Finance Solution

Investor Signposts: week beginning 11 December 2011

by Craig James

Are Aussie consumers starting to spend again? The latest national accounts data tends to suggest that they are with the broadest measure of spending – household consumption – rising by 1.2 per cent in the September quarter to stand 3.8 per cent higher than a year ago.

Perhaps we have spent so much time focussing on the narrower measure of “retail trade” that we have missed the big picture story? Certainly consumers are indeed spending more on “experiences” nowadays rather than physical goods. That is, we are spending on things like travel and buying fewer coats, shoes and televisions.
The 3.8 per cent annual growth of consumer spending was the strongest result in three years. And indeed the quarterly growth rate was the second strongest recorded in almost four years. So the result looks impressive.
But it needs to be kept in perspective. Over the past 50 years, “normal” annual growth of household spending was 3.8 per cent, so growth has merely returned to “normal”.

And there were some special factors. Purchases of cars soared by 7.1 per cent in the September quarter as the industry recovered from the supply issues associated with the Japanese earthquake earlier in the year. Car sales had fallen by 5.3 per cent in the June quarter.
Hotels, cafes and restaurants did well in the September quarter, up by 3.1 per cent, after a 3.5 per cent lift in the June quarter. This provides support for the theory of “consumer experiences” – more people are getting out with friends and families to enjoy a meal. Contrast this with a 3.2 per cent fall in clothing sales.
Purchases of beer, wine and spirits also rose by 3.9 per cent in the September quarter - perhaps to accompany a meal at a BYO? Alcohol sales also rose by 3.4 per cent lift in the June quarter.Other areas to record lower spending were “communications” (down 0.2 per cent), transport services (down 1.1 per cent) and “electricity gas and other fuel” (down 2.2 per cent).Overall, it gives the impression that Aussies got out an about in late winter/early spring.And there were also interesting results on gambling. In the September quarter the downtrend in gambling continued, accounting for just 2.8 per cent of all spending and down from record highs of over 4 per cent set around a decade ago. The Aussie consumer is clearly changing.

The week ahead

With only three weeks to the end of the year, you would think that we would be in wind down mode by now. But there are still a number of key indicators to be released in Australia. And in the US, the Federal Reserve holds its last meeting for 2011.

In Australia the week kicks off with data on home loans on Monday. There has been a recovery of sorts in the past six months with the number of loans for owner-occupiers trending higher. But much of the activity has been driven by home buyers refinancing loans given the attraction of lower fixed rates and competitive deals. We expect that the number of loans to owner occupiers rose one per cent in October but the actual value of loans may have eased by two per cent.

The October trade figures are also released on Monday with another healthy surplus expected of around $2 billion.

On Tuesday data on dwelling starts (commencements) is released together with the NAB business survey. Business owners should be a little more confident following the November rate cut. But little joy is expected on home building with starts likely to have fallen 2 per cent in the September quarter.

The December consumer sentiment survey is released on Wednesday with skilled vacancies data out the same day. Consumers should be happy – especially following another rate cut and with petrol prices falling and the Aussie dollar rising. Thrown in for good measure will be a speech by Reserve Bank Deputy Governor Ric Battellino.
On Thursday data on car sales is released together with the September quarter financial accounts. Car sales have risen for four of the past five months but the industry body – the Federal Chamber of Automotive Industries – expects that car sales fell by around 3 per cent in seasonally adjusted terms in November.

In the US, the week kicks off with the monthly budget figures on Monday while retail sales data follows on Tuesday together with the meeting of Federal Reserve policymakers. It may seem surprising but consumers are still spending freely with retail sales expected to have lifted 0.5 per cent in November after a 0.5 per cent increase in October.

The Federal Reserve policymakers may be a little more positive in their commentary but clearly there is no need for change in policy settings at present – in either direction.

In terms of the other indicators to be released, data on producer prices, industrial production and the current account are due on Thursday with the Empire State and Philadelphia Fed indexes thrown in for good measure. And figures on consumer prices are released on Friday.
Sharemarket

The latest interest rate cut may finally entice a few investors back to the sharemarket. And if it is dividends they are after, then certainly there are a raft of opportunities. Of the major companies the stand-out is Telstra with a dividend yield of 8.6 per cent.

But the major banks are also offering trading on healthy dividend yields of around 6-7 per cent with Westpac current yielding 7.2 per cent. As always, investors need to factor in future movements in share prices and the potential for dividends to be maintained. But it is food for thought after two consecutive rate cuts and forecasts of further reductions ahead.

Interest rates, currencies & commodities
If the world was headed for tougher times, one indicator that would show this would be the Baltic Sea freight index – a measure of the cost to ship dry commodities like iron or wheat. And while the Baltic index has eased from around 2,150 points to 1,850 points since late October, it remains significantly above lows of 1,250 points seen in April and August and 1,050 points recorded in February. Of course it bears watching over coming months, especially with reports that Chinese iron ore inventories are near record levels.

Our currency strategists have twigged their forecasts for 2012. The Aussie dollar is now seen under pressure in the first half of 2012, dragged down by expected weak economic conditions and ongoing break-up risks in the euro zone. But overall we expect the currency zone to remain intact and conditions should improve in the second half of the year.

The Aussie dollar is expected to ease to US95 cents by June 2012 before rebounding to US100 cents by end year. Against other currencies, the Aussie could ease to JPY71 yen by June but recover to JPY78 by the end of 2012. And the Aussie is expected to hold between US74-77 cents over 2012.

Financial markets have retained their aggressive expectations for interest rate cuts over 2012. The overnight indexed swap market expects the cash rate to fall to around 3.44 per cent in a year’s time but interestingly a 25 basis point rate cut isn’t only fully factored in by April 2012. We expect at least one more interest rate cut and have assumed a 25 basis point drop at the February 7 Board meeting. Interest rate settings still haven’t hit “normal” yet – the assumption being used by the Reserve Bank as the average housing rate over the past 15 years.

Published on: Friday, December 09, 2011

Confidence in financial wellbeing increased during the third quarter and 28 per cent of households say the festive season will encourage them to resume spending, according to a new survey.
The ING Direct Financial Wellbeing Index rose to 105.9 in the third quarter from 105.8 in the second quarter and from its lowest level of 104.8 in the first quarter.
The survey showed the proportion of mortgage-free households was unchanged at 23 per cent this quarter. Of the households that have a mortgage, 43 per cent are paying down ahead of time, which is up from 40 per cent in the previous quarter. The median outstanding balance is $224,853.
Also among the data, 59 per cent of respondents said they are “very comfortable” with their mortgage debt, while 54 per cent said they are “very comfortable” with their card debt.
“Despite a volatile quarter in financial markets, Australian households are proving their resilience as they get debt under control and build a strong savings base,” says Don Koch, CEO of ING Direct.
Over the holiday period, 37 per cent say they would like to increase savings before they resume personal spending. Among Gen Y, 43 per cent will most likely prioritise saving over spending.
Twenty-eight per cent of all respondents want to get debt under control before they increase spending and 27 per cent won’t spend again for at least a year.
The major barriers to spending are job security, interest rates outlook and uncertainty over the political environment. Thirty-three per cent of respondents said they would spend more if interest rates dropped and the number increased to 60 per cent among households with a mortgage of $100,000. The survey also revealed 36 per cent restrict spending because of job security fears, 30 per cent are waiting for signs of economic growth/stability before they start spending again and 28 per cent say the “volatile political environment” is the reason for restricted spending.
“Australians have worked hard to improve their financial position over the past two years,” says Koch. “We now have a very clear perspective of what’s happening in terms of financial confidence, and households clearly feel better about reduced credit card debt and increased personal savings. Overall, many households are well-placed financially.
“It’s possible that as we get closer to the festive season, households will relax their purse string a little more but right now it seems the focus is very much on protecting the gains made in financial wellbeing over the last two years."

There is currently a small contingent of Australians looking to buy property for investment in the US. People are seeing homes selling for the price of a deposit in Australia and they’re thinking: ‘hey, that’s a good deal’.
Several companies are actively marketing tours to the US for Australian property investors and many people have asked me whether US property is worth looking into. While I suspect that buying the right investment property at the right price in the US will prove financially rewarding for those who truly know what they are doing, it is not a great idea for ordinary investors. There are simply too many risks, including possible currency fluctuations. Here are the main problems:
1. If you have no knowledge of the US market, let alone the states or specific counties you’re looking at buying in, how do you determine what’s a good property and what its true market value is?
2. Research is a critical part of property investment. To buy in the US, you really need to get on a plane and spend some significant time in the specific market you’re looking at. This is obviously costly. The alternative – buying over the internet – is highly risky.
3. I generally recommend that investors buy in markets they know of, such as neighbouring suburbs to where they live or work. You already have knowledge of these areas and being close by means you can quickly deal with things when they go wrong.
4. Consider the sleep-at-night factor. How can you be sure your asset in the US is gaining value? What happens if the rental market falls over and you can’t get a tenant, or perhaps unemployment continues to be a factor and your tenant can’t pay?
RP Data recently released a report summarising the state of the US property market. RP Data is an independent Australian property research company and their report was produced using data from US property, finance and consumer research company, CoreLogic. Briefly, here are their main findings:
• Since the market peaked back in 2006, US home prices have fallen by 32 per cent. The sub prime lending crisis led to the GFC and many continuing mortgage defaults.
• While the magnitude of home price declines has moderated since early 2009, the US housing market is far from out of the woods. Home prices are still falling, transaction volumes remain well below normal and almost a quarter of all homes are showing negative equity.
• Distressed sales (that is, homes that are being sold by the lender or sold at a price lower than the amount owed on the property) comprise 30 per cent of all sales in the US.
• The number of ‘short sales’ (homes being sold for less than what is owed on them) has tripled over the past two years. CoreLogic estimates this will rise by another 25 per cent by the end of 2011.
• The percentage of homes that are at least 90 days in arrears is slightly higher than eight per cent in the US. Comparable data for Australia shows delinquent housing loans remain well below one per cent.
As you can see, there are a lot of issues.
The good news is if you’re looking for highly discounted property for investment, there are opportunities in our own backyard. The specific market offering the most highly discounted property right now is the Gold Coast, where property prices have fallen between 20 per cent and 40 per cent in premium beachside and canal suburbs.
Many Australian markets recovered from the GFC in 2009/2010 but the Gold Coast is one market that has yet to begin its recovery. I think it is likely to provide some outstanding growth over the next three to five years with far less risk compared to buying discounted property in the US. Buying well can result in a significant boost to your long-term capital gains. But be careful – you’ll need to hold your Gold Coast property for the long term to reap the rewards.

IT'S official - your home is the best investment you are likely to have made. In the constant debate over shares versus property, bricks and mortar have won out.
The ANZ review has found the family home has been the highest returning asset over the past 24 years, taking costs, taxes and gearing into account.
Owner-occupied housing outperformed investment property (which still beat shares) largely because of its exemption from capital gains tax.
The findings follow a study by RMIT, which also found property has generated better returns than the sharemarket over the past 20 years.
Before property spruikers get too excited, however, ANZ predicts the stockmarket will outperform bricks and mortar over the next decade.
Even here, though, the bank points out that when the risks associated with each investment are taken into account, the difference between shares and property is likely to be small.
The report, Australian Property Research Asset Returns: Past, Present and Future, looked at a range of data from 1987 - the earliest date when all the required information was available - to 2011. It also factored in a range of costs.
For homeowners this included assuming maintenance costs - rates, insurance and general repairs - were 1.2 per cent of the property's value.
Maintenance costs for investment property were calculated at 1.8 per cent of the dwelling's value, covering advertising and property management fees.
Stamp duty was applied across the board at 5 per cent. To keep the analysis consistent, cash flow such as rent from investment property or dividends from shares was placed in a term deposit account.
When all the numbers were crunched, owner-occupied housing was found to have generated an annual return of 12 per cent. Investment property 9.6 per cent, stocks 8.9 per cent, government bonds 4.8 per cent, commercial property 4.2 per cent and term deposits 3.7 per cent.
"Owning your own home has been the best investment you could have made by a mile," ANZ property research head Paul Braddick said.
"Even when costs and taxes were factored in, owner-occupied housing generated higher returns at a lower risk than equities."
Mr Braddick says that a $100,000 investment in your home in 1987 would be worth $1.428 million today.
A similar sum sunk into an investment property would be worth $810,000. Past performance, however, is no guide to future returns.
Looking forward, the ANZ expects the ASX 200 to outperform all property over the next 10 years.
Equities are forecast to return an average of 7.8 per cent a year, commercial property 5.6 per cent, owner-occupied property 5.2 per cent, investment property 4.5 per cent, term deposits 2.8 per cent and government bonds 2.6 per cent.
The report assumes capital growth in housing will be 5 per cent over the decade, rental yields will average 3 per cent and there will be no major shifts in interest rates.
The good news for property owners is that when the ANZ factored in the risk associated with each investment, they all came out roughly on par.
"Looking over the next decade we are basically saying that risk-adjusted, these assets are pretty much in the same band," Mr Braddick said. "Without risk both commercial property and equities are expected to have higher nominal returns over owner-occupied or investor property. Take risk into account and there is very little difference."

AUSTRALIAN banks have little direct exposure to risky European government debt and are more resilient to turbulence in international markets, a senior central bank official says.
While world policy-makers work to find solutions to Europe's debt crisis, Australia's financial system is continuing to perform relatively well, said Malcolm Edey, assistant governor (financial system) at the Reserve Bank of Australia (RBA).
"Our banks are profitable and well capitalised, and their overall asset quality remains good," Dr Edey said in Sydney on Thursday.
While Australia shouldn't expect to be immune from the unfolding events in Europe, our banks seem to be well prepared to deal with any ensuing shocks, he said.
"Australian banks have only limited direct exposures to sovereign debt in the countries that are most at risk.
"So potential effects on Australian banks' overall asset quality are not an issue."
Since the height of the global financial crisis, local banks had done a lot to strengthen their funding positions, Dr Edey said.
"They have increased their use of domestic deposits as a funding source, lengthened the average term of their wholesale funding, and correspondingly reduced their reliance on short-term wholesale debt.
"These things will help to make them more resilient to the uncertainties that are now affecting international credit markets."
Dr Edey echoed comments from fellow central bank assistant governor Guy Debelle, who yesterday expressed optimism about the stability of Australian banks in the face of global uncertainties.
The main topic of Dr Edey's speech was the challenge of introducing central clearing of "over the counter" derivative products like interest rate swaps and foreign currency options, which are traded directly between counterparties, rather than through central exchanges as futures or shares are.
The Council of Financial Regulators, comprising the RBA, ASIC, APRA and Treasury, has been considering submissions in response to a consultation paper it published in June.
"We hope to be in a position to put forward some conclusions from the consultation process soon, but I can't foreshadow those today," Dr Edey said.