Provision Newsletter

More work to be done to stimulate the economy

Rates have been reduced to help stimulate the economy. Lending rates on housing and business loans have decreased, and this has seen a pick-up in house prices, approvals to build new homes and some improvement in retail sales. However, the Australian dollar remains high, and with mining investment still falling, and some uncertainty about other parts of the economy, we believe it’s still too early to declare victory and begin raising rates. In fact, the Reserve Bank of Australia has flagged that low interest rates are likely to remain in place for a period ahead, which, in our view, could take us well into 2015.

The effect of low rates on term deposits

So, what does this mean for term deposit holders? Well, they’re likely to remain low for some time to come, and may even fall further. As a result of low rates, we’re likely to see the search for more attractive income or ‘yield’ continue. Such conditions make life difficult for those investors who have a fixed rate of return in mind, particularly those with term deposits and other cash-like investments which form a core part of their investment strategy.

Where can investors go in the search for yield?

Corporate bonds, infrastructure and property all have comparatively higher yield than term deposits and can be a good source of income. In addition, Australian shares have also been a great provider of income. In Australia, we’re fortunate in that we have high dividend payout ratios for corporates, and the franking credit system encourages the payment of decent dividends. Dividends are great for investors as they provide a relatively stable and attractive source of income, and can provide a degree of security in uncertain and volatile times.

To learn more about the benefits of dividends and investing in shares, please read 'Why I love dividends and you should too' by Dr Shane Oliver, AMP Capital.

Important note: While every care has been taken in the preparation of this information, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This information has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. Certain information in this website has been obtained from sources that we consider to be reliable and is based on present circumstances, market conditions and beliefs. We have not independently verified this information and cannot assure you that it is accurate or complete

More work to be done to stimulate the economy

Rates have been reduced to help stimulate the economy. Lending rates on housing and business loans have decreased, and this has seen a pick-up in house prices, approvals to build new homes and some improvement in retail sales. However, the Australian dollar remains high, and with mining investment still falling, and some uncertainty about other parts of the economy, we believe it’s still too early to declare victory and begin raising rates. In fact, the Reserve Bank of Australia has flagged that low interest rates are likely to remain in place for a period ahead, which, in our view, could take us well into 2015.

The effect of low rates on term deposits

So, what does this mean for term deposit holders? Well, they’re likely to remain low for some time to come, and may even fall further. As a result of low rates, we’re likely to see the search for more attractive income or ‘yield’ continue. Such conditions make life difficult for those investors who have a fixed rate of return in mind, particularly those with term deposits and other cash-like investments which form a core part of their investment strategy.

Where can investors go in the search for yield?

Corporate bonds, infrastructure and property all have comparatively higher yield than term deposits and can be a good source of income. In addition, Australian shares have also been a great provider of income. In Australia, we’re fortunate in that we have high dividend payout ratios for corporates, and the franking credit system encourages the payment of decent dividends. Dividends are great for investors as they provide a relatively stable and attractive source of income, and can provide a degree of security in uncertain and volatile times.

To learn more about the benefits of dividends and investing in shares, please read 'Why I love dividends and you should too' by Dr Shane Oliver, AMP Capital.

Important note: While every care has been taken in the preparation of this information, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This information has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. Certain information in this website has been obtained from sources that we consider to be reliable and is based on present circumstances, market conditions and beliefs. We have not independently verified this information and cannot assure you that it is accurate or complete

Myth 1: Infrastructure is a boring old 'economy style' investment

A common misconception is that infrastructure assets represent, for the most part, old economy style investments with little potential for growth and limited relevance to future economic needs. In reality nothing could be further from the truth. Consider some of the key global secular themes that are shaping the future of investment markets (such as water, communications, shale gas, electricity production)… infrastructure assets lie at the core of many of these. McKinsey estimates that US$57 trillion will be spent on Infrastructure worldwide by 2030.

Myth 2: Infrastructure assets are very susceptible to interest rate hikes

In reality, infrastructure assets typically exhibit qualities that provide dual protection against rising interest rates. Firstly, infrastructure companies have longer-term debt structures. This means they are only obliged to refinance small proportions of their debt in the short-term but have the option to refinance longer-term debt at favourable rates should market conditions allow. Secondly, contracts and regulation are often negotiated on a ‘cost-plus’ basis allowing charging structures to be increased in an environment of rising interest rates. In addition, if interest rates rise due to an increase in GDP, then this provides natural economic support and an associated increased demand for infrastructure assets.

Myth 3: Listed infrastructure returns have run out of steam

Yes, the asset class has performed well over the last five years, but does this mean it’s run out of steam? Not necessarily. The asset class ‘overcorrected’ during the Global Financial Crisis, and we believe it’s only recently returned to its long-term growth trend. This means it still has plenty of upside potential given the fundamentals.

Final thoughts

In a low interest environment with the associated chase for yield, an asset class which exhibits a defensive and stable yield profile, coupled with strong potential for growth, is an obvious candidate for consideration in any well considered long-term investment strategy. This relatively new asset class also affords exposure to the type of investment previously only accessible by institutional investors.

	About the Author Tim Humphreys is the head of AMP Capital's Global Listed Infrastructure Team with over 15 years' experience in the UK and Australia. Tim also leads the research effort of infrastructure companies in the Americas.

Important note: While every care has been taken in the preparation of this information, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This information has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. Certain information in this website has been obtained from sources that we consider to be reliable and is based on present circumstances, market conditions and beliefs. We have not independently verified this information and cannot assure you that it is accurate or complete.

 Profits not booming, but look reasonable

The June half profit reporting season that just ended was preceded by nervousness associated with the falling iron ore price and the blow to consumer confidence associated with the Budget. In the event though solid growth was confirmed for 2013-14 and consensus earnings expectations for the current financial year were affirmed. In terms of specifics:

• 54% of companies exceeded expectations, which is the best result in nine years. This is a welcome outcome for investors who were probably fearing more misses;

 Source: AMP Capital

• 68% of companies have seen their profits rise from a year ago (compared to a norm of 66%);

• 65% of companies have increased their dividends from a year ago (up from around 60% in the last two years); and

• 60% of companies saw their share price outperform the market the day they released results, the best in 4 years.

Source: AMP Capital

Key themes have been:

• strong profit growth of 25% for resources after a 19% profit slump as costs fell and volumes rose;

• financials doing well with 11.5% profit growth, helped by 9% growth from the banks and a 34% surge for insurers;

• ongoing cost control making up for still soft revenue growth resulting in 4% profit growth for industrials;

• mixed results for cyclicals – good for Boral, Stockland & Harvey Norman, not so good for JB HiFi; and

• strong dividend growth reflecting investor interest in income, strong cash flow growth and corporate confidence in earnings prospects. Dividends grew 7% after 11% growth in 2012-13.

Consensus expectations for the current financial year are for 5% earnings growth, which is unchanged from the start of the reporting season and presents a relatively low hurdle.

Source: UBS, AMP Capital

This reflects a slowing in resources profit growth to just 3% as lower commodity prices feed through partly offset by higher export volumes; bank and financials seeing profit growth slowing to 5%, but a pickup in profit growth for industrials ex-financials to 8.5%. Clearly the latter is dependent on some pick-up in economic growth.

Soft June quarter GDP, but ok outlook

The slowdown in economic growth seen in June quarter may add to concerns about the economy. Particularly so with Australian Bureau of Statistics (ABS) business investment intentions data pointing to a fall in business investment this financial year of 9 to 10%. However, the broad outlook remains for a gradual improvement in growth. The poor GDP growth seen in the June quarter is pay back for the much stronger than expected 1.1% rise seen in the March quarter. This reflected noise in the timing of exports and imports such that trade boosted growth by 1.4 percentage points in the March quarter and detracted 0.9 percentage points in the June quarter. Given this it makes sense to average the two quarters giving average quarterly growth of 0.8%, or 3.2% annualised, which is actually pretty good.

Of course, spending growth averaged over the two quarters is just 2.2% annualised which is hardly great. However, signs continue to mount that thanks to the fall in interest rates to record lows and to a lesser degree the lower $A, the economy is rebalancing towards more broad based growth.

• A housing construction boom is now underway with home building up 8.6% over the last year and more on the way.

 Source: Bloomberg, AMP Capital

• Business confidence has risen to solid levels and while consumer confidence took a hit from the Budget cutbacks scare, it seems to be clawing its way back up.

Source: Bloomberg, AMP Capital

• A range of forward looking labour market indicators – ANZ and SEEK job ads, skilled vacancies and the NAB business survey are pointing up for jobs.

Source: ABS, NAB, AMP Capital

• Lower interest rates, rising wealth levels and rising housing construction is likely to drive a pick-up in retail sales with household equipment leading the charge.

• While the investment outlook for mining and manufacturing is bleak the outlook for investment in other industries is improving. Investment intentions for what the ABS calls “other selected industries” points to a 9% to 10% gain this financial year. And the NAB business survey’s investment intentions index has actually started to rise pointing to stronger investment ahead.

 Source: ABS, NAB, AMP Capital

• Finally, we are also coming into the third and final phase of the resources boom. We will see increased export volumes as projects complete and reduced capital goods imports as resource investment slows.

Drawing these factors together our assessment remains that underlying demand and growth in Australia is gradually on the mend and should be running around trend of just above 3% through next year.

Not "dog days"

The key to the Australian economy right now is rebalancing. The mining investment boom and associated surge in interest rates and in the $A that were necessary to make way for it, led to a dramatically imbalanced economy with half of growth coming from mining investment at one point. This clearly adversely affected big parts of the non-mining economy. With mining investment now fading, lower interest rates and in time further declines in the $A are allowing the non-mining economy to bounce back. This process is slow – and it would be aided by a reinvigorated economic reform agenda – but the indicators above suggest it’s underway.

Implications for investors

First, the outlook for the economy is not nearly as gloomy as frequent headlines suggest. Profits are likely to record modest but reasonable growth over year ahead.

Second, interest rates are likely to remain on hold. Growth is not bad enough and there are enough signs rate cuts are working to argue against rate cuts. But the high level of uncertainty regarding the economic outlook, the still too high $A and low inflation argue against rate hikes. The most likely outcome is that rates will be on hold well into next year.

Finally, the combination of rising economic growth and continuing low interest rates should underpin a pick-up in non-resources earnings growth over the year ahead, which in turn should support further gains in the Australian share market. Our year-end target for the ASX 200 remains 5800.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

New Centrelink rules affecting Government age pensions and other benefits

Do you need to take action now?

If you are over 55 and potentially eligible for a Centrelink benefit, you need to read this. You may need to take action.

• New rules are coming on 1 January 2015 that could reduce your Centrelink benefits. These rules change the way that superannuation-based pensions will affect entitlements to Centrelink benefits that are subject to an income test (such as the age pension)

• The new rules will only affect those who start receiving their Centrelink benefits after 1 January 2015, or who start or change their superannuation-based pensions after that date.

• If you may be eligible for both a Centrelink benefit and a superannuation-based pension next year, you may need to take action this year to maximise your Centrelink benefits in the future. It’s important that to consider your own situation before you decide what to do.

Your financial adviser can give you a personalised recommendation to help you consider whether to:

• start a new superannuation-based pension now; or

• make changes to an existing superannuation-based pension before the deadline; or

• apply for Centrelink entitlements that you are not receiving.

These things take time, so it’s important you and act now.

Will the changes reduce the amount you receive?

From 1 January 2015 new Centrelink rules could affect your government age pension entitlements for the rest of your life. It pays to be aware that if you receive a government age pension and set up or make changes to an account-based pension after 1 January 2015, you may be worse off. Use the time before the end of this year to work out whether reviewing or setting-up an account-based pension before 1 January 2015 will help you—and put your plan in place.

What will the changes mean for you?

All account-based pensions (ABPs)—including allocated pensions—set-up after 1 January 2015 will be assessed the same way as other financial assets. So if you’re receiving a government age pension it may be reduced as a result. This also applies to those ABPs set up before this date that are not eligible to preserve the old rules.

If you’re eligible, it’s not too late to set up an ABP before 1 January 2015 under the current rules. In fact, doing so may preserve your government age pension entitlements.

What if you make changes to your existing ABP?

Any changes you make to your ABP after 1 January 2015 could make your ABP assessable under the new rules—for example, if you:

• Change your ABP provider

• Add or remove a reversionary beneficiary (a person you’ve nominated to receive your pension income when you die)

• Combine multiple ABPs or consolidate super into your ABP

• Cease receipt of a government payment Start a death benefit pension for anyone other than a reversionary beneficiary.

It’s important to speak with your financial adviser about whether setting up or reviewing your ABP now will help you preserve any age pension entitlements you may have. Now might also be a good time to review your estate plan.

What You Need to Know

Any advice contained in this newsletter is of a general nature only and does not take into account the objectives, financial situation or needs of any particular person. Therefore, before making any decision, you should consider the appropriateness of the advice with regard to those matters. If you decide to purchase or vary a financial product, your financial planner, our practice, AMP Financial Planning Pty Ltd and other companies within the AMP Group will receive fees and other benefits, which will be a dollar amount and/or a percentage of either the premium you pay or the value of your investments. You can ask us for more details.

 The US – looking good but not booming

After a contraction in the March quarter driven by mostly temporary factors, the US economy rebounded in the June quarter and looks on track for growth of around 3% in the current quarter. The jobs market and business investment are improving and the shale oil boom is providing a long term boost both directly and indirectly via cheap electricity costs for business. However, while the US is looking a lot stronger it’s a long way from booming, let alone overheating, with growth seemingly stuck in a 2-3% range as the housing recovery and consumer spending have slowed a bit of late.

Source: Bloomberg, AMP Capital

Which brings us to what the Federal Reserve will do. On the one hand US growth has improved enough to allow the Fed to continue “tapering” its quantitative easing program which means it’s on track to end probably in October. On the other hand it’s unclear that conditions are strong enough to warrant interest rate hikes just yet. This is something the Fed is grappling with, but the conclusion seems to be that – with inflation remaining low at just 1.5% on the Fed’s preferred measure, wages/labour cost growth stuck around 2% and broad measures of labour market slack (ie allowing for the unemployed, underemployed and discouraged workers) remaining high – its unlikely to rush into raising rates.

Source: Bloomberg, AMP Capital

Our assessment is that the Fed is gradually inching towards an interest rate hike, but it’s probably not going to occur until sometime in the June quarter next year.

The Eurozone – better but not great

The Eurozone returned to growth about a year ago but it is far from robust and stalled in the June quarter with weakness in Germany, Italy and France. Uncertainty regarding Russian sanctions and Ukraine are not helping. What’s more bank lending growth has remained negative and inflation has fallen to just 0.4% year on year. This has all led to concerns that Europe is sliding into Japanese style stagnation and that the ECB needs to do more.

Source: Bloomberg, AMP Capital

Our assessment though is that Europe is gradually mending: growth has returned to Spain, Ireland, Portugal and Greece; these countries have all made significant structural reforms to their economies and France and Italy look to be gradually heading down that path; the troubled countries have all seen their bond yields collapse, eg Spain’s 10 year bond yield is now just 2.17%; the ECB announced further stimulus in June, but looks to be ready to launch into quantitative easing involving the purchase of private debt in the next few months; and bank lending should improve once the ECB’s bank stress tests are out of the way in a few months.

Japan – Abenomics on track

Japan’s growth was hit in the June quarter by the pull- forward effect of the April sales tax hike. However, a range of indicators suggest that despite the volatility the Japanese economy has weathered the sales tax hike well with ultra-easy monetary policy and economic reforms providing confidence growth will bounce back from the current quarter.

Source: Bloomberg, AMP Capital

However, given the uncertainty, the Bank of Japan will either have to maintain its very easy monetary conditions or possibly have to ease further.

China running hot and cold

For the last three years now Chinese economic data has been running hot and cold every six months leading to periodic worries about growth. Another slowdown in the Chinese property market is adding to these concerns.

Source: Bloomberg, AMP Capital

With the Chinese Government repeatedly indicating that there is a floor to growth of around 7%, and supporting this by mini-stimulus measures as they have done this year, our assessment remains that the Chinese economy is on track for growth of around 7.5%. But don’t count on more.

Emerging world

The emerging world more generally is a lot messier than it used to be. Of the major’s, China and Mexico look ok and the election of reform oriented governments in India and Indonesia is positive, but Brazil looks to have lost the plot under the current Government, and Russia already weakened looks to have shot itself in the foot over Ukraine. A lack of structural reforms over the last decade has led to lower growth potential in the emerging world. That said it’s still on track for growth around 4.5% this year and next.

Global growth – two steps forward, one back

Bringing this together, global business conditions indicators are consistent with good but not booming growth.

Source: Bloomberg, AMP Capital

Although global growth is likely to pick up, it’s hard to describe global conditions as synchronised and the global economic expansion remains very much a process of two steps forward, one step back. This was clearly evident in the first half of the year with the US and Japan both having negative quarters, China slowing in the first quarter and Europe stalling in the June quarter. And of course geopolitical events continue to wax and wane and the threat from Ebola remains in the background – all of which impart a deflationary impact in terms of their dampening impact on confidence and spending. Against this backdrop it is hard to see the Fed wanting to rock the boat prematurely with talk of interest rate hikes, let alone actual hikes, and the ECB, Bank of Japan and People’s Bank of China are likely to maintain ultra-easy policy or ease further.

Investment implications

There are several implications for investors. First, gradually improving global growth, still benign inflation and easy monetary conditions tell us we are still in the sweet spot of the economic cycle which augurs well for growth assets.

Second, the desynchronised global economic and monetary cycles confirm that the “risk off, risk on” phenomenon of a few years ago where all growth assets move up and down together has faded. This should make it easier for fund managers and investors to benefit from opportunities in individual regions, assets or stocks. Eg we think there is currently good value in Chinese shares, European shares and commodities. The divergence in monetary cycles is also likely to mean upwards pressure on the $US but downwards pressure on the Yen and Euro.

Thirdly, the constrained global growth cycle provides a reminder not to expect double digit gains from growth assets year after year. It will still be a relatively constrained world in terms of sustainable returns.

Finally, the big thing globally to keep an eye out for will be when the Fed will start to raise interest rates. This, or rather its anticipation, will likely cause a few bumps (just like last year’s taper tantrum did), but it’s still a fair way off and when it does come its unlikely to spell the end of the cyclical bull market in shares as it will be a long while before monetary conditions actually become tight.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.