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Thursday, 25 August 2011 13:03

Dummies Guide to the Debt Crisis

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What's the debt crisis really about? Why is everyone panicked and what should you do about it?

John Addis from Intelligent Investor offers a salutary guide for the worried.

What is sovereign debt?

Sovereign or public debt is the term used to describe money owed not by a nation but by a nation’s government.

Governments issue bonds to finance their debt. Those purchased by its own citizens constitute a domestic debt whilst those borrowed overseas from non-residents are an external debt.

The distinction is important, especially if you happen to be Greek. At the end of 2009, Greek sovereign debt stood at 113% of GDP, 82% of which was external. Interest payments on that debt leave the country, depressing economic activity and making further repayments more difficult.

Italy on the other hand had public debt of 115%, of which only 19% was external. Italy’s interest burden is largely paid to Italians, which is why its problems aren’t as serious as other PIIGS.

The other consideration is the currency in which debt is issued. Whereas most countries have to issue bonds in a foreign currency (typically the US dollar), the United States does not. If the US gets into trouble, it can simply print more dollars to repay debt (something it’s busy doing right now).

Countries carrying a large percentage of external debt don’t have that option, which is why Portugal, Ireland, Greece and Spain are in more serious trouble.

Is sovereign debt bad?

It depends. Societies’ religious background colours views; many see debt as a moral failing. In Sanskrit, Hebrew and Aramaic, the word for debt and sin are essentially the same so discussions of the subject can sound like a morality play—Debt is bad, we have sinned, we should pay it all back and suffer. We can see the political expression of that in the Tea Party.

But government debt is different. It’s constantly refinanced and investors accept it because the money is invested in health, education, infrastructure and wars, which tend to be economically beneficial. But that’s not to say countries don’t get into trouble from too much debt; they do, quite a lot.


So countries do default on their debt?

Conventional wisdom suggests debt defaults are infrequent. History suggests the opposite. In This time it’s different, Carmen Reinhart and Kenneth Rogoff examine ‘default episodes’ over eight centuries and establish that, especially among emerging economies, defaults aren’t exceptional at all.

Between 1300 and 1799 the emerging economies of France and Spain defaulted eight and six times respectively. In the 19th century alone Spain defaulted seven times. From the Great Depression of the 1930s to the 1950s, nearly half of all countries were in default or ‘restructuring’—a euphemism for default—representing almost 40% of global GDP.

More recently, there was a wave of defaults in the 1980s and 90s, including Russia in 1998 then Argentina, which defaulted on part of its external debt in 2002. Countries default all the time, even in Asia and Europe.

Ominously, Reinhart and Rogoff remark that ‘whereas one and two decade lulls in defaults are not at all uncommon, each lull has invariably been followed by a new wave of default.’ The period between 2003 and 2007 was one such lull. We all know what happened next.

Also, we should remember that most defaults aren’t about an inability to pay but, at least in a democracy, a lack of political will to do so. The alternatives to default are austerity measures—cutbacks on government services—and tax increases. Neither are big vote winners. It’s much easier for politicians to punish those (non-voting) horrible, dirty foreigners stupid enough to lend them money in the first place.

What are the consequences of default?

Let’s take Argentina as an example. After its $132bn default in 2002, investors fled the country, causing a currency collapse (in fact, in anticipation of default they were leaving in droves before it). The value of the countries’ exports plummeted despite the currency falling. Without financing, the government was forced to cut expenditure, slashing state pensions. Private sector wages fell, too.

Unemployment soared to 20%, inflation skyrocketed as the cost of imports rose and the government printed money, debasing the currency further. In a year, the economy shrunk by an incredible 13% and about a quarter of the population resorted to bartering. Bartering!

The long term consequences are most evident in the credit ratings and rates on Argentinean bonds. Japan is carrying debt of 225% of GDP, the highest in the world. It pays 1% on its 10-year bonds. Argentina, with debt standing at 52% of GDP, pays 10%. Argentina has a credit rating of B; Japan AAA. Much of that differential is explained by Argentina’s default. Investors want a higher return for trusting them again.


Why the panic now?

Firstly, no one’s panicking about Australia—quite the opposite in fact. The problems are in the largest economies of the developed nations. And it’s not debt per se that’s the problem—it’s the extent of it and what it’s been used for.

In 2006 the average debt level of the G7 nations (Canada, France, Germany, Italy, Japan, the UK and the US) was 84% of GDP—not bad enough to send us all to the great margin loan in the sky. By 2010 it was 112%, the highest level since World War II.

Those averages disguise some alarming figures. In the United States debt has risen from under 60% of GDP to well over 100% in 2010. According to the IMF, in 2010 Japan, Greece, Italy, Belgium, Singapore, Ireland, the US, France, Portugal, Canada, the UK and Germany carried government debt of 75% or more, far greater than economic powerhouses like Malawi (40%) and Uzbekistan (10.4%).

For debtor countries especially, the GFC made matters far worse. Bank bailouts resulted in private debt being made public and, in an attempt to kick start slumping economies, massive fiscal stimulus packages were undertaken. Government debt increased hugely as a consequence.


How can countries fix their debt problems?

The first option is economic growth. If GDP is increasing at a rate faster than the increase in national debt, although the debt is rising in absolute terms, as a percentage of GDP it’s falling. That’s good.

Countries like the United States, the UK and Japan, which can take on more debt cheaply, have this option. For Spain and Italy, with 10-year bond rates around 5%, it’s a remote possibility. For Greece, with a 10-year bond rate of 17%, it’s out of the question.

Reducing debt by cutting government expenditure and increasing revenues is the second policy choice. The UK in particular is following this strategy, favouring cutbacks over tax increases.

The trouble is that increasing taxes and cutting back on government expenditures at a time when economic conditions are already shaky can make things worse. In that sense, these two options conflict.

The third policy option is to inflate the problem away. Inflation reduces in real terms the debt owed, which is why indebted governments have a big incentive to encourage inflation. Although governments won’t admit to it, policies like quantitative easing (see Quantitative easing made easy) have this as one of their aims.

Currency devaluations have much the same effect, which is why the US dollar and UK pound are at historically low levels. Lower exchange rates also benefit economic recovery, making exports cheaper and imports relatively more expensive. In the aftermath of the GFC, Iceland, as well as letting private banks collapse, used a currency devaluation to great effect.

Unfortunately, indebted European countries tied to the Euro at a rate set largely by Germans aren’t able to do this. That’s why the situation in Europe, where the problems are structural and immediate, is more pressing than in it is the United States.

Remember also that a currency’s value is relative; countries can’t all devalue at the same time. With a troubled US and Europe, and half of the rest of the world pegged to the US dollar, devaluation is unlikely to do the trick.


We’ll be okay because of China, right?

Not necessarily. The United States and Europe are China’s two biggest markets. If things take a turn for the worse in those economies, China will be affected.

China is an export-driven nation; domestic consumption is insufficient to compensate for another deep recession in the US and Europe. If that were to occur, we could expect to see a rapid fall in commodity prices, the local currency and our terms of trade.

China also has its own problems, including massive (and under-reported) local government debt, social unrest and inflation concerns. It’s not the beacon of economic stability it’s made out to be.


What are the chances of a double-dip recession?

The global economy is three years into a debt recession, which tend to last longer and are more severe than normal recessions. Charles R Morris in The Trillion Dollar Meltdown said, ‘A credit bubble is different. Credit is the air that financial markets breathe, and when the air is poisoned, there’s no place to hide.’

We’re all breathing toxic air and it needs cleaning. That takes time. Look at the Japanese and their lost decade. We can expect a few more problems yet, although that doesn’t mean we’re going to face Japan-style problems.


How does this affect my investment strategy?


First, don’t panic. Corporate debt is much lower, corporate profits much higher. The banks have been recapitalised. This might feel like 2007 all over again but it doesn’t look like it.

Second, understand that the local currency isn’t the safe haven it appears. A weak US dollar and an unsustainable and risky Chinese stimulus program make it look that way. Australia remains a small economy heavily reliant on the financial and resources sectors. That's why investors should consider overseas exposure.

Pricing power is also going to be important. That means—and we’re going to sound like a broken record here—that you should buy best of breed companies and hold some cash—volatile markets are likely to be the norm.

Also, be more demanding with your valuation estimates. If a company reaches fair value then consider selling it for cheaper stocks (it's sensible to swap cheap for cheaper still). As we’ve already seen, a volatile environment offers plenty of opportunities for patient investors.

Nevertheless, prepare for a world of lower growth. Dividends will become more important and low interest rates more prevalent. That should influence the stocks you buy and sell. In the latest Platinum Quarterly Report, Kerr Nielson posits that more than two thirds of the total real return from equities in the period 1900 to 2008 came from dividends. There’s no reason why the next 90-odd years won’t follow a similar pattern.

Finally, acknowledge that humans have an amazing capacity to muddle through. Crises pass and problems are solved, after which we forget they existed in the first place, thus creating the conditions for them to happen all over again. We are indeed a strange mob.

This article has been reproduced with permission from Intelligent Investor – their website is


Note: Advice contained in this article is general in nature and does not consider your personal situation or needs. Please do not act on this advice until its appropriateness has been determined by a qualified adviser.  While the taxation implications of this strategy have been considered, we are not, nor do we purport to be registered tax agents. We strongly recommend you seek detailed tax advice from an appropriately qualified tax agent before proceeding.  The information provided is current as at August 2011.



Monday, 22 August 2011 20:14

Small Business CGT Concessions Overview

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In many cases, proceeds from the sale of a business form a large part of a small business owner’s retirement funds. Maximising the return on sale is therefore important to ensure a comfortable retirement

Tax concessions are available to small business owners who are selling business assets if certain basic conditions are met. A summary of these tax concessions and the basic criteria that must be met is summarised below.

As this is a complicated area, we recommend individuals obtain tax advice specific to their business structure and arrangements..


The four CGT concessions.

The four small business capital gains tax (CGT) concessions are:

  • 15-year exemption – this concession totally exempts any capital gain made upon sale of the business asset. To be eligible, a small business entity must have continuously owned the CGT asset for a minimum of 15 years and, at the time of disposal, the individual is 55 or over and the disposal is connected to their retirement, or the individual is permanently incapacitated. If the business operates as a company or under a trust structure then the entity must have a ‘significant individual’ for any period or periods totalling 15 years during the period of ownership.
  • The 50% active assets reduction – a 50% reduction of a capital gain.
  • The retirement exemption – an exemption of capital gains up to a lifetime limit of $500,000. If the recipient is under 55, the amount must be paid into a superannuation fund and normal preservation rules apply.
  • The rollover concession – a deferral of a capital gain if a replacement asset is acquired. The deferred capital gain may later crystallise when the replacement asset is sold or its use changes.
  • If an asset is being sold by an individual and the asset has been held for more than 12 months, the capital gain must first be reduced using the 50% discount before applying any of the above mentioned small business CGT concessions.


The eligibility conditions?

To be eligible to use the small business CGT concessions, an individual (or entity) must first satisfy several basic conditions:

  • the $6 million net asset value test or the $2 million • aggregated turnover test
  • the active asset test, an
  • if the business operates as a company or under a trust structure, it must also meet the 20% significant individual test.


$6 million net asset value test?

A business that meets the $6 million net asset test is considered a small business by the ATO. To meet this test, the net value of CGT assets of the individual and certain related entities must be less than $6 million.

The net value of CGT assets is the market value of those assets less any liabilities relating to those assets.

Certain assets are excluded from the test, such as assets held for personal use and enjoyment, superannuation entitlements and the value of life insurance policies.


$2 million aggregated turnover test

A business that fails the $6 million net asset value test can still be considered a small business by the ATO if it meets the $2 million aggregated turnover test.

To meet this test, the aggregated turnover of the individual plus any affiliated or connected business entities must be less than $2 million.

There are three methods for determining aggregated turnover:

  • using the previous year’s aggregated turnover
  • estimating the current year’s aggregated turnover, or
  • using the actual current year’s turnover


Active asset test

A CGT asset is an active asset if it is owned by the individual (or entity) and it is used, or held ready for use, in a business carried on by the individual (or entity), the individual’s affiliate, their spouse or child, or a connected entity.

The asset does not need to have been active at the time of disposal, but it must have been active for the lesser of 71/2 years or half of the period of ownership.

If the asset being sold is a share in a company or unit in a trust, an 80% look-through test applies, meaning that the shares or units will be considered active assets if at least 80% of the market value of the underlying assets of the company or trust are active assets.

Significant individual test

If a business is run through a company or trust structure, one of the following additional basic conditions must be satisfied just before the CGT event:

  • the entity claiming the concession must be a CGT concession stakeholder in the company or trust, or
  • the CGT concession stakeholders in the company or trust together have a small business participation percentage in the entity of at least 90% (the 90% test).

An individual is a CGT concession stakeholder of a company or trust if they are a significant individual, or the spouse of a significant individual where the spouse has a small business participation percentage in the company or trust. This participation percentage can be held directly or indirectly through one or more interposed entities.

An individual is a significant individual in a company or trust if they have a small business participation percentage in the company or trust of at least 20%. The 20% can be made up of direct and indirect percentages.


Note: Any advice contained in this flyer is general in nature and does not consider your particular situation or needs. Please do not act on this advice until its appropriateness has been determined by a qualified adviser. We are not, nor do we purport to be registered tax agents. We strongly recommend you seek detailed tax advice from an appropriately qualified tax agent.


For more information about the Small Business CGT Concessions or to arrange a no-cost, no-obligation first consultation, please contact:


GEM Capital

Phone Number: 08 8273 3222

Thursday, 18 August 2011 20:12

Review Salary Sacrifice Agreements

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The beginning of the financial year is an ideal time to review salary sacrifice arrangements.  This is especially important for individuals likely to be close to their contribution caps, or wishing to maximise their concessional contributions to superannuation.  As a reminder, the concessional contributions cap is $25,000 (or $50,000 for individuals who are aged 50 or over on the last day of the financial year).

Exceeding Contribution Limits can lead to additional tax which effectively taxes your excess contributions at 46% or possibly higher depending on other contributions.

When reviewing or creating a new salary sacrifice agreement, consideration should be given to:

  • the terms of the agreement specifying the amount(s) and timing of salary sacrifice contributions, e.g. whether additional items will be sacrificed, such as end of year bonuses.
  • the number of pay cycles in the coming financial year. In 2011/12, for employees who are paid on a Friday, there will be 53 weekly pay cycles in the year or there may be 27 pay cycles in the year if paid fortnightly.  You may have an extra pay cycle during the financial year and possibly additional superannuation guarantee (SG) and/or salary sacrifice contributions, depending on when your employer makes these contributions and your level of income.
  • factoring in concessional contributions from all sources that will be paid in coming financial year, even if they relate to the previous financial year.   This includes items such as SG and insurance premiums paid by your employer or you for cover effected through superannuation.  For details about contributions that count against the concessional cap contact your Financial Adviser.
  • capturing SG and salary sacrifice contributions made in situations where you changes job, and
  • factoring in a reasonable buffer for pay rises or bonuses received that may occur during the financial year or unexpected employer contributions.
  • understanding your employer's policy regarding SG contributions and whether your employer pays 9% on employee earnings in excess of the maximum quarterly earnings base of $43,820 (2011/12 year).

While the above planning may help avoid an excess contributions problem, it would be wise to review the actual concessional contributions made before the end of the financial year.  This way you can ensure any changes in your employment, income or superannuation contributions since 1 July don't derail your plans.


Sound confusing?  Contact us for more information about salary sacrifice and contribution caps or to arrange a, no-obligation first consultation, please contact:


GEM Capital

Phone: 08 8273 3222


Note: Advice contained in this flyer is general in nature and does not consider your particular situation or needs. Please do not act on this advice until its appropriateness has been determined by a qualified adviser. While the taxation implications of this information have been considered, we are not, nor do we purport to be registered tax agents. We strongly recommend you seek detailed tax advice from an appropriately qualified tax agent before proceeding.  The information provided is current as at July 2011.

Monday, 08 August 2011 16:51


Written by


Notwithstanding the considerable uncertainty in financial markets we remain calm and comfortable with the risk profile of the Magellan Global Fund.

Since the inflection of market sentiment in early April, the Magellan Global Fund unit price has remained stable.

In our view the portfolio is well constructed to deal with these events and is focussed on extremely high quality businesses that continue to excel in the current environment. Almost without exception the companies in the Magellan Global Fund which have recently reported have delivered outstanding operating performance with improved competitive positions, strong revenue and earnings growth.


Performance 1 April  to 5 August 2011:

Magellan Global Fund        -1.7%

S&P/ ASX 200 Index    -14.7%

MSCI TR Net World AUD       -10.6%


The sovereign debt issues in Europe and recent poor economic data out of the United States have led to considerable market volatility in recent days and months.  The sovereign debt issues in Europe cross two complex and associated issues.

The first issue is a solvency issue. In our view Greece is effectively insolvent and Portugal and Ireland have potential solvency issues. The good news is that the European Union and the European Central Bank have finally recognised the insolvency issue in Greece. The new Greek bailout package is a fundamental step in the right direction. The package materially reduces Greece’s financial burden via the extension of loan terms and the reduction in interest rates; these measures were also extended to Ireland and Portugal. The proposed involvement of private sector creditors to swap Greek sovereign debt for longer duration lower interest debt will also materially reduce the present value of Greece’s outstanding debt. This reduction in Greece’s debt burden is a fundamental step in putting Greece on a path to sustainability. We suspect that more still needs to be done, however we are optimistic that the tools and policies are now in place to address Greece’s solvency issues.

The second issue engulfing Europe is a potential sovereign debt liquidity crisis affecting larger European countries, particularly Italy and Spain. We do not believe that either of Spain or Italy are insolvent, however a collapse in bond market confidence could push yields on sovereign debt to levels that create a true liquidity crisis. In our view monetary union presents particular challenges to addressing this situation. For a country that has its own currency and an independent central bank able to readily print money this situation would be addressable. In such circumstances the central bank could print money and buy bonds on the open market to drive down yields and monetise government funding requirements. The current policy path potentially involves the European Stability Fund (which is constrained in size) and the ECB buying affected bonds (with necessary offsetting asset sales) on the market to stabilise yields.

Unfortunately if this situation continues to escalate and in the absence of a dramatic and possibly unlimited increase in the size of the European Stability Fund, this policy path is akin to bringing a pea shooter to a gun fight.

We do believe that there are two potential policy options which would address these liquidity difficulties; either allowing the ECB and EU central banks to print money or allowing the EU to issue Eurobonds to finance the struggling economies.

We feel it is unlikely that these liquidity issues will result in a financial Armageddon scenario and that correct policies will eventually be pursued. However there are divergent views on the correct path of action and thus we could have a sustained period of considerable volatility until this is resolved.

We remain realistic and relaxed about the difficulties facing the US economy.The recent decision to raise the US debt ceiling has removed considerable risk in the short term and we are confident that the US will take action over the next few years to ensure it is on a sustainable long term fiscal path.

Magellan continues to focus on the preservation of investors’ capital and our disciplined approach to investing in the world’s highest quality companies and we are confident of delivering the portfolio’s objectives over the long term.

Kind regards,

Magellan Asset Management

Important Information: Units in the Magellan Global Fund are issued by Magellan Asset Management Limited (ABN 31 120 593 946, AFS Licence No 304 301). This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement (PDS) available at or by calling 02 8114 1888.


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Magellan Asset Management

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Sydney, NSW 2000

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Monday, 01 August 2011 16:57

Financial Ruin awaits those failing to register their car

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South Australia recently reported an alarming increase in the number of motorists driving an unregistered car.  Around 2,000 motorists per month are now being detected in South Australia driving an unregistered vehicle.  We can only imagine similar statistics exist in all states.

What does this have to do with Financial Planning I hear you say?

The answer lies with the fact that motorists driving an unregistered vehicle run the risk of losing everything, including their house.

One of the components of motor registration is the premium of compulsory Motor Injury Insurance.  This is the insurance coverage that pays compensation to people injured in a motor vehicle accident.

Those who do not register their vehicle, do not have this insurance cover.  This could mean that in the event of a motor vehicle accident, where another person was injured, the owner of the unregistered motor vehicle could become liable for the compensation amount that would normally be paid by the Motor Injury Insurance provider.

To put some perspective on this subject we highlight the accident in 1986 involving high profile Australian actor John Blake.  He was ultimately awarded $7.7 million in compensation as a result of a car accident.

If this compensation could not be paid by the Motor Injury Insurance because the offending vehicle was not registered, the liability would most likely fall to the vehicle owner which would more than likely result in bankruptcy for most.

Risk management is a key plank of any good financial strategy.  Failure to register a motor vehicle puts at risk an individual’s assets.

As part of your overall financial health, we recommend that you double check to ensure that your vehicles are registered.


Note: Advice contained in this article is general in nature and does not consider your personal situation or needs. Please do not act on this advice until its appropriateness has been determined by a qualified adviser.  While the taxation implications of this strategy have been considered, we are not, nor do we purport to be registered tax agents. We strongly recommend you seek detailed tax advice from an appropriately qualified tax agent before proceeding.  The information provided is current as at August 2011.




Late June and early July saw a surge in market sentiment, as various European Union entities and the International Monetary Fund apparently cobbled together yet another rescue package for Greece. Slightly more positive data also emerged from the US and Japan, where the post „quake recovery seems to be proceeding better than originally expected.

Some emerging markets are also taking comfort from the fall in the price of oil, even if this may itself be a symptom of weaker growth in developed economies.

However, we note that most of Asia has inverted to flat yield curves and that these have traditionally been good indicators of economic slowdowns and often recession.

We remain cautious and maintain relatively high levels of cash and bullion in our portfolios. We are sensitive to the degree of hedging  we have in  the VGT, ASV and  GDG, with some expectation  that the long  period of Australian dollar out performance may soon come to an abrupt end. Our problem is that it is not clear what currencies would outperform the A$ given the threats to developed world currencies.

Looking at another area of potential instability, the Europeans‟ political commitment to the Euro project seems increasingly untenable on economic grounds. Greece faces a significant restructuring of its debts, as the economy continues to shrink, while government debt spirals despite an unprecedented austerity programme. We doubt the Greek populace will have stomach for much more hardship, especially when it fully grasps that the current multilateral  so-called  rescues  are  more  focussed  on  protecting  bank  lenders  from  France  and  Germany  than helping the Greeks themselves. The real solution to Greece‟s problems is a default and withdrawal from the Euro allowing the restoration of the drachma and dirt cheap holidays in Greece for hard-working Northern Europeans.

We are no more optimistic on the prospects for two other sick small countries in Europe: Portugal and Ireland. The real test of the Euro and the European Central Bank will be bail outs for Italy and Spain, both of which have come under attack in the bond markets in recent days with soaring yields. Sovereign defaults by these two countries will have systemic impacts on the solvency of many European banks and probably the European Central Bank itself, and would put an end to what many commentators deride as the current “Extend and Pretend” routine in continental Europe.

Europe‟s problems do not end at the English Channel. Britain has the balance sheet of “Club Med” but the interest rates of the thrifty Northern Europeans. It still looks vulnerable, even before it feels the effects of the long overdue, but still painful impact of cuts in its bloated public sector. Given the shrivelled nature of its manufacturing sector, it is also not clear how much benefit it is getting from continued falls in the pound sterling.

The theme of weakening government tax revenues exceeded by rising government spending is evident in most developed economies. This is perhaps in its most extreme form in Japan, but it is increasingly apparent in Australia too, despite the well rehearsed, but increasingly unconvincing pledges to bring the Commonwealth budget back to surplus.

Where Australia stands out, and indeed looks more like an emerging market, is its willingness to use monetary policy to offset the fiscal laxity. Like developing Asia, Australia is seeing inflationary pressures. Unlike Asia, these relate more to labour shortages in WA and Queensland and rising government charges than raw material costs. Unfortunately structural inefficiencies in Australia prevent labour in the struggling Brisbane to Melbourne corridor flowing to the growth states as they have in previous resource booms. In the meantime the Reserve Bank of Australia‟s tough monetary stance is pushing up the Australian dollar, which adds to the pain in the mortgage belts of the large cities of eastern Australia through the destruction of traditional blue collar manufacturing jobs.

Increasing doubts about the sustainability of China‟s investment intensive economic growth model have seen many raw material prices plateau or dip. While it would be wrong to underestimate the capacity of China‟s central planners to keep the growth engines firing, signs are emerging that the conflicting need to put a cap on inflation through tougher monetary policy is putting the country‟s financial system under strain. What is clear is that if China does catch a cold, Australia, most of Africa and much of South America will get influenza.

The potential vulnerability of Australia‟s position is exacerbated by the increasingly apparent frailty of its housing market, which could have significant impacts on the country‟s banks, due to their high level of dependence on the sector. Australian banks have managed to slightly reduce their reliance on foreign borrowing, but still have high levels of loans to their core deposit bases. As well as having a huge traded sector, Australia is connected to the rest of the world‟s economy through our banking sector‟s reliance on wholesale funding to bridge the gap between loans and deposits. And if interest rates go up internationally Australian banks will be squeezed.  Any uncertainty about their financial strength will hurt the Australian dollar – and put the focus on the effective blank cheque the Commonwealth has written to protect Australian bank deposits.

How equity markets perform in this environment is not clear. We believe the 20 year bull-run in developed country government bonds is coming to a close and the inflationary impacts of lax fiscal and monetary policies in most developed economies are reaching an inflexion point. Rising costs of doing business in China will also remove the biggest deflationary force of this period caused by cheap manufactured imports. In our view, long term fixed interest investments are likely to do badly while equities are likely to do less badly.

We are of the view that the long swing of outperformance of Australian shares over foreign shares, especially when measured in Australian dollar terms is petering out. To this end, it is our present strategy to cut our hedges on our foreign holdings in the VGT, GDG and ASV as soon as we gain confidence in a decisive break in Australian dollar strength, and gradually cut our exposure to Australian stocks in the VGT as well.

At the country level we are still nervous about China, and fundamentally more bullish about India, especially if, as we believe, the recent monetary tightening phase is coming to an end, and recent oil price weakness is sustained.

The paradox of Europe is that great export companies from Germany, France, Scandinavia, the Benelux region and even northern Italy are benefiting from the currency weaknesses caused by the stresses at the heart of the Euro project. Japan contains elements of both the US and Europe so far as the prospects of individual companies are concerned, but seems frozen in even greater apathy at the political level, and in far too many cases companies there still treat shareholder as passengers rather than owners.

Meanwhile in the US, signs of a recovery in the housing market remain at best tentative, and even record company profits are not prompting much new hiring. At the same time most US governments seem incapable of cutting spending, with the only hurdle to increased indebtedness coming from mandatory debt limits at the federal, state and municipal level, increases in which typically require legislative approval.

Nevertheless, we do feel the US could be the one market that provides upside surprise potential. The one level where we have confidence is the ingenuity of corporate management, especially in companies with international sales, which are more likely to profit than lose from a weak currency and a soft labour market.

This is now being joined by an expansion in consumer credit in Q1 (the first since 2005); an improvement in US credit scores (which hit their highest level in four years in May); and senior loan officers willingness to lend is increasing markedly.

What if the best place to invest is the US and not Asia as many people think? This is not our base case given the sharp rises already seen in the market, the fiscal incontinence and coming budget issues, but food for thought if these can be addressed in a timely manner.

As our portfolio managers go about their work however the key remit remains unchanged from our inception nearly 20 years ago: to find stocks that are not just cheap, but cheap despite the quality of their businesses and managements and their prospects for growth.

Please  be  advised  that  Monthly  Performance  Reports  for  the  Funds,  as  well  as  other  relevant  marketing information can be emailed to you. If you would like to subscribe to this service, or have any further queries regarding Hunter Hall, please contact our Investor Relations Department by email at This email address is being protected from spambots. You need JavaScript enabled to view it. by calling 1800 651 674 (0800 448 305 for New Zealand callers).


Tuesday, 05 July 2011 14:43

5 Tips For Combating Everyday Stress

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HALF of Australia is so stressed out that it is making us sick, according to an annual poll taken for the past four years.

Lifeline spokesperson Brendan Maher said the problem is growing every year with 93 per cent of 1201 respondents said to be stressed as compared to 90 per cent in 2010.

"This year we can put some of it down to the natural disasters affecting our nation, but much of it will be due to poor stress management," he said.

Supporting partner Bupa said the poll identified work as the number one stresser and research that they have done have backed this claim.

5 tips for combating everyday stress are:

1. Get active: exercise programs have been proven to help reduce anxiety and exercising for as little as 30 minutes a day, as recommended in the National Physical Activity Guidelines, may help to combat stress while keeping you in good physical condition.

2. Eat a healthy, balanced diet: a healthy diet is one of your best tickets to good health. Good health means one less thing to stress about.

3. Get good, quality sleep: lack of sleep affects both our mental performance and our mood. Bupa Healthwatch research found that sleep-deprived people reported feeling more stressed, sad, angry, mentally exhausted and less optimistic about their lives as a whole.

4. Stop smoking and limit caffeine: Nicotine in cigarettes and caffeine in coffee, cola and energy drinks are stimulants that may increase your stress levels.

5. Be smart about how much alcohol you drink: it's likely that drinking too much may negatively affect how well you perform, increasing the stress you're under.

Tuesday, 21 June 2011 15:31

Financial markets are anticipatory animals

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How often have you seen a company make a record profit announcement, only to see their share price decline that day.  This happens as the markets had factored in a better result than was released, and that higher forecast was already built into the price.

Conversely investors often see share prices rise when companies announce bad news as the news was not as bad as had been built into the share price.

While this may seem counter intuitive to many, the fact is that financial markets are anticipatory by nature.  In other words, what is built into share prices takes into account information that is known as well factoring in forecasts of events expected to happen.

With this point in mind we look to the current pricing of share markets and ask why are they so cheap, when company earnings are rising?

The chart below tracks the average Price to Earnings Multiple (PE multiple) over many years to demonstrate whether the share market is cheap or expensive compared to history.  A PE multiple is simply how many times company earnings, investors are prepared to pay for a company.  Generally the higher the multiple, the higher the price of the company or market.

For example a company earns $1-00 per share, and its share price is $12, therefore the Price Earnings multiple of 12, but if the share price rose to $15 while earnings remained the same, the Price Earnings multiple would be 15.



What this chart shows is that the share market appears to have already anticipated the uncertainties in the world economy listed above by discounting the price earnings multiple it is willing to pay for companies (and in doing so reducing share prices)

Price earnings multiples are now trading at well below long term averages.

The key point is that markets seem to be already priced for many uncertainties in the global economy.  Investors need to ask whether the market is pricing in too much bad news as they were in early 2009.  If it turns out that markets are factoring in worse news than actually happens, investors could see share prices rise as a result of the market increasing PE multiples.

In the long term company earnings drive returns for investors in share markets, but in the shorter term numerous other factors impact share prices.


Sunday, 05 June 2011 11:14

Greek Debt Crisis

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Friday, 20 May 2011 15:20

Investing is a rising inflationary environment

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The Reserve Bank has a formal inflation target in place and most investment commentators regularly talk and discuss the threat inflation may have on investors.  This article explains why inflation should be considered by investors and some tips on protecting an investment portfolio in a rising inflationary environment.

For many years there have been deflationary pressures, particularly from 1. an increasing Australian dollar which lowers the cost of imports, and 2. cheap Chinese labour (translating to cheap imports).

In the past 12 months, Chinese wages have increased 30% for average workers, while Chinese construction workers have received about 100% wage increases (source Platinum Asset Management).  Food and energy shortages around the world are also putting upward pressure on prices of basic essentials for daily living.  We believe that the days of deflationary pressures are over for now.

Why is this important?

Consider a business that sells widgets.  It sells 1,000 widgets for $100 each, while the cost to produce the widgets is $50 per widget.  The gross profit for this business is therefore $50,000.

If however the cost to produce widgets due to rising energy prices, increased wages etc goes up to $60, the gross profit falls 20% to $40,000.  Of course the business could raise the sale price of widgets to protect their profits, or sell more widgets if the market will bear, but this is easier said than done. So inflation hurts business profits (read share prices) as well as making the cost of living higher.

What typically happens to interest rates when inflation rises?

History suggests that when inflation rises, interest rates rise.  Below is a chart sourced from the Reserve Bank of Australia that shows the movements of inflation (top part of the chart) and interest rates (referred to as cash rate in green line) over the past 25 years.  You can see how they move closely together.

With these points in mind here are some simple techniques to help you inflation proof your portfolio:

Share Market Investments

Seek to invest in companies that have the ability to pass on price increases to their customers.  These companies typically have the following attributes:

  • Well recognised brand and a dominant market position  (meaning they can pass on increased costs)
  • Management with experience from previous inflationary cycles

If using managed funds, ensure that the fund manager responsible for investment selection is on top of the threat of global inflation.  Evidence of this could come in the form of commentary from the fund manager in recent communications.  Your adviser could also have direct contact with the fund managers’ investment personnel and can confirm this for you as well.

Fixed Interest Investments

Exercise extreme care when investing in long dated fixed interest investments.  Consider an investor who invested $100,000 into a 10 year bond paying 5% interest.  Interest received is $5,000pa.  If interest rates rose to 10%, in order to receive $5,000 of interest the investor would only require $50,000 of capital.  The point here is that if this investor wished to sell their 10 year bond, before the 10 year period was due, it would be unlikely that they would receive anywhere near $100,000.  It is possible to lose capital in fixed interest investments in a rising interest rate environment.

Instead, look at fixed interest investments that are linked to interest rates.  So as interests rates go up, the payment received goes up as well.  Your financial adviser can help you with investments that have these characteristics.

Other suggestions

Property (particularly commercial property) can provide protection in an inflationary environment as lease agreements normally contain an inflation adjustment each year.

Infrastructure investments such as toll roads also contain clauses in the legal agreement, where the toll paid by consumers is increased by inflation each year.

Talk to your adviser to ensure that your portfolio is prepared for the threat of a global inflationary environment.