December Review Comments
Written by Tony Gray   
Tuesday, 07 December 2010 16:32

Portfolio Valuation & Comment

A reminder that access to the portfolio is available via the website and please contact us if you require user name and password details.

TG Financial will be closed over the Christmas break, with the following details:

Thursday 23rd December:  Office Closed from 4.30 pm
Tuesday 4th January:  Office Open 10 am to 4 pm, with reduced staffing
Monday 10th January: Office Open

Please also note that I will be taking leave from the 10th to the 21st of January.

With these dates in mind, I encourage you to contact me prior to Christmas if there is any element of your planning or portfolio position that you wish to discuss.  Similarly, if you expect or intend to execute sharemarket transactions whilst the office is closed, please contact us so arrangements can be made.

International Situation

The dangers to Australia from excessive debt and world trade and money flow imbalances are real.  We do not know if the eurozone system is sustainable but expect to see more shocks.  We do not know if China will go too far in trying to contain property and price inflation.  We do not know if the US can move to a sustainable economic recovery without unleashing inflation.  In Australia, we do not know if house prices will correct lower, if international funding of Australian banks is sustainable or how long prices and volumes for iron ore and coal will remain high.

What we do know is that the private sector is heavily indebted, the savings rate is finally improving, retail spending has weakened and business is also paying off debt and deferring investment.  We also know that there have been no meaningful (positive) reforms in Australia for some time.

On the positive side, share prices are relatively cheap compared to bonds and earnings and most companies continue to reduce debt and pay healthy dividend yields.   We also observe that historically there are almost always risks and that despite this, markets tend to rise over time.

The question for each investor is how much to allocate to growth and defensive assets to manage the risks and achieve objectives.

2010 Comment & Outlook

Growth market returns for the calendar year have been subdued.  As suspected, 2010 has turned out to be a year of ranging investment markets, after the recovery phase in 2009.  Although there will be positive and negative years ahead across the various asset classes, we continue to expect relatively subdued returns due to the long-term deleveraging of the world economy.


At-call interest rates rose during 2010 and the most commonly held client account, the ANZ V2+ account, is presently paying 5.35%.  This is a premium to the Reserve Bank of Australia’s overnight cash rate of 4.75%, which started the year at 3.75%.

An at-call interest of 5.35% is historically high relative to inflation of 2.78% (CPI for the year to the end of September 2010).

Fixed interest

Term deposit rates have changed very little during 2010.  The premium over at-call interest has narrowed – so that an extra return of perhaps 1.0% is typically available for twelve month terms.

The real return from term deposits is also historically attractive.  As term deposits represent a defensive component of the portfolio, the biggest risk is that interest rates fall and maturing deposits are reinvested at lower levels.  The next risk is that inflation rises and the interest return is locked in at lower levels.  The former risk is one that could have quite a negative impact for investors relying on the income, whereas the latter risk will represent a temporary narrowing of the real (after inflation) return.

For investors who rely on interest income to meet pension payments or living expenses, it is prudent to consider introducing some longer dated term deposits as part of the maturity profile.  This is despite interest rates being only modestly higher for 3 year terms compared to 1 year terms.

We highlight the fact that it is now cheaper to lock in 3 year fixed rate home loans compared to a variable loan (this is unusual).  Similarly, 10 year Commonwealth Government Bond yields are presently 5.51% - also lower than term deposit rates.  These both suggest a risk of lower future interest rates.

 Listed Property

We focus on listed property, since (1) we do not recommend unlisted property funds due to liquidity concerns, and (2) directly held property investment is usually not within TG Financial’s mandate.

The listed property index started the year at 897 points and is presently 850 points – a decline of 5.24%.  Balance sheets for the larger trusts have been repaired, yields are typically above 6% per annum, property values have stabilised (the downward valuation cycle appears to have ended) and most trusts continue to trade at historically high discounts to asset backing of 15% to 20%.

We remain comfortable with the total return outlook for listed property, with the expectation that rental income will rise in line with inflation and generate high single digit returns, or low double digit returns if we see the discount to asset backing gradually narrow or property prices rise.

International Shares

The Morgan Stanley Capital Index (MSCI) started the year at 1,168 points and is presently 1,237 points, a 5.9% rise.  However, the strength of the Australian dollar against most currencies has more than wiped out this underlying improvement.  We started the year at US89.73 cents for each Australian Dollar and this is presently US99.19 cents.  This represents a 10.5% rise in our dollar against the US.  While the rise against other currencies has not been quite as strong, all the same it has meant once again a disappointing total return from international shares.

Recognising the rising currency trend, for much of the year we have recommended low exposures to international shares relative to the investment strategy range.  Whilst we acknowledge the potential for the Australian dollar to continue to rise, we think the actual percentage impact on returns from this point will be relatively low.

Whilst investing in international shares may be uncomfortable in the short-term, it is our belief that we will see outperformance relative to other growth assets in the medium term.  The last time this occurred was in the 1995 to 2000 period, where rising markets and a falling local dollar generated returns in excess of 30% per annum.  By 2000, common ‘wisdom’ was that growth oriented funds should have around 45% of assets invested internationally – all too late of course!

The number of low cost exchange traded funds listed in Australia, but tracking various international indices, has risen sharply in recent years.  The website has some useful fact sheets for those interested.

Australian Shares

The All Ordinaries Index started the year at 4,882 and presently stands at 4,780 – a decline of 2.1%.  Mining and mining related stocks are modestly higher and most other sectors are modestly lower.

Consumer discretionary stocks have been hit hard due to low retail spending growth, particularly following the last few interest rate increases.  It now seems households are saving around 10% of income each year, up from 1.8% in 2007.  This is something that had to happen for the long-term sustainability of the Australian economy.  We are now at the point where spending can grow in line with household income growth and maintain a relatively high savings rate.  If this transpires, then retail stocks could do quite well from this point.

The energy sector (excluding coal) fell during 2010, even whilst mining stocks recovered from mid-year lows.  This sector seems to represent decent growth potential, with the oil price in a gradual rising trend.
Many individual stocks have established quite wide trading ranges and we continue to see active lightening of stocks high in the range and addition of stocks lower in ranges as adding value – compared to a buy and hold approach.


In conclusion, we expect the most likely outcome for 2011 is a continuation of a ranging Australian sharemarket.  We expect moderate returns from listed property and potentially stronger returns from international shares.  It is possible that international shares outperform if we see the Australian dollar fall as international investors move funds into other markets.

Within the Australian share market, the biggest decision is whether to participate in the mining and mining related boom (higher potential returns and risks).  We do see some inflation hedging benefits in boosting exposure to the energy sector.

We do not expect at-call interest rates or term deposits to rise much further and see some benefits in including longer dated deposits in portfolios to reduce the risk of interest rate falls.

Thank you for your support during 2010 and a request that you contact me if you feel we are not meeting expectations or if you feel there are things we can do better.  A reminder also that regular two way communication is important, so do not hesitate to make contact if you have any investment or planning questions, or would like us to discuss the portfolio and positioning.

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.

Last Updated on Tuesday, 07 December 2010 16:42

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