August 2015 Review & Comments
Written by Tony Gray   
Wednesday, 09 September 2015 12:16

Where do we start…

We have reviewed a new multi-million dollar portfolio this week that was 95% exposed to financial stocks - including loads of longer dated bank income securities – frightening stuff that makes us wonder how many investors are similarly positioned across the country?

Some of the concerns we have been banging on about since last year and especially in recent months are now becoming more widely recognised by ‘the market’. The slow-down in the global economy and the domestic economy, especially with weakness amongst our major trading partners, means that holding a large financial sector exposure could be much riskier than the average person comprehends.  We hope we’re wrong.

We have been reluctant to apply reserves to growth assets for some time on the basis that either market risk (e.g. US market valuations arising from a mature bull market) or individual earnings/valuations limited the field of assets we were comfortable buying.

On the other hand, with healthy cash reserves and value now more apparent, it is prudent to commit some funds to growth assets at this time – even if our fear is that the market fall may run for some time yet?  This is since income yields do appear quite attractive in some areas, with sufficiently strong earnings and balance sheets that only low growth is required to generate healthy total returns over time.  Should the local and global economy work through the current slow-down, then current prices may well turn out to have been an appropriate time to get opportunity reserves into long-term assets.

So what are we actually recommending?

International Shares

  • Lightening some Asia sector exposure due to the economic slow-down in China and changed investor sentiment; and

  • Avoiding US centric international exposures (including index exposures which are typically 50% to 60% US).

The $A may well weaken further, but in percentage gains we suspect the bulk of excess returns for US investments have already accrued.  It also appears to us that the 7 year bull market trend for the US broke down last month (see the chart over the page) and that the risks lie to the down-side.

Our view is that a negative lead from the largest global stock market will make it difficult to generate decent gains from local (or other) assets – so whilst there are individual asset opportunities to begin accumulating, it is probably too early to buy aggressively.

The Iress chart over the page, setting out the monthly price move over the last 20 year for the US Standard & Poors 500 index, says it all so far as trends go (charts are useful as a gauge of investor sentiment):


Australian Shares

Below are some general comments on various sectors.

  • Financials:  Reducing or limiting exposure to financials generally to an extent is recommended (only to an extent, since financials represent almost half of the Australian stockmarket by market capitalisation).  Many financial stock earnings are correlated with investment markets – so falling markets result in falling revenues, falling profits and a bigger than market fall in share prices.

  • Banking:  Part of the financial sector noted above, but with sector specific risks.  If the local economy continues to slow then Australia will be in recession and bad and doubtful debt provisions will rise.  Provisions as a proportion of loan books were 17.5 times higher at their worst in the 1991 recession – giving a hint as to just how low current provisions are.  Even a minor rise in provisions will wipe out all profit growth for the banking sector.  Couple with increased shares on issue to meet the high APRA capital requirements by July 2016, this makes declines in earnings per share during 2015/2016 likely in my opinion.

It may be that Australia avoids recession and a meaningful lift in provisions and that the 6%+ franked yields offered by the banks are sustainable and attractive to investors – so while we recommend lightening large individual stock holdings or large overall sector holdings (subject to tax considerations) we’re not brave enough to recommend an exit.

Think of the lightening decision for your portfolio in these terms – if your portfolio has a lower exposure to the higher yielding bank sector and there is no major economic slow-down, then you will have missed out on some extra income and some recovery potential.  If the bear scenario comes to pass, then the impact of major prices falls and reduced income returns will have been mitigated.

  • Opportunities:  There are a range of interesting smaller companies well down in price from recent peaks – but still trending lower and not quite at the point where we are buying – but they are 70% to 80% of the way to target levels. It does appear worthwhile adding an initial part exposure to some of the major mining and energy stocks at this time.  Some hold very low debt levels, are generating high free cash-flow at current commodity prices and paying quite attractive franked dividend yields.  There are also some stocks that appear oversold (e.g. Origin Energy) that do entail some balance sheet risk (although this would require a very extended period of lower oil/gas prices) but equally offer quite significant recovery/growth potential.  Note – for many portfolios this is in the context of not previously holding any mining or energy exposure.


Property Trusts (A-REITS) have been trending lower for a while now and premiums to net asset backing trimmed to more acceptable levels.  There are one (nearly two) assets we have started to add – but generally more falls are required to build a margin of safety.  It would not surprise us if prices moved to a discount to asset backing if the local economy slows further and rising interest rates remain a risk to valuations.

Fixed Interest

Returns are terrible – both for bonds and deposits.  Bond yields have hardly changed despite all the turmoil (US and Australian).  Higher yielding deposits in portfolios are steadily maturing and we are keeping new deposits short-dated or at-call, depending on the level of funds available to invest in growth assets (i.e. with reference to Investment Strategy ranges).

We recommend against taking up any of the new bank income securities.  Understand that generally the new notes automatically become shares on a price fall below trigger points, or if capital reserves fall below certain points or if APRA directs that they convert.  This means that in the event of a major fall in bank prices that bank income securities may result in quite sizeable losses.  Put simply, investors are accepting equity type risk for income type returns.

We have a number of older style income securities in portfolios maturing next year and there is one perpetual note we are prepared to recommend – but subject to overall banking exposure in portfolios.  This is since, as the notes cease to serve as capital under the international banking rules, the banks will have a strong incentive to buy them out – most likely at a premium to current prices.


Reporting season has now finished, although there is a lot of research time ahead to make sense of some of the numbers.  Our focus remains on investment markets and reporting at this time – planning matters will be addressed later.  Make a phone call or send me an email with questions about your portfolio – regular but brief discussions allow me to make recommendations and provide feedback on more portfolios.

If you are concerned that your portfolio is not positioned defensively enough, or conversely feel that you are comfortable applying some excess at-call monies to work, then please make contact.  Otherwise we will continue to progressively review portfolios and be in contact with recommendations.

Best wishes,


A.W. (Tony) Gray BCom, LLB, Dip FP, GDipAppFin, CFP, FFin

Principal, TG Financial


Please treat the above comments as General Advice or general information, with no action to occur until we have considered with reference to your financial position, needs and goals.

Last Updated on Wednesday, 09 September 2015 14:51

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