February Review Comments
Written by Tony Gray   
Monday, 22 February 2010 14:41

Outlook Comment

Investment markets have been generally negative since mid-January.  Initially markets fell on news of the US plan to split-up the savings and investment banks and China’s decision to increase the reserve requirements for Chinese banks.  The latter is expected to slow growth in China and is partly responsible for falling metal and oil prices.  The preparedness of the Chinese to slow growth and take the heat out of property markets is a longer term positive, if it lessens the likely boom/bust cycle developing.

The far bigger threat recognised by markets is the sharply rising risk of default by Greece on its sovereign debt and the problems this may cause for the Euro.  Concerns over debt levels for Portugal, Italy and Spain also exist – although it may just be some bored bond trader seeking to complete a handy acronym.

PIMCO's February 2010 Investment Outlook, "The Ring of Fire" by Bill Gross, is now available at www.pimco.com.  This is a timely article, referencing academic work on previous credit/sovereign debt cycles and the applicability in the current cycle.

The conclusion of the Managing Director of PIMCO (Bill Gross), one of the largest bond firms in the world, is that you would invest growth assets in the developing economies or in better placed countries such as Canada or Germany (or Australia) and that you would avoid the UK!

Well apart from the risk of default, the next most obvious consequence is that as public debt to GDP rises above 90%, the average rate of GDP growth slows by one percentage point. Many European economies are in or are approaching this zone over the next few years.  A prolonged period of de-leveraging is necessary and likely to result in lower rates of economic growth across the developed world.  We would expect generally lower than average share price premiums relative to earnings.

 Cash & Fixed Interest

The Reserve Bank of Australia did not increase interest rates in February, contrary to market expectations.  Term deposit yields have eased slightly and with a reduced risk of sizeable short-term interest rate increases, applying surplus funds to term deposits will yield above average cash interest.  The government guarantee period for amounts below $1 million runs until October 2011.

Growth Assets

Australia is well placed relative to most other developed economies, with lower budget deficits and lower levels of public debt.  Our economy is also relatively open to world trade, with freely floating exchange rates and a responsive Reserve Bank.

The Australian dollar has been weakening and this is a positive for large sectors of the Australian economy.  Although it will not help share prices while international owners exit, a lower dollar will especially cushion lower metal prices for mining companies.  Share prices for companies such as Fortescue Mining and Oz Minerals have suffered more than the likes of BHP in the down-turn so far and may soon present buying opportunities.

Without discounting the overseas risks, we are comfortable with the value presented by many major listed companies and trusts and are not expecting a new bear market to develop.  A correction is underway and technically this could see falls up to 20% (~4000 on the All Ordinaries Index).  Smaller companies have fallen especially rapidly and also offer the greatest recovery potential – subject to the February half-yearly reporting season.

As such, we are tracking a wide range of companies with the intention to purchase in the short-term.

Woolworths is a key defensive stock we have been introducing to portfolios, with low debt levels, strong cash-flow, a very sound business, healthy and rising dividends and trading at the lowest levels relative to earnings since 2004.

Please contact us with any planning or investment queries.

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

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


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