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Economic and market prospects
Brian Parker CFA
Investment Strategist
MLC Investment Management
August 15 2008
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
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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.
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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.
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the current Product Disclosure Statement (‘PDS’), copies of which are available upon request by phoning MLC on 131 831 or on our
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27 years of balanced fund returns
35
MLC Horizon 4 return (%) for financial year ended 30 June
30
25
20
15
10
5
0
-5
-10
1982
1985
1988
1991
1994
1997
2000
Source: Mercer. Performance is after fees and superannuation tax
2003
2006
A tough time for share and LPT investors
1300 Value of A$1000 invested at end June 2007
1200
1100
1000
Global bonds $1100, 8.5% p.a
Cash $1084, 7.2% p.a
Aust. Bonds $1081, 6.9% p.a
900
Emerging mkts $925, -6.5% p.a
800
700
600
Global shares $843, -13.6% p.a
Aust. Shares $819, -15.8% p.a
LPTs $629, -32.8% p.a
500
400
Jun-07 Sep-07 Dec-07 Mar-08 Jun-08
Source: Thompson Financial Datastream. Last observation is 13 August 2008
Global economy in snapshot
..and unemployment rates are starting
to drift higher..
Economic growth in the G4 economies
has slowed...
Real GDP y/y%
6
10
Unemployment rate %
Source: Thomson Financial Datastream
4
8
2
Source: Thomson Financial Datastream
6
z
0
4
-2
US
-4
Euro-area
Japan
UK
2
US
0
Q1 1997
Q1 1999
Q1 2001
Q1 2003
Q1 2005
Q1 2007
Jul-00
EPS Q1 2002 equals 100
300
US
Euro-area
6
Japan
UK
2
200
0
150
-2
50
Q1 1998
Q1 2002
Q1 2004
-6
Q1 2006
Jul-06
Jul-08
6 mthly % change
-4
Source: Thomson Financial Datastream
Q1 2000
Jul-04
UK
Source: Thomson Financial Datastream
4
250
100
Jul-02
Japan
..and the leading indicators are
consistent with further weakness
..earnings have started to decline..
350
Euro-area
Q1 2008
Jul-98
G7 industrial output
Jul-00
Jul-02
G7 leading indicator
Jul-04
Jul-06
Jul-08
A global crisis of confidence?
Business and consumer confidence in the major economies#
2.5
Deviation from recent history
2.0
# Weighted average of US, Euro-area, Japan
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
-2.5
Q1 1992
Manufacturing conditions
Consumer sentiment
Q1 1995
Q1 1998
Q1 2001
Q1 2004
Q1 2007
The US economy is probably in
recession already
Consumer confidence is already
at recession levels
135
125
US Univ. of Michigan consumer sentiment indices
GDP growth is OK, but the leading
indicators look lousy
10
Expected conditions
Current conditions
8
Annual change %
Conference Board leading index
Real GDP
115
6
105
95
4
85
2
75
65
0
55
-2
45
35
Jan-81 Jan-86 Jan-91 Jan-96 Jan-01 Jan-06
Source: Thomson Financial Datastream
-4
Q1 1988 Q1 1992 Q1 1996 Q1 2000 Q1 2004 Q1 2008
US housing: the state of play
..helping to create a huge overhang of
unsold homes
Home sales have plummeted..
8500
'000 annualised
12
7500
Unsold single-family homes to total sales ratio
10
6500
8
5500
6
4500
Total home sales (new + existing)
3500
2500
Jan-93
4
2
Jan-96
Jan-99
Jan-02
Jan-05
Jan-08
Jan-85 Jan-88 Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06
Housing starts have fallen in response
to sharply weaker demand..
..but more forced sales are likely as
delinquency rates have soared.
2500
4.0
Delinquency rate % of loans outstanding
3.5
2000
3.0
1500
2.5
2.0
1000
Housing starts (lhs)
1.5
1.0
500
Jan-93
Jan-96
Jan-99
Jan-02
Jan-05
Source: Thomson Financial Datastream
Jan-08
Q2 1990
Q2 1993
Q2 1996
Q2 1999
Q2 2002
Q2 2005
House prices in the English speaking (!?) economies.
US houses have come down a long way…
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
Q1 2000
Q1 2003
Q1 2006
..which has improved affordability..
150
Housing affordability index
140
130
120
110
100
90
Jan-88
Jan-91
Jan-94
Jan-97
Source: Thompson Financial Datastream
Jan-00
Jan-03
Jan-06
..but that’s a fat lot of good if the banks
aren’t lending!
US Consumer lending standards are
tightening..
100 Net % of lenders tightening standards
80
..as are standards for both large and
small businesses..
70
Credit cards
Other consumer lending
Prime mortgages
Sub-prime mortgages
60
Net % of lenders tightening standards
Large & medium firms
Small firms
50
40
60
30
20
40
10
20
0
-10
0
-20
-30
-20
Q3 1998
Q3 2000
Q3 2002
Q3 2004
Sources: US Federal Reserve, Datastream
Q3 2006
Q3 2008
Q3 1998 Q3 2000 Q3 2002 Q3 2004 Q3 2006 Q3 2008
How much more debt can be rammed down the throats
of consumers in the English speaking world anyway?..
Australian 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
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
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
Europe and Japan are in real danger
of recession
Japanese growth undermined by
domestic spending
Sentiment data are consistent with a
Eurozone recession in late 2008
5.0
%
Index
120
4.5
%
Net exports contrib to y/y% growth
Real GDP y/y% (lhs)
4.5
EU Economic sentiment index (rhs)
115
4.0
4.0
Domestic demand contrib to y/y% growth
3.5
Real GDP y/y%
110
3.0
3.5
105
3.0
2.5
100
2.0
95
2.5
2.0
1.5
1.0
1.5
90
0.5
1.0
0.5
Last figure
is July 2008
85
0.0
80
Q1 1998 Q1 2000 Q1 2002 Q1 2004 Q1 2006 Q1 2008
0.0
-0.5
Q1 2003
Q1 2005
Q1 2007
China is not immune, but is well
placed to weather the storm
Export growth has slowed only slightly,
while imports have accelerated
China's growth eases back somewhat
Annual change (%)
20
18
16
14
12
10
8
6
Industrial output
4
Real GDP
2
0
Q1 1996 Q1 1998 Q1 2000 Q1 2002 Q1 2004 Q1 2006 Q1 2008
China's non-food CPI has picked up, but
from a very low base.
Annual change (%)
10
9
8
Headline CPI
7
Non-food CPI
6
5
4
3
2
1
0
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
60
50
40
Annual change (%)
Exports
Imports
30
20
10
0
-10
-20
Q1 1996 Q1 1998 Q1 2000 Q1 2002 Q1 2004 Q1 2006 Q1 2008
• Chinese exports have slowed a little, and
are likely to slow further, but the overall
impact on growth is not likely to be severe.
• Domestic spending is the key driver –
consumer demand has accelerated, and
investment spending not likely to slow
dramatically, despite a series of policy
tightening measures.
• Inflation has soared on the back of food
and energy costs, but core inflation is still
very subdued.
Global economic and investment prospects
• US is either in recession now or heading into one, and the other major
economies are slowing down.
• Inflation concerns are largely misplaced, and the rate hike by ECB has
only made growth prospects marginally worse..
• ..but the Chinese economy is well-placed to weather the storm (good
news for Australia)
• The US Federal Reserve and Treasury now understands the magnitude
of the problem, and have responded (aggressive rate cuts, massive
liquidity injections, public support to key institutions)..
• ..and the economy and financial markets will recover (every crisis, every
recession, every market downturn comes to an end!)..
• ..but we are most unlikely to see a repeat of the kind of investment
returns seen in recent years.
Australia in summary
• Reported growth still solid in March quarter, but more recently..
•
•
•
•
•
Retail sales have been flat since end 2007
Credit growth has slowed dramatically
Home loan approvals have plunged
Consumer sentiment is just above 17 year lows
Business surveys have shown significant weakness..
• And all this has happened BEFORE the bulk of the impact of past rate
hikes could be expected to hit the economy
• Bright spots?
• Exports
• Huge pipeline of investment spending
• If domestic demand continues to weaken (likely) RBA’s inflation worries
will evaporate. The next move in rates is DOWN, and very soon!
RBA has done enough (borrowing costs
already too high?)
Nominal interest rates the highest since (at least) 1996..
14
%
Source: RBA
12
10
8
6
4
Cash rate
Bank std. variable
2
Bank small/med. business rate
0
Jan-95
Jan-98
Jan-01
Jan-04
Jan-07
Interest rates and oil prices are biting
Retail sales figure for June was a
shocker - trend is now flat
2.0
Consumer sentiment just above
levels not seen in seventeen years
%
140
130
1.5
120
1.0
110
0.5
100
0.0
90
80
-0.5
70
-1.0
-1.5
Jul-05
m/m% sadj
60
m/m% trend
Jul-06
Jul-07
Jul-08
50
Feb-79 Feb-84 Feb-89 Feb-94 Feb-99 Feb-04
Business surveys are the weakest in
nearly seven years
NAB business survey points to weaker growth
25 Net balance (%)
20
15
10
5
0
-5
-10
Actual business conditions
Confidence
-15
-20
Mar-97
Mar-99
Mar-01
Mar-03
Mar-05
Mar-07
Huge pipeline of resources projects
The $A big picture
AUD is still miles above purchasing power parity estimates
1.0
USD
2008 ave.
average
0.9
latest
0.8
0.7
0.6
OECD's PPP
estimate
0.5
Calendar
year average
0.4
1983
1989
1995
2001
2007
Key drivers of the Australian Dollar
Australian Dollar has tracked the terms of
trade over time
170
165
Real trade-weighted AUD
160
exchange rate (lhs)
155
150
Terms of trade (rhs)
145
140
Source: JPMorgan, Thomson Financial Datastream
135
130
125
120
115
110
105
100
95
90
85
Q1 1983 Q1 1987 Q1 1991 Q1 1995 Q1 1999 Q1 2003 Q1 2007
There has been a reasonable link between
the $A and interest rate differentials
120
800
bps
700
105
600
USD
Aus/US mid-curve interest rate differential (lhs)
0.95
AUD/USD (rhs)
Source: Thomson Financial Datastream
500
90
1.05
0.85
400
0.75
300
200
75
0.65
100
0.55
0
60
-100
Jan-89
0.45
Jan-92
Jan-95
Jan-98
Jan-01
Jan-04
Jan-07
Let’s keep the recent weakness in
perspective
7000
ASX300 Index
6500
6000
5500
How will this look in
5 years’ time?
10 years’ time?
5000
4500
4000
3500
3000
Source: Thomson Financial Datastream
2500
Aug-03
Aug-04
Aug-05
Aug-06
Aug-07
Aug-08
1987
1050
Australian share prices - daily
1000
950
900
850
800
750
700
650
600
550
500
Jul-87
Aug-87
Sep-87
Oct-87
Nov-87
Dec-87
1987
1050
Australian share prices - daily
1000
950
900
850
800
750
700
650
600
550
500
Dec-86 Jun-87 Dec-87 Jun-88 Dec-88 Jun-89 Dec-89 Jun-90 Dec-90
1987
1800
Australian share prices - daily
1600
1400
1200
1000
800
600
400
200
Dec-84
Dec-86
Dec-88
Dec-90
Dec-92
1987
2500
Australian share prices - daily
2000
1500
1000
500
0
Dec-82
Dec-84
Dec-86
Dec-88
Dec-90
Dec-92
Dec-94
Dec-96
1987
4000
Australian share prices - weekly
3500
3000
2500
2000
1500
1000
500
0
Dec-79
Dec-82
Dec-85
Dec-88
Dec-91
Dec-94
Dec-97
1987
9000
Australian share prices - weekly
8000
7000
6000
5000
4000
3000
2000
1000
0
Dec-75
Dec-80
Dec-85
Dec-90
Dec-95
Dec-00
Dec-05
1987
10000
Australian share prices - weekly
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
Jan-73
Jan-78
Jan-83
Jan-88
Jan-93
Jan-98
Jan-03
Jan-08
..“Maybe I should head into cash
until things settle down?!?”
• Need to get 2 calls right – when to get out, AND
when to get back in
• Macro indicators are often useless when it comes to
timing these things
• Dalbar (2007) Investor performance 20 years to end
2006:
Market return (S&P500) 11.8%
Investors return 4.3%
The difference? Trying to time markets!
“.. 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
The cash trap: “I can get 7-8% at the
bank. Why shouldn’t I take it?”
• Market timing is difficult for the best managers, and impossible for the
average person
• 7.25% is a cyclical peak – cash and TD rates are likely to FALL from here
• For non-super money, you lose up to half in tax and half through inflation
• For superannuation money, Cash NEVER builds long-term wealth
• Would you rather lend to the bank or own it?
Quoted Div. Yield
NAB
7.3%
ANZ
7.8%
CBA
5.9%
SGB
5.6%
WBC
5.6%
Banks Index*
6.5%
Grossed-up#
10.4%
11.1%
8.4%
8.0%
8.0%
9.2%
Source: MLC Investment Management, ASX. Data as at 12 August 2008.
*Datastream index of Australian Bank stocks. #Quoted dividend yield multiplied by 1.429
There’s always things to worry about
•
•
•
•
•
•
•
•
•
•
The 1929 crash
Great depression
WW II
Korean War
Cuban missile crisis
Vietnam War
OPEC oil crisis I
OPEC oil crisis II
Latin American debt crisis
Australia’s ‘banana republic”
moment
• 1987 stockmarket crash
•
•
•
•
•
•
•
•
•
•
•
•
The fall of the Berlin Wall
Iraq War I
US savings and loan crisis
The recession we had to have
Bond market crash 1994
Mexican debt crisis 1995
Asian crisis 1997
Russian debt/LTCM crisis
Tech wreck
September 11
Afghanistan
Iraq War II
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!