Capricorn Investment Partners LimitedClient Presentation
8 March 2012
General advice warning
This presentation and the associated discussion is general in nature and does not take your individual situation into account.
You are advised not to act on anything contained herein, or discussed as a consequence of the contents of this
document, without receiving financial advice from a suitably qualified person such as a
financial planner, lawyer or accountant.
What will be covered
Australia and the Global Economic Environment
&
Stock Market Performance
A quick look back at 2011...
Characterised by crises, both natural and financial:
Natural
• Floods in Queensland (January), Thailand (November), New South Wales (December)
• Cyclone Yasi
• Earthquakes in Japan and New Zealand
Financial
• Ongoing Greek and Euro-zone sovereign debt issue
• European austerity measures and public reaction
• US government debt ceiling negotiations
• USA loses AAA credit rating
The impact of these events on the ASX
Japanese earthquake & tsunami
US govt debt ceiling negotiations
Greek debt crises
2011
The Australian economy remains relatively strong
Despite the wide-ranging crises of 2011, the Australian economy is still relatively well-positioned
GDP growth has remained positive and is expected to be around trend at 2.5 to 3.0%. Inflation is also under control and expected to be within RBA target
The retail sector continues to struggle
Australian retailers are being forced to cut costs and rationalise store numbers, as sales growth disappears
And this is why..... ”Paradox of Thrift”
Household debt levels may have peaked
Not only are we saving more, we’re also less inclined to take on more debt, be it credit cards, car loans or mortgages
The property market has also suffered, with average prices falling by over 5% in 2011
The ‘Two-speed’ economy remains an issue
ASX – Net Profits by Sector
Banking
Mining
Most growth and the majority of corporate profits are concentrated in the mining sector
No growth in profits
Mining industry dominates investment
The majority of business investment now takes place in the mining industry, with less emphasis on traditional sectors such as manufacturing
However the mining industry is still a relatively minor employer, with only 2.1% of Australians employed directly in the industry
But reliance on mining poses risks
If the current commodities boom should end, economic activity would slow, tax revenues would fall and the government would have few
options to stimulate demand
???
What happens if this occurs?
Primary concern remains the AUD
The continued strength of the AUD presents problems for a range of sectors of the economy: retail, travel, manufacturing and others
110% appreciation of the AUD against the USD over past decade
Average since float in 1983: 83c
The Global Economic Environment
Continuing concerns over Europe, some signs of growth in the United States
Europe: yet more crises to come
17 summits were held in 2011 to resolve the Euro-zone sovereign debt crisis and still no definitive solution has been found
‘Austerity’ is the new economic paradigm
Faced with high sovereign debt levels, governments in Europe have adopted various austerity measures to lower their debt/GDP ratios
However austerity at the time of a recession can be self-defeating where tax revenues fall faster than spending is cut
It’s still possible that Greece will default
Even after the most recent $160 billion bailout, Greece will still have a debt/GDP ratio of 120%
90% debt/GDP ratio – commonly viewed as point of no return
Greek economic recovery assumptions are heroic
For Greece to avoid default, its economy must exhibit a stunning turn-around over the next few years
The reality is very different: 48% youth unemployment, -6.8% GDP growth, $6 billion of annual tax evasion, 13.6% govt deficit
Collapse in Greek Manufacturing
Greek Manufacturing PMI
A rapid economic recovery in Greece looks unlikely when you consider what is happening to the manufacturing sector
The Greek stock market reflects the gloom
The Greek stock market is down 86% from its pre-GFC peak
Why does Greece matter?
With an economy the same size as Victoria’s, Greece is a minor economic player, the real issue is the European banking system
Greece Owes $400bn to banks in Europe
If Greece defaults...
The banks write-off their loans
A number of banks in Europe collapse
or are nationalised
Which leads to a credit crisis in
Europe as banks pull their funding
Resulting in a European recession
Contagion then spreads to other Euro nations such as...
Italy & SpainAnd on it goes...
Problems of too much debt are widespread
Many countries are close to the 90% government debt/GDP ratio, which usually presages an economic crisis
Recent ECB action has helped avoid a crisis
Similar to action taken by the US Federal Reserve, the European Central Bank has taken steps to provide liquidity to the European
banking system through a form of quantitative easing
LTRO = Long-Term Refinancing Option
The ECB agrees to supply unlimited amounts of Euros for 3 years at 1%
European banks have so far borrowed €1.018 trillion
Which is then invested in sovereign bonds yielding upwards of 6%
LTRO has had a significant impact
The costs of funding for highly-indebted European countries has fallen significantly as European banks invested funds from the
LTRO in Euro-zone government debt
Italian 10-year bond yield
LTRO 1
LTRO 2
A similar outcome for Spain
LTRO 1
LTRO 2
Spanish 10-year bond yield
Primary purpose of LTRO is to buy time for indebted countries to act to reduce their debt/GDP ratios – it is not a permanent solution
United States – signs of recovery
Growing signs of a recovery by the US economy may help to offset any fallout from the ongoing European sovereign debt crisis
Weak but clear signs of recovery in US rail growth
Manufacturing in the US has also improved
The health of the manufacturing sector closely tracks overall GDP and recent readings are positive
Another positive sign – US car sales
US consumers are regaining some level of confidence following the GFC, evidenced through their willingness to buy new cars
US unemployment finally recovering...
Sustained reduction in the US unemployment rate as the private sector begins to re-hire workers
...although there is still a long way to go
But...the US Housing market is still weak
Despite the pickup in employment and faster economic growth, the US housing market, the source of the GFC, still remains weak. A
sustained recovery requires an improvement in the housing market
Stabilising but not yet growing
Stock market performance
Fairly cheap by historical standards
Based on the past 20 years, the Australian stock market appears undervalued
1994 bond market crisis
Dotcom bubble collapse
Pre-GFC high
GFC market low
ASX All Ordinaries – 1992 to 2012
Similar story over 40 year timeframe
8.37% compound annual growth rate from 1974/75 to 2009
ASX All Ordinaries – 1970 to 2012
Yet the ASX has underperformed US market
Despite the Australian economy not having a recession during the GFC, and the lack of a housing crash, our stock market has
significantly underperformed the US market over the past 2 years
All Ords down 7.73%
Dow Jones up 24.74%
Most likely explanation for the underperformance – the persistently strong AUD
Investment approach
Given the local and global economic situation, our investment approach remains focused on:
- generating a high level of portfolio income through fixed-interest investments and fully-franked dividend paying industrials; and
- investing in selected cyclical and growth-oriented companies where appropriate
Current opportunities we favour:
- selected fixed interest securities (e.g. Origin, recent and existing bank issues)
- specific companies where we consider them oversold or underappreciated: NIB, Cromwell (income), Origin, Telstra, Leighton Holdings
Thoughts for the year ahead
2012 is likely to be dominated by a number of key issues:
- ongoing sovereign debt crisis in Europe, and
- the resilience or otherwise of the US economic recovery
In regards to Australia:
- we expect slowing economic conditions to force the RBA’s hand, with a number of interest rate cuts by the end of the year, and
- stock market performance, while volatile, should improve over the -13% experienced over 2011
Questions
?
Thank you