Quarterly Newsletter - July 2010

Major Indices   (as of 1/07/10)

 
Currency
(AUD)
Interest Rate(%)
Share Index
* PE ratio
(historical)
GDP (2009) IMF
GDP Forecast (2010) IMF
Population
(m=million)
Foreign Surplus (Debt) %GDP
Australia
1.00
4.50
All Ords
4,246
20.17
0.7
2.0
21m
(5.0)
USA (Dollar)
0.84
0.25
S&P 500
1,030
19.65
-2.7
2.7
300m
(6.5)
Largest dollar deficit, 2009-USD 11.7 trillion and growing rapidly
Japan (Yen)
74
0.10
Nikkei 225
9,176
27.20
-5.4
1.7
127m (declining)
China (Yuan)
5.68
5.31
CSI 300
2,559
Hang Seng
20,128
China
15.66
Hong Kong
15.81
8.5
10.0
1,350m
2010 - USD 2.45 Trillion, number 1 largest surplus in the world
India (Rupee)
39
5.0
BSE 200
2,227
15
5.4
7.7
1,150m
Europe (Euro)
0.68
1.00
DJ Stoxx 50
2,573
17.67
-3.5
1.5 (Germany)
725m (declining)
 
UK (pound)
0.56
0.50
FTSE 100
4,916
16.62
-4.4
1.3
60m
 
Global
N/A
 
 
17.64
-1.3
4.0
6,000m
 

* PE ratios (based on historical earnings)
US 10 Yr Bond Rate – 2.93%    US 30 Yr Bond Rate – 4.11%
Source: Bloomberg

Commodities

Oil - Nymex (USD/barrel) 76
Natural Gas (per million mbtu) 4.62
Coal-thermal ($/tonne) 107
Uranium (USD/pound) 45
Gold (USD/ounce) 1,240
Wheat (cents/bushel) 465
 
Iron Ore ($/tonne) spot price 167
Copper (USD/pound) 2.89
Nickel (USD/pound) 8.75
Zinc (USD/pound) 0.80
Aluminium (USD/pound) 0.86
Corn (cents/bushel) 354
  [www.kitco.com]
Source : Kitco, quotemarkets

 

Baltic Dry Index (BDI) July 2,351
US Retail Sales Forecast
(USD Trillion)
July (forecast)
365
August (forecast)
369
September (forecast)
339
U.S. Retail Sales (mUSD)


Commentary – Past 3 months

Fourth Quarter 09/10 financial year saw most share markets globally move down about 20% as global concerns grew over the Euro debt crisis, persistent U.S. job and housing market weakness, and some slowing in Chinese growth.
An exception to this was the Indian BSE which rose slightly highlighting again India’s resilience to the GFC. Somewhat surprisingly the Chinese market has fallen further, now being very good value on some mild concerns China may be slowing.

Europe's high-stakes debt troubles, persistent U.S. job and housing market weakness.

US retail sales have been flat and US unemployment is fairly stable at 10% unemployed, or 90% employed if you are looking on the positive side.

India and other parts of Asia, especially South East Asia are going along very strongly, oblivious to the Western world’s woes.

The Baltic Dry Index (BDI) has weakened considerably, to 2,351.

Global GDP is still low in all the western countries with most of them hovering around 0-2.5%, apparently coming out of recession with hopes for world growth in 2010 to reach 4.0% (IMF forecast)

Global Interest Rates have not really changed this past 3 months while US long term bonds rates have not changed much. The RBA (Australia) has led raised rates further to 4.5% now high relative to the Western countries.

Currencies over the quarter were summarized by a weakening in the Euro. The Australian dollar (AUD) also fell off a cliff in May compared to all major currencies and ended the quarter the major loser along with the Euro. The Chinese Government announced that they will allow the Chinese Yuan to float (and hence appreciate) more freely but still with some controls. Many analysts think the Chinese currency is as much as 40% undervalued.

Commodities
Generally most commodities declined significantly over the quarter as concern grew about a second dip in the GFC caused by the European and other Sovereign debts.

Oil declined slightly over the quarter to USD 76, while Natural Gas increased strongly over the quarter from $3.87 to $4.62. This was quite amazing considering the fall in all other commodities. This shows the swing towards cleaner energies.

Gold was the other standout performer for the quarter rising to $1,240 from $1,112 per ounce.

Copper fell back on renewed concerns about global growth to $2.89.

Iron Ore rose sharply as it moves to spot prices rather than contract prices. Coal also did well.

Soft commodities were generally weaker.

House prices
Australian properties are still trading at around 6-8x average salary compared to around 2-3x in the USA and many other countries. This still places Australia as having one of the most expensive property markets in the world making it hard to see property prices going upwards. It is more likely to have a decade of moving sideways.


Commentary – Forecast next 6 months

Share markets remain overvalued especially if earning growth is not very strong. There is still a possibility for a second wave down in the GFC caused by the European Debt Crisis.

The Baltic Dry Shipping Index has dropped significantly which is a worrying sign and US Retail sales forecasts are fairly stagnant. Suggesting any recovery will still be weak and prolonged.

Share markets are likely to move sideways or down in the next few months as valuations fall back to more reasonable levels and the fear and issues around the European Debt Crisis play out.

Most markets PE ratios suggest corporate earnings need to increase significantly with the recovery otherwise share markets are definitively still overvalued.

Investors that hold significant cash should still be patient for now and only enter the market gradually or on large dips or phase back into the market over time; however investors who have been aggressively placed to benefit from the recovery should continue to cash up somewhat and lock in some profits just in case there is a second leg down in this 2 year old global recession.

The Euro should still be avoided as should any currency where the country has excessive debt levels as at last the world has begun to realize the huge problems it faces with many countries heavily in debt and no real solution to fix their trade deficits.

Chinese shares are looking well valued at present and with the Yuan likely to appreciate suggests China is a good place to invest, but still do cautiously due the background of Global economic problems.

India also looks quite good, but for similar reasons be cautious.

The emerging economies that are well managed and have strong trade surpluses and current account balances such as China and alot of SE Asia, as well and parts of Africa and South America 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.

  • Keep some Cash or safe fixed interest. At least 60% for Growth clients, 70% for Moderate Clients and 80% for conservative clients. As Australian rates rise it may pay to hold more cash.
  • Avoid US, Euro, and the UK pound currency, and be cautious still on all share markets as they are currently priced for a perfect recovery and I believe still overvalued at present excluding China, India and some other emerging markets..
  • Invest in countries with currency surpluses and positive GDP (eg; China)
  • Avoid Bonds (they perform poorly when interest rates start to rise)
  • In the short term only, decrease or don’t increase exposure to overvalued share markets
  • Be cautious or don’t buy overvalued Australian residential property.
  • Consider some exposure to well valued Emerging Markets such as China and India

Euro Debt Crisis

Continuing on with the Sovereign debt theme from previous newsletters where we evaluated US debt, Dubai’s debt crisis and so on this newsletter we look at the Euro debt crisis led by Greece’s near collapse followed closely by Spain Portugal, Ireland England and others all with alarmingly high sovereign debt levels.

The most likely outcome from this latest crisis is that the Euro will devalue and some countries may even be forced out of the EU.

The side effect of all this again is most likely to be an unsettling of global share markets with significant downside risk especially if you have exposure to European markets or the Euro.

The World Financial Imbalances

Looking back at the last two and half years what can we learn and what can we see as the causal factors of all this havoc in the world share markets and economies.

In my humble opinion, this is all happening and will continue to happen for perhaps another two decades because of the side effects of Globalisation.

That is, since we began to predominately buy and sell goods and services on a global basis not a national basis there has been a severe imbalance in trade flows due mostly to cheap labour from the emerging economies.

This has led to the developed world not manufacturing many goods and providing less global services.

Some classic examples of this are the huge manufacturing of goods in Chinese factories, and the massive call centre businesses in India.

This is causing a massive shift of wealth from the West to the East (see discussion on this topic in previous newsletters).

An example is that most developed economies are struggling now with huge sovereign (Government) debts as their economies are importing a lot more than they are exporting.

This is leading to wave after wave of debt crises around the globe especially in the developed economies.Where in the past it was in the emerging economies where we saw such problems.

So where will it all end and how does it affect investors?

  1. The countries that have positive trade surpluses and build up foreign account surpluses will get richer and their economies will prosper as will their currencies. As a consequence of this we will see a rise in living standards and average salaries as well as property and share values in these countries. Eg: China in the past decade has had massive trade surpluses and the salaries, shares and property prices have all risen dramatically. The Next 11 type countries will follow the Chinese and Indian example. They include Indonesia, Vietnam, Thailand, Philippines, Pakistan as well as many rising countries in South America, Eastern Europe and some smart African countries as well.
  2. The countries that have negative trade surpluses and run up debts will see declining or stalling salaries and living standards, and a gradual decline in their currency and hence global wealth. Egs; USA, UK, Europe (exclude Germany as it usually runs surpluses from selling cars to the world) and many other developed economies. Japan may be ok as it usually runs surpluses again from selling cars to the world. Australia and Canada may also be ok while they still have resources to sell, but once these finite minerals evaporate they may well be in trouble too.

Investors therefore will need to be very aware of what countries debt levels are, and then ideally invest in those countries that are benefitting from the tectonic forces of Globalisation.

Perhaps the good thing to come from all this change is that the people of the world who work so hard for so little (often just a few dollars a day) will finally be lifted to a better life which they deserve. They will earn more and begin to be able to rise out of poverty. This will also affect immigration levels as people realize they might be better to stay in their country where wealth is rising rapidly.

Federal Budget Summary May 2010

  • 50% tax savings discount for interest income from 1 July 2011
    The Government plans to provide a 50% tax discount on up to $1,000 of interest earned by individuals, including interest earned on deposits held in authorised deposit taking institutions, bonds, debentures and annuities. Currently there are relatively higher levels of taxation applying to interest income, compared to other forms of investment income. The discount will be available for interest income earned directly as well as indirectly, such as via a trust or managed investment scheme, and is expected to benefit around 5.7 million taxpayers in 2011-12.

  • Standard tax deduction from 1 July 2012
    The Government plans to introduce a standard deduction for work-related expenses and the cost of managing tax affairs. The standard deduction will be $500 for the 2012/13 financial year, and then $1,000 for the 2013/14 and subsequent financial years.

  • Increased Medicare levy low income threshold from 1 July 2009
    The Government will increase the Medicare levy low income threshold to $18,488 for individuals and $31,196 for families. The additional amount of threshold for each dependent child or student will also increase to $2,865. The Medicare levy threshold for pensioners below age pension age will also be increased to $27,697. This is to ensure that pensioners below age pension age will not have a Medicare liability where they don’t have an income tax liability.
    Additionally, the low income tax offset will increase to $1,500 from its current $1,350 with the upper income threshold being raised to $67,500 from $63,750.

  • Net medical expenses tax offset from 1 July 2010
    The Government plans to increase the threshold above which a taxpayer may claim the net medical expense tax offset (NMETO) from $1,500 to $2,000. This threshold will be indexed to the Consumer Price Index (CPI) on an annual basis.

  • Managed Investment Trusts – Government’s response to the Board of Taxation’s review – effective from 1 July 2011
    The Government plans to introduce a new taxation regime for Australian managed Investment trusts (MITs) in response to the Board of Taxation’s Report on its review of the tax arrangements applying to MITs.

  • Capital protected borrowings – increase to benchmark interest rate from 11 May 2010
    The Government has proposed to increase the benchmark interest rate that applies to capital protected borrowings to the Reserve Bank of Australia (RBA) indicator rate for standard variable housing loans plus 100 basis points. Prior to this announcement the benchmark interest rate was set at the RBA indicator rate for standard variable housing loans.

  • Co-contribution – permanent reduction to matching rate and maximum payable
     
    2009-10
    2010-11
    2011-12
    2012-13
    2013-14
    2014-15
    Matching rate
    100%
    100%
    100%
    125%
    125%
    150%
    Maximum co-contribution
    $1000
    $1000
    $1000
    $1250
    $1250
    $1500
    Reduction rate for each $ above threshold
    3.333 cents
    3.333 cents
    3.333 cents
    4.167 cents
    4.167 cents
    5 cents

  • Co-contribution - indexation of income thresholds paused for two years from 1 July 2010
    The Government plans to freeze for 2010/11 and 2011/12 the indexation applied on the income threshold above which the maximum superannuation co-contribution begins to phase down. The maximum co-contribution of $1,000 is reduced by 3.333 cents for every dollar that a taxpayer’s total income exceeds $31,920 until it reaches or exceeds $61,920.

  • ATO discretion on excess contributions tax assessments.
    This measure proposes giving the Commissioner the ability to exercise its discretion prior to an assessment being issued for excess contributions tax.

  • Changes to First Home Owners Savers Accounts (FHSA) scheme from date of assent
    The Government proposes that savings in an FHSA can be paid into an approved mortgage after the end of a minimum qualifying period, rather than requiring it to be paid to a superannuation account. The current rules require that FHSA holders keep their savings in an FHSA for 4 financial years before they are able to use those savings to buy a home. At present if an account holder buys a home before the end of that 4-year period, the balance of their FHSA must be transferred to their superannuation.11
    The changes will apply for houses purchased after assent of the legislation that will give effect to this measure.

  • Family Tax Benefit non-lodgement suspensions - exemptions
    In the 2008 Budget, the Government had proposed to suspend FTB payments to people who had not lodged their tax return in 12 months and had not responded to Centrelink requests to do so. This measure will be retained with two exceptions. Payments will continue to people who do not have any FTB debt, or where ceasing the payments would cause undue hardship.

  • Family Tax Benefit –A: Strengthening participation requirements from 1 July 2010
    In the 2009 Budget, the Government extended FTB Part A to cover children aged 16-20 who do not have a Year 12 or equivalent qualification, and who participate in full-time education or training, or part-time education or training in combination with other approved activities. The participation measure will now be strengthened. Children will now be required to participate in full-time education or training. Part-time education or training will not be sufficient. These participation requirements will be introduced when the measure commences on 1 July 2010.

  • Child Care Rebate capped from 1 July 2010
    The Child Care Rebate will be capped at $7,500 per child (2008/09 level) from the current annual cap of $7,778 per child. Also indexation of the cap will be paused for four years from 1 July 2010. The out-of-pocket reimbursement of child care expenses will remain at 50 per cent up to the annual cap.12.

  • Expanded Special Disability Trust criteria from 1 January 2011
    The Government will amend the eligibility criteria and allowable uses for Special Disability Trusts. The definition of a beneficiary will be expanded to include people with a disability who can work up to seven hours per week.

  • Disability Support Pension (DSP): refined assessment process
    When determining eligibility for the DSP Centrelink will have a greater focus on the individual’s potential to work. Claimants who do not have sufficient evidence to demonstrate that they cannot be assisted back to work will have their DSP claim rejected and will instead be referred to an employment service to build their employment capacity. Claimants who are clearly unable to work will not be affected, including those with profound disability, serious medical conditions or terminal illness. In addition to these changes from 1 July 2010, assessment for the DSP will be simplified to fast-track more claimants who are clearly eligible due to a cancer, congenital or catastrophic disability.

  • Henry response confirmation
    As expected, the 2010 Budget reiterated the Government’s commitment to the following proposals announced in response to the Henry Tax Review:
    • Increase of super guarantee rate from 9% to 12%, commencing 1 July 2013.
    • Raising the super guarantee maximum eligibility age to 75 from 70.
    • Introducing a 15% low income earners Government contribution capped at $500, effectively refunding contributions tax on up to $3,330 of concessional contributions.
    • Retaining the $50,000 concessional cap for those age 50 or over who have super balances of less than $500,000.
    • Reducing the standard company tax rate to 29% from 1 July 2013 then 28% from 1 July 2014.
    • Reducing the small business company tax rate to 28% from 1 July 2012.
    • Allowing small businesses to immediately write off assets valued at under $5,000 and other assets in a single 30% rate depreciation pool.

  • Personal tax rate from 1 July 2010
    $0 - $6,000 0%
    $6,001 - $37,000 15%
    $37,001 - $80,000 30%
    $80,001 - $180,000 37%
    $180,000 - 45%

 

To find out more please contact an adviser at contactus@hnwfinancialadvising.com.au .

 

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.