June 2012 Review Comments
Written by Tony Gray   
Friday, 08 June 2012 15:17

Portfolio Valuation & Comment

Cash & Fixed Interest

The Reserve Bank cut interest rates by a further 0.25% in early June, with a total cut of 1.25% since November 2011.  Term deposit rates fell in anticipation and then a bit more – right across the yield curve.  Term deposits still represent an ‘ok’ interest premium to at-call rates and inflation.  Short dated deposits (6 months) pay a good interest premium to at-call money.

Australian Government Bonds have continued to rise as yields have fallen to the lowest since Federation.  At one stage the yield on a 10 year bond was 2.9% (presently 3.04%) and below the low 3% range set in the depths of World War II.

If bond markets are priced correctly, then they are forecasting recession, with longer dated yields well below the overnight cash rate.  I believe the low yields are more a function of markets, with overseas money chasing our scarce AAA rate government debt (already ~90% owned by foreign institutions) – since the yields and credit rating are still higher relative to repressive (negative real) interest rates in Europe and the United States.

In order to justify investing in AAA Australian Government bonds at this time, in preference to higher yielding term deposits guaranteed by the government (up to $250,000 per institution), then an expectation of further falls in long bond yields is required.  When the interest rate curves reverts to normal, significant losses on bond holdings will occur.

While prepared to hold inflation linked bonds and bond funds with short duration, we are very close to exiting bond holdings in portfolios, due to the increasing risk of loss or subdued returns.  As is often the case, fixed interest funds are attracting big fund inflows at the moment – right when the risk of losses is high.

Listed Property

We are exiting retail property exposure on the rally in unit prices/narrowing of the discount to asset backing.  Westfield has reduced rents to a minor degree to maintain occupancy.  The risk is that capitalisation rates rise and the supposed discount to asset backing evaporates.

We are struggling to find acceptable trusts to purchase at current levels, with prices seemingly unaffected by the European banking and sovereign debt crisis – which is curious because this has the potential to restrict debt funding considerably.

International Shares

We continue to accumulate international stocks.  One boutique manager I spoke to last week made the point that everywhere in the world he visits reinforces how expensive Australia has become – from wages to housing to goods and services and government charges.  Diversifying away from the Australian economy is a prudent measure at this time.

I note that the trailing price to earnings multiple for the Standard & Poors Global 100 index (which tracks the top 100 freely traded global stocks) is a low 11 times earnings.

‘Other’ Assets

We advocate holding some USD ($US) as a hedge against a potentially sharp fall in the $A and as we believe the local currency will fall in the event of a major sharemarket sell-off.

The behaviour of gold has changed again, with recent sharp falls seeing a rise in the price of gold.  It appears that gold is now trading contrary to markets again and hence is worth re-considering as a hedge within portfolios.
For some larger portfolios (that meet the Sophisticated Investor definition), there are some hedge fund managers to consider as a minor allocation.

Australian Shares

The mining sector has been forming recent lows, with prices well below July-September 2011 lows.  Energy stocks have also been weak as have mining service companies.  Most other sectors, including the banks, have fallen to a modest degree and sit well above 2011 lows.

The result is that the fall in the index has not provided the buying opportunities hoped for just yet.  We are not interested in adding mid cost to high cost miners – if prices do fall over the coming years then we will see major write-downs and corporate failures.  BHP and RIO are moving into interesting territory, but we would like to see another 10%+ off current price levels to consider.  As low cost producers they will make tidy profits when others are shutting down.

As always, if there is a material change in your position or goals, or if you have any investment or planning queries or concerns, please contact me. 

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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