could cause a similar upset. However, the historical experience tells us that the start of a monetary tightening cycle is not necessarily bad for shares. The next table shows US shares around past Fed tightening cycles. The initial reaction after three months is mixed with shares up half the time and down half the time. But after 12 and 24 months a positive response dominates. The reason is because in the early phases of a tightening cycle higher interest rates reflect better economic and profit growth. It’s only as rates rise to onerous levels to quell inflation that it becomes a problem. But that’s a fair way off.

 

US shares after first Fed monetary tightening moves

Source: Thomson Reuters, AMP Capital

It’s also worth noting that the rally in shares over the last five years is not just due to easy money. It has helped, but the rally has been underpinned by record profit levels in the US.

Bonds – the commencement of a monetary tightening cycle in the US is expected to put upwards pressure on US and hence global bond yields in response to uncertainty as to how high rates will ultimately go and as to how quickly the Fed will reduce its bond holdings. A 1994 style bond crash is a risk, but unlikely as the US/global economy is not as strong as back then. What’s more the monetary tightening will not be synchronised with Europe, Japan and China possibly easing further. As such the back up in bond yields is likely to be gradual and the broad environment will remain one of low interest rates and bond yields for some time yet.

US dollar – the combination of anticipated then actual tightening of US monetary policy at a time of easy/easing monetary policy in many other parts of the world will likely put further upwards pressure on the value of the US dollar.

Emerging market assets – tightening US monetary conditions could weigh on some emerging countries that are dependent on foreign capital inflows. It remains a time to be selective when investing in emerging market shares.

What about the impact on Australia?

The gradual move towards US monetary tightening has taken pressure off the $A allowing it to resume its downtrend which is likely to take it down to $US0.80 over the next year or two. This is necessary to deal with Australia’s high cost base and weakening export prices. While the Australian share market could underperform as the $A heads down as foreigners stay away, ultimately it will provide a huge boost as it helps trade exposed sectors become more competitive and boosts the value of foreign sourced earnings. Roughly speaking each 10% fall in the $A adds about 3% to earnings.

Concluding comments

With the US economy on a sounder footing, the Fed is getting closer to a tightening cycle. While this could contribute to short term share market volatility, the tightening is likely to be gradual given the constrained global economic recovery & we are a long way from tight monetary conditions that will seriously threaten the cyclical rally in shares.

 

Shane Oliver

AMP Chief Economist

 

This information is of a general nature only and neither represents nor is intended to be personal advice on any particular matter. We strongly suggest that no person should act specifically on the basis of the information contained herein, but should obtain appropriate professional advice based upon their own personal circumstances including personal financial advice from a licensed financial adviser and legal advice. Fortnum Private Wealth Pty Ltd ABN 54 139 889 535 AFSL 357306

 

Wednesday, 10 September 2014 08:18

QV Equities Update - Sept 2014 (podcast)

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Simon Conn (Portfolio Manager, Investors Mutual) talks with Mark Draper (Adviser, GEM Capital) about how the recently listed investment company QV Equities is currently invested.

 

They also talk about the investment strategy for the listed investment company and how they are dealing with a share market that is at a relatively high point at the moment.

 

Simon outlines the key criteria for stocks that make the grade to become an investment in QV Equities.

 

Click on the white arrow contained in the orange circle to play the podcast.

 

 

 

 

This information is of a general nature only and neither represents nor is intended to be personal advice on any particular matter. We strongly suggest that no person should act specifically on the basis of the information contained herein, but should obtain appropriate professional advice based upon their own personal circumstances including personal financial advice from a licensed financial adviser and legal advice. Fortnum Private Wealth Pty Ltd ABN 54 139 889 535 AFSL 357306

Wednesday, 27 August 2014 16:41

Global Economic Outlook - August 2014

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Key pointsInvestment research globe

  • The global economy is still on the mend, but it’s still a two steps forward, one step back affair. Of the major regions the US is doing the best, but Europe is lagging.
  • This means occasional bouts of uncertainty, but it’s not such a bad thing if it keeps central banks supportive.
  • The main implications are: we are still in the sweet spot of the global economic cycle, which is good for growth assets; the lack of global synchronisation means that fundamentals for individual regions, assets and stocks matter; constrained global growth will mean constrained returns; and the big event to watch for is when the Fed starts to hike rates – but it still looks a way off at present.

Introduction

We are having yet another year where investors started off optimistic about the global economic outlook with talk of synchronised growth only to find that the global growth story remains patchy. In fact, so much so that it’s possible to paint wildly different pictures as to the outlook – some are worried about growth and inflation taking off, whereas others warn of imminent collapse. The truth is likely to remain somewhere in between these extremes. But, in a way, this is not a bad thing as it keeps central banks supportive.
This note looks at the major regions in terms of growth, inflation and interest rates and what it means for investors.

The US – looking good but not booming
After a contraction in the March quarter driven by mostly temporary factors, the US economy rebounded in the June quarter and looks on track for growth of around 3% in the current quarter. The jobs market and business investment are improving and the shale oil boom is providing a long term boost both directly and indirectly via cheap electricity costs for business. However, while the US is looking a lot stronger it’s a long way from booming, let alone overheating, with growth seemingly stuck in a 2-3% range as the housing recovery and consumer spending have slowed a bit of late. 

 
Source: Bloomberg, AMP Capital

Which brings us to what the Federal Reserve will do. On the one hand US growth has improved enough to allow the Fed to continue “tapering” its quantitative easing program which means it’s on track to end probably in October. On the other hand it’s unclear that conditions are strong enough to warrant interest rate hikes just yet. This is something the Fed is grappling with, but the conclusion seems to be that - with inflation remaining low at just 1.5% on the Fed’s preferred measure, wages/labour cost growth stuck around 2% and broad measures of labour market slack (ie allowing for the unemployed, underemployed and discouraged workers) remaining high - its unlikely to rush into raising rates.

 
Source: Bloomberg, AMP Capital

Our assessment is that the Fed is gradually inching towards an interest rate hike, but it’s probably not going to occur until sometime in the June quarter next year.

The Eurozone – better but not great
The Eurozone returned to growth about a year ago but it is far from robust and stalled in the June quarter with weakness in Germany, Italy and France. Uncertainty regarding Russian sanctions and Ukraine are not helping. What’s more bank lending growth has remained negative and inflation has fallen to just 0.4% year on year. This has all led to concerns that Europe is sliding into Japanese style stagnation and that the ECB needs to do more. 

 
Source: Bloomberg, AMP Capital

Our assessment though is that Europe is gradually mending: growth has returned to Spain, Ireland, Portugal and Greece; these countries have all made significant structural reforms to their economies and France and Italy look to be gradually heading down that path; the troubled countries have all seen their bond yields collapse, eg Spain’s 10 year bond yield is now just 2.17%; the ECB announced further stimulus in June, but looks to be ready to launch into quantitative easing involving the purchase of private debt in the next few months; and bank lending should improve once the ECB’s bank stress tests are out of the way in a few months.

Japan – Abenomics on track
Japan’s growth was hit in the June quarter by the pull- forward effect of the April sales tax hike. However, a range of indicators suggest that despite the volatility the Japanese economy has weathered the sales tax hike well with ultra-easy monetary policy and economic reforms providing confidence growth will bounce back from the current quarter.

 
Source: Bloomberg, AMP Capital

However, given the uncertainty, the Bank of Japan will either have to maintain its very easy monetary conditions or possibly have to ease further.

China running hot and cold
For the last three years now Chinese economic data has been running hot and cold every six months leading to periodic worries about growth. Another slowdown in the Chinese property market is adding to these concerns. 

 
Source: Bloomberg, AMP Capital

With the Chinese Government repeatedly indicating that there is a floor to growth of around 7%, and supporting this by mini-stimulus measures as they have done this year, our assessment remains that the Chinese economy is on track for growth of around 7.5%. But don’t count on more.

Emerging world
The emerging world more generally is a lot messier than it used to be. Of the major’s, China and Mexico look ok and the election of reform oriented governments in India and Indonesia is positive, but Brazil looks to have lost the plot under the current Government, and Russia already weakened looks to have shot itself in the foot over Ukraine. A lack of structural reforms over the last decade has led to lower growth potential in the emerging world. That said it’s still on track for growth around 4.5% this year and next. 

Global growth – two steps forward, one back 
Bringing this together, global business conditions indicators are consistent with good but not booming growth.

 
Source: Bloomberg, AMP Capital 

Although global growth is likely to pick up, it's hard to describe global conditions as synchronised and the global economic expansion remains very much a process of two steps forward, one step back. This was clearly evident in the first half of the year with the US and Japan both having negative quarters, China slowing in the first quarter and Europe stalling in the June quarter. And of course geopolitical events continue to wax and wane and the threat from Ebola remains in the background – all of which impart a deflationary impact in terms of their dampening impact on confidence and spending. Against this backdrop it is hard to see the Fed wanting to rock the boat prematurely with talk of interest rate hikes, let alone actual hikes, and the ECB, Bank of Japan and People’s Bank of China are likely to maintain ultra-easy policy or ease further.

Investment implications
There are several implications for investors. First, gradually improving global growth, still benign inflation and easy monetary conditions tell us we are still in the sweet spot of the economic cycle which augurs well for growth assets.

Second, the desynchronised global economic and monetary cycles confirm that the “risk off, risk on” phenomenon of a few years ago where all growth assets move up and down together has faded. This should make it easier for fund managers and investors to benefit from opportunities in individual regions, assets or stocks. Eg we think there is currently good value in Chinese shares, European shares and commodities. The divergence in monetary cycles is also likely to mean upwards pressure on the $US but downwards pressure on the Yen and Euro.

Thirdly, the constrained global growth cycle provides a reminder not to expect double digit gains from growth assets year after year. It will still be a relatively constrained world in terms of sustainable returns. 

Finally, the big thing globally to keep an eye out for will be when the Fed will start to raise interest rates. This, or rather its anticipation, will likely cause a few bumps (just like last year's taper tantrum did), but it's still a fair way off and when it does come its unlikely to spell the end of the cyclical bull market in shares as it will be a long while before monetary conditions actually become tight. 

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital

 

Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

 

 

Key points

- The past financial year saw solid to strong returns from most asset classes drive good returns from balanced and growth oriented investment strategies, including from super funds. 

- Investors should expect returns to slow over the year ahead, but they are likely to remain solid as share valuations are still reasonable, the global economy continues to grow, the Australian growth outlook improves and monetary conditions remain easy.

Introduction

The past financial year saw another 12 months of strong returns. Returns of around 20% from shares, solid returns from property assets and good returns from bonds saw balanced growth superannuation funds return around 13% on average. This was the second year in a row of double digit gains. By contrast the return from cash was poor and average 12 month bank term deposits returned less than 4%.

Source: Thomson Reuters, AMP Capital

As always there has been plenty to fret about, including:

  • The mid 2013 "taper tantrum" in the US, with investors fearing the Fed's decision to start winding down its quantitative easing program would threaten the US economy and shares;
  • The US Government shutdown and debt default worries in October and the March quarter economic contraction;
  • The slow recovery and deflation worries in Europe;
  • Fears of a sales tax hike driven recession in Japan;
  • Another bout of hard landing worries regarding China centred on the property and shadow banking sectors;
  • Worries about the impact on emerging countries of Fed tapering;
  • Geopolitical worries regarding Syria, Ukraine and Iraq;
  • Ongoing worries as to how Australia will fare as the mining boom fades and whether the May Budget will worsen the economic outlook; and
  • The last six months has seen intensifying concerns that share markets are set for a fall.

But these concerns were offset by a range of factors:

  • A continuing improvement in the global economy;
  • The Fed's tapering has clearly been contingent on improving growth with a rate hike still a fair way off;
  • Further easing measures by the European Central Bank;
  • Little global economic damage from geopolitical risks;
  • Continuing record monetary stimulus in Japan;
  • A stabilisation in Chinese economic growth helped by various mini-stimulus measures;
  • No sign of capital flight from emerging countries and election optimism regarding India and Indonesia; and
  • Okay growth in Australia helped by low interest rates.

This has all seen growth assets boosted by a reasonable growth and profit outlook and bonds helped by continued easy monetary conditions. The latter has also seen an ongoing search for yield by investors. With shares no longer dirt cheap its likely returns will slow – indeed they have over the last six months. However, the cyclical bull market in shares likely has further to go. This along with reasonable returns from property assets should underpin further gains in diversified investment portfolios over the year ahead.

Equity valuations – ok

After strong gains through 2012 and 2013 shares are no longer dirt cheap. However, as can be seen in the next chart valuation measures (which are based on a range of measures including a comparison of the yield on shares with that on bonds) show shares are not expensive.

Source: Bloomberg, AMP Capital

Cyclical bull markets in shares invariably see three phases. First an unwinding of cheap valuations helped by low interest rates. The second is driven by stronger profits. And the third phase is a blow off as investor confidence becomes excessive pushing shares into expensive territory. Our assessment is that we are still in the second phase and as such the cyclical/profit backdrop remains critically important.

The economic cycle – slow improvement

We are still in the sweet spot of the global economic cycle. Growth is on the mend but only gradually such that spare capacity and excess savings remains immense so inflation remains tame, monetary conditions easy and bond yields low. In fact the March quarter growth soft patch seen in the US, Europe and China was more positive than negative because it wasn't threatening but further pushed out the timing of any monetary tightening. By region:

  • After a contraction in the March quarter driven by mostly temporary factors, the US economy is continuing to improve and looks on track for circa 3% growth. The jobs market and business investment are improving and shale oil boom is providing a long term boost both directly and indirectly via cheap electricity costs for business.
  • Growth has returned to Europe. Ireland and Portugal have emerged from their bailout programs and structural reform seems to be on track. But growth is far from robust, inflation too low and uncertainty around the banks is likely to linger till later this year after the completion of the ECB's bank asset quality review. All of which means continuing recovery but ongoing need for ECB support.
  • Japan appears to be weathering its sales tax hike well, with ultra easy money and economic reforms providing confidence growth will continue.
  • Chinese growth looks to be on track for around 7.5% helped by various mini-stimulus measures.
  • Emerging world growth generally isn't as strong as it used to be but it looks to be stabilising around 5%.

Reflecting this, the global manufacturing conditions PMI is at levels consistent with good, but not booming global growth.

Source: Bloomberg, AMP Capital

This suggests global growth is likely to pick up a notch which should underpin a modest improvement in profit growth.

In Australia, while the mining investment slowdown, the impact on confidence from the May Budget and the too high $A pose a short term threat, underlying growth is likely to have picked up to a 3% pace by year end and continue through next year helped by a housing construction boom, a Senate induced softening in some of the harsher aspects of the Budget and strength in resource export volumes.

Monetary conditions to remain easy

When the Fed will start to raise interest rates and reverse its QE program has been a constant source of speculation. While such speculation may intensify over the next six months – resulting in bouts of volatility for investment markets – global monetary conditions are set to remain easy:

  • The tightening US jobs market indicates the first rate hike in the US is coming on to the horizon. But continuing high levels of excess capacity indicate it may still be 9-12 months away and will be a gradual process when it starts. In other words it will take a long time before US monetary policy is tight – with above "normal" interest rates and short term rates being above long term rates.
  • The ECB has only just eased monetary policy and has signalled it stands ready to do more, including via a quantitative easing program, if deflation risks don't recede. Rate hikes are well over the horizon.
  • Unprecedented quantitative easing in Japan will continue until underlying inflation is firmly ensconced around 2% and there is still a way to go. Rate hikes are not in sight.
  • In Australia, the RBA is not expected to start raising rates till sometime next year. And as the Fed is likely to go first, the Australian dollar is likely to resume its downtrend.

While there will be a few bumps regarding the Fed (just like last year's taper tantrum) the monetary backdrop is set to remain supportive for investment markets.

Investor sentiment a long way from excessive

We remain a long way from the sort of investor exuberance seen at major share market tops. It seems everyone is talking about share market corrections and crashes and tail risk hedging seems all the rage. In the US the mountain of money built up in bond funds during the post GFC "irrational exuberance for safety" has yet to really reverse.

Source: ICI, AMP Capital

And in Australia, the amount of cash sitting in the superannuation system is still double average levels seen prior to the GFC and Australians continue to prefer bank deposits and paying down debt to shares and superannuation. There is still a lot of money that can come into equity markets as confidence improves.

Source: Westpac/Melb Institute, AMP Capital

Concluding comments

After a bout of relatively smooth sailing there will inevitably be a correction at some point. There are plenty of possible triggers: geopolitical risks, the risk of an inflation/Fed rate hike scare, deflation in Europe, the property slowdown in China and in Australia the transition to more broad based growth. However, while investment returns are likely to slow, still reasonable share valuations, gradually improving economic conditions, easy monetary conditions and a lack of excessive optimism suggest further decent investment returns ahead.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital

Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

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Wednesday, 16 July 2014 11:10

Rotation out of Term Deposits - still yet to occur

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Following the GFC - the value of term deposits held by Australian investors reached record highs as investors redeemed money from more volatile investments to move into safe havens.

Some commentators have suggested that the recent rise in the Australian share market is as a result of money being withdrawn from term deposit and invested into the share market.  We did not sense that this commentary was true - but can now confirm this with statistics.

Below is a graph showing the value of term deposits in Australia on the left hand graph.  It is clear that the record value of term deposits has stabilised, but not materially decreased over the past 12-18 months, despite low interest rates and good returns from share and property markets.

The graph on the right hand side shows whether term deposits are increasing or decreasing (increasing if above 0 and decreasing if line is below 0)

Further downward pressure on term deposit rates seems likely given the lower refinancing costs in International funding markets, which means banks are again able to fund their loan books at a lower cost through Wholesale funding, rather than relying on term deposits.  Now that Term Deposit rates generally have a "3" in front of them it will be interesting to see how investors react.  Anecdotally, we believe we are at the beginning now of investors starting to rotate out of term deposits to obtain a higher rate of return.

Term Deposits - June 2014 

 

 

 

Tuesday, 17 June 2014 09:07

China Growth Slowdown underway

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(an update from Sam Churchill - economist Magellan Financial Group)

 

Great Wall of ChinaChina’s extraordinary economic growth of recent decades has been driven by the mass mobilisation of rural labour, huge capital investment, low-cost manufacturing exports and the acquisition of foreign technology. However, in recent years, a number of imbalances have been developing that pose risks to the country’s stability. Since the GFC, China has experienced an unprecedented expansion of credit, from around 140% of GDP in 2008 to over 200% of GDP in 2014. Meanwhile, it has experienced a property construction boom that has shifted its housing market from structural undersupply to oversupply, with millions of properties now lying vacant.

Credit growth

The Chinese financial system comprises a traditional banking system of state-controlled banks and a shadow banking system made up of investors, borrowers and unregulated financial intermediaries. The traditional system is highly regulated and credit creation within it is tightly controlled by the government. However, rapid credit creation in the loosely-regulated shadow banking system is of particular concern. Shadow lending has grown to approximately 70% of GDP and now accounts for most of China’s new credit, which is expanding at a rate of around 15% of GDP per year.

Credit expansion has been concentrated in 3 main areas:

  1. Corporate borrowing makes up the majority of new credit creation, particularly by state-owned enterprises. China’s corporate sector is among the most heavily indebted in the world, with corporate credit having risen from around 90% of GDP in 2008 to around 125% of GDP in 2013.
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  2. Household borrowing remains low compared to other countries, but the pace of recent growth has been quite strong. Household debt, most of which is mortgage-related, has risen from around 11% of GDP in 2008 to around 20% in 2013. The ratio of household debt to disposable income has doubled between 2008 and 2013.
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  3. Provincial government borrowing makes up a large proportion of new government borrowing which has been undertaken to fund construction of infrastructure, property and local enterprises. Provincial government debt has risen from around 27% of GDP in 2010 to around 33% in 2013, according to a recent audit.

China’s shadow banking system is comprised of opaque financial instruments, such as trusts and Wealth Management Products (WMPs), sold as deposit-like products to investors hoping for higher rates of return than are available in a Chinese bank account. These products provide equity and debt capital to Chinese corporates, local government financing vehicles (LGFVs) or other financial instruments on unknown terms. Investors are generally unaware of the underlying exposures. Most WMPs have short-term maturities, which could lead to a systemic liquidity problem in the event of defaults and an investor run.

The extent of moral hazard in China’s financial system adds to such concerns, with many investors relying on an implicit guarantee from the central government in the event of counterparty default.

A recent run on a small rural Chinese bank demonstrates the vulnerability of the financial system to changing investor sentiment, as well as the likely response of the government. In this case the PBOC (People’s Bank of China) quickly came to the rescue to restore order to the local financial system.

Not all credit booms end in economic crisis. According to a 2012 IMF paper around 23% of credit booms are followed by a financial crisis and economic underperformance. China is no stranger to banking crises but these have been typically well managed. In the late 1990s, non-performing loans (NPLs) at Chinese financial institutions rose to well over 20% before government-backed Asset Management Companies took over the debt to recapitalise the banking system. Reported NPLs of Chinese banks are currently low, but are likely understated.

China’s domestic debt levels significantly exceed those of its emerging markets peers, but generally remain below the levels of advanced economies. However, the pace of recent credit growth is of greater concern as it may reflect the misallocation of capital towards unproductive investments, low credit standards, and generally unsustainable spending growth. A material portion of recent credit growth may be related to the rollover of existing debts rather than real economic activity.

Property market

Following the privatisation of the housing market in the late 1990s, China has rapidly become a nation of property owners, with approximately 80-90% of households owning at least one property. At the same time property development has become a major industry. In 2007, the country was constructing around 1.5 billion square metres of gross residential floor space per year (or 15 million housing units) to support urbanisation, replace demolished old housing stock and to meet the upgrading and investment needs of Chinese households. During the GFC property market restrictions were loosened considerably, driving up prices and increasing speculative investment. Growth in land sales by local governments and construction by developers followed suit, and the annual residential construction rate reached 2 billion square metres in 2013. This rate of construction equates to at least several million more units of housing than new households being formed, a story analogous to recent construction booms in the United States, Spain and Ireland.

Most of China’s excess housing supply is thought to be vacant stock held by private investors, with the remainder sitting on the books of real estate developers, many of whom are highly indebted. There is also a serious geographic mismatch between housing supply and demand. Tier 1 cities such as Beijing and Shanghai generally suffer from housing shortages, while Tier 3 and 4 cities hold most of the excess supply. Another problem is the lack of affordable housing available for migrant workers who account for most of new urban household formation.

The risk is that the build-up of unoccupied properties held by developers will result in a major contraction of construction activity. Developers that have borrowed from shadow banks may default if their properties remain unoccupied or unsold. A fire sale could lead to large falls in prices and result in huge capital losses, rendering developers insolvent. Furthermore, investors may choose to dump some or all of their property holdings to mitigate losses, exacerbating any downturn. Interest rate liberalisation, the opening up of capital markets and availability of alternative investments (e.g. WMPs) could also undermine faith in the property market. Real estate accounts for around half of household wealth in China so there could be meaningful wealth effects on consumption; however the threat of negative equity for households appears low given limited mortgage debt.

What does this mean for markets?

Although there are a number of reasons to be optimistic about China’s long-term economic future, the short-to-medium term challenges are considerable.

To run down current excess residential property supply it is possible that China’s residential property construction activity could fall by as much as 50%. With housing construction representing around 9% of GDP this would cause a major slowdown in the economy and perhaps even a recession. There are signs that the rate of urbanisation may be slowing, and the Chinese leadership will be hoping that the housing adjustment can be managed gradually, alongside offsetting economic stimulus measures and orderly defaults. A ramp up in social housing initiatives is likely to form part of the solution, while helping to maintain positive sentiment.

China’s ongoing push to reign in excessive credit growth and liberalise financial markets risks creating a credit event somewhere in the shadow banking system. This could be linked to the property market or LGFVs. Although a major growth slowdown was avoided during China’s financial crisis of the late 1990s, the shadow banking system may prove a lot more difficult to control, especially since products such as WMPs are complex and involve millions of retail investors. Recent defaults by trust products and corporate bonds, as well as changes to lending regulations, are prime examples of such moves.

The Chinese government has a number of tools it can use to deal with any crisis, with combined central and provincial government debt relatively low at 56% of GDP. It can stimulate the economy or nationalise a large share of the debt if systemic problems arise, as the debt is domestically held, RMB denominated and issuance is fully controlled by the government itself. Notwithstanding recent moves to internationalise the RMB and open the country’s capital account, China’s economy remains relatively closed and the financial system remains fully funded by domestic deposit holders. A large domestic debt problem is more manageable than a large external debt problem, as the economy is less vulnerable to capital flight. Furthermore, the country’s huge foreign exchange reserves and current account surplus make it highly resilient to external financial shocks.

It is possible that we could see a larger-than-expected slowdown in China’s economy in the years ahead. This would have major effects on countries to which it has trade and financial links. Commodity exporters such as Australia and Brazil would be particularly vulnerable, as would emerging economies in Asia, Japan and Germany. Financial links between Chinese and Hong Kong or Singaporean banks could be channels for the international transmission of a Chinese financial shock. Furthermore, capital repatriation by Chinese investors could hit property markets in Canada, Australia, the UK and Hong Kong, while any move by China to sell its foreign currency reserve holdings could also lead to global asset price volatility, including a spike in US Treasury yields.

China is entering a period of heightened risk and uncertainty as it attempts to address some key systemic risks. As a major driver of global growth, China’s stability and growth performance will bear very close watching in the years ahead.

Sam Churchill is an Economist at Magellan Asset Management

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