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Market Watch

Monetary Policy Decision – Statement by Philip Lowe, RBA Governor, February, 2019

Posted On:Feb 05th, 2019     Posted In:Rss-feed-market    Posted By:Provision Wealth

At its meeting today, the Board decided to leave the cash rate unchanged at 1.50 per cent.

The global economy grew above trend in 2018, although it slowed in the second half of the year. Unemployment rates in most advanced economies are low. The outlook for global growth remains reasonable, although downside risks have increased. The trade tensions are affecting global trade and

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At its meeting today, the Board decided to leave the cash rate unchanged at 1.50 per cent.

The global economy grew above trend in 2018, although it slowed in the second half of the year. Unemployment rates in most advanced economies are low. The outlook for global growth remains reasonable, although downside risks have increased. The trade tensions are affecting global trade and some investment decisions. Growth in the Chinese economy has continued to slow, with the authorities easing policy while continuing to pay close attention to the risks in the financial sector. Globally, headline inflation rates have moved lower due to the decline in oil prices, although core inflation has picked up in a number of economies.

Financial conditions in the advanced economies tightened in late 2018, but remain accommodative. Equity prices declined and credit spreads increased, but these moves have since been partly reversed. Market participants no longer expect a further tightening of monetary policy in the United States. Government bond yields have declined in most countries, including Australia. The Australian dollar has remained within the narrow range of recent times. The terms of trade have increased over the past couple of years, but are expected to decline over time.

The central scenario is for the Australian economy to grow by around 3 per cent this year and by a little less in 2020 due to slower growth in exports of resources. The growth outlook is being supported by rising business investment and higher levels of spending on public infrastructure. As is the case globally, some downside risks have increased. GDP growth in the September quarter was weaker than expected. This was largely due to slow growth in household consumption and income, although the consumption data have been volatile and subject to revision over recent quarters. Growth in household income has been low over recent years, but is expected to pick up and support household spending. The main domestic uncertainty remains around the outlook for household spending and the effect of falling housing prices in some cities.

The housing markets in Sydney and Melbourne are going through a period of adjustment, after an earlier large run-up in prices. Conditions have weakened further in both markets and rent inflation remains low. Credit conditions for some borrowers are tighter than they have been. At the same time, the demand for credit by investors in the housing market has slowed noticeably as the dynamics of the housing market have changed. Growth in credit extended to owner-occupiers has eased to an annualised pace of 5½ per cent. Mortgage rates remain low and there is strong competition for borrowers of high credit quality.

The labour market remains strong, with the unemployment rate at 5 per cent. A further decline in the unemployment rate to 4¾ per cent is expected over the next couple of years. The vacancy rate is high and there are reports of skills shortages in some areas. The stronger labour market has led to some pick-up in wages growth, which is a welcome development. The improvement in the labour market should see some further lift in wages growth over time, although this is still expected to be a gradual process.

Inflation remains low and stable. Over 2018, CPI inflation was 1.8 per cent and in underlying terms inflation was 1¾ per cent. Underlying inflation is expected to pick up over the next couple of years, with the pick-up likely to be gradual and to take a little longer than earlier expected. The central scenario is for underlying inflation to be 2 per cent this year and 2¼ per cent in 2020. Headline inflation is expected to decline in the near term because of lower petrol prices.

The low level of interest rates is continuing to support the Australian economy. Further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual. Taking account of the available information, the Board judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.

Source: Reserve Bank of Australia, February 5th, 2019

Enquiries

Media and Communications
Secretary’s Department
Reserve Bank of Australia
SYDNEY

Phone: +61 2 9551 9720
Fax: +61 2 9551 8033

Email: rbainfo@rba.gov.au

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Four reasons the 2019 global economic outlook looks positive

Posted On:Jan 15th, 2019     Posted In:Rss-feed-market    Posted By:Provision Wealth

Many investors have been rattled by falls in share markets and are fretting about what the new year may hold.

But there are a number of reasons to suggest that after a weak 2018, 2019 will be better, and that a well-diversified portfolio should deliver reasonable returns.

1. This is a “mid-cycle” correction

Firstly, while some investors fear a recession and full-blown bear

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Many investors have been rattled by falls in share markets and are fretting about what the new year may hold.

But there are a number of reasons to suggest that after a weak 2018, 2019 will be better, and that a well-diversified portfolio should deliver reasonable returns.

1. This is a “mid-cycle” correction

Firstly, while some investors fear a recession and full-blown bear market, when you look at the global economy, what you see is not a major recession, but yet another “mid-cycle” correction. As the timeline below illustrates, the recovery since the global financial crisis has been anything but straightforward with several mid-cycle slowdowns along the way including around 2011 and 2015-16.

2. No full-blown recession

But while we are in a growth slowdown globally, I don’t see the conditions being in place to drive that into a full-blown recession. I don’t see excess investment; I don’t see lots of interest rate hikes around the world; I don’t see tight monetary policy; and I don’t see a major inflation problem.

My feeling is that growth might be a little bit subdued in the first part of 2019, but as we go through the year, we will see another pick-up in growth and that will keep the global economic growth going.

3. Oil prices falling

Another reason I have for optimism is that oil prices have fallen 30-odd per cent. That takes pressure off inflation and also puts money in the hands of consumers – a bit like a tax cut.

It’s a classic example of the benefits of these mini-downturns. It’s not so good for share markets, but ultimately lower oil prices help extend the cycle and therefore are likely to drive a recovery in share markets as we go in 2019.

4. Modest rate hikes or even cuts

The fourth reason is that interest rate rises should be constrained in 2019. The US Federal Reserve will probably raise interest rates a bit more through 2019, but I think it’s going to be at a slower pace, and it wouldn’t surprise me at all if they have a pause through the first part of 2019.

That’s reflecting the slower pace of growth that we have seen and signs that US inflation in the very short term may be constrained around the Federal Reserve’s 2% target. Other major countries are very unlikely to raise rates and some (such as China) are likely to cut them.

The impact on investment returns

Despite the concerns of investors, the four reasons above mean I don’t believe we are headed for a deep bear market or major recession and therefore I anticipate better returns in 2019, albeit things could still get worse before they get better.


** Warning: These forecasts are prospective financial information based on various assumptions. The forecasts are predictive in nature, may be affected by inaccurate assumptions or by known or unknown risks and uncertainties, and may differ materially from results ultimately achieved. Source: AMP Capital

Australia’s outlook

The local outlook is ok, but returns will be constrained.

On the one hand, there’s strength in infrastructure spending, business investment looks healthier, and export values should hold up; on the other hand, there’s the housing slowdown, which will constrain things, all of which should keep Australian interest rates on hold, or if, as we expect, ultimately drive a rate cut. So the return outlook for bank deposits will remain very low as we go through 2019.

What to watch

There are, as always, some areas to keep an eye on through 2019.

  • Australian housing

    I expect Australian housing is going to remain weak. With credit tightening and rising supply, expectations are a lot weaker which is attracting fewer buyers into the property market. There’s also reduced foreign demand and a potential change of government on the horizon – all of those things are going to lead to more downside in Australian property prices, though that will be concentrated in Sydney and Melbourne.

  • The US Federal Reserve

    Globally, watch to see what the US Federal Reserve are doing – but as mentioned I don’t expect dramatic US rate rises in 2019.

  • The Trump trade war

    The trade issue between the US and China will bubble along periodically as we go through 2019, particularly in the first part of the year. To see whether the war flares up again, investors need to monitor what happens with the trade truce struck on the sidelines of the recent G20 summit that saw China and the US put tariff increases on hold for 90 days.

To learn more about our predictions for 2019, watch our recent webinar.

https://vimeo.com/304496565

 

Author: Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist, AMP Capital

Source: AMP Capital 15 Jan 2019

Important notes: 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.

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Best of 2018: How will innovative transportation ideas bring new opportunities?

Posted On:Jan 15th, 2019     Posted In:Rss-feed-market    Posted By:Provision Wealth

At AMP’s recent Amplify event, Mark Moore, Uber’s engineering director of aviation and Nick Earle from Hyperloop One, spoke about how innovation is likely to change the face of public transport. Emerging public transport systems are poised to free up road and rail systems, leading to less congestion and better use of infrastructure.

As an example, Uber’s vision for the future

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At AMP’s recent Amplify event, Mark Moore, Uber’s engineering director of aviation and Nick Earle from Hyperloop One, spoke about how innovation is likely to change the face of public transport. Emerging public transport systems are poised to free up road and rail systems, leading to less congestion and better use of infrastructure.

As an example, Uber’s vision for the future of commuting involves a self-driving electric car picking up a passenger and taking them to a nearby teleport, from which an unmanned air taxi would take them to their destination teleport, where another Uber car would pick them up and take them to their final destination.

Hyperloop One’s vision is different but likely to be complementary. They envisage ‘packetised transportation’ that can carry both passengers and cargo in a pod which travels at high speed through a tube using magnetic levitation. It’s energy agnostic and has the ability to draw power from various sources including renewable sources such as solar. The target speed is just below the speed of sound, so a Sydney to Melbourne trip could take just 60 minutes.

Both visions will slash trip times and take cars off the road, and also provide new infrastructure investment opportunities.

The future of infrastructure

Any reduction in the number of vehicles on roads will have further flow on effects to related infrastructure and this is a major trend of which infrastructure investors need to be aware. For instance, there will be less need for big CBD parking stations, which may be able to be repurposed, for example as logistics hubs or as electric vehicle charging stations.

These changes may also impact the nature of our cities. They may allow for even larger cities, possibly incorporating several centralised hubs, and larger population densities.

Given competition will be fierce among technology providers, one strategy for infrastructure investors may be to back the facilities and systems needed to support new transport modes.

For example, an electric-vehicle future may require an amplification of renewable generation and distribution capacity. This will require construction of many battery charging or swap stations in major built up areas. This is an opportunity for investors.

Ultimately, it will take time, new regulations and substantial public education to switch to a new model for public transport. While it’s impossible to predict the future, given how gridlocked Australia’s road and rail networks are, it’s only a matter of time before new approaches make practical and economic sense.

 

Author: John Julian, Investment Director Sydney, Australia

Source: AMP Capital 31 July 2018

Important notes: 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.

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Best of 2018: Who is the most vulnerable as housing prices head lower?

Posted On:Jan 15th, 2019     Posted In:Rss-feed-market    Posted By:Provision Wealth

https://vimeo.com/291021827

The long-term rise in Australian home prices has led to a huge inter-generational transfer of wealth from the young to the old. A material reversal in property values will go some way to unwinding this, creating winners and losers amongst the generations.

Australia has long had a love affair with home ownership, which is illustrated by the strong growth in residential

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https://vimeo.com/291021827

The long-term rise in Australian home prices has led to a huge inter-generational transfer of wealth from the young to the old. A material reversal in property values will go some way to unwinding this, creating winners and losers amongst the generations.

Australia has long had a love affair with home ownership, which is illustrated by the strong growth in residential prices over the past two decades. Prices accelerated particularly strongly over the five years to 2017 amid a strong domestic economy, low mortgage rates, tax-breaks for domestic investors and sustained interest from overseas buyers, especially from China.

These factors were supported by ongoing immigration, a widespread cultural desire in Australia to own property and a highly limited supply of new land available in the capital cities in which most Australians live and work. A flood of virtual reality tv shows based on home ownership and renovations struck a chord with aspirational Australians. A political consensus in favour of measures supportive of property owners came to be established.

This included borrowers being able to take advantage of historically low interest rates to purchase more expensive homes.

However, 2017 saw the peak in prices as lenders came under regulatory pressure to constrain lending multiples, review prospective borrowers’ spending commitments more closely and limit interest-only loans.

Furthermore, rising global interest rates have pushed up Australian mortgage rates despite domestic interest rates remaining at their historic low of 1.5%.

The withdrawal of investment buyers from the market has been followed by a more hesitant mood amongst owner-occupiers, who are either unable or unwilling to borrow the funds and provide the deposits necessary to maintain the housing market’s momentum.

Australians are likely to find themselves in very different situations depending on their home ownership history. They may be grouped into three distinct demographic cohorts, many of whose members share some broad characteristics.

Millennials

Most Australians under the age of 35 have struggled to gain a foothold on the housing ladder. By the time they had found settled jobs and saved deposits, they found that house prices had risen beyond their reach.

Sometimes characterised as the ‘smashed-avocado generation’, this group has tended to prioritise experiential spending over property acquisition. This may be partly due to a cultural shift in society, but undoubtedly at least partly reflects the low possibility of purchasing even a very modest home within reasonable proximity to work.

Property purchases have tended to be restricted to those either on the highest incomes and/or those who have enjoyed the good fortune of parents or grandparents willing and able to help fund ever increasing deposit and stamp duty payments.

There are signs that some millennials on more typical income levels have simply given up on the Aussie dream of home ownership – at least until they become beneficiaries of a future inheritance.

Families

Australians in the 35-55 age group are much more likely to be property owners. However, the 20-year upward trend in home prices has left this generation suffering varying degrees of financial stress. This has been caused by the need to take on oversized mortgages to buy their first home, typically some years after their parents would have taken the plunge into the housing market.

They are now faced with increasing mortgage rates just at the time that living costs, such as utility bills, insurance and school fees are also rising.

Accordingly, this group faces the biggest challenge as they manage their spending in the face of rising demands on their lean layer of discretionary spending.

Baby boomers

This group comprises the retired and soon-to-retire, who in Australia have been the principle beneficiaries of the long-term boom in house prices, built on low interest rates and tax benefits, such as negative gearing.

Having entered the market at much lower price levels relative to incomes, members of this group are now largely mortgage-free and sit on valuable capital gains that some have realised as they retire, re-locate and downsize.

Some members of this demographic have used gains from the property boom to help their off-spring gather the deposits necessary to get onto the housing ladder. This trend is often described as the ‘Bank of Mum and Dad’, with some analysts referring to it as the fifth biggest bank in Australia.

The boom has led to a massive intergenerational transfer of wealth from the young to old as prolonged low interest rates led to massive asset inflation, which especially affected residential housing in Australia.

However, any decline in home prices will affect these three groups in significantly different ways.

Millennials

The cohort that remains largely outside the housing market is likely to have the most to gain and least to lose from a period of falling home prices in Australia.

A significant fall in home values is not the base case of most analysts, however the more extended the correction, the more millennials will find themselves coming into reach of home ownership. Therefore, this group is viewing any extended downward trend in prices relatively positively.

Such a market correction could focus on the sale of investment properties, which could reduce the supply of rental properties and put upwards pressure on rental levels. This would be a negative for millennials not able to take advantage of falling values to buy a first home, at least in the earlier stages of a slump.

A relatively small number of this group have managed to enter the market by taking on excessively large mortgages or have bought in secondary locations where selling could become challenging. Such buyers could well face financial stress, however, these are likely to be a minority of this group.

Families

These are the people who are most exposed to a slide in home prices in Australia. This group includes the most recent entrants to the property market and thus are likely to have bought at higher price levels with larger mortgages. Unlike those who are long established in the market, many in this group will not have benefitted from much of the rise in values and thus enjoy less protection from price falls.

They are already facing the financial stress described earlier and hence are much more careful with their spending, focusing on essentials and taking advantage of cost savings found online or in discount bricks and mortar stores. This is illustrated by the high numbers of baby and kids-focussed stores closing in Australia over the last few years.

This group stands to be further impacted if a significant fall in house prices leads to them receiving lower inheritances or post-downsizing gifts from their parents.

Baby boomers

This demographic is generally mortgage-free and unlikely to move home other than to downsize to a more suitable retirement property. Thus, they are unlikely to suffer the same stress faced by families.

Their ability to make lifetime gifts and leave bequests could well be affected though, however the real impact of this will be felt by younger demographics.

Baby boomers have been the principle beneficiaries of the buy-to-let boom, and hence some members who are heavily invested in residential property will be impacted by price falls. However, even these will be affected more in terms of their ability to make gifts from reduced capital, rather than falls in the achievable rental values that provide their income.

The housing market has appeared to be a one-way bet for a long time, and the wealth level of most Australians depends largely on the point in time at which they were able to enter the market.

Younger Australians stand to gain the most from lower housing prices but will inherit less. Families will likely experience increasing financial stress from this trend, especially the more recent home purchasers or those with less certain incomes in the face of rising living costs. Most older Australians will be less affected on a day-to-day basis but the ‘Bank of Mum and Dad’ may turn out to be less liquid than had been hoped by some anticipating sizeable withdrawals.

 

Author: Dermot Ryan, Sydney, Australia

Source: AMP Capital 20 Sept 2018

Important notes: 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.

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Best of 2018: The questions you should be asking about Australian equities

Posted On:Jan 15th, 2019     Posted In:Rss-feed-market    Posted By:Provision Wealth

Investor uncertainty and market volatility appear to be increasing as the economy continues to strengthen, leading to higher bond yields and eventual interest rate rises.

Australian equity investors trying to navigate the choppy waters that lie ahead should ignore the day-to-day ‘noise’ of the markets and instead focus on seven key questions. The answers to these will help investors better understand

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Investor uncertainty and market volatility appear to be increasing as the economy continues to strengthen, leading to higher bond yields and eventual interest rate rises.

Australian equity investors trying to navigate the choppy waters that lie ahead should ignore the day-to-day ‘noise’ of the markets and instead focus on seven key questions. The answers to these will help investors better understand the approaching dangers and opportunities.

Will Aussie banks keep paying out big dividends?

Banking has been the principle beneficiary of the 25-year bull market in residential mortgages that has followed in the wake of Australia’s housing boom.

Bank share prices have powered ahead over recent years, fueled by the sustained and predictable earnings that strong mortgage lending delivered. Retail investors in particular have been drawn to the strong growth in (franking credit-enhanced) bank dividends.

Banks have been able to capture generous mortgage lending margins because the regulatory environment has prioritised banking solvency. The banks’ balance sheets further benefitted from the 30-year decline in bond yields.

However, regulatory focus may now shift from institutional stability towards promoting customer interests, following the Royal Commission.

Meanwhile, global bond markets are now moving into a period of rising yields, even if Australian interest rates are unlikely to increase for some time yet. These trends will not be positive for bank valuations.

Moreover, personal debt in Australia has reached historically high levels, leaving many recent homebuyers looking vulnerable. The most highly indebted are now worryingly exposed to a downside shock.

Credit conditions for borrowers are continuing to tighten, as maximum earnings multiples fall and living expenses are considered more cautiously by loan officers. Buy-to-let investors and first-time buyers with modest deposits appear to be withdrawing from the market now that home prices are falling in Sydney and Melbourne.

Why are Aussie consumers looking so glum?

The high level of indebtedness is having a significant impact on consumer spending in Australia. Under-employment remains high and wage growth for large parts of the labour force remains fairly stagnant.

Families who bought their home more recently at elevated price levels and now face increasing mortgage payments are especially impacted.

This is leading many families to look much more closely at their weekly spending, especially those seeking to pay down debt.

The retail sector is seeing shoppers switch their spending to market challengers such as Aldi, where private labels are priced at a significant discount to the major grocery stores, which is forcing down pricing on the majors’ own goods.

Investing in price cutting is not expected to be sustainable over the long-term and could detract from the major supermarkets’ earnings.

A wider range of businesses that depend on such price-sensitive shoppers will struggle to grow earnings as real wage growth remains subdued and debt servicing costs rise.

When will the next capex boom ride to the economy’s rescue?

The end of the mining investment boom led to resources companies taking an extended capex holiday that has been a major drag on the Australian economy. However the depletion of older mines is now leading to investment in new facilities.

Meanwhile Federal and State governments are continuing to support infrastructure investment, often as part of asset recycling programs in an attempt to grow productivity levels.

Australia’s growing population faces energy supply limitations as many base load power generation assets need upgrading or replacement and renewable energy targets loom large. This will require a capital investment uplift in power generation and transmission assets.

Finally Australia’s LNG market is moving from a period of oversupply during which capex was highly restricted, to one of undersupply. This is leading to a renewed surge of investments in brownfield sites.

This is likely to present the opportunity for well-positioned developers and contractors to grow earnings over the next phase of the capex cycle.

How can Australia make beautiful returns from a Beautiful China?

President Xi recently announced the intention to build a “Beautiful China” that would reduce the country’s toxic levels of air, water and soil pollution.

Older polluting coal power stations are likely to be shut. However, while the country is expected to continue importing high volumes of Australian coal, cleaner fuels such as LNG may grow in relative importance. Australian companies are expected to continue to benefit throughout this shift as they begin to invest in new LNG projects again.

In addition to ongoing demand for high-grade seaborne commodities, Australian companies exposed to China’s growing demand for clean energy, electric vehicles and batteries have the opportunity to grow earnings.

How will regulatory change impact companies?

The Federal Government in Canberra is now intervening much more actively across a number of areas of the economy. This is motivated by a desire to bring down those costs to voters and companies that threaten the economic recovery and the government’s political fortunes.

This is especially impacting regulated infrastructure companies, where some have been assigned especially low rates of return by regulators. Consequently, the less attractive earnings outlook may start to be reflected in companies’ market valuations.

Therefore, investors should be cautious about the wider regulated utility market, especially transmission assets facing government pricing decisions. The implementation of the National Energy Guarantee by the end of 2018 is likely to influence the returns and valuations of a range of energy businesses.

Meanwhile, gaming reform that impacts margin bets, advertising and taxation poses a potential threat to companies in the sector.

However media deregulation may well permit increased consolidation in the industry, which will potentially be supportive of earnings and valuations.

Which companies will be bitten by rising bond yields?

Rising global bond yields have been signaling the start of the return to more normal levels of interest rates for some time now. The rate-hiking cycle is well advanced in the US and has now started in the UK and some other markets.

Such an environment is generally considered to be negative for the market valuations of companies whose earnings are relatively stable and predictable. These include those in the infrastructure, listed real estate and telecommunications sectors. This is because as bond yields rise, investors apply a higher discount rate to their expected earnings, which reduces the implied valuation levels.

Therefore a cautious approach to these sectors is likely to be appropriate during the next phase of the business cycle.

However, certain companies in these markets are nonetheless able to grow earnings independently of the business cycle. These include real estate companies exposed to the growth of data centres and e-commerce, which are poised to outperform the market even during a period of rising interest rates.

Should I be investing in growth or income companies?

Australian growth companies have strongly outperformed value/income stocks since the last round of Chinese economic stimulus. This is to be expected during a stage of the economic cycle when earnings growth is generally positive and interest rates remain at historically low levels

However, the valuations of growth companies are now notably high, trading at large premiums to their 10-year average price/earnings ratio and relative to the wider Australian equity market.

Such lofty valuation levels require very strong and sustained earnings growth in order to justify the present market premiums. Therefore many growth companies appear to be highly vulnerable to any events that slow the upward path of corporate earnings.

Hence investors may now find more attractive opportunities in companies that are characterised by sustainable dividend payouts and/or more attractive valuation levels.

 

Author: Dermot Ryan, Sydney, Australia

Source: AMP Capital 22 July 2018

Important notes: 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.

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The impact of global economics on infrastructure trends

Posted On:Dec 18th, 2018     Posted In:Rss-feed-market    Posted By:Provision Wealth

The impact of global economic trends on the demand for new infrastructure assets and the growth of existing ones cannot be underestimated.

On this front, the World Bank 2018 Global Economic Prospects – which provides economic forecasts out to 2020 and insights on the prospects of both developed and emerging economies – provides both good and bad news. The good news is that the global economy

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The impact of global economic trends on the demand for new infrastructure assets and the growth of existing ones cannot be underestimated.

On this front, the World Bank 2018 Global Economic Prospects – which provides economic forecasts out to 2020 and insights on the prospects of both developed and emerging economies – provides both good and bad news. The good news is that the global economy may at last be returning to sustainable global growth following the global financial crisis (GFC). As the World Bank notes:

“About half the world’s countries are experiencing an increase in growth. This synchronised recovery may lead to even faster growth in the near term, as stronger growth in, say, China or the United States spills over to other parts of the world. All the consensus forecasts for 2018 and 2019 reflect optimism. And this growth is occurring for the right reasons – investment and trade growth.” 1

This optimism is reflected in their forecast of world growth over the next few years as shown in  Figure A below.


Source: World Bank Group, Global Economic Prospects, TH eTurning of the Tide? 2018.

This forecast highlights the growing contribution of emerging markets and developing economies (EMDEs) on future global growth.  Growth in developed (or advanced) economies is projected to moderate gradually as current stimulus initiatives are withdrawn and labour market slack  decreases, before a moderate level of sustainable growth is reached.

However, the bad news is that the World Bank also highlights forecast growth is highly sensitive to two factors:

  1. Continuing access to reasonably priced debt to allow ongoing investment. The wind down in stimulus packages in developed economies will reduce liquidity and cause rising interest rates globally which may affect investment in highly leveraged EMDE economies.

  2. The rise of geopolitical risk, particularly popularism and protectionism in developed economies. This has the potential to hurt growth in both developed and EMDE economies.

The impact on infrastructure

Future economic growth is important for infrastructure investors.  An understanding of likely economic trends allows us to estimate the potential demand for new infrastructure and effects on existing infrastructure asset performance and valuations.

Historically, the performance of a nation’s infrastructure has been a key determinant of that nation’s economic performance. For example, US studies on the benefit-cost ratio of highways in Texas show that it could exceed 6:1.2 More locally, recently benefit-cost analysis on Sydney’s West Connex F6 motorway indicates a benefit cost ratio of 2:1.3

Conversely, inadequate transport, communications and energy infrastructures are often limitations to growth in emerging and developing economies. High interest rates can also dampen investment and subsequently slow growth. 

Infrastructure investment characteristics

Infrastructure offers a range of very diverse investments which can broadly be categorised as shown in the following table.

Infrastructure category

Risk return profile 

Growth/Yield

Comments 

Cash flows linked to GDP growth (eg: airports, ports, communications, logistics, toll roads)

Higher risk/higher returns 

Predominantly capital growth

Equity type returns (not a bond proxy)

Economically regulated

(eg: energy and water utilities)

Medium risk/medium returns

Predominantly yield

Good bond proxy

Public Private Partnerships

(eg: hospitals, schools and courts) 

Lower risk/lower returns

Highest yielding including return of capital

Better bond proxy. Fixed term development and operational concession under contract to government.

Most risks, including demand and inflation passed through to government.

From this table, it is apparent that cash flows of different types of infrastructure assets may respond differently in a sustained, moderate growth, post-GFC environment.

  • In a gross domestic product (GDP)-linked asset, a return to sustained growth would result in sustained growth in future cash flows and give investors the confidence to invest for future growth. Bond rates could also be expected to rise in a sustained growth environment, increasing debt costs. However, as cash flows are also likely to increase, the net impact on valuations should be positive with moderate economic growth and prudent gearing levels.

  • For economically regulated assets, most economic risks are passed through to consumers over the longer term. That is, over the longer term, net cash flows should be largely indifferent to the changing economic circumstances, although the regulatory cycle may impose delays. Utility-style infrastructure has traditionally been a ‘go to’ investment in times of market uncertainty, as infrastructure cash flows may, in large part, be decoupled from market and economic cycles. This characteristic led to many investors using utilities as a bond proxy as a consequence of the post-GFC erosion of bond yields. 

  • Public Private Partnerships (PPP) enjoy many of the protections of economically regulated assets, with minimal regulatory risk. They are, however, exposed to limited operational risk (e.g. an obligation to maintain facilities in a fit-for-purpose condition) and debt financing risk. Pass through of consumer price index (CPI) and debt hedges protect against interest rate increases. However, as PPP’s are effectively a bond proxy, improving bond yields may reduce demand for such assets.

Unlisted/Listed infrastructure investments 

Infrastructure equity investments can be accessed either through unlisted or listed markets. While the operational results for listed and unlisted assets tend to be are similar, the difference in market access has important effects on the characteristics of the investments, as summarised in the table below. These differences can be exploited to increase diversity and reduce volatility in an infrastructure portfolio.

For most retail investors, an investment in a specialist fund is the most practical way to invest in both unlisted and listed assets as this brings down the minimum investment size to reasonable levels, while also enabling access to well diversified portfolios. For example, while there are some high-quality infrastructure companies listed on the Australian stock exchange, there is only a small handful of them. This means investing directly in these stocks makes it hard to implement a well-diversified infrastructure portfolio. Investing through a specialist fund typically provides exposure to a well-diversified global infrastructure portfolio.

The following table summarises the characteristics of both unlisted and listed infrastructure investments and is based on AMP Capital’s more than 20 years of experience of infrastructure investing. 

 Factor

Unlisted 

Listed

Comments 

Typical retail investor minimum investment size

+$10,0004

+$10,0005

As noted above, for most retail investors, an investment in a specialist fund is the most practical way to access both unlisted and listed assets.

Valuations

Fundamental Discounted Cash Flow

Market Caps

Listed assets are exposed to public market sentiment. 

Total return range (% per annum)6

7%~12%

8%~12%

Over the longer term returns for similar types of assets tend to be similar.

Yield range (% per annum)6

3%~9%

3%~5%

Listed PPP assets tend to trade at high multiples to net asset backing reducing yield in comparison to unlisted PPPs.

Risk (% annum volatility)6

5%~10%

10%~15%

Listed market sentiment causes higher volatility.

Liquidity

Limited

Daily

Specialist hybrid funds (which include both listed and unlisted assets) can offer improved liquidity.

Dept of market

$US1 tr.

$US2.5 tr.

Listed markets have greater depth, primarily through access to US utility assets.

Considerations for portfolio construction

The above considerations highlight the benefits of maintaining a well-diversified infrastructure portfolio. For example, if the World Bank forecasts prove to be substantially correct, we would expect to see some softening demand for bond proxy-type assets, while growth-linked assets would prosper.

If the risk factors highlighted by the World Bank dominate, producing a lower growth outcome, we expect demand for bond proxy assets would still remain high while valuation growth for growth assets would remain at current levels.

Additionally, a mix of listed and unlisted assets in a portfolio provides further diversification opportunities such as:

  • The different basis for unlisted and listed valuations means that the movement in valuations is largely uncorrelated (that is, they don’t necessarily move in the same direction at the same time). For example, listed markets usually respond negatively to an interest rate movement. As discussed above, interest increases may have very little impact on the fundamental valuation of unlisted assets, or may even be positive in the case of a growth-linked asset. This means that the movement in valuations in a combined listed/unlisted infrastructure portfolio can cancel each other out to a degree, effectively reducing overall portfolio risk.

  • Listed markets provide access to assets which are not generally available as unlisted investments, for example, US utilities. This allows greater geographic and sector diversification.

Final thoughts

The World Bank forecasts clearly show the increasing reliance global growth has on EMDE performance. Growth in EMDEs will drive the need for additional infrastructure in those economies, which in turn will lead to an expanded set of infrastructure investment opportunities for investors over the medium term. At the same time, while growth in developed economies is not expected to be as strong as in the EMDEs, there will still be a need for substantial infrastructure spend in those markets due to themes such as replacing existing ageing infrastructure, the advent of disruptive technologies, and the ageing demographic.

 

Author: Greg Maclean, Global Head of Research, Infrastructure

Source: AMP Capital 4 December 2018

 

1 World Bank Group, Global Economic Prospects, The Turning of the Tide? 2018. 

2 McFarland, W and Memmott, J. Ranking Highway Construction Projects: Comparison of Benefit-Cost Analysis with Other Techniques.

3 Infrastructure Australia, Project Business Case Evaluation, West Connex, 2016.

4 AMP Capital Core Infrastructure Fund

5 AMP Capital Global Infrastructure Securities Fund (Hedged)

6 Based on observed long-term historical performance. Performance may vary according to a range of factors including economic conditions, the type of asset and market cycles. Past performance is not an indicator of future returns.


Important notes:
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.

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