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1. Just How Worrying is the "Worry List" for Investors?
2. The Facts About Life and ...Death
3. Making Sense of Redundancy
4. Be Safe Rather Than Sorry
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Portfolio Managers'
Investor Insights
August, 2009
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Welcome to the August, 2009 edition of Investor Insights.
Please feel free to forward this newsletter to any friends or associates that may find the information beneficial.
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Just How Worrying in the 'Worry List' for Investors?
Introduction
Shares have just wrapped up two consecutive years of big losses. After such a slump the list of worries is long and the outlook is viewed with some trepidation. The temptation is to assume more of the same. This note looks at why the ‘worry list’ might not be so worrying.
The ‘worry list’ for investors
The past year saw its fair share of extremes, including the worst financial crisis and global recession since the 1930s, one of the worst bear markets ever and the biggest fiscal and monetary easing since World War 2. Add to this less favourable demographic trends and it is possible to paint an endless list of problems.
While it is wrong to ignore the risks, there is a danger in getting carried away. The main worries are addressed in turn below:
‘Reluctance by households to take on more debt and by banks to lend will prevent any economic recovery’
This is the most common worry. However, there are several points to note. Firstly, consumers do appear to be responding to fiscal stimulus and lower interest rates. This is certainly evident in Australia where retail sales are up 7% year-on-year, car sales appear to have turned the corner and various housing indicators have improved dramatically. These trends suggest that consumers have not lost the inclination to consume. In the US, retail sales have not collapsed (despite the rise in unemployment), car sales are showing signs of recovering and consumer sentiment has started to improve. While a more cautious attitude towards debt will likely constrain the recovery in consumer spending, so far there is nothing to suggest consumers are just focused on debt reduction.
Secondly, some indicators such as car sales and housing starts have fallen below the level consistent with underlying demand, suggesting that sooner or later there will be a spring back. In fact, the number of US new houses for sale has collapsed and housing starts at record lows may soon lead to a housing shortage if construction doesn’t pick up soon.
Thirdly, the experience in the early 1990s indicates debt deleveraging won’t necessarily stop a recovery. For example, the fall in private debt in the US in the 1990s didn’t prevent an economic and share market recovery. In fact, private sector credit normally lags an economic recovery. This was evident in Australia in the early 1990s.
‘The blow-out in budget deficits is a major concern’
Currently, the increase in budget deficits globally is appropriate because without it we would be having a worse recession. Also, budget deficits are unlikely to boost interest rates yet, as higher public borrowing is being offset by less private sector borrowing. Hence, it is not a major issue right now. However, in several years once recovery has occurred governments will have to unwind their borrowing which could cause increased economic volatility.
‘Easy money means the US will be the next Zimbabwe’
Many worry that quantitative monetary easing will create inflation. However, comparisons with Zimbabwe are ridiculous. Zimbabwe’s inflation rose 250 million percent because it wiped out its productive potential and the government turned to printing money to finance spending and pay public servants. Simply put, no goods plus lots of money meant prices surged.
At present, the main concern in the US and elsewhere is deflation, as the global recession is resulting in idle factories and rising unemployment queues putting downward pressure on prices. In fact, consumer prices are already falling in the US, Japan and Europe (where inflation is below zero). In Australia, inflation is just 2.1%. While narrow money supply measures have surged, this is because central bank easing has boosted bank reserves. Only when this feeds through to a broader increase in credit and economic activity returns to more normal levels will inflation be a serious risk. However, given the amount of excess capacity that has to be worked off, this is likely to be at least two or three years away. At this point, the inflationary impact will depend on how quickly central banks soak up the extra money. However, that is an issue for several years down the track. It is also doubtful independent inflation targeting central banks will simply acquiesce to permitting higher inflation as a means to reduce public debt burdens.
‘Expect a double dip recession’
Worries about a double dip are common towards the end of most recessions. The main fear is that once the policy stimulus wears off, growth will collapse anew. Our view is that it is too early to talk about a double dip because we haven’t emerged from this recession yet. Also, given the impact of fiscal stimulus still to occur, particularly via infrastructure spending, and the likelihood that we will start to see a housing recovery in both the US and Australia next year, a double dip next year appears unlikely. That said, it is likely that the unwinding of fiscal and monetary stimulus could result in renewed weakness, but this is several years away.
‘The US dollar (US$) will crash, creating renewed financial panic’
This worry seems to appear every time a government suggests diversifying its reserves away from US$. However, while a further improvement in global confidence may result in more downward pressure on the US$, a collapse is unlikely as the two most traded alternatives (the Japanese yen and the euro) are no more attractive and China will not allow a sharp rise in the renminbi.
‘Demographics is destiny’
Using demographics to predict the share market is back in the headlines following Harry Dent’s latest book “The Great Depression Ahead” in which he predicts, largely on the back of demographic trends based on the number of people in the peak spending age of 45 to 49 in the economy, America will enter a Great Depression in 2010 and shares will not bottom until 2012.
The relationship between demographic variables and share markets is very rough and encompasses only a few big 30 to 40 year swings. Additionally, the combination of having children later, living longer and delaying retirement all mean the relationship between demographics and economic and financial variables will change over time. Finally, demographics indicated that US shares should have boomed over the last decade. Harry Dent’s book “The Next Great Bubble Boom” from three or four years ago predicted that the Dow Jones will reach 40,000 by 2010. However, so far it has been a terrible decade (the Dow is now at 8500 or 1998 levels). Thus, with demographic theories having not worked so well over the last decade, there is a danger in relying on them too much for the next decade in terms of making big calls on shares.
‘Shares are now expensive after their rally’
Shares have had very strong gains from their March lows. Forward price-to-earnings multiples (the ratio of share prices to year ahead consensus earnings expectations) have increased from around 8 or 9 times at the March lows to around 14 times for both global and Australian shares. However, this is still below longer term averages around 15 times. In other words, shares have gone from being very cheap at their lows, but they are still not expensive.
Our assessment
The ‘worry list’ is long and mainstream global equity markets will likely face a more volatile and constrained ride over the longer term. Shares may also have a rougher ride through the traditionally weak September quarter than was the case in the last quarter.
However, we think that many of the current worries doing the rounds are overblown and are not enough to prevent solid gains in shares over the year ahead. Shares are still cheap and attractive relative to low yielding cash and bonds. Additionally an economic recovery from later this year is likely to underpin an eventual improvement in profits and most investors are still underweight shares so there is a lot of cash sitting on the sidelines.
Source: AMP Capital Investors
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HERE'S A THOUGHT . . .
"I thought it was impossible too, before I did it." ~ Lance Armstrong
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The Facts About Life and .... Death
Little known facts
People tend to insure assets such as their car or home, but many people don't insure their most important asset – their ability to earn income. Some little-known facts about Australians and their health include:
• Over 1,600 people die on Australian roads every year, most aged between 26 and 59 years.
• Almost 3,000 men die each year of prostate cancer and around 18,700 new cases are diagnosed every year. More than 2,640 women will die from breast cancer in a single year – that’s over 7 women each day and over 1,600 Australians die from skin cancer each year. One third of women and a quarter of all men will suffer cancer at some stage in their lifetime – over half of whom will live for longer than five years after diagnosis.
• Cardio-vascular disease (heart, stroke, blood vessel diseases) kills one Australian every ten minutes. It prevents 1.4 million people from living a full life because of disability caused by the disease and is one of Australia’s largest health problems. Despite improvements over the last few decades, the health and economic burden of cardio-vascular disease exceeds that of any other disease.
Underinsurance is an issue
In May 2005, a study conducted on behalf of the Investment and Financial Services Association (IFSA) by Rice Walker Actuaries estimated that as many as 60% of all Australians are underinsured. Today, the problem is still a major concern. The harsh reality is that in the event of an accident or illness leading to death or permanent disablement, many Australian families would not receive a large enough payout to cover even a year’s income and an estimated 80% of people would only have enough to last up to five years.
Case study
Doug is 45 years old and is married with three children aged 15, 12 and 7 years old. He has been working as an accountant for the last 20 years and enjoys a comfortable lifestyle on Sydney’s northern beaches. He has a mortgage on his house of $500,000 and his two oldest children attend private high schools.
Doug has recently been diagnosed with bowel cancer. He has been given a life expectancy of no more than 12 months. As you can understand, Doug and his family are devastated at this news. However, as well as dealing with the emotional stress, they now have to consider how they are going to continue paying for the mortgage, school fees and other bills without Doug in their life.
Fortunately, for Doug and his family, Doug has Death, TPD and salary continuance insurance through his superannuation fund.
He claimed under both his Death & TPD and Salary Continuance policies. His Death & TPD policy was for $800,000 death and TPD cover. His salary continuance policy was for $10,000 per month (75% of income).
As Doug was terminally ill, the insurer released the $800,000 death amount in full settlement of his death and TPD insurance cover. After a waiting period of 90 days, the insurer commenced paying his monthly income protection payment which was paid up until the date of his death eight months later.
Was Doug adequately insured?
With $800,000 death and TPD cover and $10,000 per month salary continuance cover and a superannuation account of $100,000, it would seem like Doug was well insured. The insurance certainly helped. It paid off the mortgage and provided a continued income for Doug up to the time of his death which eased the family’s emotional stress and allowed Doug to undergo treatment which extended his life by a couple of months.
However, the reality is that after paying off the mortgage, Doug’s family were only left with $400,000 and his salary continuance payments ceased on his death. With young children and years of private school fees to be paid and her own retirement income to think of, Doug’s wife had no choice but to return to full-time work, in order to maintain the same standard of living for the family.
However, the insurance meant that Doug’s family could keep their house, stay in their same area and that his children could continue at their schools.
Seek Appropriate Advice
As specialist financial advisers, Portfolio Managers are skilled in evaluating your risk protection circumstances and assessing what is the most suitable path for you to follow in order to protect your most valuable asset.
Remember, long term financial planning is pivotal in securing your financial independence in later life.
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HERE'S A THOUGHT . . .
"Commitment leads to action. Action brings your dream closer" ~ Marcia Wieder
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Making Sense of Redundancy
Understanding redundancy and its financial implications has become more relevant than ever in 2009’s turbulent economic environment.
In Australia, many major corporations have had to downsize as a result of the current global financial crisis. Small businesses have not escaped the downturn either, and reducing headcount may be a necessary means for many companies to scale back their operating costs.
This mass scale back is having very real effects on the Australian job market. The Australian Bureau of Statistics reports that the Australian jobless rate rose to a two-year high of 4.5 per cent in December 2008, with 44,000 full-time jobs lost. In February 2009, 53,800 full-time jobs were lost and the unemployment rate rose to 5.2%. In June 2009, the unemployment rate hit 5.8% and the government forecast predicted unemployment could reach 8.5% by mid-2010.
These job losses are making redundancy a more common issue in many Australian lives. Welcomed by some, but dreaded by most, redundancy generally makes for a stressful time where big lifestyle and financial decisions need to be made. And making sense of it all can be tricky.
Fully understanding the financial implications of redundancy, such as tax consequences and changes to social welfare entitlements, helps you make an informed decision around making the most of your redundancy package. Once you know where you stand, there are a number of strategies you can take advantage of to ensure you get the best outcome from your payout.
Seeking financial advice from Portfolio Managers can be your best port of call to guide you through these strategies. The difference between no advice and good advice may be the difference in how well you manage the redundancy process.
Where to start?
The first step is being aware of what you’re entitled to and how the payments affect your current plans and income. Ensuring you get your full entitlements can make a big difference in dollar terms.
Many people are unaware of what they can expect from a redundancy package. Any outstanding wages, unused annual leave and long service leave should be taken into account. Then, depending on the nature of work and workplace agreement, there can also be a termination payment, some of which may be in the form of a tax-free lump sum.
Tax implications
Where things start to get complex is with the tax consequences of payments. Each component of the package is taxed differently and depends on a number of factors, so there are no hard and fast ways of discussing redundancy taxation – it all depends on the individual.
What each individual has in common, however, is the need for professional financial planning advice. Depending on what stage in life you are at, the financial planning opportunities can be quite different, For example, in some cases you could direct your payment into superannuation to generate tax savings. If you are approaching preservation age or retirement you might be able to draw this out as a superannuation pension.
Or, if you’re receiving any government benefits, such as family tax benefits, baby bonus, or low income tax offset, these could be impacted by a termination payment. Portfolio Managers can outline how other benefits may be affected and find ways to minimise the impact.
Make sure you’re covered
In the event of redundancy, a natural reaction is to make cutbacks to maximise cash flow. In the absence of an employment income, people often look for ways to reduce expenses. Some may view the reduction or cancellation of an insurance policy as a quick way to reduce costs. But at this time, it’s even more important that you are covered in case something happens. Portfolio Managers can help you review your insurance arrangements to determine whether your premiums could be funded more effectively.
Portfolio Managers can also explain how unemployment could impact the potential benefits payable under your insurance policy.
Managing debt
The continuance of good debt management is often front of mind for those who have recently lost their main source of income.
One common issue with lump sum payments is whether or not you should use it to reduce debt, such as mortgage or credit card debts. There are different tax and social security implications between using redraw facilities and mortgage offset accounts and these need to be taken into consideration.
Like the other aspects of redundancy, seek advice from Portfolio Managers to help you with debt management as solid strategies to help you manage the debt, superannuation, insurance and tax implications of redundancy may help you get the best outcome out of your situation.
For more information on redundancy matters, please contact Portfolio Managers.
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HERE'S A THOUGHT . . .
"In the realm of ideas everything depends on enthusiasm.. in the real world all rests on perseverance" ~ Johann Wolfgang von Goethe
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Be Safe Rather Than Sorry
Not everyone will do it, but most people will consider it at some stage in their lives – borrowing to buy their very own home. It can be an exciting venture, but also a scary one if you don't plan well.
Whether you are borrowing to buy your first home, or upgrade your existing property, it is imperative you take the necessary steps to ensure you do not borrow more than you can comfortably repay. You might think that's blatantly obvious, but this can be an extremely emotional time and under such stress, sometimes common sense disappears.
You should be aware of your exact financial position, how much you can afford in repayments and have emergency plans to cater for contingencies such as increasing interest rates or changes in income.
A great idea is to keep income and expense records for a period before you take out a new mortgage to track your cashflow movements. You might even have a trial run for a few months to prove that you really can set aside the full amount of your planned repayments without too much pain.
Then, when it's time to establish the loan, keep in mind the following...
• Is the interest rate the lowest available?
• Are the features of the loan right for you? Don't pay extra interest for features you do not need.
• If rates are increasing, consider having a fixed rate for at least part of the loan, this will provide you with some protection.
• Don't borrow more then you are sure you are able to repay.
• Allow for unforeseen emergencies such as ill health or unemployment. You should have Income Protection Insurance to provide you with cover against sickness or accidents.
• Make sure you won't have obvious major expenses coming up, such as replacing your car, before you commit to a mortgage.
Once you have enjoyed the excitement of moving into your new home you should be prepared to forgo new luxury items until you have significantly reduced the level of your mortgage. A golden rule is to never take on further debt, such as adding more non essential items to your credit card, once you have your mortgage.
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This newsletter contains general information only and does not take into account the investment objectives, personal circumstances or financial needs of any particular investor. You should therefore obtain professional financial advice before making any investment decision based on the information provided in this document. In the event that this newsletter contains information about a particular financial product, you should also obtain a Product Disclosure Statement in respect of that product prior to making any decision to acquire that product.
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For more information please contact:
Brett Davis, Paul Hewins or Danielle Barber
Portfolio Managers Pty Ltd
Ph: (03) 9226 0835
Fax: (03) 9222 2019
Australian Financial Services Licence No. 232459
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