Download Source: Thomson Financial Datastream

Economic and investment prospects
Brian Parker CFA
Investment Strategist
MLC Investment Management
April 2008
1
General advice warning and disclaimer
Any opinions expressed in this presentation constitute our judgement at the time of issue and are subject to
change. We believe that the information contained in this presentation is correct and that any estimates, opinions,
conclusions or recommendations are reasonably held or made as at the time of compilation. However, no
warranty is made as to their accuracy or reliability (which may change without notice) or other information
contained in this presentation. To the maximum extent permitted by law, we disclaim all liability and responsibility
for any direct or indirect loss or damage which may be suffered by any recipient through relying on anything
contained in or omitted from this presentation.
This presentation contains general information and may constitute general advice. It does not take into account
any person’s particular investment objectives, financial situation or individual needs. It should not be relied upon
as a substitute for financial or other specialist advice. It has been prepared solely as an information service for
financial advisers and should not be distributed to clients.
Before making any decisions on the basis of this presentation, you should consider the appropriateness of its
content having regard to your particular investment objectives, financial situation or individual needs.
Opinions expressed constitute our judgement at the time of issue and are subject to change. The presenter is a
representative of MLC Investments Limited. MLC Investments Limited ABN 30 002 641 661 105-153 Miller Street,
North Sydney NSW 2060 is a member of the National group of companies.
MLC Investments Limited is the issuer of the MLC MasterKey Unit Trust. Information about the MLC MasterKey
Unit Trust is contained in the current Product Disclosure Statement (‘PDS’), copies of which are available upon
request by phoning MLC on 131 831 or on our website at mlc.com.au.
2
The state of play
•
Too much liquidity
•
Too much leverage
•
Too much complacency
•
Voracious risk appetites
•
A benign macroeconomic environment
Have led to….
•
Risk being way underpriced – too little reward on offer for risks that have
not been properly understood
•
In short, returns have been too high, and volatility has been too low,
and this situation is now normalising
The problem was (and still is) much larger than just US subprime mortgages!
3
When too much debt just isn’t enough
Total US debt as % of GDP
“In the end, the root of the problem is unavoidable. At some point US
consumption will have to come into line with US incomes, and US growth will
need to be built without constantly growing debt levels. This adjustment will be
painful. The pain can be spread across time and across people, but it cannot be
avoided.”
- Bridgewater 24 March 2008
4
US housing: the state of play
..helping to create a huge overhang of
unsold homes
Home sales have plummetted..
8500
'000 annualised
12
7500
10
6500
8
5500
Unsold single-family homes to total sales ratio
6
4500
4
Total home sales (new + existing)
3500
2500
Jan-93
2
Jan-96
Jan-99
Jan-02
Jan-05
Jan-85 Jan-88 Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06
Jan-08
..but more forced sales are likely as
delinquency rates have soared.
Housing starts have fallen in response
to sharply weaker demand..
2500
3.5
Delinquency rate % of loans outstanding
3.0
2000
2.5
1500
2.0
1000
1.5
Housing starts (lhs)
1.0
500
Jan-93
Jan-96
Jan-99
Jan-02
Jan-05
Source: Thomson Financial Datastream
Q2 1990
Jan-08
5
Q2 1993
Q2 1996
Q2 1999
Q2 2002
Q2 2005
The US economy is probably in recession already
Consumer confidence is already at recession
levels
GDP growth is OK, but the leading indicators
look lousy
10
Annual change %
135
Conference Board leading index
Real GDP
125
Expected
conditions
115
Current
conditions
8
6
US University of Michigan consumer sentiment indices
105
95
4
85
2
75
65
0
55
-2
45
-4
Q1 1988 Q1 1991 Q1 1994 Q1 1997 Q1 2000 Q1 2003 Q1 2006
Source: Thomson Financial Datastream
35
Jan-88 Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06
6
No, it’s not just a US problem
..and G3 consumer sentiment is
also falling
EU, Japanese manufacturing
confidence is following US lower..
3
Std deviations away from 5yr average
US
3
Std deviations away from 3yr average
EU-15 and Japan
US
2
2
1
1
0
0
-1
-1
-2
-2
-3
Q1 1990
-3
Q1 1990
Q1 1995
Q1 2000
Q1 2005
Source: Thomson Financial Datastream, MLC Investment Management
7
Q1 1995
EU-15 and Japan
Q1 2000
Q1 2005
Markets have been a little better of late, but the view
through the windscreen still looks pretty ordinary…
130
Selected share price indices (end June '07 equals 100)
120
Australia
US
Japan
UK
Euro-area
EMEs
110
100
90
80
70
60
Jun-07
Aug-07
Oct-07
Dec-07
Source: Thomson Financial Datastream
Feb-08
8
Apr-08
Some of the major central banks have started
the rescue operation…
9
Official interest rates %
9
Official interest rates %
8
8
7
7
6
6
5
5
4
4
3
3
2
2
1
1
0
May-04 Feb-05 Nov-05 Aug-06 May-07 Feb-08
0
May-04 Feb-05 Nov-05 Aug-06 May-07 Feb-08
US
Canada
Euro-area
UK
Australia
New Zealand
Japan
China
Source: Thomson Financial Datastream. US rate is target rate for Federal Funds. For Europe, short-term repo rate.
Canadian rate is Bank of Canada policy rate. Australian rate is the RBA cash rate target. Chinese rate is the
1yr benchmark lending rate. NZ rate is RBNZ cash rate target.
9
..but how much more debt can be rammed down the
throats of consumers in the English speaking world?..
Australian household debt
US household debt
%
180
160
as % of GDP
140
as % of disposable income
120
100
80
60
40
20
0
Q1 1980 Q1 1985 Q1 1990 Q1 1995 Q1 2000 Q1 2005
180 %
160
as % of GDP
140
as % of disposable income
120
100
80
60
40
20
0
Q1 1980 Q1 1985 Q1 1990 Q1 1995 Q1 2000 Q1 2005
UK household debt
%
180
160
as % of GDP
140
as % of disposable income
120
100
80
60
40
20
0
Q1 1980 Q1 1985 Q1 1990 Q1 1995 Q1 2000 Q1 2005
Source: Thomson Financial Datastream
10
House prices in the English speaking (!?) economies
300
Real (inflation adjusted) house prices. March quarter 1988 equals 100
US
250
UK
Aust
200
150
100
Sources: Datastream, RBA, MLC Investment Management
50
Q1 1988
Q1 1991
Q1 1994
Q1 1997
11
Q1 2000
Q1 2003
Q1 2006
“.. there are known unknowns; that
is to say we know there are some
things we do not know. But there
are also unknown unknowns -- the
ones we don't know we don't know."
…”
• What we don’t know…(and may not know, that we
don’t know)
? How far US house prices will fall
? How much damage will be done to household
balance sheets
? The full impact on US financial institutions’ balance
sheets (and hence their ability to create credit)
? The full impact on household spending and hence
the economy
? The full impact on corporate earnings
12
Previous US house price booms…
13
Previous US house price booms…and the
subsequent busts
14
Global economic and investment prospects
• Global economy slowing down (the US is in
recession now)
• ..but the Chinese economy is well-placed to
weather the storm (good news for Australia)
• The US Federal Reserve now understands the
magnitude of the problem, and is responding..
• ..and the economy and financial markets will
eventually recover..
• ..but we are most unlikely to see a repeat of the
kind of investment returns seen in recent years.
15
Australian economic prospects
• Australian economic growth to slow significantly (either the economy
slows ‘by itself’ or RBA will make it slow!)
• (Patriotism has paid handsomely over past five years, but this
will not last!)
Australia's economy accelerated while the G4 was slowing
6
Annual growth in real GDP %
5
4
3
2
1
0
Q1 2000
Q1 2002
Q1 2004
16
Q1 2006
Q1 2008
An already tight labour market became even
tighter over the last year…
%
%
25
12
10
Trend
unemployment rate (rhs)
20
8
15
6
10
Cash rate (lhs)
4
5
0
Jan-83
2
0
Jan-87
Jan-91
Jan-95
17
Jan-99
Jan-03
Jan-07
..helping to keep inflation above the RBA’s target range
The RBA's worst target 'miss' of the low-inflation era?
7.0
Consumer prices y/y% - average of RBA's preferred measures
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Q2 1989 Q2 1991 Q2 1993 Q2 1995 Q2 1997 Q2 1999 Q2 2001 Q2 2003 Q2 2005 Q2 2007
18
Has RBA done enough? (Are borrowing costs too high?)
..but higher inflation has kept
real borrrowing costs lower
Nominal interest rates the
highest since (at least) 1996..
14
%
10
%
Source: RBA
9
Source: RBA, MLC Investment Management
12
8
10
7
6
8
5
6
4
4
Cash rate
Bank std. variable
2
Mortgage managers standard
Mortgage managers basic
3
Cash rate
2
Bank std. variable
1
Mortgage managers standard
Mortgage managers basic
Bank small/med. business rate
0
Jan-95
Jan-98
Jan-01
Jan-04
0
Jan-95
Jan-07
19
Bank small/med. business rate
Jan-98
Jan-01
Jan-04
Jan-07
Retail sales, confidence figures suggest rate are
starting to have an effect
…and consumer sentiment
has plummeted
Retail sales are slowing..
2.0
m/m%
Seasonally adjusted
Trend
140
Index
130
1.5
120
110
1.0
100
0.5
90
80
0.0
70
-0.5
Jan-06
Jul-06
Jan-07
Jul-07
60
Jan-82 Jan-87 Jan-92 Jan-97 Jan-02 Jan-07
Jan-08
20
Outlook for business investment is still very strong
Non-residential construction:
Still heaps of work in the pipeline
16
14
12
Engineering construction
Chain volumes $bn
$Abn
14
70
60
50
10
8
Work done
Work yet-to-be-done
6
4
2
0
Sep-86
Mar-93
Sep-99
Mar-06
Mar-90
Sep-96
Mar-03
40
10
8
30
6
20
4
10
2
0
0
Mar-95
90000
80000
70000
60000
50000
40000
30000
20000
10000
0
8
7
6
Approvals
Commencements
Work done
5
4
3
2
1
0
Mar-95
Mar-97
Mar-99
Mar-01
Mar-03
Mar-05
Mar-97
Mar-99
Mar-01
Mar-03
Mar-05
Mar-07
CAPEX survey: latest estimate of year-ahead
spending is up sharply on last year
Current prices
$Abn
By private sector for private sector
By private for public sector
Public sector
Total
12
Non-residential building indicators
9
Work done, 2003/04 prices
$Abn
$A million
2000/01
Mar-07
21
2002/03
2004/05
2006/07
2008/09
Huge pipeline of resources projects
22
Let’s keep the recent volatility in perspective
7000
ASX300 Index
6500
6000
5500
5000
4500
4000
3500
3000
2500
Apr-03
Source: Thomson Financial Datastream
Apr-04
Apr-05
Apr-06
23
Apr-07
Apr-08
Australian shares have been incredibly strong.
These returns were NEVER going to last
30
Rolling 5yr real returns - Datastream Australian Market Index
25
20
15
10
5
0
-5
-10
-15
Q1 1977 Q1 1982
Q1 1987
Source: Thomson Financial Datastream
Q1 1992 Q1 1997
24
Q1 2002 Q1 2007
The problem isn’t ‘P’..it’s ‘E’
PE ratio close to its lowest since 1991
suggests local market is cheap...
30
Trailing PE ratio
..as long as you think these earnings are
sustainable!
100
Real Earnings per share (Index)
90
25
80
20
70
60
15
50
40
10
30
5
20
10
0
Jan-80 Jan-84 Jan-88 Jan-92 Jan-96 Jan-00 Jan-04 Jan-08
Source: Thomson Financial Datastream
0
Q4 1979 Q4 1984 Q4 1989 Q4 1994 Q4 1999 Q4 2004
25
The share of the pie (GDP) going to profits is about
as high as it ever gets…
Australian corporate profits as a share
of GDP are just off record highs..
26
..and US corporate profits are not far
below their post-1945 peak
Gross operating surplus ex dwellings, general govt as % of GDP
13 Private sector pre-tax profits as % of GDP
24
12
22
11
10
20
9
18
8
16
7
14
6
12
5
10
Q3 1959
4
Q1 1959
Q3 1969
Q3 1979
Q3 1989
Q3 1999
Source: Thomson Financial Datastream
26
Q1 1969
Q1 1979
Q1 1989
Q1 1999
The KISS principle at work: building wealth made easy
1. Supply capital to businesses - both in Australia and
around the world


Equity capital
Debt capital
2. Be patient
3. Understand (and be comfortable with) the risks you
are taking
Investing does not need to be complex, opaque, and
dangerous, but too many people in recent years
have made it that way!
27
Let’s be realistic about the kind of returns that are
achievable and sustainable over time
Periods to end Dec 2007
5yr
10yr
MLC's Long-term
expectation? #
Cash
Australian bonds
LPTs
Global equities (unhedged)
Australian shares
5.8
4.5
14.8
7.2
21.1
5.5
5.6
13.2
4.1
13.9
5.0
5.8
6.4
8.4
8.4
Source: Thomson Financial Datastream, MLC Investment Management
#
MLC base case equilibrium assumptions for asset class returns over the next 10 years,
assuming that markets are fairly valued at the commencement of the period, that the
global and domestic economies grow at around a trend-like pace, and inflation outcomes
are in line with central bank targets. Estimates are subject to change without notice.
28
Some questions…
• Do you know your own tolerance for risk (the
‘sleep-at-night’ test)?
• Do you know your financial goals and needs (both
near term and longer term)?
• Do you understand what kind of investment returns
are achievable and sustainable over time?
• Is all of this embodied in a financial plan produced
by an appropriately qualified financial adviser?
If the answer is ‘yes’ to all of the above, then
nothing that’s happened in markets recently
should cause you to do much at all!
29
20 Years of Multi-manager investing
MLC Moderate Option
Comparison with the Mercer Pooled Fund Survey Universe
Annualised Risk and Return for 20 years ended March 2008
- - - - Median
(after tax and after fees)
32 funds started this race
in May 1985.Where the
lines intersect shows the
median risk and return
result of the 12 managers
who survived the 22 year
period
9.8
9.6
9.4
Annual
Return
(% pa)
9.2
MLC Balanced Fund
9.0
8.8
8.6
8.4
6.0
6.3
6.6
6.9
7.2
Annualised Standard Deviation (% pa) calculated monthly
MLC
30
7.5