Global and Australian Economic and Investment Update - September 2014

Baiocchi Griffin Private Wealth

Economic and Investment Markets Update

24th September 2014

General Advice Warning

This presentation and the associated discussion is general in nature and does not take your individual situation into account. You should not act on anything contained

herein, or discussed as a consequence of the contents of this document, without receiving

personal financial advice from a suitably qualified person such as a financial advisor.

What will be covered

A look at the global economic environment

&

Australia: the State of the Nation

&

An update on investment markets

The Global Economy

Revisiting an old theme…

Firstly, the ‘Good’…

The world’s largest economy is firmly in recovery mode, with falling unemployment, rising home prices and increases in business investment

The recovery has been led by energy gains

The timely development of new oil and gas drilling technologies and

discovery of new shale oil reserves have underpinned the recovery

The US now produces more oil and gas than Saudi Arabia

Increased production = lower prices

Note the disparity in US gas prices with the rest of the world (Australian prices are $6 to $7)

A natural gas glut forced US gas prices down to record levels

US energy self-sufficiency is close

Energy self-sufficiency levels are back to the same level as 1987 – total self-sufficiency is expected to occur by 2035 (IEA)

The benefits of cheap energy

All of these companies have announced new or re-opened factories and plants in the US

PricewaterhouseCoopers: One million new manufacturing jobs by 2025 due to cheap energy costs (compare with Australia)

Between 2010 and the end of March 2013, almost 100 chemical industry projects valued at around $72bn were announced

Not everyone will benefit

There will be losers from the US energy boom:

• Other oil & gas producers, primarily in the Middle East

• Australian East Coast LNG operators?

• Those countries which compete with US manufacturers (Europe and some parts of Asia/South America)

Geo-political considerations also apply:

The US may have less interest in the Middle East, given a reduced reliance on oil & gas from the Middle East

It’s not all good news however

The US Federal Reserve’s

Balance Sheet

Various programs to

stimulate the US economy have resulted in the

Fed owning over $4 trillion in

debt securities

A different view of the problem

How does the Fed get back to here?

And what are the implications of this

process?

US Federal Reserve Balance Sheet

On the way up = falling interest rates rising stock, bond & property marketsOn the way down = ?

Normalising interest rates is important

US interest rates cannot remain at close to 0% indefinitely – increasing rates without damaging the US economy will be a delicate (impossible?) task

And now…The ‘Bad’…

Europe survived the sovereign debt crisis

on 2010 (so far), but faces weak

economic growth and the threat of

deflation

Europe’s primary threat:

Inflation in major Euro nations and the Eurozone as a whole are at worrying levels

Annual Inflation Rates 2011 to 2014

What’s wrong with low inflation?

Low inflation itself is not the problem, the problem arises when prices stop rising and begin falling (deflation)

Why is deflation bad?

1. When people expect prices to fall they become less willing to spend and less willing to borrow

2. Deflation worsens the position of borrowers (debts have to be paid back with dollars that are worth more than the dollars you borrowed)

3. Wages tend to fall along with prices and because most people are usually reluctant to accept wage cuts, this is normally achieved through mass unemployment

Slow economic growth is now a long term issue

Eurozone GDP growth rates 1961 to 2013

Slowing economic growth rates are a feature of the Eurozone economies, although the past 5 years have been particularly weak

Fixing Europe

In the short term:

• Earlier this month the European Central Bank announced plans to buy asset-backed securities from banks, hoping to increase bank lending

It is expected that the ECB will have to adopt its own Quantitative Easing, much like the US Federal Reserve adopted in 2008

In the medium to long term:

• Europe will need to undertake long overdue structural reform Labour market deregulation Tighter fiscal integration A Eurozone-wide banking union Increased competition Reduced regulation and administration

NEIN

And finally, …the ‘Ugly’.

Australia’s largest trading partner faces an uncertain short-term future

China: major challenges

In our view China must deal with three major issues in the short to medium term:

1. Transition of the economy from a reliance on infrastructure spending and government stimulus

2. Managing the fallout from a significant property and credit bubble

3. Balancing increased economic freedoms with restrictive political freedoms (a topic for another day)

1. Economic transition

From this…

…To this

Progress has been made

China needs less growth from

Investment and more growth

from Consumption

But more work is required

Very high relative to

other Asian nations

2. A property and credit bubble

Cheap Expensive

In 2011 China had some of the most expensive housing in the world

Now: house prices are falling

And credit growth is slowing

The rise and fall of the ‘shadow banking’

sector

Implications for Australia

Iron ore exports were worth $60 billion last yearThe WA 2014-15 budget assumed an average price of $122 p/tonne

The May Federal government budget assumed a price of $110 p/tonne

Australia: State of the Nation

Undergoing our own transition

From this…

…To this

Why we have a problem

By 2016 annual mining

investment expenditure

will fall to nearly zero, down from over $100

billion at the peak

The RBA’s response:

Real interest rates are

once again negative, almost at the same level as

during the GFC

The housing market is responding…

…though building approvals have slowed

Jan-2007

Mar-2007

May-2007

Jul-2007

Sep-2007

Nov-2007

Jan-2008

Mar-2008

May-2008

Jul-2008

Sep-2008

Nov-2008

Jan-2009

Mar-2009

May-2009

Jul-2009

Sep-2009

Nov-2009

Jan-2010

Mar-2010

May-2010

Jul-2010

Sep-2010

Nov-2010

Jan-2011

Mar-2011

May-2011

Jul-2011

Sep-2011

Nov-2011

Jan-2012

Mar-2012

May-2012

Jul-2012

Sep-2012

Nov-2012

Jan-2013

Mar-2013

May-2013

Jul-2013

Sep-2013

Nov-2013

Jan-2014

Mar-2014

May-2014

Jul-2014

4,000

5,000

6,000

7,000

8,000

9,000

10,000

11,000

Australian Home Building Approvals 2007 to July 2014

Mining remains important

Contribution to GDP Growth:

Year-ended June 2014

Positive, but still too low

Weak economy ~ Strong GDP

GDP = C + I + G + Net Exports

Weak WeakStable Strong

Mar

-200

5Se

p-20

05M

ar-2

006

Sep-

2006

Mar

-200

7Se

p-20

07M

ar-2

008

Sep-

2008

Mar

-200

9Se

p-20

09M

ar-2

010

Sep-

2010

Mar

-201

1Se

p-20

11M

ar-2

012

Sep-

2012

Mar

-201

3Se

p-20

13M

ar-2

014

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00

Australia - Quarterly GDP Growth Rates (%)

Strong exports ≠ Strong jobs

No growthWe may be exporting more than ever, but this does not necessarily result in more jobs

Our economy is getting some help

Australian Dollar/US Dollar Exchange Rate – May 2006 to Sep 2014

A weaker Australian dollar will provide assistance to sectors such as agriculture, tourism, manufacturing and mining

Two important indicators:

An improvement in credit growth hints at signs of economic growth &Low wage growth means that wage-drive inflation is not an issue

Overall a mixed outlook

Housing construction Unemployment

Interest rates Mining slowdown

Weakening AUD US economic growth

9/19/2

013

9/27/2

013

10/5/2

013

10/13/2

013

10/21/2

013

10/29/2

013

11/6/2

013

11/14/2

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013

11/30/2

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12/8/2

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12/16/2

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12/24/2

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1/1/2

014

1/9/2

014

1/17/2

014

1/25/2

014

2/2/2

014

2/10/2

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2/26/2

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3/6/2

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3/14/2

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3/22/2

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014

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8/21/2

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014

9/14/2

0145,000

5,100

5,200

5,300

5,400

5,500

5,600

5,700

ASX 200 Index – Past 12 Months

Annual Return: 2.83%

Ukraine crisisEmerging markets worries

Significant falls during September

The stock market

Recent market volatility

Company Capital loss in September

Westpac Bank -6.37%

ANZ Bank -5.98%

Commonwealth Bank -4.86%

National Australia Bank -4.86%

All Ordinaries Index -3.25%

• Overseas investors

• Capital adequacy requirements

8/3/1

984

5/3/1

985

2/3/1

986

11/3/1

986

8/3/1

987

5/3/1

988

2/3/1

989

11/3/1

989

8/3/1

990

5/3/1

991

2/3/1

992

11/3/1

992

8/3/1

993

5/3/1

994

2/3/1

995

11/3/1

995

8/3/1

996

5/3/1

997

2/3/1

998

11/3/1

998

8/3/1

999

5/3/2

000

2/3/2

001

11/3/2

001

8/3/2

002

5/3/2

003

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004

8/3/2

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5/3/2

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010

8/3/2

011

5/3/2

012

2/3/2

013

11/3/2

013

8/3/2

014748.00

1,496.00

2,992.00

5,984.00

Long-term view – ASX Ords Index

1987 crash

‘Dot com’ bubble

Pre-GFC peak

Market low – Mar 2009

“The recession we had to have”

A note on portfolio construction

The role of cash in a portfolio

Cash

Liquidity

DefensiveDiversification

Active“Dry Powder”

Acknowledgement: Pimco Asset Management

Finally, our expectations

• We still expect that underlying Australian economic growth will be weak for the next 12 to 18 months (ignoring the impact of mining exports)

• Interest rates are likely to remain on hold until early or mid-2015, subject to an improvement in housing construction & business investment

• The prospect of higher US interest rates will result in significant levels of market volatility

• Key issues to focus on in the short to medium term:− Mortgage delinquencies & loan arrears− Increased levels of debt, particularly the commercial property sector− Private equity transactions− ‘Funny money’ and financial engineering

?Any questions before I hand over to Ray?

• Recent events in the financial planning/advice industry

• Looking forward

Some comments on the industry

“FOFA reforms sell retirees short” SMH May 12

“Scandal shows its time to clean up financial planning industry” SMH June 26

?Thank you

Please join us for morning tea

Global and Australian Economic and Investment Update - September 2014

Economy & Finance

Transcript of Global and Australian Economic and Investment Update - September 2014