Our attempt to assess the likelihood of a range of economic outcomes with a 3 year view.

There has been talk for some time of a two-speed Australian economy, with the resources sector booming whilst other parts of the economy trend sideways. Momentum appears to be growing for this to be a global phenomenon. The developing economies of China, India, and Asia more broadly, appear to be growing strongly, even while the old developed economies of the US, Europe and Japan, struggle to stay out of recession.

India reported economic growth of over 8% last quarter. Significantly this growth was fuelled by local consumption. In fact it was noted that the middle class (most important for consumption) in India is now larger than the entire population of the United States.

China continues to grow at around 10% and whilst a long way behind India, their middle class is growing as wages rise. As these economies develop, they are becoming less reliant on selling exports to the developed nations, and so are less exposed to these economies when they suffer a slow down.

Fortunately, here in Australia, we have many businesses that benefit from trade to these growing economies. Most obviously our resource companies such as BHP and Rio. Recent export figures for the June quarter saw the largest reduction in our current account deficit (imports minus exports) in almost 50 years.

But it’s not just our miners that benefit. These growing economies have large populations, as they get wealthier they demand more food, especially proteins. Australia is a significant exporter of agricultural commodities.

Our construction companies such as Leighton’s, have pushed into Asia, as have the ANZ bank and to a lesser extent the CBA. You also have companies such as Pacific Brands (best known for Bonds underwear), who were on the brink of extinction but are now profitable by moving production to Asia whilst running the design and marketing locally.

If the US can get it’s unemployment rate down, there is enormous potential for economic growth in that country. But it is becoming clearer by the day, that even if the US economy just limps along, much as Japan has over recent years, Australian investors still have reason for optimism over the coming years. What we produce is in demand, and we are in the right part of the world.

Following weak economic data out of the US this week, we have increased the likelihood of a double-dip recession scenario from 10% to 15%, with a corresponding reduction in likelihood for the anaemic and patchy growth scenario from 75% to 70%.  Our estimate of strong growth fuelled by low interest rates, remains stable at 15%.

Important Notes

This information is of a general nature only and has been prepared without taking into account your particular financial needs, circumstances and objectives and should NOT to be construed as legal, professional or financial product advice. You should obtain a Product Disclosure Statement and consider obtaining personal financial advice from an Australian Financial Services Licensee, or representative thereof before making the decision to acquire, vary or dispose of any financial product.

Whilst all reasonable efforts are made to ensure that the information contained herein is accurate and reliable the parties make no representation or warranty regarding the correctness or reliability of the information provided.

© Guidance Financial Services Pty Ltd

At present we consider the range of market possibilities and their chance of occurring as follows:

· Global economic growth flourishes over the next 3 years, and as a result of low interest rates, significant money flows into share markets, causing prices to rise strongly.  Likelihood we will see this outcome 15-20%.

· Global growth occurs but is fairly anaemic and differs greatly between countries and regions.  Investment caution remains with share prices mirroring the modest profit growth.  Likelihood we will see this outcome 50-70%.

· A “Double Dip’ recession occurs, leading to profit declines and consequent falling share prices.  Likelihood we will see this outcome 5-15%.

· A country defaults on its debt leading to a financial meltdown.  Likelihood we will see this outcome 5%.

We are regularly asked by our clients where we see markets heading.  Our views change as new information is released, and the fact is we don’t have a crystal ball.  As such, the most useful answer we can provide is a range of possibilities, and what we see as the likelihood of them occurring.

The above represents our view as at 30 June 2010.

Paul Benson

Principal – Guidance Financial Services Pty Ltd

Important Notes

This information is of a general nature only and has been prepared without taking into account your particular financial needs, circumstances and objectives and should NOT to be construed as legal, professional or financial product advice. You should obtain a Product Disclosure Statement and consider obtaining personal financial advice from an Australian Financial Services Licensee, or representative thereof before making the decision to acquire, vary or dispose of any financial product.

Whilst all reasonable efforts are made to ensure that the information contained herein is accurate and reliable the parties make no representation or warranty regarding the correctness or reliability of the information provided.

© Guidance Financial Services Pty Ltd

We received this article from our friends at CommSec and felt it was worth sharing.

Click this link – CommSec – Panic of 2010

Hope you find it of interest.

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The Australian share market is having a terrible time of it at present.  The combination of global share market falls, with the proposed new Resources Tax, has meant that our market has fallen far more heavily than elsewhere.

There has been one positive however and that has been the fall in the Australian dollar.  The media portrays a falling dollar as a bad thing, yet it actually has many positives.

For one, our exporters benefit as either their AUD income increases where prices are set in USD, or else their customers pay less for their products, (with the Australian producer still making the same profit).  Our farmers and manufacturers will be very pleased.  

Businesses with significant overseas operations (eg. NAB, CSL, Cochlear, and Brambles), will also be winners, as the profits from those businesses, when remitted back into Australian dollars, will be larger than would have otherwise been the case.

Australian’s whose investment portfolio’s are appropriately diversified into International shares will also gain from the falling AUD.  In 5 weeks the AUD has fallen 12.9% against the USD, whilst the US S&P500 index has declined 8.5%.  That means that once you adjust for the currency, Australian’s holdings in US investment have risen in value during this volatile time.  Exposure to unhedged US investments is something we have been implementing with our clients for some time as a resilience measure within portfolios, so it is very pleasing to see this bear fruit.

Of course rarely is there a circumstance where there are all winners and no losers.  Importers whose prices are set in USD will suffer.  However most would recognise that they have done very well out of a high AUD (by historical standards) recently, and even at current levels, the AUD is still above it’s long term average.

I was fortunate today to attend a briefing from Dr Philippa Malmgren, whose very impressive CV can be found here.  She consults to the likes of the White House and Deutsche Bank on global markets and the implications of policy actions.

Items I found of interest were:

• At best, Greek citizens can expect 3 years of depression followed by 10 years of recession as a consequence of the bailout package and the conditions attached.
• Given this, will citizens accept that peacefully?  No in Philippa’s opinion.  Governments will get thrown out, not just in Greece, but globally, as citizens wake up to the fact that the debt’s their governments took on to get them out of the global recession have to be paid back, and that means higher taxes, less money for services, less money for pensions, etc.
• She noted that default on government debt could happen in several ways – One is via inflation, which is the way she expects the US and UK to dig themselves out.  In this instance the lender get’s all their money back, it just doesn’t buy what it used to. More traditionally a default involves the lender not getting all of their money back.  Taking a “hair-cut”.  She felt this was inevitable for some countries and felt this wouldn’t be so bad – the lenders would get most of their money back, and the countries in question could still offer their citizens a reasonable quality of life.  She observed that Russia went through this process with little long term detrimental effects. 

  A third option, which she discussed specifically with regards Greece, is that they could drop out of the Euro and revert to Drachma.  In this way the currency could adjust to reflect Greece’s specific economic circumstances.  Philippa noted that this was a key advantage the UK had compared to it’s European neighbours.

• Inflation is coming.  Food inflation has already been significant, as has commodity inflation.  Inflation in China now exceeds bank interest rates, meaning it costs you money to leave your money in the bank.  As a consequence she expects stagflation, similar to that which occurred in the 70’s although not as extreme.
• In an inflationary world, business margins will be squeezed, unless they have a strong enough brand/market position to be able to pass on the rising costs.
• More strikes are likely as workers battle to have their incomes keep pace with inflation.
• China is especially afraid of inflation as it hits the poor the most, leading to the potential for civil unrest.  However economic growth is also required to maintain a happy citizenry.  As such they are hitting the accelerator and brake at the same time.  Currently they are trying to contain the property market, but the money will just pop-up somewhere else.
• Government’s around the world, faced with massive debts, will tax everything that doesn’t move – mining and property as examples.  The likes of our Resources Super Tax will become common.
• Corporate bond rates for Shell and Warren Buffet’s Berkshire Hathaway, are lower than US government bond rates.  This is the new world.  Quality corporates with strong cash flows are less risky than governments with on-going deficits.
• Finally, and most importantly for us here in Australia, China’s demand for the resources we produce wont diminish, even if they slow down certain sectors of their economy.  The need to build infrastructure and improve the living standards of the population is essential to the ruling government retaining power.

Hope some of these insights are of value to you.

Now I know many people would answer the above question with “when aren’t they boring”, but for a financial planner, often budget’s lead to planning opportunities to exploit.  Something to be done before the end of the financial year, or conversely, something that we best hold off after July 1.  But this one – nothing!

Most of what was announced had either already been announced or was otherwise leaked – Resources Tax, health spending, tax cuts.  As per the Henry review recommendations, they have paved the way for individual tax returns to be abolished, which I would have thought had some significance, yet they have presented it in such a way that it makes no headlines, presumably for fear of upsetting the accounting fraternity.

It can only be assumed that they have held back on the interesting stuff until the election campaign.  Suggests to me they are worried.

There was some excitement about the fact the federal budget will return to surplus earlier than expected.  I would have thought a key swing factor in federal government revenues was unemployment.  If someone losses their job, they stop paying tax and they start claiming unemployment benefits.  Our unemployment rate is below 6%, which in historical terns is very low.  Why are we running deficits at all with such a low unemployment rate.  Spain has been coping a hammering about it’s economy recently, but their unemployment rate is 20.1%.  If we can’t balance our budget with 94% of the population working and paying taxes, how would we be if only 80% were contributing?

Initial report from Bloomberg can be found here.

It will be interesting to see how international markets react tonight.  Given the scale of the package, there was clearly some very significant concern as to where markets were heading.  Lets hope this addresses the slide.

As at midday, The Australian share market is up approximately 1.5% on the news.

The week started with the mining companies getting slammed courtesy of the new Rudd tax.  Then the world decided to have a melt down on fears Greece’s debt problems are the tip of the iceberg, causing our market from Wednesday onwards to dive further.  Truly horrible stuff with another 1.7% wiped off our market today.

The big question is what happens from here?  Here’s the issues as I see it:

• The world got itself out of recession through governments spending.  Since no Western government actually have any savings, that necessitated them borrowing.  As a consequence many governments around the world have a lot of debt and in many cases that debt is rising as their outflows exceed their inflows.  There is only so-much money in the world, so if governments are sucking up ever increasing amounts, that means there is less for banks and the businesses and consumers they lend to.  That means the cost of money rises as more compete for a scarce resource.  Interest rates rise, putting pressure on business and slowing the global economy.
• The European countries are financially very intertwined.  There was a great diagram in yesterday’s Financial Review that showed the various flows.  The one that stood out to me was that France had $511bn in loans to Italy.  That is amazing.  So the Europeans are certainly all in this together.  I think that is a good thing though it does justify the concerns of contagion.
• US economic data was a little weaker than hoped this week, but the domestic economic story there still looks fairly positive.
• So far there has been no suggestion of problems with the growth engines of the world economy – China, India, and the rest of Asia.
• Our dollar has dropped, which is good for our exporters, and good for those with investments in international equities as the falling exchange rate will have cushioned the market drop for you (a strategy we have been putting in place for clients for some months).

Prior to these European worries, the US seemed to be on track for economic recovery, which is positive to for the globe given they are the largest economy.  Let’s hope the Greek bailout stems the flow in Europe, and in a month or two’s time we wonder what all the fuss was about.