Quarterly Newsletter - July 07

Major Indices   (as of 1/7/07)

 
Currency
(AUD)
Interest Rate(%)
Share Index
* PE ratio
(forward)
GDP (%) 2006
GDP Forecast (2007)
Population
(m=million)
Foreign Surplus / (Debt) %GDP
Australia
1.00
6.25
All Ords
6,392
15.0
3
3.0
20m
(6.0)
USA (Dollar)
85
5.25
S&P 500
1,524
17.8
3
2.0-2.5
300m
(6.5)
Largest dollar deficit 2006
( 857 billion)
Japan (Yen)
105
0.474
Nikkei 225
18,221
22.2
1-2
1-2
127m (declining)
2007 - USD 875 billion 2nd largest dollar surplus
China (Yuan)
6.5
6.39
CSI 300 (Shanghai/Shenzhen)
3,615
19.0
10.7
8-10
1,350m
2007 - Over USD 1.2 trillion, largest surplus
India (Rupee)
35
7.50
BSE 200
1,811
24.4
8
8-9
1,100m
Europe (Euro)
0.63
4.00
DJ Stoxx 50
3,976
N/A
2-3
2-3
725m (declining)
UK (pound)
0.42
5.75
FTSE 100
6,673
15.2
2-3
2-3
60m
Global
N/A
17.1
5
5.0
6,000m

* PE ratios as of May 07 (based on 1 year estimate forward earnings)
US 10 Yr Bond Rate – 4.50%    US 30 Yr Bond Rate – 4.75%
Source: Bloomberg

Commodities

Oil - Nymex (USD/barrel) 71
Natural Gas (per million m btu) 6.63
Coal-thermal ($/tonne) 60
Uranium (USD/pound) 140
Gold (USD/ounce)653
 
Iron Ore (cents/dmtu) 84.7
Copper (USD/pound) 3.58
Nickel (USD/pound) 16.26
Zinc (USD/pound) 1.59
Aluminium (USD/pound) 1.23
 
Source : Kitco, quotemarkets

Commentary – Past 3 months

Fourth Quarter 06/07 financial year saw share markets globally boom despite large volatility in the overvalued local Shanghai A market (mainly on the downwards side). A 15% fall in June was triggered by the Chinese Government increasing stamp duty on share transactions from 0.1% to 0.3% in an attempt to cool the sharemarket. Fears over sub-prime mortgages in the USA and a slowing US economy (read housing market) caused little worry on global markets, however recent increases in long term US bonds have caused a small market pullback .This has been most noticeable in those sectors that are most sensitive to increasing interest rates such as listed property and infrastructure.
The best performing sectors for the past 3 months were resources and, the worst being global bonds. World growth remained robust; especially China, India, and other parts of the Asian region, Europe and Japan remain fairly strong, whilst USA continues with weak yet positive growth.
This quarter we saw the beginning of a possible strong new trend. That is, Chinese sovereign funds investing into global equity markets through fund managers or private equity such as the Blackstone deal (see section below on sovereign funds).
We also saw a solid rise in the Australian dollar particularly against the Yen and the US dollar.

Commodities

World oil prices have risen again in recent months currently at around USD $71 /barrel. Other resources prices have remained high, in particular Copper and Uranium. Copper is trading at a 6 month high trading at USD 3.58 /pound. Uranium also has continued it’s meteoric rise and has most probably peaked at around USD 1.40/pound. Finally iron ore has continued it’s strength helped by the Indian iron ore tax (making Indian ore more expensive), and Nickel has at last dropped back to some sort of reality.
There has also been somewhat of a swing in analysts views towards the stronger for longer viewpoint regarding commodity prices, a view I have always held based on the relative undervaluation of commodities in 2000 when adjusted for inflation, and the global urbanization we are currently witnessing in China, India, Vietnam, Brazil, Russia and much of South America and Eastern Europe. Interestingly, the resource rich Ukraine was the highest performing sharemarket last year just beating out the local Chinese Shanghai and Shenzen markets.
The Aussie dollar strengthened considerably relative to the Japanese Yen and the US dollar.

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. Having said that, an increase in inflation due to say an oil price spike, may suddenly cause rates to rise. Also, I would not be surprised to see further increase in US long term bond rates which will hurt interest rate sensitive areas such as bonds, property and infrastructure. It will also slow the borrowing to invest mania of the last few years, which means global liquidity and some asset prices should decrease somewhat.

Most expectations are that the world economy will continue to grow at an above-average pace in the year ahead. While growth in the United States is expected to remain weak, this is being offset by very strong Asian, Eastern European and South American growth. Perhaps a sign of this is that Mexican telephone tycoon Carlos Slim has now overtaken USA’s Bill Gates as the world’s richest man with wealth of USD 68 billion. 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.

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. 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. A rise in inflation triggered by oil price spikes.
  6. Increases in US long term bonds effecting property and infrastructure valuations negatively.


On the positive side:

  1. World growth remains strong at around 5% (especially China and India)
  2. Inflation is under control
  3. World liquidity is still good whilst rates are at current levels
  4. Chinese sovereign funds will commence buying global equities
  5. Continued rise in wealth and spending power of the Indian and Chinese middle class
  6. Asia has become less reliant on exports to USA and now more Asian exports go to China than to USA.

Those regions of the world that have strong GDP growth and are valued reasonably will do well, whilst areas that are overvalued or that have weak growth will do poorly. My favourites regions currently include Venezuela (PE 7.7), Korea (PE 13.4) and Brazil (PE 13.4). Additionally playing China through the better valued Hong Kong market will continue to be a good play leading up to the Beijing Olympics in August 2008. Areas to avoid continue to be USA largely due to their massive debt and the likelihood of continuing weakening currency, overvalued industrial shares in Australia, and most western countries residential property which is still overvalued.

Remember that emerging markets are growing on average at twice the rate of the developed markets and the numbers of population involved is staggering (emerging countries make up over 2/3 of the world population).

An example is mobile phone penetration rates in the following countries;
USA – 77%
Japan – 78%
China - 33%
India – 13%
You can see developing countries still have a long way to grow.So playing China and India is a very wise long term play and provided you are wary of the overvalued Shanghai A market will continue to be solid performers. Alternatively you can play the urbanization theme through global resource funds or the big diversified miners such as BHP, Rio, and CVRD. I expect the resource companies to continue to perform strongly, particularly those that are diversified and have exposure to the main building industry commodities such as Iron ore, Copper and Aluminum.

Finally I expect the Aussie dollar to continue to strengthen relative to the US dollar.

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. Home affordability in Australia is still at record lows and building activity is at recessionary levels. Tourism is not performing well, leaving mining to prop up the Australian economy.

We have just had a massive liquidity boom that will start to slow and the Industrial sector which is somewhat overvalued (PE of around 19) may well stall or fall, however I expect the Resources sector to continue to prosper and it is still the hidden gem within Australia trading on a ridiculously low PE of around 13, at a time when there is a massive demand for resources, and soon we will see the Chinese buy more resource companies perhaps a large one such as BHP, Rio or CVRD.

Overall continue to expect financial services, energy (in particular biofuels) and resources to do well and property trusts overvalued industrials, and some infrastructure companies to struggle.

The Australian share (ASX 500) market historical PE ratio is at 18.0, suggesting a market correction of 10% is looking likely in the next 3-6 months. Again this is most likely in the industrial shares where many are trading at lofty PE ratios around 30.

Sovereign Funds

A Sovereign Fund is a country's investment fund, usually using their foreign surpluses to invest into shares and property all over the world, and causing asset prices to boom as a result. Britain did this in the early 1900’s, Japan in the 1980’s, Singapore (Temasek) in the 70’s, 80’s and 90’s , and now it's China and the oil surplus nations (Saudi Arabia ,Russia) turn. The only difference is this time it is on a scale the world has never seen. For example, China’s foreign account surplus last year was 9.5% of GDP, more than double the highest ratio ever achieved by the Japanese in their hey day.

Lou Jiwei is the head of China’s new State Investment Corporation (SIC). He recently placed $US 3 billion with the private equity firm Blackstone to invest on behalf of China. This is just the beginning of an avalanche of Chinese Sovereign Fund investments who will have part of the massive $US1.2 trillion Chinese current account surplus to invest. The Chinese will remain linked to the US by way of their US treasury bond investments (usually around 70% of foreign reserves), however this is thought to be capped at around $US 1 trillion. That leaves $US 200 billion available for SIC to invest initially and with China’s foreign reserves growing around $US250 billion pa , they would have over a trillion US dollars to invest in less than 5 years. Now that can massively move markets.

So where would they invest these funds?
No1 place will be resources needed by China to ensure their growth continues. The main resources will be those that China is short of geographically but needs to fuel its production. These are Oil, Copper, Iron ore, Zinc and Platinum.
Think BHP, Rio, CVRD, Woodside in fact think “Global resources” funds.
No 2 place will be Chinese companies that are expanding globally.

How will the Chinese place these funds?
They probably won’t buy direct companies in countries likely to oppose takeover of their national assets. Eg : The Chinese failed bid for US oil major Unocal .
They are more likely to invest through major investment banks or private equity groups such as Citigroup, HSBC, UBS, Pimco , Blackrock and Investco. These groups would then quietly purchase up stakes in companies such as BHP etc coming under the radar of governments, and gradually gaining China large stakes in the very companies that they help to make rich by buying their products.

So, in conclusion, be ready for a new wave of massive Chinese, Russian and Saudi Arabian money that will push up prices of shares and property throughout the world over the next 5-10 years. A great period to own resource companies and in all likelihood most quality assets around the world, as the savers of China push up the values of overseas assets, similar to what we have already seen in the local Chinese property and share markets this last few years. The big question will be what assets overseas do the Chinese most desire? Once you answer this question you will become very rich indeed.

Latest Government Changes

From Budget night (8/5/07)

  • Changes to the Tax Thresholds
    New Tax Tables for 07/08
    Tax Thresholds ($) Tax rate (%)
    0 – 6,000 0
    6,001 – 30,000 15
    30,001 – 75,000 30
    75,001 – 150,000 40
    150,001 –> 45
       
    New Tax Tables for 08/09
    Tax Thresholds ($) Tax rate (%)
    0 – 6,000 0
    6,001 – 30,000 15
    30,001 – 80,000 30
    80,001180,000 40
    180,001 –> 45

    Nb: Plus medicare, plus medicare surcharge if applicable
    Nb: Bold areas represent the thresholds that have changed
  • 2005-06 Government Super Co-Contribution recipients to receive a one-off doubling of their payment received to be in their Super account by June 30.
  • $1,000 ‘Seniors Bonus’ -- tax free bonus to senior citizens that receive the utilities or seniors concession allowances, or individuals that receive the mature age allowance, widows allowance or partners allowance.
  • $600 ‘Carers Bonus’—For those that receive a careers allowance they will receive $600 for each person in their care.
  • $1,000 for those receiving careers payments.

From July 1,2007

  • Low Income Tax Offset to increase to $750 from $600, and phase–out to begin at $30,000 up from $25,000
  • The dependent spouse rebate (for tax payers with non-working spouses to increase to $2,100 from $1,655.
  • Tax department will help fill out your electronic tax return. They will pre-populate areas such as salary, welfare payments, interest, dividends, health insurance details. You will just need to put in your deductions.
  • $8,000 rebate for installing solar hot water system to your home. Money towards promoting energy efficient light bulbs.
  • Apprentices under age 30 in skill-shortage trades will get $1,000 in two installments.
  • The Government will allow the number of migrants to increase to 152,800 up from 144,000.

Summary of where the Budget Surpluses (next 4 year plan) will go:

  1. Future Fund – To pay for unfunded Government workers retirement (Super).
  2. Tax Cuts – see above
  3. Welfare increases – see above
  4. $5b University/Education Endowment Fund the interest to be used on our universities.
  5. $22b(07/08) for the defence- 24 new super hornet planes($6.6b over 13 yrs), Iraq ($302m), Afghanistan($448m)

Pension Changes

  • Table of Super Pensions New Minimum Amounts from 1 July, 2007
    Under 65       4%
    65 - 74   5%
    75 - 79   6%
    80 - 84   7%
    85 - 89   9%
    90 - 94   11%
    95 or older   14%

    Nb : There will be no maximum.

  • Transition to Retirement Pensions
    From July 1,2007, only 10% of your Super can be taken as a transition pension each year. Remember also you cannot withdraw a lump sum from ‘transition pensions’.
    Eg: Is the same as having a 10% maximum amount

  • Account-based pensions to be the new name for Allocated Pensions

 

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.