January 2013 Review Comments
Written by Tony Gray   
Thursday, 24 January 2013 07:16

Portfolio Valuation & Comment

Whilst for much of 2012 the ‘feeling’ of the market was that investment markets were pretty tough, by the close of the year solid increase in portfolio values was apparent. As it turned out, calendar year results from most asset classes were pretty good – with only fixed interest assets declining in the last 6 months of the year.

Listed property prices rose solidly and in conjunction with income distributions generated well above average returns. I now have reservations about the sustainability of returns from this sector, but whilst short-term interest rates continue to fall the upward price trend remains intact.

Australian shares rose modestly according to the index, but most portfolios did significantly better due to low exposures to the underperforming mining, mining service and energy sectors (although these sectors have staged modest recoveries in the last 6 months).

International shares rose strongly, more than recovering the 2011 declines – despite a strong $A. This seems to be a co-ordinated rise, with all markets doing better – from the US to Japan to Europe and Emerging Markets. Even China’s stockmarket is doing well – after years of declines.

At-call and term deposit yields dropped significantly over the year, which we had considered a key risk in late 2011. Interestingly, long bond yields in Australia and the US have been rising since June 2012 lows – and I am now not so concerned about the risk of protracted low interest rates lowering income on the defensive side of portfolios.

Fixed Interest Markets & Consequences

From mid 2012 we stopped rolling out deposits on 5 year terms on the view that rates had fallen too low. The rise in 10 year Commonwealth Government Bond yields has been trending higher for 7 months and the interest rate curve is reverting to a normal shape (i.e. rising further out in time). In June 2012 yields bottomed at around 2.77% for a 10 year bond while the cash rate was 3.50%. Today, the cash rate sits at 3.00% and the 10 year bond rate at 3.43%.

While economists expect further falls in at-call rates in the short-term, my feeling is that during 2013 the view will switch to interest rate increases. The chart over the page indicates the down-trend for 10 year bonds has been broken and the same behaviour is observed for US yields.

Fixed Interest Markets and Consequences

Our view on interest rates shapes our positioning of portfolios in the following ways:

Term Deposits

We are keeping new term deposits to shorter 6 to 12 months terms – which pay a decent premium to the at-call rate. We are relying on higher long dated term deposit yields becoming available later - and most deposit portfolios have maturities out to 2016 and 2017 to hold up the average interest yield.

Fixed Interest

Apart from retaining some inflation index bond exposure in some portfolios, we are exiting any remaining bond fund exposures in portfolios. Losses from bonds are a distinct possibility if long bond yields continue to rise.

Australian Shares

Whilst shares have benefited from money flows as investors apply maturing term deposits to buying stock, we do not expect rising bond yields to reverse this flow. At this stage further short-term declines in at-call and term deposit rates are expected and that this will help drive share prices higher.

Looking slightly further out, we do not expect share prices to fall appreciably when interest rates do start rising. I refer investors back to the October 2011 review comments (available on the website). Back then our expectation was that markets would weaken further as interest rates declined – but then markets would begin rising and continue to rally as interest rates bottomed and then turned positive.

This cycle appears to be turning out to fit the theory and we remain positive on share returns from this point. Most portfolios bulked up share exposures during 2012, but for those who chose to remain at the conservative end of the scale, it is not too late to add some additional holdings at reasonable prices.

Australian Listed Property

More commonly known as A-REITS (Australian Real Estate Investment Trusts), my feeling is that prices are now above fair value – with the tail wind of rising earnings as interest costs fell potentially becoming a headwind in later 2013. Many trusts now trade at a premium to asset backing. We are not yet sellers, but are closer to an exit point than an entry point. If we do see further price rallies as interest rates are cut this year, then selling down exposures will be recommended.

The $A & International Shares

Despite the Australian dollar strengthening, the share price trend for international sharemarkets has turned upward.

While we see strong inward bound investment into Australia to support the very large expansion in energy production, this seems to be supporting the $A to a much larger degree then the fund flow to buy Australian bonds.

This investment spend is expected to peak in 2014 and we may then see some weakness in the $A? In the meantime, the continued printing of money overseas is keeping Australia high up the list of markets in which to ‘park’ money.

Ultimately, as international markets recover, there is a ‘risk’ that the $A declines sharply (positive for the value of international assets). There is also the possibility that the $A trends higher over the course of 2013 – but our view remains that with international share prices trending higher from relatively low levels, that the high $A represents a great opportunity to bulk up international shares in portfolios.

There are a number of active fund managers that justify their fees to consider and that are suited to regular monthly investments to average entry to the sector. This can be supplemented by purchases of lower cost exchange traded funds that provide a specific sector exposure and an immediate boost to portfolios. Examples of ETFs we are using include the S&P Global 100 (IOO), iShares MSCI Emerging Markets (IEM), iShares S&P Asia 50 (IAA) and the iShares FTSE China 25 (IZZ). Volatility for IEM, IAA and IZZ is expected to be high – but with the potential for strong growth.

The disadvantage of international shares – the lower and less reliable dividend yield – is now of lesser consequence when compared to the low at-call interest rates on offer.

Whilst I endeavour to review portfolio and planning matters on a rolling basis, sometimes market or regulatory changes intervene – so do not be shy in making contact with any queries in relation to your portfolio, markets or planning.

Best wishes,

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

Please treat the above comments as General Advice or general information, with no action to occur until we have considered with reference to your financial position, needs and goals.

Last Updated on Thursday, 24 January 2013 07:32

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