A SPECIAL ECONOMIC AND MARKET UPDATE
FOR DOLLAR GROWTH FINANCIAL PLANNING CLIENTS
January, 2009
The Issues
Where are we now? Where are we headed to? How long will it take before markets return to some degree of normality?
Global & Domestic Economic Events
As you are no doubt aware, significant changes and crises have characterised world debt markets in recent months that have had a drastic knock on effect on the performance of Client Investment Portfolios.
Generally, global investors continue to be in a state of shock as a result of these overwhelming economic developments. It is also quite clear that events have not yet run their course and people are mindful of further negative developments and the potential impact of major unresolved issues (such as, the ongoing financial difficulties being experienced by the three U.S. auto makers and the expectant interventionist actions of the incoming Obama Administration), on market trends and sentiments around the world. This scenario is sustaining the fear factor and is exacerbating the general turmoil on currency and asset markets.
These global events have led to a tightening of credit with Banks and Government Agencies around the world becoming far more reluctant and discerning as to whom they choose to lend money to. And when they do lend, they now tend to charge more than they would normally do. This is occurring in Australia too. The Reserve Bank of Australia (RBA) has raised interest rates numerous times in the past year as part of monetary policy aimed at containing inflation growth.
In March this year we made the observation that there was a danger that the RBA would raise interest rates excessively and so unnecessarily choke economic growth.
Well it has.
This has been one of the principal reasons why we have seen a number of impromptu and large cuts to interest rates in the last three months– we feel more of the same will continue into the first half of this year. But this will not necessarily bring back investor confidence in the short term.
In theory, activist monetary policy such as this feeds into the Australian economy more quickly than by the Federal Government using fiscal policy. The fiscal lever as an economic management tool requires the Government to increase Government expenditure (which stimulates the economy by increasing the demand for goods and services which in turn fuel further inflationary consequences); or alternatively, the Government can reduce its expenditure. This latter approach tends to dampen consumption demand which causes the economy to slow further and so create a less-than-desired growth in GDP, declining general price levels and falling inflation.
This is a deflationary scenario. We feel that in the present circumstances it would be disastrous to dampen consumption and investment levels as it could very easily stall the economy and rapidly lead to high unemployment, and a further loss of consumer confidence leading inevitably to even more economic pain down the track.
A short explanation is necessary at this point.
‘Deflation’ isn’t necessarily a bad outcome for an economy as it is associated with a general reduction in prices for goods and services in the economy. But when it is caused by a reduction in the amount of money (cash + credit) available to consumers, economic activity contracts, people start to lose their jobs, banks stop lending because they fear customers would default, which leads to a further reduction of money in the economic system and the downward spiral continues until it potentially gets out of control. As prices spiralled downward businesses would no longer be able to cover its costs and would be forced to close down. (If however, prices decreased because goods and services were able to be manufactured more cheaply, then everyone benefits. This is what happened during the last decade through the utilisation of higher productivity (technology + lower labour costs: read China/Asia!) During this period inflation was kept under control, world wide.
In contrast the monetarist approach is to manipulate interest rates and the supply of money. The Federal Government previously depended on monetarist policy only; now it is utilising fiscal as well as monetary policy.
Across the Globe we have all seen various Governments providing major financial support to ailing sectors and the most needy parts of the global economy. In Australia the Federal Government has announced a number of fiscal initiatives to stimulate the domestic economy – this is called “pump priming”. But this will only produce strong results if the federal Government primes the right pumps and is prepared to keep doing it until a general upturn in economic activity is achieved. In the 1930’s the New Deal economic stimulus introduced by the F. D. Roosevelt Administration in the U.S. was only partly successful and nearly failed, as the Government literally got cold feet and started to raise taxes to ward off what they feared was rising inflation. Only time will tell whether the Rudd Government has the political will to stick to its strategy and keep priming the economy, even if it means going heavily into deficit.
The main point to note is that for the Global economy to recover in a rational sense the world and domestic money markets must return to a point where credit is no longer rationed, which is what is occurring now. The Banks and second tier funding organisations are still rationing credit (which in effect is placing a cushion under the price of credit and keeping the costs up for businesses more than it should). This is clearly demonstrated by the RBA drastically reducing interest rates in an effort to stimulate business activity (but not all lending institutions are routinely passing on the full extent of these rate cuts.)
In other words the Federal Government’s stimulus packages (reducing interest rates; increasing Government expenditure, consumption spending and hand-outs) may not produce the results that would normally be expected when investment markets are behaving rationally.
Dollar Growth Investment Strategy
At Dollar Growth we have re-evaluated and re-assessed our Portfolio strategy through to 2012 based on the following assumptions:
ü That the current economic & market carnage/ uncertainty/ fear/ credit squeeze should have fully worked its way out of the domestic & global economies by 31/12/2011
ü Dollar Growth manages each Client Portfolio on an individual basis
ü The process of re-positioning each Client Portfolio must take into consideration the prevailing portfolio structure; the Client’s risk profile; their overall financial position; the tax implications of each portfolio; the ownership structure of the portfolio (are investments held by clients individually; by a discretionary trust or another legal entity); where the portfolio is in relation to the superannuation accumulation phase and the allocated pension phase, (where of course consistent pension income is of paramount importance)
ü That each portfolio contains investments which will re-group and despite them having fallen in value; and that it would be prudent to ride out this storm-tragic as it is for many people-and still retain their assets; (i.e. we do not want to throw out the baby with the bath-water!)
PORTFOLIO STRATEGY (2009 to 2011/ 2012)
(1) Global
Economic back drop
Ø North America (particularly USA) – economically challenging; the US Federal Reserve is bailing out the US economy; the US is in recession
Ø Europe – we continue to remain cautious; a number of European countries face falling GDP and increasing unemployment
Ø Asia – will hold up better than the USA & Europe
Ø Emerging Markets – definitely better off than USA & Europe
Ø China – GDP slowing in nominal terms but don’t be fooled
Ø India – GDP has slowed and will remain weaker than China
Ø Japan – could surprise on the upside but don’t hold your breath
Ø Tight credit markets incl. inter-bank markets till May – July 2009 at least?
Investment Sectors Portfolio
Range
CFI (Commercial Fixed Interest) 0% to 6%
Cash (as a proxy for CFI also) 3% to 10%
Equities – via global funds 5% to 55%
Equities – mining & resources 5% to 15%
Property - global, but reduce Europe if feasible 0% to12%
Infrastructure 0% to 6%
( caution required due to the inherent difficulties of Debt Refinancing)
Commodities – Hard & Soft 0% to 12%
Alternative Investments 3% to 25%
By Region
Asia Asia – regional focus preferred
Country specific – China and India acceptable
Japan – principally real estate
Europe Europe regional (remain cautionary) – low exposure preferred
North America No specific exposure except for real estate already held
Emerging Markets No specific country exposure – regional focus only
Global sectors
ü Property (cautionary)
ü Resources
ü Commodities – soft & hard
ü Agriculture – driven by global food shortages
(2) Australia
Economic back drop
Ø Slowing economy
Ø GDP down 1% for 2008/2009 to 2%; increase in GDP 2009/2010 to be marginally positive; average GDP 2009 to 2010 estimated at 2.50%
Ø Unemployment to rise
Ø Regulatory risk to remain (corporate non-disclosure; guarantee of bank deposits; mortgage and unlisted property trusts to remain locked up till at least December 2010)
Ø Increase in credit risk resulting in further company failures; defaults; bankruptcies rising – tight credit markets till May – July 2009?
Ø General lack of confidence and fear till July/ August 2009
Ø Interest rates – further falls to come in the first half of 2009
Ø Going into the second half of 2010 interest rates to be placed slightly under pressure and may therefore, increase
Ø Inflation – declining but could start to rise during the second half of 2009
Investment Sectors Portfolio
Range
CFI (Commercial Fixed Interest) 0% to 0%
Cash (as a proxy for CFI also) 3% to 35%
Equities – hybrids & preference shares 5% to 20%
Equities – large cap (caution financials) 15% to 50%
Equities – small market cap (cautionary) 0% to 25%
Equities – mining & resources 5% to 15%
Property – LPT (selective approach)* 0% to 15%
Property Unlisted - (selective approach) 5% to 12%
Infrastructure – (extreme caution) 0% to 8%
*Existing Listed Property Trusts (LPT’s) – top up when capital raisings justify this approach but be selective and average down on a case-by-case basis.
Comment
In 2008 we had two contradictory forces at work: companies potentially faced substantial down-grades in company earnings (negative for share prices), but on the other hand offered increasingly attractive share price valuations (positive for share prices), as markets had clearly over-sold many valuable and well performing businesses.
However the impact of credit rationing remains a significant hurdle to overcome. On the other hand, this is allowing inflation to be managed more easily (so long as it doesn’t tip too far and leads to deflation becoming an unintended consequence).
Conclusion
v The important point to note is to focus on the medium to long term
v In the mean-time, we will continue to stick to our tried and true philosophy of doing what is best for our clients
v A pertinent point to note is that a feature of our portfolio management style is that invariably, our portfolio’s are the first to be affected but are then the first to re-group and consolidate. Certain signs have emerged that we have entered the “re-grouping stage”
Should there be any aspects that you wish to discuss please don’t hesitate to contact us.
Philip Enger
Authorised Representative of
Financial Planning Services Australia Pty Ltd
DISCLAIMER: While Financial Planning Services Australia Pty Ltd believes that the information contained herein is correct, no warranty of accuracy, reliability or completeness is given and that professional investment advice should be obtained before making any adjustments to Portfolios or transacting securities, managed funds or wholesale funds. This document is general in nature and does not take into account clients’ personal circumstances and should therefore not be used or relied upon as a basis for advice.
DOLLAR GROWTH GROUP
BUSINESSES
Dollar Growth Financial Planning Pty Ltd
Corporate Authorised Representative (No: 321108) of Financial Planning
Services Australia Pty Ltd AFSL: 225982 ABN: 55 010 521 810 www.fpsa.com.au
Dollar Growth Tax & Accounting Strategies Pty Ltd
Dollar Growth Estate Planning Pty Ltd
Dollar Growth Mortgage Solutions Pty Ltd
Dollar Growth Business Services Pty Ltd
Dollar Growth Insurance Pty Ltd
Dollar Growth Centre (Qld) Pty Ltd
In association with:
Harper Financial Services Pty Ltd
Working hand-in-hand with you to provide
Advice for Life
Suit 101, 1-5 Commercial Road, Kingsgrove, NSW 2208
(02) 9554 8555 www.dollargrowth.com.au FAX: (02) 9554 8666
