March Review Comments
Written by Tony Gray   
Tuesday, 16 March 2010 12:15

Outlook Comment

The general consensus seems to be ‘business as normal’ for global stockmarkets, including Australia.  Greece’s debt problems barely impacted global markets and Dubai is hardly mentioned at all.  In Australia, recovering company earnings need to be shared across a lot more shares on issue – with headline profit growth not necessarily translating into earnings per share growth.

However, it seems to me that investment markets are almost oblivious to risk at present?  I have observed this phenomenon previously – with the Australian sharemarket setting all time highs only a few months after September 11, 2001 and again after the sub-prime crisis in July 2007.

Whilst the high level of indebtedness of many ‘developed’ economies may not be the trigger for a market or economic down-turn, it will magnify the reaction of markets to any ‘left field’ events.  For example, whilst it may not be a high probability that the world economy slides back into recession, the impact on investment markets from such an outcome would be very severe.

The most likely risk to share prices is higher interest rates.  As bond yields rise, the price to earnings multiple that investors are prepared to pay for shares falls.  This means that share prices could fall or fail to rise, even though earnings increase.  This is in line with market behaviour in the 1970’s.

Bond yields are likely to rise globally for a number of reasons; (1) risks are higher due to higher levels of government debt, requiring a higher risk premium in pricing; (2) inflation did not fall sharply during the recession, putting into question the ability of central banks and governments to control inflation as growth returns; (3) the surpluses generated in Asia and available to lend to the developed world have reduced; and (4) China has massively increased their money supply, making inflation in that economy more likely, rather than the deflation that was ‘exported’ through lower prices.

All-up, be prepared for lower than average returns from growth assets, especially as global and local interest rates rise.

Cash & Fixed Interest

The Reserve Bank of Australia lifted interest rates by another 0.25% this month, with comments suggesting further rises this year.  A cash rate of 5.00% (presently 4.00%) seems to be the consensus target for a neutral setting.  Term deposits have already priced in these rises and only a modest increase in rates is anticipated in the short-to-medium term.

Term deposit rates from 6 months onwards have almost levelled off and applying some surplus reserves to a series of rolling maturities remains the general preferred strategy at this time (as opposed to holding all reserves at-call).  A weighting to cash and fixed interest above the standard neutral setting for portfolios is recommended.

In light of our view on rising bond yields, we recommend against investing in bond funds, unless focused on short duration (i.e. close to maturity) series.

Australian Shares

Standard & Poors have announced the re-balancing of various indices – to take effect after the market closes on Friday the 19th of March.  Of 62 new additions to the All Ordinaries Index, 41 companies are mining or energy stocks and another 7 are biotechnology (health) stocks.  Whilst still dominated by the larger companies, an index style exposure is becoming less relevant to investors who are seeking reliable earnings and dividends.

The big issue for mining and energy stocks is that in most instances they are price takers and operate in a commodity market.  The mining boom was the outcome of a sustained under-investment in new mines during the late 1990’s – which meant that supply could not meet the compounding growth from China.  The history of the mining sector is one of boom and bust and I have doubts about the long-term sustainability of the presently large profit margins on basic commodities such as coal and iron ore.

Australian shares appear reasonable value but with reference to the higher risks associated with the current leverage (debt) within the global economy and rising interest rates, only a neutral weight to Australian shares is generally recommended at this time.

International Shares

The Australian dollar seems to have ceased its upward trend, staying close to the US 90 cent level for some time, although still strengthening against Sterling as the UK’s perilous financial position becomes clearer.

Following some research conducted by fund manager, Perpetual, it is apparent that the emerging markets index is 90% correlated with Australian shares.  This is since the largest sectors in this index are banks, materials and energy – similar to the Australian market.  As such, exposure to emerging markets should be via a non-indexed fund.

Whilst international share returns have lagged for a decade, the relatively high Australian dollar and historically moderate pricing of earnings suggests an increase to a neutral weighting to international shares is justified.  Exposure should be targeted at sectors not well represented in Australia.  This is leading us to move away from our earlier preference for indexed funds, accepting the higher fees of an active manager or, for larger portfolios, targeting specific stocks.


Residential property is not a sector to which we profess to have any expertise, but values appear historically high relative to income.  The median Sydney house is 12 times average annual earnings and the median Melbourne house is 10 times earnings.

Whilst there are supply constraints due to population growth, it is risky to assume that the exceptionally high immigration rates of 2008 and 2009 will continue.  Further, there are a number of tailwinds for the sector that are easing – (1) Interest rates are continuing to increase; (2) first home owner grants have reduced and demand from this segment has already been brought forward; and (3) early baby boomers are now retiring, down-sizing and aiming to realise some cash from their property value.

Aside from this cautionary note on residential property, I recommend investing only in listed property trusts with low levels of gearing (debt).


I continue to recommend some exposure to gold in portfolios.  Newcrest Mining represents the largest Australian miner, is a very low cost producer and has little or no debt.  The exchange traded commodity fund (trading under the symbol GOLD) provides an Australian dollar gold price exposure, backed by physical gold.

You are welcome to contact us with specific investment and planning queries.

Best wishes,

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

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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