April 2016 Review & Comments
Written by Tony Gray   
Monday, 16 May 2016 10:31

Portfolio Report – May 2016

Financial Planning/Budget

There were some inequitable changes to superannuation introduced by the government in the budget – with measures that disadvantage those who strive to be self-sufficient. Limits on tax free contributions have been backdated to 1 July 2007 and the retrospective nature undermines trust in the rules. Our political leaders are falling well short of the standards set in the 1980’s and 1990’s when it comes to understanding incentives and sustainability.

The budget superannuation changes are vast in scope and the overall complexity of the system has increased enormously. As such, the general thrust towards simplifying structures and using superannuation as the primary retirement and investment vehicle, will swing back to using trusts and companies. It now becomes important to utilise personal tax-free thresholds and careful planning will be needed to prevent the mixing of taxable and tax-free components – as the former represents a ‘death tax’ of sorts.

On the positive side, there have been some sensible changes that remove the distinction between employed and self-employed people; and non-working people in the 65 to 75 age bracket will be able to contribute to superannuation without meeting the work test.

Initially we will be making contact with clients where current and 2016-17 financial year action is beneficial, but otherwise we will be working through adjustments for all clients - seeking to minimise the impact as much as we can.

The ALP opposes the retrospective nature of the contribution limits and pension changes – but their plan to tax pension incomes and track record on fiscal sustainability and raiding the superannuation pot hardly instils confidence. The Greens support the Liberal Party changes but argue they do not go far enough. The next 14 months will be a busy time in a planning sense – and no doubt many of the finer details will emerge after the election.

Investment Markets

The Reserve Bank of Australia on Tuesday cut the overnight cash rate to a new record low of 1.75% (it appears after all that the RBA Governor is that desperate). The banks have cut mortgage rates, so we will see an impact on term deposit rates flow through – to likely below 3.0%. With 10 year Australian Commonwealth Government Bonds yielding 2.44% there are no attractive defensive assets. One slight positive is that credit spreads have widened, so risk and return have improved for some corporate debt exposure and now look to offer reasonable potential relative to deposits.

We, like most others, struggle to comprehend some of the extremes developing with bond markets. Something in the order of 25% of all government bonds now trade on negative interest rates. Put another way, 25% of all bonds held will result in losses if held to maturity. In total, something in the order of 60% of government bonds on issue globally yield less than 1.0% per annum! We would have thought that with the deficit position and growing levels of gearing for the global economy, coupled with low and slowing growth, that a premium for the increasing credit risk would be rational? Of course that thinking is quite old fashioned – and clearly wrong according to markets.

Presently the European Central Bank will lend money to the banks at negative 0.4%. Put another way, the central bank will pay banks to borrow the money. The catch – the banks can only access this money if they are on-lending. The whole situation smacks of desperation – but again, presumably we are missing something?

There is a chance that Australian interest rates trend lower – although our 10 year bond yield is now just 70 basis points (0.70%) higher than for the US – a very narrow premium. This could see the re-emergence of the buy for yield story – but while there may be profits to be made in the short-term, we know how that scrip will ultimately end.

US shares continue to levitate, despite quite significant earnings declines (S&P 500 earnings are down 7% for the first quarter compared to a year ago). We would not be surprised to see a sell-off in this market. Elsewhere in the world share prices have adjusted lower to the point where value is more apparent.

Clearly our concerns with the banking sector remain – although pricing of bank stocks reflects this as a more widely held view than 12 and 18 months ago. Mining and energy stocks have bounced nicely, although we doubt the former is sustainable in the short-term – a normal cycle would involve a protracted period of low prices and gradually improving balance sheets, cash-flow and income yields.


Smaller and especially micro-cap stocks remain of interest – although do not suit some client portfolios. We have also used some specialist managers to good effect in this area.

We remain wary of regulated businesses (an ongoing risk that governments and regulators will price or tax away excess returns) and also businesses involving leverage. Listed property trades at a sizeable premium to asset backing and gearing has been gradually creeping up as many forget the 2008 and 2009 lessons. That said we are nowhere close to the gearing levels or premiums of 2007.

The price of gold continues to trend up in $US terms and with the $A having stopped its recent ascent we are at record local prices for gold. I cannot think of any other commodity trading at or even close to record prices at this time and we don’t believe the expansion in cash-flow and profit margin is fully appreciated. There are a range of gold exposures to consider – from local miners, to $A priced gold to $US hedged gold to a global gold miner exchange traded fund.

Summary

There have been some decent price falls over the past year or so and there is sufficient value to apply funds to certain share exposures. The same holds for some international markets. Applying extra at-call funds to deposits and perhaps a corporate debt exposure (diversified and high quality) and holding a little gold as a hedge/growth pretty much sums up our general adjustments to portfolios.

We remain on the conservative side of Investment Strategy ranges – the risks from high and rising leverage in the economy increases the risk to capital. This limits short-term income, but holding a reserve allows price weakness to be treated as an opportunity.

As always, please make contact with any questions about your portfolio and positioning.

Best wishes,


A.W. (Tony) Gray BCom, LLB, Dip FP, GDipAppFin, CFP, FFin

Principal, TG Financial


Please treat the above comments as General Advice or general information, with no action to occur until we have considered with reference to your financial position, needs and goals

Last Updated on Monday, 16 May 2016 10:46
 

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