Quarterly Newsletter - October 09
Major Indices (as of 30/9/09)
* PE ratios (based on historical
Commentary – Past 3 months
First Quarter 09/10 financial year saw share markets globally continue their strong recovery now lasting 6 months since March 2009.
The last quarter recovery was very broadly spread across the globe, with Australia doing very well with a gain of around 25% for the quarter.
Global exports have picked up a bit and global unemployment is stabilizing around the world hopefully suggesting the worst is behind us.
The past 6 months has seen companies forced to replenish their inventories and hence a pick up in global industrial production but the general consensus is that this has now been done and it will take real world growth to continue the process.
Unfortunately this growth is not really materializing as yet, as the global construction industry is still quite dead (with the exception of infrastructure and government projects).
This is evidenced by the Baltic Dry Index (BDI) having dropped substantially in recent months now almost 50% lower than it was in June – a dramatic and worrying fall (see graph below).
Global GDP is still low in all the western countries with most of them hovering around 0%, technically out of recession but not by much.
China and India continue to be the two outstanding exemptions, as does Indonesia, Philippines and some of the Next 11 countries. The common thread here being poorer countries that have large domestic economies that drive their growth as their people strive for a better life.
Investor sentiment has improved dramatically but is still fragile.
In Australia the best performing sectors for the past 3 months were finance (banking) and property.
Global Interest Rates have not really changed this past 3 months and US long term bonds have also been stagnant in the past quarter. Most Federal reserves have stated that rates are on hold for the foreseeable future, however the RBA (Australia) is hinting of rising rates soon.
Currencies over the quarter were summarized by a further weakening of the US dollar--- a currency surely to avoid!! The Australian dollar gained against most currencies.
Oil has stayed roughly the same over the quarter hovering around $70/barrel, whilst gold has increased approaching the magical $1,000 per ounce.
Copper continued to increase reaching $3 per pound in late July but dropping recently back to $2.66 – another sign that the global construction industry is still languishing.
Iron Ore spot prices are starting to come under pressure as there is currently an excess supply of Iron Ore.
Soft commodities were generally unchanged.
Baltic Dry Index (BDI) in “blue”- Sept 2009
The first home buyer’s scheme is being
phased out from October this year.
Commentary – Forecast next 6 months
Whilst the global economy is a lot more stable than it was 6 months ago and the banking systems have avoided collapse, the Western Governments (USA, UK, Europe, and Australia) have taken the massive private debt onto their books leading to a huge burden for future tax payers to bear. For example the US now has $US11.7 trillion of debt (see “USA, UK, Europe and Australia falling under a mountain of Debt “ below).
the positive side the credit spreads are back to 2007 pre crisis
levels allowing the banks to have cheap access to credit, even though
the banks are being a lot more careful and stricter on who and how
they lend to.
Share markets are likely to consolidate or fall back for the next few months while global economies slowly start to (hopefully) gain traction again.
Investors that hold significant cash should continue to phase back into the share markets especially given the low cash rate, however investors who have been aggressively placed to benefit from the recovery should cash up somewhat and lock in some profits just in case there is a second leg down in this 2 year old global recession.
Valuations in the Asian and Emerging Markets are arguably stretched with PEs around 20, as is the case in USA and Europe and are priced for a perfect global recovery which may not come. Australia is more reasonably valued on a historical PE of 14.23.
As previously stated, it would be wise to concentrate on quality assets, with low debt levels that can benefit from the recovery and on those countries with positive GDP Growth, low debt and strong demographics such as China (nb: Chinese demographics are not so good) and India. The Next 11 emerging economies such as Indonesia, Vietnam and Philippines also should do well over time.
The fallout of the Global Financial Crisis (GFC) is that the developed economies Governments have massively increased their debt levels (see April 2009 HNW newsletter and article below), which is likely to lead to weakening of their currency and possibly inflation and rising interest rates in those countries.
Therefore it is wise to be cautious on investing in those countries with huge debts such as USA, UK, Australia and some parts of Europe.
The debt ridden Western economies may therefore suffer a cycle of deflation, currency collapse, hyperinflation, rising interest rates and further deflation.
The emerging economies that are well managed such as China and India will continue to flourish despite a slowdown in exports to the western countries. Their currencies will strengthen, and they will continue to buy commodities such as iron ore and copper to build cities to house their rising urbanization and affluence.
That is, we will see the wealth and currencies of the Western economies (excluding Japan) decline whilst the well managed emerging economies becoming increasingly wealthy. In effect a massive transfer from West to East.
What to do?
Continue to be cautious.
USA, UK, Europe, and Australia falling under a mountain of Debt
At June 1 this year, US debt amounted to $US11.7 trillion ($13.3 trillion AUD), or about 81 per cent of the nation's $US14.5 trillion GDP. This is a debt of around $33K per person. This figure was a mere $US 0.9 trillion in 1980 representing just 33% of GDP (see graph below). This is a staggering and very worrying increase in debt.
Comparatively, Australian net foreign debt liability is 633 billion AUD or around $27K per person.
Foreign investment in US debt amounts to about $US3.5 trillion, of which about 60 per cent is held by foreign governments, including China ($US760 billion) and Japan ($US686 billion) - relatively small sums when compared with the deficit of $US11.7 trillion. How long will foreign governments and investors keep investing in US debt (ie: treasury bonds)? There are signs of waning appetite especially as the Chinese and Japanese see the US dollar declining and their investments decreasing in value.
These investors are, in rough terms, sourced: 25 per cent foreign (such as China, the oil states and Europe); 25 per cent US domestic investors, and 50 per cent US intra-government agencies. Borrowings from US government agencies are sourced from funds either controlled or influenced by the Treasury, with the major contributors being trust funds established for special purposes, including the Social Security Trust Fund, Medicare Funds, Military Retirement Fund, Civil Service Retirement and the Disability Trust Fund. This means that it will be the US retirees who suffer as age pension and health care funds are severely cut back at a time of increasing ageing population and a declining tax base.
Over the past 50 years the US has a track record of deficits, with only an occasional surplus before 1970. Since then, each year has recorded a deficit with a brief exception during the Clinton administration for the years 1999 to 2001.
Even if the budget were to move into surplus it would make little impression on a US federal debt expected to surpass $US14 trillion, excluding guarantee obligations and borrowings of Fanny Mae and Freddy Mac and so forth. Worse still, a contracting US economy, reduced production and rising unemployment are by no means conducive to increasing receipts through taxation.
The unfunded liability for Social Security and Medicare is massive, in the range of $US58 trillion.
The US is the world's leader in international trade, but each year for the past 30 years it has been running an unfavourable balance of trade, or a trade deficit, meaning the country imports more than it exports and the gap is growing larger.
On all three major economic fronts - the federal debt, budget deficits and the balance of trade, the outlook for the US would appear dim.
The US federal debt now stands at $US11.7 trillion, the budget deficit for 2009 is forecast in the vicinity of $US1.7 trillion and, together with continuing adverse balance of trade outcomes, puts in stark relief the effects of a nation spending far in excess of its earnings.
The status of the US as the world's leading economy and industrial base, with its domestic political stability, has traditionally been an attraction to foreign investors. The Government's ability to borrow has, until recently, not been questioned.
Yet this may change, for the financial crisis which emanated from Wall Street has not only been a major factor in causing the crisis but has also created doubts about the capacity of the US to continue borrowing at present levels to finance its deficits and stimulus packages, which are expected to exceed more than $US4 trillion.
These circumstances present a dilemma to the credit rating agencies. If the massive debt burden and continuing deficits were assessed, for the sake of illustration, according to reasonable commercial standards the US Administration would be seriously insolvent.
All this would suggest distasteful financial adjustments are inevitable, possible leading to social upheaval, as well as a decline in the prestige of the nation.
Until a program is developed to competently address the federal debt and the derivatives markets, the prospects of sustained global recovery, and even stability, remain in question.
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