Quarterly Newsletter - October 2010

Major Indices   (as of 1/10/10)

 
Currency
(AUD)
Interest Rate(%)
Share Index
* PE ratio
(historical)
GDP (2010) IMF
GDP Forecast (2011) IMF
Population
(m=million)
Foreign Surplus (Debt) %GDP
Australia
1.00
4.50
All Ords
4,634
18.20
3.0
3.5
21m
2009 - (5.0)
USA (Dollar)
0.97
0.25
S&P 500
1,141
17.58
3.3
2.9
300m
2010 - (14.5)
Largest USD deficit, 14.5 trillion
Japan (Yen)
81
0.10
Nikkei 225
9,404
22.58
2.4
1.8
127m (declining)
China (Yuan)
6.51
5.31
CSI 300
2,935
Hang Seng
22,358
China
15.63
Hong Kong
15.31
10.5
9.6
1,350m
2010 - USD 2 Trillion
Number 1 largest surplus in the world
India (Rupee)
43
5.0
BSE 200
2,579
?
9.4
8.4
1,150m
2009 - USD 277 billion surplus
Europe (Euro)
0.71
1.00
DJ Stoxx 50
2,750
16.27
1.4
(Germany)
1.6
(Germany)
725m (declining)
 
UK (pound)
0.61
0.50
FTSE 100
5,597
15.61
1.2
2.1
60m
 
Global
N/A
 
 
17.40
3.0
3.5
6,000m
 

* PE ratios (based on historical earnings)
US 10 Yr Bond Rate – 2.62%    US 30 Yr Bond Rate – 3.87%
Source: Bloomberg

Commodities

Oil - Nymex (USD/barrel) 80
Natural Gas (per million mbtu) 3.82
Coal-thermal ($/tonne) 105
Uranium (USD/pound) 49
Gold (USD/ounce) 1,316
Wheat (cents/bushel) 674
 
Iron Ore ($/tonne) spot price 167
Copper (USD/pound) 3.62
Nickel (USD/pound) 10.52
Zinc (USD/pound) 0.97
Aluminium (USD/pound) 1.04
Corn (cents/bushel) 495
  [www.kitco.com]
Source : Kitco, quotemarkets

 

Baltic Dry Index (BDI) October 2,446
US Retail Sales Forecast
(USD Trillion)
October (forecast)
352
November (forecast)
353
December (forecast)
413
U.S. Retail Sales


Commentary – Past 3 months

First Quarter 10/11 financial year saw most share markets globally move slightly downwards as global confidence remained fragile and fears of a double dip recession remain. See discussion below about Nouriel Rubini.

An exception to this was the Hong Kong Hang Seng and the India BSE 200 which both improved over the quarter. Other exceptions were in the booming developing economies of Philippines (up 34% for the year to date), Thailand (up 30%) and Indonesia (up 28%).

It appears that no-one told these countries that times are tough. They are all running at a super pace to catch up to the Western lifestyle with GDPs around 7% pa.

Global share market
Price to Earnings (PE) ratios have declined somewhat however are still a bit high perhaps with the exception of the booming developing economies.

Global exports have started to slow and economists are predicting further slowdown in 2010.

US employment is flat still hovering at around 10% unemployed, and Australia around 5% unemployed.

China and India continue to do well. An IMF GDP forecast for 2010/2011 of 10% growth is quite incredible in the current world climate.
Other parts of Asia and South America, especially South East Asia continues to go along very strongly, oblivious to the Western world’s woes.

The Baltic Dry Index (BDI) has recently weakened to 2,446, another bearish sign.

US retail sales forecasts are flat.

Global GDP is still low in all the western countries (especially bad in Europe and UK) with most of them hovering around 0-3.0%, apparently coming out of recession with hopes for world growth in 2011 to reach 3.5% (IMFs Sept 2010 forecast). The IMF has recently upgraded GDP forecasts to India similar to that of China, and both amazing growth. It is definitely a two speed world - the slow developed and booming developing economies.

Global Interest Rates have not changed this past 3 months while US long term bonds rates have fallen sharply (especially the 10 yr US Bond) to historically low levels (see chart below), a bearish sign that indicates the World economies are still struggling particularly the developed economies and may well indicate we are heading for a second wave down. The RBA (Australia) has led the G20 again by raising rates by a further 0.5% in attempt to prick the Australian housing bubble. Australia is the only country in the table above where interest rates rose in the past quarter.

Currencies over the quarter were summarized by a weakening in the Euro and US dollar. The Australian dollar (AUD) rose compared to all major currencies with only the Japanese Yen outperforming it despite the Japanese Governments attempts to lower it’s currency.
The Aussie dollar is likely to soon reach parity with the US dollar and perhaps continue to move higher

Commodities
Oil has not changed over the quarter and still sits at USD 80, while Natural Gas barely changed also over the quarter.

Gold has increased further and is currently $1,316 per ounce, a stellar run.

Copper continued to increase slightly, reaching $3.62 per pound a good sign that the construction industry is slowly recovering, or at least Chinese demand is still strong.

Coal increased significantly, however Iron Ore prices have now doubled from the old contract prices as are now sold on the Spot market at a great price of $167/ tone. A boom for Vale, Rio and BHP.

Soft commodities were significantly higher lead by wheat and corn, on drought concerns.

A recent trend may be that the Chinese are buying Commodities and stockpiling them rather than buying US Treasury Bonds. A wise move indeed.

Australian House prices
Australian house prices continue to remain largely stagnant, and this is expected for several years to come until the housing bubble is slowly deflated despite continual bias press ‘propaganda’ about the housing shortage in Australia.

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, unless the bubble is pricked by Glenn Stevens (Governor of the RBA) rising rates and crippling the average mortgage holder in Australia.


Commentary – Forecast next 6 months

Leading indicators are somewhat bearish and the share markets remain slightly overvalued (not as bad as 3 months ago), especially if earning growth is not very strong as appears likely. There is considered a 40% risk of a second wave down in the GFC caused by the European Debt Crisis etc.

The Baltic Dry Shipping Index has decreased 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 continue to 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 slightly with the recovery otherwise share markets are definitively still slightly overvalued.

The Euro should 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.

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 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.

  • Aggressive and Growth investors should cash up a bit and lock in some profits or invest in the developing economies.
  • Keep some Cash or safe fixed interest. At least 40% for Growth clients, 60% for Moderate Clients and 80% for conservative clients. As Australian rates rise it may pay to hold more cash.
  • Avoid US and Euro, and UK currency, and be cautious still on most share markets as they are currently slightly overvalued..
  • 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.

Aussie Dollar approaches parity with the US Dollar

The Australian dollar has never achieved parity with the US dollar since it was freed to float on the currency markets by the Hawke government on December 12, 1983, and if you take a longer view, it is not at record highs. It was as high as $1.48 to the US dollar, for example, in the first half of the 1970s, when it was being arbitrarily set by the government, and used as a device to combat rampant inflation.

It was fetching ¥422 in 1974, before Japan's status as an industrial superpower was confirmed, and today it buys about ¥80. It has climbed from a global crisis low of just over 48 euro cents to more than 70 euro cents but was above 60 euro cents before the crisis.

Nouriel Roubini predicts a 40% chance of a double dip recession

Nouriel Roubini (renowned economist) is the man who predicted the Global Financial Crisis (GFC) correctly. Currently he predicts a 40% chance of a double dip recession. So it would be wise to at least be prepared in case things turn ugly again. His arguments are based on the weak state of employment in the developed economies and the massive sovereign debts held by these countries such as USA, Europe and UK. The most likely outcome is that we will get a very weak and prolonged recovery in the West. That is better than a second GFC at least.
In this scenario Nouriel sees developed equity and currency markets as being stagnant with low PEs due to low growth; and emerging markets(EM) having rallying currencies and equities and higher PEs and growth. For further information on different scenarios click through to this link.

US Debt problems still there

(A recent article from a financial magazine)

With the interest bill on the country's $US13 trillion-plus ($A14.5 trillion) national debt the equivalent of 14 per cent of its gross domestic product (GDP), Kotlikoff predicts inevitable long-term pain.

"The first possibility is massive benefit cuts visited on the (US) baby boomers in retirement,'' Kotlikoff wrote for Bloomberg.

''The second is astronomical tax increases that leave the young with little incentive to work and save.

"And the third is the government simply printing vast quantities of money to cover its bills. Most likely we will see a combination of all three responses …

"This is an awful, downhill road to follow, but it's the one we are on. And bond traders will kick us miles down our road once they wake up and realise the US is in worse fiscal shape than Greece."

Where the World is heading?

The U.S. Fed and the Bank of England are going to keep printing money which is only a short term solution to boost asset prices such as shares and property. For investors the strategy remains to invest in inflation wealth protection and growth such as agricultural commodities, gold, silver, metals and mining. Emerging economies such as China, India, Russia, Chile, Brazil, and developed economies such as Australia and Canada (mining countries) will continue to do well as their appreciating currencies will protect your investments purchasing power.

We will continue to see a convergence of GDP per capita between east and west. Assets prices in the developed Western economies will stagnate, while those in the developing Eastern economies will rise steadily. This will be magnified by the relative strengthening of the emerging counties currencies.

A wise move would be to buy some assets in the Emerging economies, ideally real estate or shares. India, Indonesia and the Philippines are three emerging economies with growing wages, asset prices and excellent demographics.

One of the safest ways would be to buy into an Emerging Markets Share or Property Fund.

India and the Emerging Markets

Continuing on from the July 2010 newsletter where we discussed the massive global imbalances of trade into the surplus emerging economies), we take a look at India in some more detail as an example of a booming emerging economy.

BRIC Facts reminder

  • BRIC stands for Brazil, Russia, India and China
  • By 2020 Ernst and Young forecast that the BRIC economies will contribute 40% to global growth.

India Facts

  • 1.1 billion people, with a 300 million middle class growing rapidly.
  • 54% of the population is under 25 years old.
  • The second fastest growing economy in the World at 8.5% pa only just behind China, and predicted to overtake China soon as the world’s fastest growing economy.
  • USD 277 billion in foreign surplus reserves as of September 2009.
  • India’s domestic consumption as a percentage of GDP is the highest in the Asia Pacific region at 57% of GDP.
  • 44.5 million new mobile phone subscribers during the first quarter of 2009 at the height of the GFC.
  • The Indian economy is driven mostly by domestic consumption and hence it’s economy was barely effected by the GFC.
  • Booming IT sector, the number one call centre of the World.
  • Booming but not well known manufacturing sector with global companies such as Samsung, Hyundai, Suzuki, Panasonic, LG and Nokia all setting up huge factories in India.
  • Booming Steel and Resources industry headed up by Tata Group. A Global leader.
  • Tata Group’s Tata Motor now sells the world’s cheapest car the Tata Nano for USD 2,000.
  • The Indian Government is currently planning to spend USD 350 billion (YES billion) to upgrade and improve the countries poor infrastructure (roads, bridges, ports and railways).
  • By 2016 India is expected to be the world’s seventh largest car producer (currently eleventh).
  • By 2025 the Indian middle class population is expected to increase 10 fold with a 3 fold increase in household income.
  • Currently 361 shopping centres under construction
  • Massive growth in the aviation, power and tourism industries where they cannot meet consumer demand
  • “Bollywood” now a global force in movies after several global hits such as Slumdog Millionaire

 

 

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.