April Review Comments
Written by Tony Gray   
Tuesday, 12 April 2011 10:22

Portfolio Valuation & Comment

Please find attached a copy of your portfolio as at the 31st of March.  Also attached is a $500,000 note – but don’t get too excited – it’s from Zimbabwe and worth about a ¼ of a cent Australian – that’s the outcome of hyper-inflation.

The following provides context for investment recommendations and portfolio positioning.

United States of America

The US has a deepening fiscal crisis.  The federal government borrowed 37% of what they spent in the last year, with no clear path to cutting this reliance on new debt.  In fact tax cuts have been entrenched and the welfare net expanded. 

There are some cyclical factors at work.  Assuming employment continues to gradually recover, then welfare costs for the government fall and tax revenue rises.  All the same, there remains a sizeable structural budget deficit.  State governments in the US are also in a weak fiscal position.

The US strategy to dealing with the global financial crisis has been with monetary levers.  By slashing interest rates and keeping them low they have supported the sharemarket and eased the interest burden for consumers, companies and the government.  Company earnings and debt levels are in quite good shape, but earnings growth is likely to be low from this point.  The government has also printed money to buy some 70% of their newly issued debt!  Pimco, the largest global bond fund now has a short position on US bonds.

There is a big push to cease printing money by June of this year and the question is ‘who will buy US government bonds’?  The answer is that new bonds will be issued to fund the budget deficit but that interest rates will have to rise to attract borrowers.  Market (not government) interest rate rises may well see a fall in the US sharemarket and slow the growth of the US economy.
There are major fiscal and monetary imbalances in the world’s largest economy and risks to the downside for US shares.


Parts of Europe have adopted austerity measures in an attempt to move government budgets out of deficit.  This has reduced demand and economic growth but needed to happen.

Ireland and Southern European countries are already suffering from much higher interest rates – making it even more difficult for governments to move out of deficit.  This is the debt trap the US somehow needs to avoid.

Northern Europe represents some 70% of the economy and is in much stronger shape, with lower unemployment, lower budget deficits and lower interest rates.  They are also benefitting from a weaker Euro, which is assisting competitiveness.  The problem for northern Europe is that their banks have lent a lot of money to southern Europe and government debt default would break the banking system.

For this reason the European Central Bank (ECB) has been buying new debt issued by the likes of Ireland, Greece and Portgual, with Spain in line.  This is providing new debt while those economies restructure, but the ECB cannot lend money forever (well they can, but it will lead to hyper-inflation).

Europe has a population that is older and ageing faster than the United States.  Unless government budgets can be moved out of deficit, then debt will compound as governments struggle to cut spending and maintain tax revenue.

European governments have cut spending but need to grow the regional economy and lift tax revenues in the face of an ageing population and attendant welfare costs.  Europe is in a poor position if world economic growth slows.


The picture from China is not clear at all.  The bearish view is that of a massive over-build of housing and factories, with rampant inflation and a ponzi scheme of bank lending at artificially low rates on assets with little or no income producing capacity.  The working population of China has peaked and is now slowly declining (as a consequence of the one child policy).  There is social discontent and the property bubble will burst.  With it will go demand for metals and Australia’s economy will suffer as a result.

The bullish view is that China will overtake the US as the world’s largest economy in the 2020 to 2030 period, inflation will be contained, there is no bubble in property and large numbers of people will continue to move from the countryside to the cities.  The Chinese domestic economy will transition from industrialisation to consumerism.  Demand for metals will grow exponentially and high prices maintained.

My view is that China’s recent growth rates are unsustainable.  They have the most rapidly ageing population in the world with no welfare net.  The new 5 year plan (2011-2015) is for 7% p.a. growth – down from more than 11% p.a. for the previous 5 years.  There is a problem with inflation (running at 5% to 6% per annum) and interest rate rises are needed to contain this and a property bubble.  If inflation gets out of hand, then this could see prices for metals rise even further in the short-term but will inevitably lead to a bust.

My opinion is dramatically different to the one assumed by the Australian government and the mining sector – who have adopted the bullish scenario.  I make the point that in 2003 not one of Australia’s mining houses were positioned for the China boom and equally that they cannot position themselves for a bust.  The ultimate conclusion to draw from China is that Australia is woefully unprepared if the China golden goose lays an ordinary egg!  From this leads a degree of caution as to the types of assets held in portfolios.


Housing finance figures, increased time to sell property, increased numbers of property for sale, reduced housing finance approvals mean property prices are primed to fall – although to what degree is unclear. 

It has been a very long time since Australia had a bear market in residential property.  It may not happen, but with most landlords being baby boomers and moving into retirement for the next 20 years there is a risk that selling pushes down prices.

The direct risks from a decline in house prices are via some of the residential property developers, building companies, retailers (especially hardware) and the banking sector.

Property will not necessarily fall and house prices may merely lag household income rises – but the warning signs are there.

Everything Else

Gold and oil remain in uptrend as does the Australian dollar.  My suspicion is that when we see metal prices falling, we will see the Australian dollar falling and interest rates cut.

Silver has rallied very sharply in the last 6 months relative to the gold price  – this has been the prelude to precious metals falling (including gold) since the 1970’s (I did not look further back than this).

All the same, holding some gold as a hedge, extending term deposit maturities to lock in current rates (deposits of less than $1 million are guaranteed by the government) and having some exposure to energy and agriculture is recommended.  Non bank industrials may have their turn in the sun as money rotates from the mining and banking sectors.

I believe the most likely outcome for Australian shares is that prices continue to range sideways and presently are falling from the high end of the range.  Prices are reasonable for most listed companies BUT I note the increasing number of services companies (engineering, construction, contracting) that are reporting reduced earnings/losses (the biggest and most recent example being Leighton Holdings).  This whole sector operates on thin margins and sharp falls in earnings and share prices occur for every company on occasion.

The Last Word

Don’t take the above as a basis for storing up on survival rations and digging in.  The intent is to raise some of the global issues at play and Australian housing.  There are many investments NOT included or recommended in portfolios.

There are some pretty reasonable valuations available in the local sharemarket, with good balance sheets, good businesses and decent dividend yields on offer.

Planning Issues

A cautionary reminder that the concessional contribution cap for those claiming tax deductions/salary sacrificing into superannuation is $25,000 p.a. for those under age 50 (includes SGC contributions).  For those 50 and above, the transitional limit is $50,000 p.a. until 30 June 2012.  Excess contributions will be taxed at 46.5% and count towards the non-concessional limit of $150,000 per annum.

Any amounts in excess of the $150,000 non concessional contribution limits are also taxed at 46.5% (but be aware of a ‘bring forward rule’ for those under age 65) and this is in addition to any tax paid on concessional contributions.

This means it is conceivable that an astounding 93% tax is payable on superannuation contributions where the caps are exceeded.  If you have any doubt on your position, please contact me or raise this at the next review.

Best wishes,

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

Last Updated on Monday, 18 April 2011 10:31

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