February Newsletter 2010

The recovery hits a rough patch

After a very positive run of around ten months, financial markets posted negative results in January. This was amid problems in Greece, concerns about China and doubts about the strength of the Global Economic recovery.

Despite the returns on portfolios for the year ended 31^st January have been excellent with investors with a growth asset allocation enjoying returns of around 20% for that year. Of course this was much needed after the previous losses.

The question is- was January a reversal of the recent recovery or a merely a break in the trend which will resume? Our view is that it is the latter and the recovery still has plenty of life, despite there being challenges ahead.

Greece & Government debt

The main news headline has been the problems facing Greece which has extended to a much lesser degree to concerns about other European economies.

During the crisis, it was the Private sector that met difficulties and in many cases, private entities failed, or were only saved with Government support.  As part of this process much of the problems and debts that were weighing on the private sector were transferred to the Governments or public sector.  We now have many countries with much higher debt levels and questions are being asked about the ability of those countries to repay the debts.  We even had Barnaby Joyce questioning the ability of Australia to repay its debts in the future.  This was a little hysterical to say the least and probably reminded some of us about the banana republic comments by Paul Keating many years ago.

The reality is that debt must be repaid at some point and we have many developed countries labouring under the load of heavy debt.  The problem is compounded by aging populations making it more challenging for Governments to generate revenue.

These developed countries include Greece, Iceland, Ireland, Spain, Portugal and Poland, none of which are significant economies individually. It is unlikely they will default on their loan repayments as they will gain support of other European countries (mainly France & Germany) but whilst there is talk of concerns they will still create doubts and impact investor confidence. 

The next group is the US & UK who have very large debts and are facing a long period of slow economic growth. 

All these countries need their consumers to spend to generate economic growth.  The problem is that many consumers are focussed on repaying loans and they are reducing spending and the populations are aging which also leads to less spending and less tax revenue collected.

Our approach

The traditional approach of many Financial Planners is to invest in overseas funds that have exposure to countries based on their size.  Place the most money in the biggest (US), then next biggest, etc.  We have never subscribed to this view and our choice of managers continues to reflect this.  Whilst we have not given up on the major economies as there are still companies in those countries that are worthwhile, we have included exposure to the Emerging Economies.  Those that have excellent growth prospect and will dominate the world economy in the future. 

China - what's the problem?

The problem is that the Chinese Government was worried that their economy was growing too strongly, something most countries wish they had to contend with at the moment.  They have taken measures to slow their growth to a more manageable rate. This will occur periodically in Emerging economies as they endeavour to find the right level of economic growth.

It is still expected that China will grow at around 9-10% this calendar year which is no cause for alarm.  

Australia - A developed economy benefiting from the Emerging markets

Australia is one of better functioning developed economies.  Our level of Government debt is really quite low by world standards.

We should see strong economic growth this year, unemployment continuing to fall and the ongoing advantage of our relationship with the Asian economies.

This means that the assets within your portfolio that have exposure to Australian assets should perform well.

Working for you behind the scenes

As part of our regular review of the investments that we have approved for use in client portfolios, we have recently made a number of changes to the funds and amount allocated to the various asset classes.

We are not trying to pick sectors or funds; we know that stock picking is not the way to add value on a consistent basis over the long term.  Our approach is to make adjustments to the portfolio to ensure it is well positioned for the future.  You will see these changes as we conduct your next review.

The US Federal Reserve raises its discount rate.

What is the discount rate? It is the interest rate charged to commercial banks on loans they receive from their regional Federal Reserve Bank's. 

This made a good headline as it is a clear step in the unwinding of the massive economic stimulus measures in the US.  There will be those who see it as a negative move as it will slow the economy and risk the US falling back into a recession. However we should think about why it is happening.  Do we really think the Federal Reserve wants to return to a recession?  A more realistic view is that the US economy is strengthening and is it an opportunity to begin to return rates to normal level.

It is true that if rates do rise by large amounts over a short period that it will have a negative impact on sharemarkets.  However what we have seen is a 0.25% movement aimed at helping to prevent the economy growing too strongly and returning to the boom-bust cycle.

Summary

We are seeing considerable change and much of it is occurring for positive a reason, that is the outlook is improving.  We also should keep in mind that the diabolical predictions of a depression did not eventuate. 

It is now about the Governments and Reserve banks around the world managing the recovery.