Quarterly Newsletter - October 2014
Major Indices (as of 1/10/2014)
* PE ratios (based on historical earnings)
Commentary - Past 3 months
The past 3 months for share markets was a mixed bag…..Australia and Europe did poorly while China boomed.
The US share market (despite all the hype) moved sideways over the quarter, with US money printing coming to an end soon. The Fed tapering will end by November, and it is expected that the Fed may raise interest rates by mid 2015 especially if unemployment stays below 6.5%. The US 2nd quarter GDP did rebound strongly as expected after the negative 2.8% first quarter.
European shares were little changed, however European debt to GDP has decreased somewhat.
The Hong Kong share market went sideways this quarter, while the Chinese equity market moved up 13.3% over the quarter, mostly on news of the Shanghai-Hong Kong stock connect (see story later in this newsletter). Chinese Manufacturing remains sluggish (Chinese PMI around 50).
The Indian share market moved sideways after last quarter's 16% surge. After 100 days in office it is now time to see if President Narendra Modi can deliver his promises of reform for India.
The Japanese share market also moved sideways over the quarter.
Asian shares overall had an ok quarter rising slightly overall. Adjusting back to AUD saw a great quarter (up about 10%) for Asian Shares as most of the gains were due to the AUD fall.
The Australian Share market fell slightly over the quarter as miners and banks did poorly.
Global share market Prices to Earnings (PE) ratios are still well above fair value and their average is 19.14. USA, Europe and Japan are still the most overvalued. Australia PE is 15.47 and in fair value range... Emerging Markets are a bit expensive at a PE of 19.86 and Asia at a PE of 13.59 is the better value.
Global exports are improving slightly and the BDI has risen sharply to 1,141 (positive).
US employment is down again by 0.2% currently at
6.1%, and Australia up and down finishing the quarter at 6.1% unemployed.
However the US trend is down and Australia is up.
USA job creation or fabrication continues to do well, by transferring people to work fewer hours for less pay. US home sales have stalled somewhat again indicating a very weak and fragile US recovery. The IMF still forecasts 2015 US growth at 3.0% despite the fact 2014 US growth will likely disappoint and come in around 2%.
Europe is continuing to recover from the GFC with anemic growth.
Chinese manufacturing has been weak again; and Chinese property remains over supplied and weak. Some Government measures have been introduced to help, but the oversupply will take time to clear.
India continues to be jubilant and has launched
a new program "Make in India" to help their economy. Either
way India does seem more positive under Modi and improving.
Global GDP is still low in all the western countries (especially bad in Japan and Europe) with most of them hovering around 0-2%. The IMF has estimated World Growth for 2015 at 3.9% which is ok ,noting most of that will be in the Emerging Markets.
Global Interest Rates have remained mostly the same this quarter except Europe decreasing again by 0.10% to 0.05% to further bolster its sluggish economy.
US long term bonds rates fell again slightly over the quarter perhaps reflecting views that Bonds don’t do well when rates start to rise. Also indicates investors are not as fearful.
Inflation has still been mild in most countries and currently not a great concern for now.
Currencies over the quarter were summarized by a
significant weakening (8%) in the Australian dollar from 0.94 down
to 0.87 to the US dollar. Only the Euro was able to perform as badly.
Oil moved significantly down over the quarter finishing at USD 91 on oversupply concerns, despite attacks in Syria and Iraq; and Natural Gas also fell to USD 4.13.
Copper was weak dropping to $3.01 per pound. The other base metals were mixed and mostly flat.
Iron Ore prices continued their shocking past year falling again this quarter ending at $82 a tonne, due to the China housing and construction slowdown.
Coking Coal rose slightly over the quarter at $119 per tonne.
Uranium seems to have passed it’s shocking lows rising from $28 tonne to $36 a tonne over the quarter.
Gold fell slightly to reach $1,207 as US money printing winds down.
Soft commodities were weaker again over the last
quarter falling heavily.
In summary, it was a terrible quarter again for iron ore …..as a result of the China construction slowdown. However the bottom for many commodities seems to have been reached or is near. The next question is will there be a recovery. Looks likely but only a weak recovery for now, as still too many empty properties (oversupply) in China.
Commentary - Forecast next 6 months
Leading indicators are mildly positive for global growth especially the BDI.
The Baltic Dry Shipping Index (BDI) – (the cost to ship raw materials such as coal & iron ore) has risen in the last quarter and moved from 831 to 1,147, a positive sign of global and China recovery. It may suggest some Resources recovery coming soon.
US Retail sales are forecasted to rise slightly –a mildly positive sign.
The HSBC Chinese Manufacturing PMI index – September 50.2 is indicating the Chinese manufacturing sector is stalling still. A figure below 50 suggests contraction, and above 50 suggests expansion. Note the new Government is trying to shift the economic growth from manufacturing industries to service industries, and consumer consumption.
A summary of the above leading indicators is to expect "a slight China and Resources recovery". Commodities used in construction such as Iron Ore have been smashed the past year but should at least stabilize now. However the recovery will likely be weak given the Chinese housing oversupply.
Western (developed countries) share markets are likely to
move sideways or down, or grind slightly upwards as Bonds and Term
deposits are so low clients are desperate to get a better return so
chase the share market….. Expect Australia to continue to struggle.
Asian, Emerging and Frontier markets shares and property (as well as Global Resources) should do well over the next decade despite some recent setbacks.
The ASEAN and Next 11 countries– led by Indonesia, Philippines, Vietnam, Cambodia, Turkey Pakistan, etc… That is, the cheap labour countries that are getting all the jobs…will show the best returns.
If the US or Europe collapses under their mountain of debt then all economies and share markets will suffer.
The USD, Euro, Yen, and AUD should be avoided, as should any currency where the country has excessive debt levels or high labour costs, 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 West (developed economies) may likely move sideways for another decade or two while they sort out their debt problems (personal and Government debts), meanwhile the emerging economies that participate successfully in Globalization will become increasingly wealthy. In effect a massive transfer from West to East or a steady equalization of the World over the next two decades. I see salaries and asset prices being equal between West and East by 2030.
NB: Western companies whose main client markets are in the emerging markets can still do well.
Australian residential house prices have stalled.
BlackRock, Pimco sue Deutsche Bank, U.S. Bank for USD 250 Billion
Blackrock Inc. and Pacific Investment Management Co. (PIMCO) are
US fund management giants. They’re still smarting over losses
incurred from mortgage backed securities that failed so spectacularly
when the US housing bubble burst in 2007-08.
This really could be a big deal for China stocks (from CNBC July 17)
Plans to allow greater foreign investment in Shanghai's A-share market could prove to be a game changer for investment in Chinese shares, analysts say. A scheme called the Shanghai-Hong Kong stock connect, announced earlier this year and due to be formally launched in October, will allow foreign investors to place buy or sell orders on Shanghai's A-share market through brokers in Hong Kong. Chinese investors meanwhile will be able to use mainland brokers to invest in Hong Kong's H-share market.
"So far it is relatively difficult for international investors to get access to Chinese A-shares and with this connect scheme, we will have an additional 550 billion renminbi ($88.6 billion) on top of existing [investment] allocations, so there is more money going into this space," said Francois Perrin, head of greater China equities at BNP Paribas Investment Partners.
According Citibank, foreign investors make up about 1 percent of the turnover in the Chinese A-share market while domestic retail investors account for about 80 percent. In a June report Citibank said one long-term implication of the Shanghai-Hong Kong stock connect scheme would be to "improve A-share market fundamentals and efficiency with a more balanced investor base. A-shares may be added to global indexes (for example the MSCI Emerging Market stock index) which would result in substantial liquidity flow into the A-share market."
Still, analysts say the connect scheme should provide a significant boost to Chinese shares in the second half of this year.
"But going through 2104, we have strong momentum on Chinese equities linked with the Shanghai-Hong Kong stock connect," he added. "It will put China back on the agenda for a number of international and domestic investors and is something that could be a game changer for Chinese equities." Stephen Sheung, head of investment strategy at SHK Private, said that while establishing the connect scheme was significant; the impact on Chinese shares was likely to be felt over a longer time period. "This [the Shanghai-Hong Kong connect] is a big deal here," said the Hong-Kong based analyst.
"The official timing for its launch is October, but it could take longer. This is a game changer but it is most likely that the impact will be felt later rather than right now," Sheung added. Also the other half of this new deal will lead a lot of Chinese money into Honk Kong Shares.
Shanghai and Shenzhen Stock exchanges likely to be included in the MSCI and/or FTSE Global Share Indices
As a next step the China A-shares listed in the Shanghai and Shenzhen exchanges (with market capitalization totaling around US$4 trillion) are likely to be eligible to be included in the global equity market indices from MSCI, FTSE, and other providers. That will be a big boom for Chinese shares. If A-shares were included in global benchmarks without any quota restrictions or foreign ownership restrictions, the weight of China in the FTSE Emerging All Cap index could nearly double from 19% to nearly 38%. This is expected to happen in 2015.
The PICS are growing faster than the BRICS
According to recent research from Compagnie Française d’Assurance pour le Commerce Extérieur (COFACE) the PICS are growing faster then the PICS.
The PICS are the Philippines, Peru, Indonesia, Colombia and Sri Lanka and their combined GDPs is higher than the BRICS (Brazil, Russia, India, China and South Africa).
The criteria used by COFACE to determine the new emerging economies include intermediate level of per capita income (above that of less advanced economies but below that of advanced economies); higher GDP growth rate than most advanced economies; and major institutional transformations.
COFACE cited the Philippines as a country with high growth potential and the most favorable prospect of increasing production capacity in the years to come.
The Philippines will boom this next decade
Three reasons why the Philippines will boom this next decade…. And why you should buy well valued property (residential & commercial) and banks here in the Philippines….
ASEAN - Joining together in 2015
The Association of Southeast Asian Nations (ASEAN) comprises the nations of Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam. ASEAN has a population of 600 million people, approximately 10% of the world’s population, and a nominal GDP of USD 2.0 trillion, approximately 3.5% of the world economy. ASEAN also has impressive economic growth rates. In the 13-year period from 1999 to 2012, the bloc’s economy grew in real terms at an average annual rate of 5.5%. This is expected to continue into the future.. According to IMF estimates, ASEAN5 (composed of Singapore, Malaysia, Thailand, Indonesia and the Philippines), will experience GDP growth rates in excess of 5.5% over the next five years. This will likely significantly outstrip growth in developed economies over the same period. Many brokerage firms such as OCBC Securities in Singapore and Boom Securities in Hong Kong, for example, give you the option of trading in all of the five ASEAN markets covered by ASEAN Stocks.
Summary of DBS’s Asian expectations – GDP, middle class -Asian Growth story
How Asians spend their salary;
One of the best ways to profit from the Asian middle class tripling in the next 5.5 years is to buy into companies and funds that sell food and consumer staples to Asians. Banks will also do very well, as will household items and personal items such as TVs, Smart phones etc.
One such fund is CFS Global Emerging Markets Select - Whilst this Fund also has exposure to all emerging markets including Asia, Arabia and Africa and Western companies that sell heavily to emerging markets – it is currently focusing on Consumer Staples (food etc) and Utilities making it a bit safer in down times. Unilever is an example of a top holding. Unilever makes and sells products under more than 1,000 brand names worldwide. Two billion people use them on any given day. Product examples are Sunsilk, Streets, Rexona, Jif, Lipton, Omo, Surf, Lux etc. http://www.unilever.com.au/brands-in-action/view-brands.aspx
Other ways to profit from this is via First Choice Asian
Shares currently focusing on Asian Financials (banks etc), Consumer
Discretionary (eg; Samsung) and IT.
World GDP – distribution of growth tilted to Asia (lead by China)
A more conservative estimate is from McKinsey Global Institute. They estimate that about 32 percent of global financial flows went to emerging economies in 2012, up from 5 percent in 2002. McKinsey recently predicted that 1.8 billion people will join the consuming class by 2025, nearly all of them in emerging markets. And the firm expects emerging markets consumers to spend $30 trillion annually by 2025, up from $12 trillion a year today.
Global Resources Update – Focus on Iron Ore
Is it time yet to increase exposure to Global resources?
Yes – Asian and Emerging Markets rise means massive urbanization still required. DBS estimates “The Asian megacities will need to house another 290 million new people by 2020”.
No- The Iron Spot price graph below would suggest Iron Ore may even go lower (currently at about US $82).
Conclusion - I think on balance no rush to add to Global Resources especially as China (the main buyer) has reportedly 50 million homes in oversupply. Buying can be done upon large market dips, or if Iron Ore drops below US $70, it can be time to buy more. For now just continue to hold some and wait and see.
Of note the CFS Global Resources Fund gained 15% last year while Iron Ore fell 25% - an amazing fund manager there in Dr Joanne Warner….They achieved this by being early buyers into the Shale Gas revolution. A timely reminder for us the importance of a good Fund Manager as well as realizing Global Resources is not just about BHP and Iron ore. It’s about Energy (Oil, Gas, Coal), Construction (Iron Ore, Coking Coal, Copper) and transportation (Oil). With the rapidly rising Global middle class requiring more energy and construction, Global Resources should do well in the next 20 years, provided not too much new competition hits the major companies causing oversupply.
Iron Ore Spot Price history 1992-2012
Price Earning (PE) Ratios above 20 signal impending danger (or 25 if zero interest rates)
The Chart below shows the US share market over the past 100+ years in blue. In red is the PE ratio (a measure of value, the price of a share divided by it’s earnings per share).
My rule from history is generally once the PE is above 15 then overvaluation is starting to occur. However, the Rule of 20 states that the PE should be about 20 minus the prevailing Reserve Bank interest rate. So USA PE now should be 20-0.25 = 19.75…. and it is about 22, so a bit overvalued and the signal of impending danger(crash) can be moved to 25 in very low interest rate times such as now.
Of course if the growth in earnings is strong then a PE can be allowed to be a bit higher as it will soon fall as earnings increase strongly.
So in conclusion I would consider the US share market to be a bit overvalued, and Asia for example at a PE of 13 (interest rates around 5% ) to be undervalued. If US gets to a PE of 25 I will be very concerned about that market crashing soon.
The chart below of the US shares and PE shows that when PE’s have gone high (especially over 20) then big share market crashes have followed. I remember well my early advising days when the US PE was around 50, and I advised all clients to avoid US shares before the tech crash of 2001. PE s before the GFC was reasonable value just that earnings and confidence collapsed.
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