July 2011 Review Comments

Portfolio Valuation & Comment

Transaction and cash account summaries for the financial year are available upon request or via the website.  For those where we act as the mail-house and/or provide tax record keeping we are well advanced on completion of summaries.  For those accounts with unit trust investments, we are unable to complete summaries until income statements are received (usually by late August).
The following table sets out returns from the various asset classes for the financial year:
Asset Class   Year Return - 30 June 2011  Index Applied 
Australian Shares  11.90%  S&P/ASX Accumulation Index 
Listed Property  5.87%S&P/ASX A-Reit Accumulation  
International Shares  3.50% MSCI World Accum ($A) 
Fixed Interest 5.55% UBS Composite Bond Index 
RBA Cash Rate (30 June 2011)  4.75%   Reserve Bank O’night Cash 
The above returns include the value of income (we have referred to accumulation indices) and the share market return in particular may surprise.  This is since the capital gain component was achieved early in the financial year.  Returns for Australian shares were slightly negative for the second half and listed property and international share returns were negative over the last quarter.
The real question is where are returns headed?  We remain in a quandary, with Australian shares and listed property paying higher income returns than fixed interest and trading at lower than ‘normal’ valuations relative to earnings – suggesting it is worthwhile buying growth assets.
Despite this, we are maintaining a more conservative stance as many of the changes overseas appear to be structural in nature, rather than a negative phase of the economic cycle.
Internationally, there is concern that employment growth in the US has stalled, with unemployment still high at 9.3% despite ultra low interest rates and a massive budget deficit.  Europe lurches along and opinion is divided on whether the required growth needed to save key parts of the European Union from an unsustainable debt spiral will occur.
China is fighting inflation, but with the working age population having peaked is it reasonable to assume that capital expenditure will continue to represent more than 50% of the economy!  Whilst India is growing, it is a far less capital intensive economy and can get by to a greater degree without Australia’s resources.

 Our Position

On balance, we believe that the Australian sharemarket will continue to trade within the two year All Ordinaries Index trading range of 4200 to 5050 (presently 4600) – as illustrated in the chart below.  With earnings growth likely to be subdued, we do not see a catalyst that will re-rate shares materially higher.
Australian Share Market

Australian Shares

We prefer defensive assets, such as Woolworths and Telstra Limited.  Cyclical stocks that have suffered from the high $A are also of interest – on the basis that our currency will weaken in the medium term – relieving some of the pressure on stocks such as Toll Holdings and QBE Insurance.
Select retail stocks appear to have been oversold.  Pacific Brands Group has expanded profit margins, is carrying almost no debt and is paying a very healthy dividend yield (7% to 8% fully franked).  David Jones has grown earnings (albeit slowly) in recent years, has gearing of only 11%, pays a dividend yield of close to 8% fully franked and generates a return on equity above 30%.  Whilst there are structural changes occurring with the internet and retail spending, this ‘story’ has exaggerated cyclical retail spending weakness.  We would not be surprised to see retail stocks rising if/when the Reserve Bank cuts interest rates.
We are hoping to see the weak market present opportunities, with stocks such as Computershare (share registry) and ARB Corp (4WD accessories) now much closer to buy levels.

Listed Property

We remain generally comfortable with listed property – with modest discounts to asset backing, higher than term deposit income and moderate to low debt levels.  We prefer industrial exposure such as Bunnings Warehouse Property over retail (shopping centre) property as the latter trade at a premium that appears unjustified.

International Shares

Allocations to this asset class remain generally low – the high $A presents an opportunity to add exposure and valuations are below average relative to earnings, with debt levels also generally lower than normal.  The main negatives are that (1) international interest rates must rise at some point and this will restrain share price growth, and (2) many of the large developed economies are carrying too much debt (public and private) and this will restrict economic growth.

Fixed Interest

Term deposit rates have settled at lower levels.  The banks are not under pressure to raise funds as credit growth is subdued.  It appears that the level at which the government guarantee applies will be cut in October from $1 million presently to somewhere between $100,000 and $250,000.  Returns compared to inflation are reasonable and we continue to advocate a rolling maturity approach.
We remain positive on holding some bond exposure in portfolios.  We expect bond returns to roughly match term deposit returns over time, with the added benefit of outperformance if local interest rates fall (which we expect would be accompanied by economic weakness).
As always, please contact me if you have any investment or planning queries.
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.


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