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Portfolio Managers'
Investor Insights
October, 2009
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Welcome to the October, 2009 edition of Investor Insights.
Please feel free to forward this newsletter to any friends or associates that may find the information beneficial.
Index
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The “new normal” is coming.
The "old normal" is the way things were before the Global Financial Crisis and nearly everyone would like to believe that we are returning to the “old normal”. But there are some key problems with the “old normal” including too much household debt, unaffordable house prices and the economy geared to consumption over production.
But all that is changing, says Bill Gross, Managing Director of PIMCO. Gross says we have entered a world of slower growth – the “new normal”. The “new normal” means lower profit growth, permanently higher unemployment, capped consumer spending growth rates and an increasing involvement of the government sector. Staying rich in this future world will require strategies that reflect this altered vision of global economic growth and delevered financial markets. An extract of his recent article “On The ‘Course’ to a New Normal” follows:
“Will we have a New Normal global economy (and investment market)?” This “new” vs. “old” normal dichotomy was perhaps best contrasted by Barton Biggs, as I heard him on Bloomberg Radio in early 2009, when he said he was a “child of the bull market.” I thought that was a brilliant phrase, and Barton is a brilliant phrase-maker.
He went on to say though, that his point was that for as long as he’s been in the business – and that’s a long time – it has paid to buy the dips, because markets, economies, profits, and assets always rebounded and went to higher levels. That is not only the way that he learned it, but that is the way, basically, that capitalism is supposed to work. Economies grow, profits grow, just like children do. I think that’s why he said he was a child of the bull market, not just because he had experienced it for so long, but also because economic growth and higher asset prices are almost invariably a natural evolution, much like the maturation of a person. That’s how people grow, and so I think Barton was saying that capitalism just grows that way too.
Well, the surprise is that there’s been a significant break in that growth pattern, because of delevering, deglobalisation, and reregulation. All of those three in combination, to us at PIMCO, means that if you are a child of the bull market, it’s time to grow up and become a chastened adult; it’s time to recognise that things have changed and that they will continue to change for the next – yes, the next 10 years and maybe even the next 20 years. We are heading into what we call the New Normal, which is a period of time in which economies grow very slowly as opposed to growing like weeds, the way children do; in which profits are relatively static; in which the government plays a significant role in terms of deficits and reregulation and control of the economy; in which the consumer stops shopping until he drops and begins, as they do in Japan (to be a little ghoulish), starts saving to the grave.
This focus on the DDRs – delevering, deglobalisation, and reregulation – may be conceptually understandable, but nevertheless still a little hard to get one’s arms around. Why would they necessarily lead to a new, slower growth normal? A little easier to grasp might be the following approach, which feeds off the same concept, but which extends it a little further by suggesting that DD and R lead to a number of broken business or economic models that may forever change the world we once knew and make even Barton Biggs a chastened adult. They are as follows:
1. American-style capitalism and the making of paper instead of things. Inherent in the “great moderation” of the past 25 years was the acceptance of a sort of reverse mercantilism. America would consume, then print paper assets and debt in order to pay for it. Developing (and many developed) countries would make things, and accept America’s securities in return. This game is over, and unless developing countries (China, Brazil) step up and generate a consumer ethic of their own, the world will grow at a slower pace.
2. Private vs. public-driven growth. The invisible hand of free enterprise is being replaced by the visible fist of government, a temporarily necessary, but (if permanent) damnable condition itself in terms of future growth and profits. The once successful “shadow banking system” is being regulated and delevered. Perhaps a fabled “110-pound weakling” may be an exaggeration of where our financial system is headed, but rest assured it will not be looking like Charles Atlas anytime soon. Prepare to have sand kicked in your face, if you believe you are a “child of the bull market!”
3. Global economic leadership. It’s premature to award the 21st century to the Chinese as opposed to the United States, but if the last six months have been any example, China is sort of lookin’ like Muhammad Ali standing over Sonny Liston in 1964 yelling, “Get up, you big ugly bear!” Not only has China spent three times the amount of money (relative to GDP) to revive its economy, but it has managed to grow at a “near normal” 8% pace vs. our “big R” recessionary numbers. Its equity market, while volatile and lightly regulated, has almost doubled in twelve months, making ours look like that ugly bear instead of a raging bull.
4. United States housing and employment. Old normal housing models in the US encouraged home ownership, eventually peaking at 69% of households as shown in Chart 1. Subsidised and tax-deductible mortgage interest rates as well as a “see no evil – speak no evil” regulatory response to government Agencies FNMA and FHLMC promoted a long-term housing boom and now a significant housing bust. Housing cannot lead us out of this big R recession no matter what the recent Case-Shiller home price numbers may suggest. The model has been broken if only because homeownership is declining, not rising, sinking to perhaps a New Normal level of 65% as opposed to 69% of American households.
Similarly, the financialisation of assets via the shadow banking system led to an American era of consumerism because debt was available, interest rates were low, and the livin’ became easy. Savings rates plunged from 10% to -1%, as many (if not most) assumed there was no reason to save – the second mortgage would pay for everything. Now things have perhaps irreversibly changed. Savings rates are headed up, consumer spending growth rates moving down. Get ready for the New Normal.
 I could go on, reintroducing the negatives of an aging boomer society not just in the US, but worldwide. Increased health care may be GDP positive, but it’s only a plus from a “broken window” point of view. Far better to have a younger, healthier society than to spend trillions fixing up an aging, increasingly overweight and diabetic one. Same thing goes for energy. Far easier and more profitable to pump oil out of the Yates Field in Texas or even Prudhoe Bay than to spend trillions on a new “green” society. Our world, and the world’s world, is changing significantly, leading to slower growth accompanied by a redefined public/private partnership.
The investment implications of this New Normal evolution cannot easily be modelled econometrically, quantitatively, or statistically. The applicable word in New Normal is, of course, “new.” The successful investor during this transition will be one with common sense and importantly the powers of intuition, observation, and the willingness to accept uncertain outcomes.
As of now, PIMCO observes that the highest probabilities favour the following strategic conclusions:
1) Global policy rates will remain low for extended periods of time.
2) The extent and duration of quantitative easing, term financing and fiscal stimulation efforts are keys to future investment returns across a multitude of asset categories, both domestically and globally.
3) Investors should continue to anticipate and, if necessary, shake hands with government policies, utilising leverage and/or guarantees to their benefit.
4) Asia and Asian-connected economies (Australia, Brazil) will dominate future global growth.
5) The [US] dollar is vulnerable on a long-term basis."
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HERE'S A THOUGHT . . .
"There are no shortcuts to any place worth going" ~ Beverly Sills
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Are We Out of the Woods Yet?
Have we moved beyond the dreaded ‘R’ word?
A recession is commonly defined as ‘two consecutive quarters of negative GDP growth’. By this definition Australia has avoided a recession, with the economy contracting by -0.6% for the December quarter 2008, but then growing by a surprising 0.4% for the March quarter 2009 and a further 0.6% for the June quarter 2009. The general consensus is that while the worst is over there will be no miraculous recovery – but rather a slow and steady build which should last well into 2010. Although with the delayed impacts of unemployment and inflation still a factor – anything is possible in the lead up to Christmas 2009.
How do we fare against other economies?
Despite developing recession-like symptoms, Australia looks to have been only mildly affected in comparison to other developed nations. This is a view also shared by the Reserve Bank of Australia (RBA).
In the US, for example, the annualised economic growth rate plunged to -6.4% in the March 2009 quarter, with a further -1.0% annualised contraction in the June 2009 quarter, while the unemployment rate was 9.7% as at August 2009. In the UK, the economy recorded its deepest recession in over 40 years for the 12 months to June 2009 of -5.6%, while the unemployment rate was 7.8%.
By contrast, in Australia our economy has recorded two consecutive quarters of positive growth of 0.4% and 0.6% for the March and June 2009 quarters (respectively), and our unemployment rate remained steady at 5.8% as at August 2009.
More positive GDP growth results are starting to filter through from other major economies. Germany, France, Korea and Japan have all recorded positive economic growth for the June 2009 quarter. Up between 0.9% for Japan and 0.3% for Germany and France, with Korea an astonishing 2.3% lift. These are the first positive figures for Germany, France and Japan since March 2008, showing a definite turnaround in their economic outlook. This is very good news and indicates that the global economy is starting to stabilise, with the prospects for recovery growing.
What’s in store for 2010?
In a recent speech, US Federal Reserve Chairman, Ben Bernanke (newly nominated for a further 4 years) said “after contracting sharply over the past year, economic activity appears to be levelling out, both in the United States and abroad, and the prospects for a return to growth in the near term appear good”. A return to positive growth rates in economies around the world will help improve the prospects for further gains in sharemarkets.
Although there is some concern in Australia that the wind-down of direct government stimulus and the growing expectation of rising interest rates could see some of the recent economic momentum wane, Australia’s relative economic performance continues to look good. This is supported by our strong banking system, low interest rates, infrastructure investment plans, links to fast growing emerging economies and a growing population. Australia’s economy could prove even more resilient than expected by both the government and the markets.
What does this mean for the investor?
Overall, with more positive signs for the global economy and a return to better consumer and business confidence both in Australia and overseas, the worst of the economic news seems to be behind us. Investment markets have, of course, been responding positively to this change in sentiment with gains in the sharemarket of around 43% (as at 7 September 2009) off March 2009 lows. If Australia continues on its positive GDP growth trajectory this could spur further gains in the sharemarket – increasing the likelihood of better market conditions than what was expected only six months ago.
Source: Colonial First State
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HERE'S A THOUGHT . . .
"Be humble, if thou would'st attain to wisdom. Be humbler still, when wisdom thou hast mastered." ~ Helena Petronova Blavatsky
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Changes to Centrelink Benefits
Twice each year, in March and again in September, Centrelink reviews the rate of payment for range of income support benefits including the age pension.
On 20th September 2009, the full single pension will be increased by $64.98 per fortnight. This increase includes the promised $30 per week increase for single pensioners announced in last May’s budget. Couples will receive an increase of $20.28 per fortnight, combined.
These increases are in addition to the regular indexation of pensions. In previous years, pensioners have received a Telephone and Utilities Allowance paid quarterly, however, from 20th September this year, these Allowances are being rolled into a new Pension Supplement, payable fortnightly. The GST Supplement and Pharmaceutical Allowance are also included in the Pension Supplement.
The final quarterly payments of Telephone and Utilities Allowance will be paid in September 2009 along with the first payment of the Pension Supplement. There are a number of changes to the Pension Income Test that will also take effect from 20th September. These include:
Change to taper rate
Where income exceeds the minimum threshold, pension entitlements currently reduce by 40 cents for each $1 of income over the income threshold (currently $142 per fortnight for singles, and $248 for couples). From September, the taper rate will increase to 50 cents for each dollar of income over the income test threshold.
Pension Bonus Scheme
The Pension Bonus Scheme that applies to pensioners who continue in the workforce and defer claiming the age pension will be abolished from 19th September 2009.
Income test “free area” for dependent children
The current income test ‘free area’ for dependent children (currently $24.60 per child) is to be removed from 20th September 2009.
Transitional payment rates
Current pensioners will be assessed under both the current and the new rules. Where the new rules would result in a reduced pension being paid, the pensioner will be paid a transitional rate so as not to incur a reduction in their payment. Pensioners receiving a transitional rate will receive an estimated $20.28 pension increase (singles and couples combined). The transitional rate will be indexed to Consumer Price Index in March and September each year.
This will continue until such time as the pension assessment under the new rules results in the same, or a higher pension being payable under the new rules.
These changes will apply to people receiving the Age Pension, Disability Support Pension, Carer Payment, Widow B Pension, Wife Pension, and Bereavement Allowance. Those receiving the Parenting Payment Single and Disability Support Pension under 21 and without dependants, and who receive income that exceeds the income test ‘free area’, will generally not be affected by these changes.
It is fair to suggest that understanding the rules relating to the payment of Government income support benefits can be complex and difficult to understand. Your financial adviser can generally assist in working your way through this complex area. Information on these changes can be accessed at www.centrelink.gov.au
Source: Professional Investment Services
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HERE'S A THOUGHT . . .
“We are always the same age inside." ~ Gertrude Stain
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Managing Your "Ups" and "Downs"
Some days you feel like a million dollars and others you feel like something the cat dragged in. It's got nothing to do with "the way you are" – the secrets to managing your moods may be in what you eat, when you eat it and how you exercise.
You can use your body's natural drugs to help you feel good. In a similar way, you can manage those times when you feel down. To understand this you need a bit of theory.
The human brain consists of a network of cells called 'neurons' that communicate with one another via chemicals called 'neurotransmitters'. There are more than 40 neurotransmitters that regulate nerve functions, including memory, appetite, mood and the wake-sleep cycle. Among these neurotransmitters are adrenaline and serotonin.
The rush, bliss and the pits
Imagine you've been working on a major project and it's all coming together. You have great energy, your senses are highly tuned, eating and sleeping are occasional events and you love it. This is the rush feeling. It is caused by adrenaline, which allows you to push pain aside, handle many tasks at once and stay focused.
Chemical stimulants can also put you into an adrenaline state – cigarettes, coffee, red meat, speed and cocaine. The last two are often the panacea for people in high-pressure jobs. An alternative is to keep being busy – the classic workaholic syndrome.
Coming down from a high can be tough. Sometimes you end up in the pits. We've all had this feeling after completing a major project. Instead of elation, you find yourself feeling empty and hollow. But you can reduce the 'roller coaster' effect and 'stay up' naturally if you learn how to improve your body's serotonin production system.
Serotonin produces the bliss feeling. Imagine a fine day on the beach reading your favourite book, drinking a cold beer or chardonnay with someone you love - this is 'bliss'. How do we get more of this serotonin?
Eating mood buster foods will do it. Try the following:
• a skim milk banana smoothie
• a breakfast bar
• a cup of frozen berries
• a medium baked potato with salsa and cottage cheese
• half a cup of dried fruit
Don't eat too much and in 20-30 minutes you'll feel the difference. Drinking water helps too. It prevents dehydration, keeps the brain lubricated and stops the craving for sugary foods. A full glass of water every hour will signal to your system that everything is OK.
Exercise can get you aroused or relaxed depending on what you do. To increase your levels of serotonin you should stretch, do low impact aerobics or light weight lifting. The key is to keep it steady and not place too much excitement on your system.
A good diet and healthy living can keep your 'up-beat' chemistry firing and an efficient serotonin system can help you manage the inevitable ups and downs of life. The best tip of all is to listen to your body and follow its signals.
Source:Skandia
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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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