April Newsletter 2010

Investments returns continue to recover

Whilst most of the headlines have focused on the problems with Greece and also China and Australia raising interest rates, the investment markets have been performing very well.

This stage of the recovery is usually pleasing. Sharemarkets again posted a good result in March and the one year figures are as good as we could hope for.  There is still a long way to go to reach the previous highs that were set in early November 2007, however we are heading in the right direction and it has been at an excellent rate so far.

Of course returns will slow and normalise in time and there will be challenges. However patience is being rewarded.

Markets still have more to run

The first stage of the recovery in share markets is certainly nearing an end or is possibly over.  This involves moving from a position of share prices being sold down excessively and an overly pessimistic view being prominent.  As we have seen, the transition from this point has been very strong.

The second stage is where company earnings drive the returns.  That is, we see company profits growing and their expectation of future profits to be improving.  A good example is the announcement overnight by Apple Inc in the US that their profits for the March quarter this year have risen by 90% compared to last year.

This phase also usually requires better overall economic news for countries and even the world as a whole.  All these factors are present despite there being doubts and risks in some areas.  We are in the midst of reporting season in the US so sentiment will be driven by the quality of the company reporting.  In Australia we have good economic news and improving company results.

The final stage is the one that is the danger zone.  It is where investors get too excited and their expectations are unrealistic.  They believe that the markets will keep rising.  Fundamentals are ignored and share prices continue to be pushed higher, outpacing the growth in company earnings.  This is the ‘boom' part of the cycle and we know what follows.

Results like those from Apple are not sustainable and we will most likely see profits grow at a slower rate from here so returns will be more moderate whilst being well supported for growth.

China is still in the news

There is so much going on in and about China that it features very prominently in the general media and regularly in our updates.  Last week it was the news of the economy growing at 11.9% in the first quarter 2010 versus 2009.

Some of the detail behind the headlines is amazing.  Car sales are up 76% for the quarter compared to the same time last year. Mercedes Benz reported that sales were up 100% from the same period last year. Infrastructure projects are developing at an astonishing level.  The International Airport at Chongqing is being quadrupled in size. The local press in Chongqing reported that there are another 323 projects planned.  No need to ask if they are busy!

The downside of this is that all the development has to be paid for and much of it is being done with borrowed money.  In fact the level of borrowing is raising concerns within China and as a consequence they are tightening lending criteria for these projects.  This may mean that the current level of infrastructure investment in China is near a peak. 

In addition stricter requirements are being imposed on those borrowing to buy residential properties in China.  Under the new rules, purchases of a second property must involve a deposit of at least 50%.

Finally (for now) it does appear that China will allow some appreciation of its currency.  Assuming the increase is minor, it will have little real impact around the world.  As exports to China will be cheaper, our mining companies should benefit from any change.

Overall there is much happening in China and it appears that the outcome will be that the rate of growth will be more subdued in coming years as authorities there try to avoid a boom/bust scenario.  As we said last month China is attempting to apply the brakes and now seems more determined to do so.

Will our home loan rates reach 10%?

This issue was raised around a week ago and at first glance, it appears a little fanciful.  Yes rates are rising but the RBA cash rate is still at 4.25%, so it is a long way from 10%.  The logic to argument is this.  Rates as set by the RBA will continue to rise and possibly reach around 7%.  The big banks have actually increased their margin throughout the crisis, so add an extra 3% or so on top of the RBA rate and we are around 10%. 

Is this likely?  Well the RBA will continue to raise rates.  The level is very uncertain and at this stage 7% seems a long way off but if the last few years have taught us anything, it is to expect the unexpected.  Will the banks maintain their margins?  Most likely.  You wouldn't bet much on them reducing the margins.  

The consequence for increases in Home loan rates are very serious even if they do not reach the level mentioned.  The First Home Buyers Scheme of recent years meant that many people who bought houses with borrowed money and were stretched to do so will find it difficult to meet rising loan repayments.  Initially they will reduce spending elsewhere which will have an impact on the growth of our economy.

Our Portfolios continue to add value

As part our work behind the scenes we continually monitor the performance of the funds that we include in your portfolios.  We also monitor others that we are considering to use in the future.  We are satisfied that the funds we are using are adding value above the indexes and after fees. This means that your portfolios are not only performing well but also outperforming our targets.  For those clients who have been investing with us for longer periods we are seeing excellent returns through good and bad markets.

More importantly it is commonplace to see clients coming through the Global Financial Crisis with their retirements plans intact.