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Presented by Dr Shane Oliver Chief Economist & Head of Investment Strategy AMP Capital Investors APRA Liquidity Risk Management Conference – May 2007 Liquidity and investment markets What is liquidity? z Monetary liquidity – interest rates, money supply growth, FX reserves z Balance sheet liquidity – are balance sheets cashed up? z The operational liquidity of investment markets – the ease with which assets can be bought and sold z The demand for assets relative to their supply Source: AMP Capital Investors 2 2 The liquidity cycle and the current state of play z Liquidity normally follows a similar cycle to the economic cycle – easiest when economic conditions are tough (as interest rates fall and balance sheets become cashed up), tightest when conditions are good (and interest rates rise) z But liquidity conditions are still relatively easy despite economic recovery cycles being relatively mature Source: AMP Capital Investors 3 3 Liquidity conditions remain favourable Interest rates are low relative to nominal GDP growth Interest rate % Nominal GDP growth % pa* US 5.25 4.8 Germany 3.75 3.9 UK 5.25 6.7 Japan 0.50 1.9 G7 average 4.10 4.7 Australia 6.25 7.1 * Latest available Source: Thomson Financial, AMP Capital Investors 4 4 Liquidity conditions remain favourable G7 money supply is rising relative to nominal GDP 10 8 6 Broad money growth less nominal GDP growth, % yr on yr (LHS) Ratio of broad money to nominal GDP (RHS) 2 1.8 1.6 4 1.4 2 1.2 0 1 -2 0.8 -4 0.6 80 82 84 86 88 90 92 94 96 98 00 02 04 06 Source: Datastream, AMP Capital Investors 5 5 Liquidity conditions remain favourable Above trend growth in world foreign exchange reserves 50 Annual % change 40 30 20 10 Average 0 -10 -20 80 82 84 86 88 90 92 94 96 98 00 02 04 06 Source: Datastream, AMP Capital Investors 6 6 Liquidity conditions remain favourable z Corporate balance sheets are in good shape z Household balance sheets are in good shape ….so what is happening? 7 7 Key drivers of the favourable liquidity environment z Solid (but not booming) economic growth and low inflation Which are in turn driven by the following key factors z Globalisation z Competition z New technology = a positive supply shock (inverse of 1970’s oil shock) Source: AMP Capital Investors 8 8 Implications – (1) strong productivity growth 6 5 4 Productivity growth, annual % change, 3 year average Developing countries World 3 2 1 Developed countries 0 -1 -2 90 92 94 96 98 00 02 04 06 Source: IMF, AMP Capital Investors 9 9 Implications – (2) a better growth/inflation trade-off Global GDP versus change in inflation 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 Global inflation , % change (LHS) Global GDP growth (RHS), % year on year 7 6 5 4 3 2 1 0 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 Source: Datastream, AMP Capital Investors 10 10 China is a classic example of the strong growth/low inflation story 40 35 Annual % Change Retail Price Inflation (RHS) 30 30 20 25 10 20 0 15 -10 10 5 Real GDP Growth (LHS) 0 -20 -30 80 82 84 86 88 90 92 94 96 98 00 02 04 06 Source: Datastream, AMP Capital Investors 11 11 Money supply should grow faster than nominal GDP in a positive supply shock The quantity theory of money: M x V = P x T Where: M = money supply V = its velocity of circulation P = price level T = volume of activity When there is a positive supply shock T goes up As inflation and interest rates go down V goes down So M should be allowed to grow faster than nominal GDP (or P x T) or else there would be deflation Source: AMP Capital Investors 12 12 Implications – (3) high profit shares and strong balance sheets 24 Profits, % GDP 22 14 12 US, after depreciation (RHS) 20 10 18 8 16 6 14 4 12 10 1970 2 Australia (LHS) 0 1975 1980 1985 1990 1995 2000 2005 Source: Thomson Financial, AMP Capital Investors 13 13 Implications – (4) excess labour (emerging mkts) & capital (easy money), but a shortage of land (eg high commodity prices) Economist metal price index, $US 250 230 210 Nominal metal prices 190 170 150 130 110 90 70 50 Real metal prices 30 10 71 74 77 80 83 86 89 92 95 98 01 04 07 Source: Datastream, AMP Capital Investors 14 14 Implications – (5) added impetus to falling economic volatility. If inflation stays low, volatility will remain low Economic volatility has been falling 4 Rolling 10 yr standard deviation of annual GDP growth 3 US 2 Share market volatility should remain “low” 40 12 month rolling standard 35 deviation of monthly share price changes Average of 30 the US, Japan and Europe 25 20 15 1 10 Australia 0 1960 5 Australia 0 1970 1980 1990 2000 90 92 94 96 98 00 02 04 06 Source: Thomson Financial, AMP Capital Investors 15 15 Favourable liquidity – lots of cash chasing investments Unrestrictive monetary policy Positive supply shock from China/India, technology and globalisation Solid growth/ low inflation Strong balance sheets Ample liquidity chasing investments Confident lenders & investors In the absence of inflation or some blow to confidence this could go on for a lot longer Source: AMP Capital Investors 16 16 Market implications 17 17 The shift to low inflation has lead to high (and rational) capital gains z First sovereign bonds - 1980s/90s z Then equities - 1990s z Then property and infrastructure - this decade Source: AMP Capital Investors 18 18 Bond yields are now around normal longer term levels 10 year bond yields, percent 18 16 14 12 10 8 6 4 2 0 1861 Australia US 1881 1901 1921 1941 1961 1981 2001 Source: Global Financial Data, Datastream, AMP Capital Investors 19 19 Shares – potential for multiple expansion …stage three of a bull market 30 Forward PE 25 World 20 15 Australia 10 5 88 90 92 94 96 98 00 02 04 06 Source: Datastream, AMP Capital Investors 20 20 Equity risk premiums are around reasonable levels Dividend yield + Growth - Bond yield = ERP Required ERP US 1.8 5.2 4.6 2.4 2.5-3.0 UK 3.6 4.2 5.1 2.7 2.3-3.0 Europe 2.7 4.0 4.2 2.5 2.5-3.0 Japan 1.1 3.0 1.7 2.4 2.5-3.0 Asia, ex Japan 2.7 8.0 4.6 6.1 3.5-4.0 World 2.1 4.6 4.3 2.4 2.5-3.0 Australia 3.6 5.7 5.9 3.4 3.0-3.5 Source: Datastream, AMP Capital Investors 21 21 M&A activity is on the rise but still low by past standards – so could have further to go 35 30 Value of announced M&A deals, % mkt capitalisation 25 20 Australia 15 10 5 US 0 85 87 89 91 93 95 97 99 01 03 05 Source: Datastream, AMP Capital Investors 22 22 Equity is cheap vs debt – the cost of capital is below its return – providing an arbitrage opportunity for private equity takeovers US 14 Australia Percent 12 10 8 Forward earnings yield 6 4 2 10 year bond yield 85 87 89 91 93 95 97 99 01 03 05 07 14 Percent 13 12 11 Forward earnings 10 yield 9 8 7 6 5 10 year bond yield 4 88 90 92 94 96 98 00 02 04 06 Source: Datastream, AMP Capital Investors 23 23 Corporate gearing is relatively low 130 110 Ratio of debt to equity, listed nonfinancial companies, Australia 90 70 50 30 80 82 84 86 88 90 92 94 96 98 00 02 04 06 Source: ABS, Aspect Huntley, RBA, Statex, AMP Capital Investors 24 24 Are we somewhere in the equivalent of 1986? Aust All Ords price index - Comparison of 1987 to Now Aug 01 Aug 02 Aug 03 Aug 04 Aug 05 Aug 06 Aug 07 500 500 Indexed to 100 at Aug 82 and Mar 03 400 400 Jan 1981 to Dec 1987 (bottom) 300 300 200 200 Aug 2001 to Current (top) 100 0 Jan 81 100 0 Jan 82 Jan 83 Jan 84 Jan 85 Jan 86 Jan 87 Source: Thomson Financial, AMP Capital Investors 25 25 Are emerging markets now the equivalent of the US in the second half of the 1990s? z Main source of global growth z Very vibrant and dynamic z BRICs as “new paradigm” exciter (like US IT revolution of 1990s) z Fuelled by global liquidity boom Source: AMP Capital Investors 26 26 Non-residential property yields lagged the fall in other yields, so may have further to fall 14 12 Percent Earnings yield - Aust shares Composite nonresidential prop yield 10 8 6 4 2 0 Real bond yield Aust bonds Residential housing yield 80 82 84 86 88 90 92 94 96 98 00 02 04 06 Source: Jones Lang LaSalle, Datastream, AMP Capital Investors 27 27 The property risk premium is still well above early 1990’s extremes 8 The non-residential property risk premium Property risk premium = 6 yld + 2.5% less bond yld, %pa Australian unlisted property 4 2 Australian listed property trusts 0 -2 -4 90 92 94 96 98 00 02 04 06 Source: Datastream, AMP Capital Investors 28 28 Hard to see credit spreads narrowing any further, as increased debt/risk taking occurs 5 50% US Moody BAA Credit spread (LHS) 4 Equity Volatility 40% VIX (RHS) 3 30% 2 20% 1 10% 0 0% 86 88 90 92 94 96 98 00 02 04 06 Source: Datastream, AMP Capital Investors 29 29 Conclusion z The favourable liquidity environment is being driven by the global environment of reasonable growth and low inflation z This in turn is a function of globalisation, competition and new technology z The favourable liquidity backdrop has the potential to remain in place for several years pushing asset prices, gearing, etc, to extremes z Things to watch: the US economy, inflation, China, corporate debt levels Source: AMP Capital Investors 30 30 Thank you QUESTIONS? 31 31 Important note Neither AMP Capital Investors Limited (ABN 59 001 777 591)(AFSL 232497), nor any other company in the AMP Group guarantees the repayment of capital or the performance of any product or any particular rate of return referred to in this presentation. Past performance is not a reliable indicator of future performance. While every care has been taken in the preparation of this document, AMP Capital Investors makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. This document has been prepared for the purpose of providing general information, without taking account of any particular investor's objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor's objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided. 32 32