Quarterly Newsletter - October 07
Major Indices (as of 1/10/07)
* PE ratios as of Sept 07 (based on 1 year
estimate forward earnings)
Commentary – Past 3 months
First Quarter 07/08 financial year saw share markets globally falling for a month from mid July to mid August dropping between 10 and 15% due to the sub-prime US mortgage crisis and collapses of several hedge funds owned by Bear Sterns, Macquarie Bank and other investment banks. This was the share markets biggest fall since Sept 11. As a result the cost of borrowing increased, US house prices fell and the US economy slowed significantly. Many analysts now rate the chance of a US recession as 50%, recently confirmed by the August US employment numbers dropping the most in four years.
The best performing sectors for the past 3 months were resources and, the worst being listed property which fell again around 6%. Against this back drop the local Chinese share market continued to power higher creating new records and passing the 5,000 mark. In fact it grew by a staggering 54% last quarter, followed by Honk Kong and India (up 18% for the quarter).World growth remained robust; especially China, India, and other parts of the Asian region, Europe remained fairly strong, Japan slowed a bit, whilst USA continues with weak yet positive growth despite a crippling housing crisis.
The US sub prime crisis saw an unwinding of the Yen carry trade whereby the Yen appreciated 10% in a matter of days as investors sold off their risky investments and paid back their Yen denominated loans. As markets recovered the Yen carry trade resumed.
World oil prices rose strongly to USD $81 per barrel on concerns of supply disruptions and Strong Chinese demand. Other resources prices have softened a bit, in particular Nickel which has virtually halved in value from its ridiculous high. Copper remained steady and as predicted Uranium has started to drop from it’s peak and is now at USD 85 per pound. Finally iron ore has continued it’s strength with spot prices at around USD 100/tonne leading analysts to forecast price rises next year of between 20 and 40% for Iron Ore contracts.
The above softness is mostly confined to those areas that saw ridiculous growth last year, and despite a looming US recession most commodities have stayed strong buoyed by China.
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.
dollar has had a yo yo ride relative to the US dollar as a reaction
to the sub prime crisis. It finished the quarter strongly
up at US 88 cents, mostly on continued US dollar weakness.
Commentary – Forecast next 6 months
The next 6 months will see further deterioration of the USA and a 50% chance of a US recession (see below). We will also see a slowing of 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 not be derailed by the US, however the world is more interlinked than ever. China is the most likely country to be least effected by a US recession as it now exports only 20% of it’s goods to USA and has huge internal demand for it’s own goods. Growth in the Chinese economy has accelerated to around12 per cent (and India around 10%), and Europe and Japan are doing reasonably well. The oil rich and commodity nations continue to flourish.
The main areas to be cautious about at present are:
It would be wise not to be fully invested at present and to wait to see how these issues play out.
On the positive side
As we approach October 2007 (previous crashes in Oct 87 and Oct 97) with a risk of US recession and global liquidity problems, the safest place to be is in cash or safe mortgage products. As the US recession is still rated a 50% chance you may wish to hold 50% of your portfolio in cash in the short term. If you do take exposure to markets the best area to be are China and India. 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. Additionally the Chinese government has commenced a trial where the Chinese are now allowed to buy and sell shares listed in Hong Kong. This will give the Hong Kong market a large boost and is my number one hot spot to invest right now. Areas to avoid continue to be USA largely due to the housing crisis and their massive debt with the likelihood of continuing weakening currency, non-bank lenders or companies vulnerable to a credit crunch, and most western countries residential property which is still overvalued. As home loan interest rates are predicted to reach 9% by 2009 take any dips in long term rates as a last chance to fix in your loan..
I expect the Australian share market to move sideways or slightly up over the next 3-6 months, due to a weakened property market and a fairly 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 continue to unwind or slow and the banking and consumer spending sectors will probably struggle, however I expect the Resources sector to continue to do somewhat better than the market average.
High Price Earnings stocks or companies that don’t meet earnings expectations could be smashed whilst low PE shares may do ok, but cash will probably do better..
China and India
China should continue to do well driven by pre-Olympic fever and the 40 million people pa urbanization and the rise in middle class wages.
However inflation is running at a 11 year high and in September Chinese interest rates went up a further 0.54%, to 7.29%. Foreign surplus reached USD 1.4 Trillion including August surplus of USD 25 billion. Net result will be a strengthening Yuan and a continuation of the growth in Chinese asset prices including mainland and Hong Kong shares. Don’t be surprised however to see Shanghai and Shenzen markets fall back or take a breather after running up over 200% in the last year and a half.
India will follow in a similar fashion to China without the Olympic boost and all the hype.
US Recession (øsub- prime crisisÓ)
As we approach October 2007 it pays to remember history. October 1987 saw a horrific 25% global share market correction albeit from an overvalued market, then we had a 15% correction in October 1997, and as we approach October 2007 we have the USA on the brink of a recession, or at the very least in a deep housing crisis.
Over the two years around 2 million US reset mortgages (taken on a cheap introductory rate) will reset to higher rates at a time when jobs are being lost. (In August US employment numbers dropped for the first time in four years).The peak of US resets are due in March 2008 and this is when US will be at its worst. Foreclosure auctions are now common place and will become the norm.
The housing downturn caused a liquidity crisis where the lenders cost of capital has increased causing lenders to restrict lending.
Meanwhile various hedge or other funds that had geared (borrowed) to invest in US subprime mortgages began to fail commencing with 2 Bears Sterns Hedge Funds followed by Macquarie Fortress Fund and Basis Capital.
This in turn caused a mass rewinding off debt and the Yen carry trade.
As a result of forced selling the global share markets fell around 10% in July/August.
Next we saw other non-bank lenders such as Rams in trouble due to the increased cost of debt followed by panic in the UK as investors cued outside Northern Rock to get their money out.
What’s Next ?
The US will most likely avoid recession thanks to the “ Ben Bernanke put” where he reduces interest rates as per last month’s 0.5% reduction.
However, the world will continue to see a two tiered economy with the rapidly growing emerging markets of India, China, Russia and Brazil doing well while the developed world performing poorly.
Mainland Chinese companies’ earnings growth is running at 80%pa so China will continue to do well and won’t really be greatly troubled by the US slowdown.
So buy Chinese markets as bargains appear, and watch the boom in pre-Olympic Chinese profits.
Be careful of October, but after this look to invest into the growth regions being careful to avoid the overvalued local Chinese market.
Continue to avoid US stocks
Latest Government Changes
From Budget night (8/5/07)
From July 1,2007
Summary of where the Budget Surpluses (next 4 year plan) will go:
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
suitable to your own needs and objectives.