Quarterly Newsletter - January 08

Major Indices   (as of 1/1/08)

 
Currency
(AUD)
Interest Rate(%)
Share Index
* PE ratio
(forward)
GDP (%) 2006
GDP Forecast (2007)
Population
(m=million)
Foreign Surplus / (Debt) %GDP
Australia
1.00
6.75
All Ords
6,429
15.8
3.9
3.0
21m
(6.0)
USA (Dollar)
88
4.25
S&P 500
1,468
16.7
2.5
1.9
300m
(6.5)
Largest dollar deficit 2006
( 857 billion)
Japan (Yen)
99
0.5
Nikkei 225
15,341
18.4
1-2
1.5
127m (declining)
2007 - USD 875 billion 2nd largest dollar surplus
China (Yuan)
6.4
7.47
CSI 300 (Shanghai/Shenzhen)
5,580
Mainland
45
Hong Kong
179
11.7
10.0
1,350m
2007- USD 1.5 Trillion, number 1 largest surplus in the world
India (Rupee)
34.5
7.75
BSE 200
2,673
26.5
9.3
8.4
1,150m
2007 - USD 250 billion 
Europe (Euro)
0.60
4.00
DJ Stoxx 50
4,404
N/A
2-3
2.1
725m (declining)
 
UK (pound)
0.44
5.50
FTSE 100
6,456
12.6
2-3
2-3
60m
 
Global
N/A
 
 
16.4
5.3
4.80
6,000m
 

* PE ratios as of Dec 07 (based on historical earnings)
US 10 Yr Bond Rate – 4.25%    US 30 Yr Bond Rate – 5.0%
Source: Bloomberg

Commodities

Oil - Nymex (USD/barrel) 96
Natural Gas (per million m btu) 5.90
Coal-thermal ($/tonne) 89
Uranium (USD/pound) 85
Gold (USD/ounce) 834
 
Iron Ore (cents/dmtu) 84.7
~$190/tonne spot price
Copper (USD/pound) 3.01
Nickel (USD/pound) 11.76
Zinc (USD/pound) 1.05
Aluminium (USD/pound) 1.07
  [www.kitco.com]
Source : Kitco, quotemarkets

Commentary – Past 3 months

Second Quarter 07/08 financial year saw share markets globally recovering in October only to be smashed again in November and ending the quarter generally slightly lower with India being the standout exception with the BSE rising a staggering 25.4% for the quarter. The sub-prime US mortgage crisis and subsequent credit squeeze saw continued massive write downs by the large US investment banks. As a result the cost of borrowing increased, US house prices continued to fall and the US economy slowed significantly. Analysts now rate the chance of a US recession as 40%.A secondary effect of the increased cost of borrowing and credit squeeze saw Centro properties badly effected dropping 75% in a day with the Australian LPT sector down 11% in a day, and down again for the quarter. Finally BHP has made an offer to take over RIO.

The best performing sectors for the past 3 months were cash and resources, the worst being listed property which fell again around 10%. Against this back drop the Shanghai and Shenzhen bubble deflated somewhat with the CSI 300 down 4.3% for the quarter. US was down 3.8%, Japan was down a massive 9.1% and Australia down 2.4% all on fears of a US recession. India really was a standout story with 25.4% gain for the quarter. World growth slowed especially USA, Japan and to some degree Europe whilst China and India as well as the booming Saudi Arabia stayed strong.

Currencies were generally unchanged over the quarter a part from some strength in the Euro.

As discussed in previous newsletters the fall in the listed property sector has long been expected as has the fall in the local Chinese market. Both had been overvalued with the former suffering from rising interest rates as well.

Commodities

World oil prices continued to rise to USD $96 per barrel on concerns of supply disruptions and strong Chinese demand. Other resources prices have softened a bit, in particular Nickel and Copper. Gold strengthened and Uranium has started to pick up again and I expect will be a good future area with nuclear power looking more likely as a solution for the worlds energy along with renewables (see below). Coal is up 48% for the quarter, as it is used for Chinese power stations as well as in blast furnaces to make Iron. Finally Iron ore has gone crazy with spot prices at around USD 190/tonne leading analysts to forecast price rises next year of between 30 and 50% for Iron Ore contracts.

Commentary – Forecast next 6 months

The next 6 months will see a further slow down and possible recession in the USA .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 USA, however the world is more interlinked than ever. The latest view is that India with it’s burgeoning middle class will be least affected by a slowdown in world growth and for similar reasons China should be ok. Growth in the Chinese economy is around 12 per cent and India around 10%.The oil rich and commodity nations continue to flourish especially with oil almost at $100/barrel. Saudi Arabia is expected to continue to boom.

The main areas to be cautious about at present are:
  1. A spreading of mortgage defaults deeper into the main mortgage markets of USA, or more worrying, if it was to start occurring in China or other parts of the world resulting in a global liquidity crisis and US recession. US investors may withdraw funds from the emerging markets.
  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.
  4. A rise in inflation triggered by oil price spikes and subsequent increased interest rates.
  5. Chinese inflation causing global inflation and subsequent increased interest rates.

It would still be wise not to be fully invested at present and to wait to see how these issues play out.

On the positive side

  1. World growth remains strong at around 4.50% (especially China and India)
  2. Inflation is just under control and US is likely to cut rates
  3. Chinese sovereign funds will commence buying global equities
  4. Continued rise in wealth and spending power of the Indian and Chinese middle class
  5. Asia has become less reliant on exports to USA and now more Asian exports go to China than to USA.
  6. Demand for key resources has never been stronger
  7. Chinese Olympics in August 2008

As we approach 2008 with a 40% 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 40% chance you may wish to hold 40% 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. Be wary of going into India in the short term as it has had a stellar run and with a PE of 26.5 is a bit overvalued in the short term.

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. Still be wary of property trusts despite there recent large falls. 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.

Australia

I expect the Australian share market to move sideways or slightly up over the next 3-6 months. The market at PE 15.8 is bang on fair value. Home affordability in Australia is still at record lows and building activity is at recessionary levels. Tourism is not performing well, leaving mining to continue prop up the Australian economy. There has been some recovery in residential property but I expect this to be short-lived.

Avoid banks that source there funds from areas other than their deposit base as they will suffer significant erosions in their margin. Just look at what happened to Rams.

Resources sector to continue to do somewhat better than the market average.

China and India – The Elephant awakens

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 are getting high. Foreign surplus reached USD 1.5 Trillion growing at around a staggering 1 billion USD per day. Net result will be a strengthening Yuan and a continuation of the growth in Chinese asset prices including mainland and Hong Kong shares. I expect to see Shanghai and Shenzhen markets fall back a bit more but the better valued Hong Kong to do well.

The India share market performed spectacularly last quarter a sure sign that India “the Elephant has awaken”.

India will probably pause or retreat in the short term, however has massive mid to long term potential. India has the youngest population in the world with half their population below 25 years old.

US Recession ("sub- prime crisis")

USA will probably be in recession for the first half of 2008 and by the time we get the data to prove it occurred they will be on their way to recovery.

Over the next 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. The peak of US resets are due in March 2008 and this is when US will be at it’s worst. Foreclosure auctions are now common place and will become the norm.

Only massive bail outs by the US government or massive rate deceases will save the US.

But don’t worry China, India and Saudi Arabia will sustain world growth to avoid a global recession.

Avoid US stocks and currency.

What’s Next ?

But don’t worry China, India and Saudi Arabia will sustain world growth to avoid a global recession.

The reason why is simple --- “Capitalism and Urbanisation” of China, India, South America, Eastern Europe and Saudi Arabia.

To understand this we look at the past. When the USA and post war Japan urbanized it lead to a commodities boom each time and a strengthening of world growth.

Japan had 2% of the world’s population when it urbanized and that caused a 20 year commodities boom. By comparison China and India which are both urbanizing simultaneously after years of neglect represent a massive 36% of the world’s population. The effect on resources and share markets is unprecedented.

In conclusion, use any weakness this year in key areas as a chance to build your position to capitalize on this once in a lifetime boom. Don’t let fear of the US house crisis prevent you from missing this opportunity.

Key areas to invest you funds would be:

  • Cash/Mortgages - 40% (ready for buying opportunities)
  • Australian Shares – 10%
  • Emerging markets Infrastructure – 10%
  • Global Resources – 15%
  • China – 10%
  • India -10%
  • Saudi Arabia – 5%

Good Speculative Potential

  • Emerging Market Infrastructure Funds
  • Uranium shares – 441 Nuclear plants worldwide with another 70 planned and under construction. France is almost entirely nuclear now and both China and India have very large nuclear energy expansion plans for the future.
    According to the International Energy Agency, current uranium mine production
    meets only 65% of the total demand for the world’s 400-plus nuclear reactors.
    The remaining 35% has been met by official stores of uranium by national governments, or the conversion of nuclear warheads from the former Soviet Union into fuel. That supply, however, is running out.
  • Renewable Energy- Wind Energy (the most cost effective alternative), Solar, Geothermal
    - The UK have recently announced they plan to get 50% of their energy needs from Wind Energy by 2020.
  • Oil companies – With oil at 100USD a barrel this is a very lucrative business still.
  • Zinc companies – LME inventories are at very low levels.
  • Food companies – Wheat, Dairy, Beef, Pork due to rising Asian demand

Latest Government Changes

From election campaign Dec 2007

Changes to the Tax Thresholds
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 – 34,000
15
34,001 – 80,000
30
80,001 – 180,000
40
180,001 –>
45

Nb: Plus medicare, plus medicare surcharge if applicable
Nb: Bold areas represent the thresholds that have changed

New Tax Tables for 2010/11
Tax Thresholds ($) Tax rate (%)
0 – 6,000
0
6,001 – 37,000
15
37,001 – 75,000
30
75,001 – 180,000
37
180,001 –>
45
   
New Tax Tables for 2013/14
Tax Thresholds ($) Tax rate (%)
0 – 6,000
0
6,001 – 37,000
15
37,001 – 180,000
30
 
180,001 –>
40


Nb: The above assumes that Labor keeps their promise to implement the Howard 2007 election tax cuts.

50% Education Tax Refund

Eligible parents can claim;

  • 50% refund of education expenses up to a maximum of $750 (or $375 per child per year) for Primary School expenses.
  • 50% refund of education expenses up to a maximum of $1,500 (or $750 per child per year) for Secondary School expenses.

NB: To be eligible you must receive family tax benefit A, apply through your tax return.

50% Child Care Rebate

  • The Child Care rebate will increase to 50% from 30% and will cover up to $7,500 of out of pocket expenses per child paid quarterly.

First Home owners Savings Accounts (FHOSA)

  • It will work like a Super fund only is accessible for a house purchase only.
  • Pre- tax contributions (max $5,000pa indexed) – nil income tax, 15% contributions tax
  • Post tax- contributions – normal income tax paid, then nil contributions tax.
  • Tax on earnings within FHOSA– 15%
  • Withdrawals- Nil tax, Must be for a home, must have been in FHOSA for 4 years
  • To be eligible you need to be over 18 and eligible to receive the first home owners grant.

Superannuation Guarantee

  • The Labor Government sees the 9% SG as inadequate and is working towards changing this towards 15%.

Social Security Changes

  • The Utilities Allowance will increase to $500pa (singles and couples) who are Age and Veteran Service Pensioners.
  • Carer payment and Disability Support Pensioners will receive the above Utilities Allowance payment for the first time.
  • Commonwealth Seniors Health Care Card recipients will receive an increased Seniors Concession Allowance of $125 per quarter.
  • The Telephone Allowance will increase from $88 to $132pa
  • By 2009 there will be reciprocal public transport concessions between all states and territories.

 

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.