Unemployment up – Bad news is sometimes good news

Australia’s seasonally adjusted unemployment rate increased 0.1% from 5.3% to 5.4% in December, as announced by the ABS today.

The ABS reported the number of people employed decreased by 5,500 to 11,538,900 in December. The decrease was driven by a reduction of 13,800 people to 8,112,500 in full-time employment and was only partially offset by increased male part-time employment. The fall in employment was concentrated in Queensland, where employment fell by 23,000, whereas job numbers actually rose in NSW and VIC.

The number of people unemployed increased by 16,600 people to 656,400.The seasonally adjusted labour force participation rate remained steady at 65.1%. (more…)

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Commodity prices seem to be stabilising

The Reserve Bank of Australia has released its monthly index of commodity prices, one of the most important charts for the Australian economy at present. The index tracks the prices of commodities, weighted according to the relative importance of each commodity in Australia’s total commodity export earnings.

The index consists of rural commodities (around 13% of the index) such as beef and veal, wheat and wool, base metals (10% of the index) such as aluminium, copper, lead and zinc, and “other resources” – by far the largest category at 77%. The “other resources” category includes the bulk commodities, and is made up primarily of iron ore (20%), metallurgical coal (16%), gold (15%) and thermal coal (10%). (more…)

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Fiscal cliff averted … for now; US politicians finally see some sense!

The US House of Representatives late Tuesday night voted to approve a tax deal which had already received overwhelming support from the Senate. This deal will hopefully prevent the most significant effects of the “fiscal cliff” from scuttling the US economy – once it gains President Obama’s signature. The House voted 257-167 in favour of the plan, with the more partisan Republicans split between supporters of compromise and die-hard recalcitrants. (more…)

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How much capital do we need to retire? Part II – The drawdown phase

“Dear Santa, I have been working very hard and have been good throughout my years… all I want this Christmas is to own my own home and $1M in the kitty when I am 64….”

This time last year, we provided an example of an ‘HILV’ (higher income lower volatility) portfolio as an option to provide a comfortable retirement. Today, we revisit the topic and explore whether this strategy is actually sustainable and if so, for how long?

But before we do so, we will investigate the merit of holding 100% cash for the extremely risk averse household as an alternate strategy for one’s retirement.

100% cash

Using the same starting point as in Part 1 (shown in Table 1), we have modelled a portfolio of 100% cash and found that the accumulation phase including a 25% superannuation contribution, at 66 years of age, will result in approximately $45,000 less (in today’s dollars) than the HILV portfolio. While this appears not to be significantly different and comes with a much reduced volatility compared to the HILV portfolio, we note that a 100% cash portfolio at retirement would only be able to generate about $32,000 – $33,000 in present day values due to exceptionally low interest rates – providing a very modest retirement lifestyle for a couple. Some retired couples would be happy with a modest lifestyle as a trade-off for minimal risk; in such cases, the 100% cash option may be appropriate, bearing in mind that there remains the risk of higher inflation in the future eroding the value of that cash balance.

With global central banks pumping liquidity into the global financial system, whilst we believe over the short to mid-term, the inflation risk is low, in the mid to longer-term future, the risk of high inflation may escalate. Increased inflation during the drawdown phase will reduce the purchasing power of cash.

To mitigate the risk of inflation, one would need at least some growth and higher yield with some modestly growing assets. Thus in our view, an HILV portfolio where we can buy securities during periods of market weakness may suit the mass middle age affluent (that is, the top 20% of the high net wealth households).

Other issues for a 100% cash portfolio during its drawdown phase include:

• An extremely risk averse household would not at retirement be moving up in the risk curve at age 66 to set up an HILV or a growth portfolio to sustain a more comfortable retirement. In either case, the sum accumulated would at that stage be about $45,000 less to start with.
• The retired household or individual who started on an HILV strategy in the accumulation phase would have become used to high single digit volatility in the portfolio. Despite this volatility, the portfolio is well in the steady state where it is possible to generate an income stream for a modest to comfortable retirement lifestyle.

>> Read Part II – The drawdown phase

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German recovery to drive Europe in 2013?

Investors looking ahead to the New Year will have a range of issues in their minds: the daily updates on the US fiscal cliff negotiations, a lukewarm rebound in Chinese growth, continued quantitative easing programs across much of the developed economies and the consequential effects on interest rate structures and currency markets. For Australian-based investors, there are issues surrounding the evident peaking of the commodities cycle and the attendant impact on a range of listed companies, the decline in the terms of trade over the last 12 months, record low official cash rates at 3.0% with prospects of further rate cuts ahead, an “uncomfortably high” AUD, and a troubled minority government which will face an election at some stage in 2013. (more…)

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Year End Investor Briefing

This video is a recording of the Sydney Year End Investor Briefing held on 6th December. The presenter is Clime Asset Management’s Chief Investment Officer, John Abernethy.

The video is clipped to remove the introduction, and a run through of the current Clime Portfolio holdings. For more information on this please call 1300 788 568. You too can attend these free presentations. Visit our Events page to find out where Clime is speaking next. >> Clime Events

Video Length: 56:09

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PEs, Productivity, Capital Flows, and a Rate Cut

Despite a bevy of international economic concerns that confronted investors in late 2011 and early 2012, it appears that the Australian share market will generate a positive 10% return over this calendar year. The key support factor for the market has been the powerful rally in our bond market. The revaluation of equities has been in the face of flat earnings, declining commodity prices and a strong $A. Earnings growth across the broader market has been subdued and so the share price increases seem to reflect an expansion of Price to Earnings ratios (PERs). This seems logical as PERs have historically increased in response to lower bond yields. Had there been earnings growth, the share market may have produced a much more significant return.

Whilst this year has produced a positive investment return, over the last two years the broader Australian market (including dividends) has produced a negligible return. The lesson is a salient one. Investors who have had a judicious stock selection process (high Return on Equity or ROE companies) and a focus on sustainable yield have been well rewarded.

Our view is that the process of PER expansion still has some way to go. This is because the forces that have acted to push PERs higher are still in place. It is almost boring to harp on about the effects of quantitative easing but this policy setting remains firmly in place in offshore economies. There is no end in sight for monetary printing in the US, Europe, United Kingdom and Japan.

Therefore the forces that have lifted our dollar and driven our bond prices higher (lower yields) remain in force. As interest rates decline in secondary markets and through direct Central Bank policy actions, the upward push in equity prices remains in place. Noteworthy is that global equities over the last 6 months have lifted against declining earnings expectations….

So are the markets in a bubble or a liquidity trap? Read the full article….

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RBA cuts rates to 3.0%

As expected, the Reserve Bank met market expectations by cutting official interest rates by 25 basis points, from 3.25% to 3.0%. Governor Glenn Stevens said in his statement:

“Global growth is forecast to be a little below average for a time. Risks to the outlook are still seen to be on the downside, largely as a result of the situation in Europe, though the uncertainty over the course of US fiscal policy is also weighing on sentiment at present. Recent data suggest that the US economy is recording moderate growth and that growth in China has stabilised. Around Asia generally, growth has been dampened by the more moderate Chinese expansion and the weakness in Europe.

“In Australia, most indicators … suggest that growth has been running close to trend over the past year, led by very large increases in capital spending in the resources sector, while some other sectors have experienced weaker conditions. Looking ahead, recent data confirm that the peak in resource investment is approaching. As it does, there will be more scope for some other areas of demand to strengthen.

“Private consumption spending is expected to grow, but a return to the very strong growth of some years ago is unlikely. Available information suggests that the near-term outlook for non-residential building investment, and investment generally outside the resources sector, remains relatively subdued. Public spending is forecast to be constrained.”

The level of interest rates has an important effect on share market valuations, and the cut in rates is good news for investors. Generally, company profits benefit from lower rates as their cost of borrowing declines, and consumers benefit as their mortgage costs fall and they can either save more or spend more. Thirdly, as investment options are measured relative to each other, with cash rates declining, the relative appeal of alternative income-generating assets (such as dividends from shares or rents from property) becomes more attractive. This is why it is common for the share market to rise as interest rates decline: the market is prepared to pay a higher PE ratio for stocks on the expectation that earnings will grow, and on the relatively lower appeal of cash.

Following through on this logic, we continue to focus on quality companies that are generating high dividends, and especially those offering franking credits. This has served portfolios particularly well during the course of 2012, with the big banks and Telstra significantly outperforming the broader market. As those companies have steadily re-rated, portfolios have enjoyed solid returns – but we now face the somewhat more difficult task of finding new investment opportunities that combine high dividend yields with consistent and predictable earnings growth, and which are trading at prices that comply with our valuation criteria. Rest assured the investment team is hard at work sifting through the market and uncovering those securities with the right attributes for long term outperformance.

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China’s economy grows 7.4% in Q3

China’s gross domestic product grew by 7.4% in the third quarter, year on year. This marks the seventh consecutive quarter of slowing growth in the world’s second largest economy. This is well below last year’s 9.3% expansion rate, and significantly below the average for the last 34 years of close to 10% (since 1978, when Deng Xiaoping launched market reforms and unshackled the economy).

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US housing starts surge to 4 year high

US figures showed new house construction jumped 15 percent to an 872,000 annual rate last month, the most since July 2008 and exceeding all forecasts.

If you are wondering why US stock prices seem to be on a run over the last month, then the recovery in US housing may provide at least part of the answer. It was the collapse in US house prices that drove down US consumer confidence, so a recovery suggests an improvement in consumer sentiment will follow. As consumers drive the US economy, a sustained recovery in US house prices will have a very meaningful effect on the US economy.

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What is happening with iron ore prices?

A good discussion of the iron ore market is to be found in a piece titled “Iron Ore is headed up through Year’s End: Here are the Catalysts” – by Seth Walters, a contributor to the Seeking Alpha blogsite.

Walters reproduces the JP Morgan producer cost curve chart, which makes for some interesting observations, and reinforces our preference for being at the low cost end of the cost curve (ie BHP and RIO). See below:

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World Economic Outlook – IMF lowers forecast, US reporting season

In its World Economic Outlook, the International Monetary Fund (IMF) yesterday downgraded its forecast for global growth next year, stating that governments had underestimated the damage done to growth by tax rises and spending cuts. Their outlook for global GDP growth has been reduced from 3.5% to 3.3% in 2012, and from 3.9% to 3.6% in 2013.

According to the IMF’s Chief Economist Olivier Blanchard, the current financial and economic crisis is expected to last for a decade:

(more…)

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