Quarterly Newsletter - January 2015

Major Indices   (as of 1/1/2015)

 
Currency
(AUD)
Interest Rate(%)
Share Index
* PE ratio
(historical)
Min daily wage (USD)
GDP Forecast (2015) IMF
Population
(million)
Public Debt as a % GDP
(June 2014)
Australia
1.00
2.50
All Ords
5,392
15.17
(All Ords)
136
2.9
23.7
27
USA (Dollar)
0.81
0.25
S&P 500
2,090
23.39
58
3.1
320
87
Japan (Yen)
98
0.1
Nikkei 225
17,450
20.37
85
0.8
127 (stagnant)
248
China (Yuan)
5.06
5.6
CSI 300
3,457
Hang Seng
23,501
China
14.4
Hong Kong
17.30
9.60
7.1
1,367
17
India (Rupee)
52
8.0
BSE 200
3,402
18
3.40
6.4
1,265
53
Europe (Euro)
0.67
0.05
DJ Stoxx 50
3,163
22.52
56
1.5
(Germany)
737 (stagnant)
84
UK (pound)
0.52
0.50
FTSE 100
6,590
13
80
2.7
64
(stagnant)
99
Global
N/A
 
 
20.52
4.0
7,264
(Fastest growing population is by far Africa)
 

* PE ratios (based on historical earnings)
US 10 Yr Bond Rate - 2.19%    US 30 Yr Bond Rate - 2.76%
Source: Bloomberg

Commodities

Oil - Nymex (USD/barrel) 53 Iron Ore ($/tonne) spot price 71
Natural Gas (per million mbtu) 3.09 Copper (USD/pound) 2.86
Coal-coking ($/tonne) 72 Nickel (USD/pound) 6.80
Uranium (USD/pound) 35 Zinc (USD/pound) 0.99
Gold (USD/ounce) 1,200 Aluminium (USD/pound) 0.83
Wheat (cents/bushel) 600 Corn (cents/bushel) 405

 

Baltic Dry Index (BDI) 1,153 (flat)
US Retail Sales forecast (% gain on last year) January (f)
5.18%
February (f)
5.21%
March (f)
Chinese PMI manufacturing Oct (HSBC)
50.4
Nov (HSBC)
50.0
Dec (HSBC)
49.6
[www.kitco.com]

US Retail Sales (no new data available)

 

Commentary - Past 3 months

The past 3 months for share markets was mostly good…..However, Russia and the Oil price collapsed, Australia and Europe did poorly, US and Japan did quite well and China BOOMED with Shanghai rising 38% for the quarter. Bear in mind Japan is rising due mostly to currency weakening, so zero net effect.

The US share market returned 13.55% for 2014, and its economy strengthened.

European shares returned a poor 2.86% for the year amid continued sluggish growth.

The Hong Kong share market returned 1.86% for the year as a lot of money shifted into the mainland Chinese markets.

Chinese equity market moved up a staggering 50.08% for 2014 despite all the talk of a slowing economy, and with Chinese Manufacturing remaining sluggish (Chinese PMI around 50).

The Indian share market moved up 29.44% for 2014 riding the popularity wave of their new leader President Narendra Modi.

The Japanese share market was up 9.69% for the year; however the currency was down heavily.

Asian shares overall had another very strong year of around 20% + return in AUD terms. The falling AUD helped this slightly however many Asian currencies fell also.

The Australian Share market did nothing in 2014 finishing up a 0.42%.

Global share market Prices to Earnings (PE) ratios are still well above fair value and their average is 20.52. USA, Europe and Japan are still the most overvalued. Australia PE is 15.17 and in fair value range... Emerging Markets are a bit expensive at a PE of 19.46 and Asia (Hong Kong, Korea, Taiwan and Singapore.) at a PE of 15.26 is the better value.

US employment is down again by 0.3% currently at 5.8%, and Australia up again by 0.2% to 6.3% unemployed. The US trend is down and Australia is up.
Note however President Obama has engineered this by penalizing employers if their workers work more than 30 hours a week by having to pay expensive health care costs.

USA economy is definitely stronger with last quarter GDP growth at 5% annualized. The IMF increased its forecasts for 2015 US growth to 3.1% .

Europe is still very weak and currently being weighed down by Russia and lower Oil prices.

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. The recent 0.4% interest rate decrease should also help. Additionally the growth mix is changing away from manufacturing to services.

India continues to be jubilant and has launched a new program “Make in India” to help their economy. Their GDP is improving.

South Asia (and ASEAN), South America and South Africa and the Frontier countries are generally still doing well. Jobs continue to move from West to East chasing cheaper labour. Wages are stagnant in the West and rising in the East. The exception to this is the large Oil producing nations (Saudi Arabia, Kuwait, Oman, UAE, and Indonesia) who are currently suffering from the Oil price collapse.

Global GDP is forecast by the IMF for 2015 at 4.0%. The Advanced Economies at 2.3%, and the Developing Economies at 5.2%. It also states;”falling oil prices will boost global GDP between 0.3 and 0.7 percent in 2015”.

Global Interest Rates have remained mostly the same this quarter except China decreasing by 0.40% to 5.6%. Interestingly the Swiss Reserve Bank decreased to negative 0.25% trying to slow the rush of Russian and other money into their country over inflating the Swiss currency.

US long term bonds rates fell again slightly over the quarter. This is conflicting with views that US interest rates will be going up soon.

Inflation has still been mild in most countries (except Russia) and currently not a great concern.

Currencies over the quarter were summarized by a significant weakening (7%) in the Australian dollar again, from 0.87 down to 0.81 to the US dollar, and down against all major currencies. That marks a fall in the past 6 months of 15% to the US dollar, and in line with my forecasts.

2014 Share market returns summarized (% pa)

Australia 0.42 Argentina
(No 1 globally)
54.5 Indonesia 20.79
USA 13.55 China (Shanghai)
(No 2 globally)
50.08 Korea -2.62
Europe 2.86 Hong Kong 1.86 Brazil -1.5
Japan 9.69 India 29.44 Russia
(worst globally)
-45

http://money.cnn.com/interactive/investing/best-performing-global-markets/

Commodities

Oil collapsed over the quarter dropping further from USD 91 to USD 53 on oversupply concerns and weak Global demand; and Natural Gas also fell 25% to USD 3.09. This has sent severe shudders through the Oil producing nations and companies, but is also a win for consumers especially in importing nations (US, China, India).

Copper was weak dropping to $2.86 per pound. The other base metals were slightly down.

Iron Ore prices continued their shocking past year falling again this quarter ending at $71 a tonne, due to the China housing and construction slowdown, and oversupply.

Coking Coal dropped heavily over the quarter at $72 per tonne.

Uranium seems to have passed its shocking lows now stable at around USD35 per pound.

Gold moved sideways to reach $1,200.

Soft commodities rallied strongly after a previous bad last 6 months.
Australian Resources Price Earnings Ratio is still very cheap at 12.55, however may be a “value trap” with mining profits falling.

In summary, it was a terrible quarter for Oil and Natural Gas, also poor for Iron Ore and Coking Coal …..As a result of Oil oversupply and 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 in 2015. Looks likely but only a weak recovery for now, as still there are too many empty properties (oversupply) in China and an oversupply of Global Oil with falling Global demand as people turn to hybrid or electric cars.

Commentary - Forecast next 6 months

Leading indicators are neutral for global growth especially the BDI.

The Baltic Dry Shipping Index (BDI) – (the cost to ship raw materials such as coal & iron ore) has been flat moving from 1,147 to 1,053, a neutral sign of global and China recovery. It suggests no changes coming soon.

US Retail sales are forecasted to rise about 5% –a positive sign.

The HSBC Chinese Manufacturing PMI index – December 49.6 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 “no immediate resources recovery and no China manufacturing recovery”. Commodities used in construction such as Iron Ore have been smashed the past year but should at least stabilize soon. The one positive is the US consumer happy to keep spending and hopefully this will spread more to the rising wave of Asian consumers.

Western (developed countries) share markets are likely to move down, or sideways….. Expect Australia to continue to struggle and 2015 may well see a recession in Australia.
In particular the US is due for a correction being clearly overvalued now (PE of around 23.4).
Chinese equities should continue to do well in 2015 as new money flows there due to the HK-China Stock connect and next year’s likely inclusion of mainland Chinese equities into the MSCI. Chinese share market valuations are reasonable at PE 14.4.
However a short term pull back is also likely given the exponential rise last quarter.

On Nov 12, 2014, I emailed all clients recommending to make sure they had enough Asia and China exposure as I was expecting the HK-China connect to boom the China local share markets.
From that date until now the China (Shanghai) market is up an incredible 17.89% in just 7 weeks.

The Emerging markets of Brazil and Russia and Global Resources should start to recover at some point in 2015.

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.

Ideas?

  • Aggressive and Growth investors should already be invested in Asian, Emerging or Frontier markets.
  • Moderate and Conservative investors should keep some Cash or safe fixed interest. Around 50% for Moderate clients and 75% for Conservative clients. Interest rates are very low so consider overseas investments while the AUD is still a bit high.
  • Avoid Share markets with a PE near or above 20 – eg: USA, Japan, Europe
  • Term Deposits are still ok in safe countries.
  • Avoid US and Euro/UK/Japanese currency AUD likely to fall further despite falling about 20% last year.
  • Sell Australian residential property unless it’s your home.
  • Invest in countries with good demographics, jobs growth, low debt and positive GDP
  • Slowly increase exposure to Emerging Markets (EM) or Frontier Markets (FM) shares or direct property in those regions. The main focus for your risk side of your portfolio should be Asia.
  • Buy direct property in countries that are benefitting from Globalization and where property is still cheap. Eg: Philippines, Thailand, Indonesia, Malaysia, Vietnam, Mexico, Myanmar, Cambodia, Laos……
  • Buy Chinese Yuan currency, or other Emerging Markets currency (Eg: Philippines Pesos)
  • Consider buying into Russia in 2015 as the Ruble and the share market are very oversold and undervalued. The oil bottom will be the time to buy. Is that USD 40 per barrel?

Australia Update

Oil, Natural Gas Iron Ore and Coal prices have all collapsed in the past year and Australia is now facing the consequences of this.

The mining capital expenditure is about to drop off a cliff in 2015 – leaving more unemployed. Are we heading back towards 10% unemployed? If you look at the underemployed or youth unemployment you will realize Australia is facing a jobs crisis. Little wonder when our minimum wage is about 10 times higher than in Asia ---

Perhaps Australia is about to have their recession.
Growth falling, Currency falling, Unemployment rising…
This may be the case for some years until Australian wages are globally competitive again.

The only bright light has been the residential property market propelled by ever lower interest rates. However this light will soon also go out.

Global Resources – Oil & Iron Ore update

Oil has dropped in half the past 6 months falling from above USD 100 to around USD 53 a barrel.
Some predictions are that there is still oversupply and that Oil may not bottom until mid next year (US summer) at around USD 40 per barrel. Off course if OPEC and others agree to suddenly reduce supply then the Oil price will likely recover sooner and stronger.
The smaller or more expensive Oil producers will likely collapse at these prices.

Iron Ore has also dropped severely in the past year from around USD 180 a tonne all the way down to about USD 71 per tonne.
This is not unexpected when you look at a 10 year Iron Ore Chart (see below).
The Iron Ore and Resources Super Cycle or boom took off around 2004/2005 as China was rapidly urbanizing and building new cities.
By about mid 2011 the Iron Ore price boom was starting to collapse as a BHP, RIO, and Vale all aggressively increased production new producers such as Fortescue and others rushed to increase production. By 2014 the Iron Ore supply was exceeding demand, and Chinese demand was slowing due to an oversupply of houses in China of around 50 million houses.
Here in Jan 2015, it is likely the smaller miners with higher production costs will continue to exit or close their mines.
Heading forward China will still need a lot of Iron Ore as they plan to double their rail capacity, and other Emerging countries lead by India will also lift demand.
So expect Iron Ore and Global resources to start to recover in 2015, and do better in 2016 onwards as Asia still requires about 290 million new homes to be built by 2020.
Expect Iron Ore Spot prices to settle between USD 60-80 per tonne.

Oil Price Ten Year Graph
Iron Ore Price Ten Year Graph
The above ten year charts suggest to me that Oil should bottom by USD 40 and Iron Ore at USD 50-60.

 

   

China wants to build the world a railway

From CNBC, “The developing world is embarking on a massive infrastructure boom. And China wants to build it—and bankroll it.

On Thursday, Chinese officials announced the latest infrastructure megaproject—a $12 billion contract to build a railway stretching more than 850 miles (1,400 kilometers) along the coast of Nigeria. It was China's single-biggest overseas contract, according to state media.

With its domestic economy cooling, China is investing heavily outside its borders in multibillion dollar infrastructure projects, launching new financing plans to help developing countries pay for them.

Much of that investment will be geared toward transportation projects like the Nigerian railway, as developing countries seek to put in place the capacity needed to keep up with increased flows of people and goods brought by economic growth.

Much like the 19th century railroad expansion that opened up the American West, many of these projects are designed to expand growth to inland regions with little access.

More recently, China's three-decade economic transformation started with coastal manufacturing hubs served by ports that provided gateways to international trade”.

And China with almost USD 4 Trillion in currency reserves has the money to do it. See below graph.


 

The Australian Dollar (AUD) – Where to next?

The Australia Dollar is influenced by several factors in order of current importance;
1) The differential between US and Australian Interest rates (currently 2.5% -0.5%= 2% difference).
2) Australia’s Trade flows and the Commodity price Index (or can use Iron Ore)….
3) Australia’s economic growth (GDP), unemployment and global competitiveness.

Looking at the three areas above I see the following going forward;
1) The Interest rate differential to narrow probably due to US rates rising. This will cause funds to leave Australia and lower the AUD.
2) Australia’s Trade deficit to worsen, commodity prices to continue to struggle. This will lead to a lower or sideways AUD.
3) GDP, unemployment and global competitiveness in Australia are all terrible going forward and will cause the AUD to lower. Especially labour costs are way too high and consequently the manufacturing sector is almost destroyed.

Conclusion – I see the AUD steadily moving considerably down over the next decade (unless wages collapse or commodities boom again). Since I called this it has already dropped from 1.10 down to about 0.81 now. I expect it will settle at around 0.60 to 0.70 to the USD over the next 3 years. And by the end of the decade perhaps lower.

NB: Interesting to see that the AUD seems to track the Iron Ore Spot Price.
So if the Iron Ore Spot Price is USD 75 then one can look for the AUD to be around 0.70.

 

Chinese Share market – The beginning of the next big boom as China “goes Global”

Six positives for a China share market boom in the next 5 years.
1) Chinese Corporates going Global
Eg: China Railway Construction Corp (CRCC) – just won a $12b bid to build a high speed railway in Nigeria.
Eg: Sany Heavy Industry. Builds a new piece of machinery every 10 mins.
Egs; Lenovo, Huawei, ZTE, CNOOC, Alibaba, Baidu,Tencent, Xiaomi, Geely, Dalian Wanda……
2) Undervalued markets – Historical PE around 14, Forward PE around 10. So Chinese share markets are currently undervalued.
3) Open Access -The Shanghai and Shenzen share markets are opening up to the World’s investors.
4) Rising Chinese wages and consumption of a rising middle class.
5) Urbanisation continuing. Currently 53% urbanized and heading towards 75% by 2030. So construction boom can continue, but at a slower pace.
6) Chinese Yuan to become a Global key trading currency.

Three negatives to remember are;
1) China has over built residential homes with perhaps as many as 50 million vacant homes in China.
2) Chinese Demographics not so good after 2016 and worse after 2020.
3) Chinese wages doubled the last 5 years so factories are closing due to lack of competitiveness.

On balance to me the positives outweigh the negatives especially as I see Chinese corporates becoming Global multinationals just as the US corporate did the past 20 years.

China to increase from 18.9% of MSCI Emerging Markets Index to 27.7%

Asian equity rises nothing like US, so less affected by QE ending

Note how little gain the PRC (Local Chinese market has had despite strong Chinese GDP the past decade)…That market is expected to open up next year and China A shares to be included in the MSCI index.
US companies have massively off shored their staff to cut expenses and Tech has boomed (Apple, FB, Google etc)……also US money printing and record low interest rates since 2008 has caused US shares to boom and become well overvalued (PE 22).
My interpretation from above is that Asia (Ex Japan) is due for the next share market boom…it has lagged the US, is fair to cheap valued, mostly has great demographics and strong growth, low personal debt., low Government debts.

So all in all.... time to be cautious but to hold your biggest stake in Asia.

 

“The Great Depression Ahead” written 2008/9 by Harry S Dent – Demographer

Harry S Dent is a well renowned demographer who picked the 1990s share market boom in his book, “The Great Boom Ahead” (written 1992), the 2000 Tech bust and the GFC.
He did this mostly following his “Spending Wave that lags US births by 46-50 years (see below).
The blue line (US Dow index adjusted for inflation) follows the “Spending Wave”. Note the Dow is today around 18,000 so well above where Harry’s graph predicts it to be at about 13,000 and soon to fall reaching about 10,000 by 2021.
Again another reason to be cautious especially on US shares. Same for Europe.

Of note most Asian countries demographics look strong especially South Asia including India and the Philippines. China not so good after 2020 thanks to the one child policy. Also many Asian cities will benefit from continued urbanization, and job creation.
The Middle East also looks strong demographically; however it is very dependent on Oil prices, which Harry predicts will fall to as low as 10 USD…..and won’t do well until the next Resources boom begins around 2020.

In summary demographics suggest tough times especially for Western markets (The Great Depression Ahead) from now until 2020-23, then after that a strong Global Growth and commodities period from around 2020 to 2035-40.

Take a look at www.hsdent.com

 

2015 predications from some arguably the top 4 market forecasters – Dent, Roubini, Schiller and Paulson

Harry Dent (US Demographer) predicts 2010-2020 to have horrific share market falls (particularly in the US), and a Global Depression similar to 1929-1930’s. Harry believes a Chinese property crash may be the trigger to set off GFC mark II. He forecasts the US Dow will drop from 17,000 to below 6,000 - that’s a 65% fall. See graph below.
“Unfortunately, the U.S. reached its demographic “peak spending” from 2003-2007 and is headed for the “demographic cliff.” Germany, England, Switzerland are all headed there too. Then China will be the first emerging market to fall off the cliff, albeit in a few decades”.


NB: The generational cycle refers to US only.

Nouriel Roubini (who was famous for successfully predicting the GFC) believes 2015 will be a good year for the US economy and hence the US share market can do ok despite being a bit overvalued. On Australia he says, “The slowdown in China and a tighter federal budget will pull Australia's growth down to as low as 2 per cent next year, prompting interest rate cuts and a 20 per cent slump in the value of the Australian dollar, a prestigious global forecaster says”. Roubini predicted this when the AUD was at 89 cents that makes it fall to about 71 cents to the US dollar.
The bearish Roubini report also identifies Australia's housing boom as "increasingly out of line with fundamentals", including demand for goods and services and the unemployment rate.

Robert Schiller
While the US market is "overpriced" it remains "not a bad investment, all things considered," Referring to the lack of alternatives for US investors with 10 year Bond yields around 2%pa.

John Paulson – US Hedge Fund owner famous for shorting the subprime mortgage market, Paulson & Co. Inc. generated a $15 billion gain. He is currently keen on Gold.
Read more: http://www.businessinsider.com/paulsons-gold-bet-will-make-him-one-of-the-richest-billionaires-by-2015-2009-12

Warren Buffet – The Worlds 2nd richest man and multi-billion-dollar investor is rumored by some to be preparing for a crash. The "Warren Buffett Indicator," also known as the "Total-Market-Cap to GDP Ratio," is breaching sell-alert status and a collapse may happen at any moment. Other reports are that Buffet is still positive on US stocks and the US economy.

Jeremy Grantham of GMO with $117 b under management is forecasting “another horrific stock market crash is coming”, and the next bust will be "unlike any other" we have seen”.

Matthew Bohlsen’s thoughts:
US, Europe and Japan share markets are all somewhat overvalued so best to avoid them.
NB: If you want to invest a small amount in the US that may be ok as the Aussie dollar fall and lack of other investment options in the US, and quite strong US corporate profits may support US stocks as baby boomers hunt for yield. However do so with smaller money only as the US PE is currently 23.39 so makes it dangerous.
Asia PE is around 15 so fair value, and the best place to take risk. Asian positives are a falling AUD, falling Oil prices, a surging middle class and strong demographics (rising young populations) and strong jobs growth (cheap labour). Negatives are a slowing China and possible Chinese real estate collapse, and any US share market collapse.
Add to Asia on the dips. Higher risk investors could buy into Russia.

Or take a further look at “Best and worst predictions of the past 25 years”.
http://www.cnbc.com/id/101744030

Predicting a gigantic shift of money from Government Bonds to Shares

“2015 is the year that the US stock market will turn exceptionally bullish. The Aussie should follow, aided by a falling Aussie dollar and positive investor sentiment. I wouldn’t be surprised to see the Aussie dollar trading at 75 US cents sometime next year. We’re in the midst of a tremendous government bond bubble. 2015 will be a year when you see a GIGANTIC shift from debt to equity (share) markets. Governments are bankrupt all over the world. Europe is a basket case and is driving this debt to equities shift .France is bankrupt and will default (or delay payment) on its debts within the next three years. Portugal, Italy, Greece and Spain will also default on their debts. The European Union (EU) is falling apart. 2015 will be a year when punters hunt for yield and may be the year that the government bond bubble bursts.

Complete Summary of 2014 Share market Returns

Overall Global stocks rose a meager 3 percent this year, according to the MSCI All Country World Index, which is made up of stocks from both emerging and developed markets.

 

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.