Quarterly Newsletter - April 07

Major Indices

 
Currency
(AUD)
Interest Rate(%)
Share Index
PE ratio
(historical)
GDP (%) 2006
GDP Forecast (2007)
Population
(m=million)
Foreign Surplus / (Debt) %GDP
Australia
1.00
6.25
All Ords - 5,978
16.8
3
2.5
20m
(6.0)
USA (Dollar)
81
5.25
S&P 500 ¬ 1,420
*18.5
3
2.0-2.5
300m
(6.5)
Largest dollar deficit 2006
( 857 billion)
Japan (Yen)
95
0.5
Nikkei 225 ¬ 17,287
*25.8
1-2
1-2
127m (declining)
2007 - USD 875 billion 2nd largest dollar surplus
China (Yuan)
6.2
6.39
Shanghai Composite 3,184
*15.9
10.7
8-10
1,350m
2007 - Over USD 1.2 trillion, largest surplus
India (Rupee)
35
7.5
BSE¬ 13,072
*23.1
8
8-9
1,100m
Europe (Euro)
0.60
3.75
DJ Stoxx600 373
N/A
2-3
2-3
725m (declining)
UK (pound)
0.41
5.25
FTSE ¬ 6,308
*17.2
2-3
2-3
60m
Global
N/A
*16.6
5
4.5
6,000m

* PE ratios as of Dec 06          US 10 Yr Bond Rate – 4.75%

Commodities

Oil -Brent (USD/barrel)68
Natural Gas (per million m btu)7.73
Coal-thermal ($/tonne)57
Uranium (USD/pound)95
Gold (USD/ounce)653
 
Iron Ore (cents/dmtu) 84.7
Copper (USD/pound) 3.14
Nickel (USD/pound) 22.02
Zinc (USD/pound) 1.48
Aluminium (USD/pound) 1.26
 

Commentary – Past 3 months

3rd Quarter 06/07 financial year saw share markets globally boom in early and mid February followed by a substantial fall late February initiated by a 9% fall on the Shanghai Composite Index in China. Fears over unwinding of the Yen carry trade and sub-prime mortgages in the USA also caused markets to get the jitters.

However mostly this was a healthy correction for the overall strong global equity markets, and March saw worries subside and markets recover.

The best performing sectors for the past 3 months were resources and, the worst being listed property. World growth remained robust, especially China, India, and other parts of the Asian region. In fact in February China’s trade surplus grew a staggering tenfold compared to the same month last year, and exports were also up a whopping 52%.

It is wise to remember that Asia represents over 60% of the world’s population and is undergoing huge growth in personal wealth as represented by their GDP and new found spending power.

Commodities

World oil prices have risen again in recent months currently at around $68 US/barrel. Other resources prices have remained high, in particular Nickel, Copper and Uranium. Copper is trading at a 3 month high back above the significant 3 USD/pound. China's copper imports more than doubled last month from a year ago on rising demand from construction companies in China. Goldman Sachs JBWere, the Australian affiliate of the world's largest investment bank, expects the copper market to have a deficit of 202,000 tons this year, more than the 57,000 tons a year ago. China's copper usage could grow 12 percent this year, exceeding 8 percent rate estimated earlier.

This again shows the strength of commodity prices and supports the stronger for longer theory for the resources boom. Uranium also has gone crazy and is now at around 95 USD/pound a fivefold increase over the last 5 years.

Finally a tax on India’s Iron ore exports has helped push Iron Ore forecasts up for 2008.

Commentary – Forecast next 6 months

In USA we are unlikely to see further interest rate rises this year, and in Australia we may get one more small (0.25%) rise. The European Central Bank and the Bank of Japan, started this process of rising rates later than the US and Australia, and are generally expected to continue on their path of raising interest rates gradually over the period ahead. For a contrary view see section on Japan and global money imbalances later in this newsletter.

Most expectations are that the world economy will continue to grow at an above-average pace in the year ahead, albeit not quite as strongly as in 2006. While growth in the United States has moderated recently and markets are naturally jittery due to the sub-prime mortgage issue, strong economic conditions are generally prevailing in other parts of the world. Growth in the Chinese economy has remained around10 per cent (and India around 8%), and there has been a significant improvement in conditions in the euro area since the beginning of the year. The expansion in Japan is continuing, and strong growth rates are being seen in a range of emerging economies in Asia and elsewhere. Overall the global expansion appears broadly based, and observers generally expect it to remain robust in the face of the moderate slowing now underway in the United States.

The main areas to be cautious about at present are :

  1. A spreading of mortgage defaults into the main mortgage markets of USA, or more worrying, if it was to start occurring in China or other parts of the world.
  2. The interest rate rise of 0.27% in China bringing rates to 6.39% is also worth monitoring. Further interest rate rises in China may well see a slowdown in the fixed asset construction (property) from its recent frenzied pace.
  3. Overvalued global residential property especially in developed nations.
    It would be wise not to be fully invested at present and to wait to see how these issues play out.
  4. A Chinese backlash to a recently introduced US tariff on some Chinese imports.
  5. An overvalued Shanghai A share market correction.

I think in the next 6 months (barring disasters or a spread of mortgage defaults into other regions) we will see a struggle between higher interest rates and commodity prices(working toward slowing growth and sharemarkets ) versus very strong Asian growth and subsequent strong World Growth (helping sharemarkets) .

Those regions of the world that have strong GDP growth and are valued reasonably (some Asian regions, excluding Japan,India,Shanghai) will do well, whilst areas that are overvalued or that have weak growth will do poorly (Japan, USA).

For example Japan trades on a historical Price Earnings (PE) ratio of 25.8 , compared to India 23.1 ,China 15.9, Germany 14.3 , or South Korea at 11.1 .(Nb: These PE ratios were as of Nov 2006) Note: Shanghai A market, PE is now above 40.

Finally it is worth remembering that the US dollar could well weaken significantly if the Asian regions start to call in their debt, or decide to lend their massive surpluses into other currencies (Euros, Yen) or into other parts of the world.

Australia

I expect the Australian share market to underperform Asian markets over the next 6 months, due to a weakened property market and a fully valued sharemarket.
However, there are huge amounts of money (future fund, baby boomers selling their investment properties to put into super before June 30, as well as the 9% super guarantee monies) that may continue to push markets up above fair value for some time yet.

There may even be a few ex–investment properties going for reasonable prices at last.

With NSW state elections and Federal elections we may see political change, and a new willingness to tackle the big infrastructure (ie; poor railways, water supply, electricity, broadband) problems .This could be positive for companies such as Leighton Holdings etc. Overall expect financial services and resources to do well and property trusts to struggle.

World Imbalance of Monies – Asia’s surplus and USA’s debt.

Japan

Japan really is a smart country. For example they have the largest surplus of any country in the world, the best transport systems in the world, and in recent years they are the biggest lender in the world.

Lets face it, it is a smart move to keep Japanese rates low, so people all over the world borrow from the Japanese banks, who make a very healthy and easy profit margin say around 2% of all loan monies. Now that is an easy way to make huge money.

So why would Japan rush to raise interest rates and possibly risk losing this lucrative multi-billion dollar business. The answer off course is, they won’t.

So Japanese rates should stay well below the worlds for some time, and the huge “Yen carry trade” will continue unless something dramatic happens.

China

Likewise China would prefer to keep their currency cheap, so they remain competitive with their exports. This, off course, leads to an ever increasing Chinese surplus which recently broke through the USD1 trillion barrier. Look for the Chinese to develop an investment fund to invest these monies back into global markets to further strengthen the Chinese movement towards being the next super power.

USA

The Chinese and other governments are in essence bankrolling US consumers, who in turn are mortgaging their children's income.

The cumulative effects of this borrowing are frightening. The total external US debt now exceeds $6 trillion. That comes to $20,000 for each American, plus interest.

Legislative Changes (since May 06 Budget)

From Budget night (9/5/06)

Undeducted Contribution Limits – Max $150,000 per financial year, or $450,000 over 3 financial years
  – $150K per financial year for over 65yo who meet the work test.(Self-Employed will need an ABN from 1/7/07)

Since Budget Night
The above rule was extended to allow maximum undeducted (actually non-concessional) contributions to Super per person until 1/7/07 to be $1,000,000. NB:Non-concessional being all those contributions for which you did not claim a deduction.

From March 07
New Deeming Rates

Single
- First $38,400 3.5% , then 5.5%
Pensioner Couple
- First $63,800 3% , then 5.5%
Allowee Couple
- First $31,900 3% , then 5.5%


From 1st July 2007
Super Contributions

  • All super types of contributions allowable up to 75 yo (eg salary sacrifice, co-contribution).
  • Withdrawal from Super for over 65 yos optional, can remain in Super
  • Self-employed persons to follow same rules as others
    Ie : 100% tax deduction on contributions, eligible for co-contribution scheme.(ie : old 75% rule abolished)
  • Age Based Limits abolished
    (under 50yos)—max deductible contributions $50,000 pa
    (over 50 yos) – max $100,000 pa phased out by 2012/13

New names for Super Contributions

  • Deductible Contributions(SG ,SS ,Self employed) -> Concessional Contributions
  • Undeducted (before tax) Contributions -> Non-concessional Contributions
  • CGT exempt component -> CGT Contribution
  • Eligible Termination Payment(ETP) -> Directed Termination Payment

Super Withdrawals

  • No tax on earnings or lump sums taken from super pensions for over 60s (previous rules to apply for 55-60yos except no lump sum tax on pre83/concessional, deductible amount to include any pre 83 or CGT exempt or post 94 invalidity in the calculation)and all pensions will get the full 15% pension rebate)
  • Withdrawal from Super for over 65 yos optional, can remain in Super
  • New names (and taxes on withdrawal for under 60yos) for Super Components(from 1/7/07)

    Old components Proposed tax treatment

    • Pre-July 1983, Concessional, Undeducted -> Exempt component – Nil tax
    • Post-June 1994 invalidity, Capital gains tax exempt
    • Post-June 1983 taxed-> Taxable component
      Under 55 – 20%*
      Over 55 but under 60--Up to $140,000 – Nil, Over $140,000 –15%*
      Over 60 – Exempt
    • Non-qualifying Excessive -> Abolished
  • *Plus 1.5% medicare levy where applicable

Strategy : If you have not used up your post 83 threshold, and/or you have a large pre 83 component, consider doing a recontribution strategy before 1/7/07 to boost your tax exempt component.(Especially if you wish to leave your Super/Allocated Pension to adult children as a lump sum).
SMSFs could separate out tax exempt components and later deplete the taxable components by running the Allocated Pension from these funds.

  • New Taxation rules on Lump Sum Withdrawals upon death (from1/7/07)
    - If you die? Lump Sum to Dependents (spouse, <18yo children) -> Everything tax free (abolished the tax free up to pension RBL as RBLs are abolished)
    - If you die? Lump Sum to Non-Dependents -> Exempt Component = Tax free & Taxable component = 15%+ medicare

Super Pensions

  • No tax on earnings for over 60 yos.
    (See above for 55-60yos – retain deductible amount and 15% pension rebate)

  • Allocated Pensions to have new minimum amounts %s , maximum amount abolished.

  • Reasonable Benefit Limits(RBLs) abolished.

Employment termination payments

From 1 July 2007 payments made in consequence of the termination of employment, ie ‘eligible termination payments’ will be replaced by ‘employment termination payments’ (excludes payments made from a superannuation fund).
It is proposed that employer ETPs will no longer be able to be rolled over into super. It is also proposed that employer ETPs would have only two components – an exempt component (post June 1994 invalidity and pre-July 1983 amounts) and a taxable component. The taxable component would be taxed at 15% (over 55) or 30% (under 55) on the first $140,000 and the top marginal tax rate on amounts over $140,000. No start date has been proposed.

Transitional rules
Individuals with employer ETPs specified in existing employment contracts as at 9 May 2006, will be able to rollover their ETP to super, provided payment is made prior to 1 July 2012.

 

From 20th September 2007

Removal of 50% asset test exemption for complying income streams(annuity/TAP)
Assets test to now reduce by $1.50 per fortnight for every $1,000 over assets test free amount.(Previously $3 per fortnight) .This will mean that based on current limits the single homeowner assets test cut off will be approx $490K , and couple homeowner $780K .

Before July 1,2007

Small business owners have the ability to contribute up to $1 million to super from the proceeds of the sale of a business.

 

Tax File Number (TFN)

It’s very important that you provide your Tax File Number (TFN) to your super fund. If you have not provided your TFN to your super fund, tax will be deducted at the top marginal rate from your taxable contributions made after 1 July 2007. Additionally, you will not be able to make any undeducted contributions.

 

NB : High Net Worth Financial Advising attempts to enhance overall return for clients by investing in undervalued regions of the world and undervalued asset classes, that have positive growth stories.

NB : The contents of this newsletter does not constitute personal advice and is general in nature ,please see your adviser for personal advice suitable to your own needs and objectives.