An Investment RoadmapKey Investment Themes
Michael KaragianisInvestment StrategistMLC Investment Management
May 2011
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General advice warning and disclaimer
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Michael Karagianis Investment StrategistMLC Investment Management
• Michael joined MLC Investment Management as an Investment Strategist in July 2010. Prior to that, he was Head of Asset Allocation at UBS Global Asset Management in Australia and Global Head of Asset Allocation and Investment Strategy at Aberdeen Asset Managers in London.
• He graduated with a BEc from the University of Adelaide, and subsequently joined the Department of Treasury in Canberra as a research officer.
• At MLC, Michael is part of the capital markets research team, and is responsible for communicating MLC’s Manager of Managers Investment process to the market place as well as involvement in the formulation of the Strategic Overlay for diversified funds including the LTAR and Horizon series of funds.
• Michael has written numerous articles, as well as undertaken presentations and training to a wide range of clients and audiences, on topics related to the investment outlook, asset allocation and risk management. He has worked and presented in Asia Pacific, the Middle East, North America and, Europe.
• Michael is a member of the Morningstar Regional Expert Panel on Asset Allocation.
MLC Investment Insights & Viewpoints
September 2010 – The post-GFC investment environment. What can history tell us?
February 2011 – An Investment Roadmap. Key investment themes for 2011
December 2010 – The rise and rise of the Australian dollar – stretching the friendship
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Proverb:
I am an optimist, sure ……..
But I am an optimist that carries an umbrella !
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Key Investment Themes for 2011
Some of the key themes that may impact over the coming year
1. The “muddle through” global recovery continues . . .
2. China - a slowing juggernaut ?
3. Those sovereign debt blues keep rolling along . . . .
4. Long live the asset bubble !
5. 2011 – the Year of the Rabbit Equity ?
6. Australia – a two or three speed economy ?
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85
90
95
100
105
110
115
120
125
130
135
Q1 2008 Q1 2009 Q1 2010 Q1 2011
China Australia
US Germany
UK Japan
Ireland Greece
Cumulative real GDP indexQ1 2008 =100
Source: Datastream
Asia booming – US economy gradually recovering post GFC
1. The “muddle through” global recovery …
Two tiered
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US housing market still a problem
Source: Financial Times
One in 9 housing mortgages in the US not being serviced – prices still falling
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Negative equity remains major overhang
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Recent bumper stickers in the US
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Geopolitical Tensions
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Middle East – Fight for Democracy or Jobs?A dangerous combination of high unemployment and young
demographics
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2. China – a slowing juggernaut?
Source: Datastream
Chinese leading indicators weakening ?
97
98
99
100
101
102
103
104
105
106
107
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
5
10
15
20
Leading indicator (lhs)
Industrial production (rhs)
% change oyachange oya
14 Source: Datastream
Now “tapping the brakes” to slow things
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3. Those sovereign debt blues keep rolling along . . .
Source: IMF
What debt ?“Zone of Worry”
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Probability of default at some stage is high European peripheral government & US municipal debt the
main concern
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4. Long live the asset bubble !
Source: Datastream
1970’s commodity boom
GFC
China super- cycle
Bubble ?
Are commodities experiencing a bubble ?
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RBA Commodity Price Index vs Australian dollar
20
40
60
80
100
120
140
160
Jul-00 Jul-04 Jul-08
0.5
0.6
0.7
0.8
0.9
1
1.1
Commodity Index US $ A$/US$ (rhs)
Index
Australian dollar reflects terms of trade boost
Source: Datastream
Could this also be a bubble?
GFC
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Asian housing prices booming – a bubble?Residential prices up 30 - 80% since 2008 on easy credit
conditions
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An Australian housing price bubble?
Source: Marc Faber “gloomboomdoom.com”
Australia has one of the most expensive housing markets globally
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End of QE2 could produce market volatility
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Global Bonds have outperformed Global Equities over 5 years
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75
100
125
150
175
01-Dec-05 01-Dec-06 01-Dec-07 01-Dec-08 01-Dec-09 01-Dec-10
Bonds (Barclays Global Agg Index)
Equities (MSCI World Index)
Total Return Indices Dec 2005 = 100
5. 2011 – the Year of the Rabbit Equity?Bonds are more expensive now – shares are relatively
attractive
Source: Datastream
?
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US corporate profits rebounding strongly
Source: Datastream
0
10
20
30
40
50
60
70
80
90
Mar-85 Mar-90 Mar-95 Mar-00 Mar-05 Mar-10
$ EPS
Weaker US$, improving profit margins and reduced write-downs all helping
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Australia
0
20
40
60
80
100
120
140
160
May-85 May-90 May-95 May-00 May-05 May-10
EPS
Australian earnings more muted recoveryNegative impact of rising AUD & interest rates and tight
labour market
Source: Datastream
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6. Australia- catching the “Dutch Disease”?
Mining booming but a high AUD hurts retail, tourism, manufacturing
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Australian Labour Force by Industry(March 2011)
Manufacturing10%
Construction10%
Wholesale4%
Retail12%
Accommodation8%
Transport6%
Government7%
Education8%
Health13%
Cultural2%
Personal4%
Electricity2%
Communication2%
Finance4%
Property2%
Mining2%
Agriculture3%
Total employed 11,457,000 (March 2011)
Manufacturing & Retailing big employers
Source: Australian Bureau of Statistics
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Impact of floods / storms . . . . . . .
• Near term - 2011 H1• Reduce growth & raise inflation
• Disrupt mining & agricultural exports
• Impact negatively on affected farmers, businesses and households
• Interest rates on hold
• Longer term - 2011 H2 onwards• Major reconstruction effort - concentrated in certain regions
• Qld a major beneciary
• Boost economic growth by up to 1-1.5% but not spread evenly
• Support construction industry – shortage of skilled workers?
• Industry recovery? Agriculture & tourism – wait and see
• Tax levy & other spending cuts to pay the bill
• Interest rates to rise further
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3
4
5
6
7
8
9
10
11
12
13
Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11
Selected interest rates (%)
Small/medium business loans
Official cash rate
Std. variable mortgage rate
Loan rates are starting to bite – heading up
Source: RBA, Datastream
Expect another 1-2 moves by the RBA later in 2011
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Housing affordability is poor nowPotentially dangerous for households with significant
mortgage debt
Source: RBA
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2011 Budget – where is the vision?Deficit > $49.4 bn in 2011 FY, $22.6 bn in 2012 FY, surplus $3.5 bn in 2013 FY
Growth > 2.25% in 2011 FY & 4% in 2012 FY
Inflation> 3.25% in 2011 FY, 2.75% in 2012
Sources of Growth
booming mining investment and disaster reconstructionmoderate consumption and weak residential construction
Positives > Spending on Labour force training and migration to boost workforce
Concerns > Very slow recovery in budget deficit despite the mining boom> Many of the measures not impacting for 2-3 years> No sovereign wealth fund to bank the benefits of the mining boom> No tax reform
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Dividends make up the majority of returns
Source: Datastream
Australian Equity Market Returns
0
200
400
600
800
1000
1200
1400
Q2 1986 Q2 1989 Q2 1992 Q2 1995 Q2 1998 Q2 2001 Q2 2004 Q2 2007 Q2 2010
All Ordinaries Accumulation Index (incl dividends)
All Ords Price Index (excl dividends)
Index = 100 at Q2 1986
9.9% pa
4.5% pa
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Dividends offer stable returnsDividends relatively more important in a “muddle through”
environment
Source: Datastream - All Ordinaries Accumulation Index
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What can you do about it?Equities preferred - valuations fair (not cheap) with reasonable earnings growth
Dividends matter - bigger share of total equity returns vs capital gains
- more reliable than capital gains and, - more tax effective than term deposits
Residential Property - beware because of poor affordability and rising interest rates
Diversification - crucial in a highly volatile, uncertain environmentglobalisation of portfolios - reduces risk !alternative asset classes - for diversification or illiquidity premia
Dollar cost averaging - systematically buying (not selling) cheap assets
Active management - active asset allocation & stock selection important for risk management not just return enhancement
Risk control - don’t take any more portfolio risk than you really need to !
Get good advice from a financial planner !
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