Market Watch

Investors plunging into residential property have been warned by the Reserve Bank of Australia (RBA) that they are taking on risks when prices are already high and growth in rents has slowed.

Following October’s Board meeting, the RBA indicated that property prices had continued to grow into the September quarter.

What’s been driving prices?

The rise in house prices over the last two decades – most recently in Sydney – can be attributed to two key factors:

• Low interest rates: A sustained period of low interest rates has enabled Australians to borrow more for a given level of income. Consequently, this higher borrowing has allowed Australians to pay more for homes.

• Undersupply: Restrictive land supply policies coupled with high stamp duty and infrastructure charges have subdued the supply of real estate in Australia. Reflecting this, residential vacancy rates remain relatively low.

Please note: While foreign and SMSF buying is playing a role in some areas, it can be argued that their overall impact is small.

Tightening the reins: Macro-prudential policies are being considered

The RBA has indicated that it is in discussion with the Australian Prudential Regulation Authority (APRA) on steps that could be taken to ensure sound lending practices are maintained with a focus on investors.

This could involve limits on loan-to-valuation ratios, or more likely, measures that would force banks to either put aside more capital for loans to property investors or impose tougher tests when granting loans. We expect to hear more on these measures in the months ahead.

What about interest rates?

Despite strong gains in property prices, the RBA has indicated that interest rates will remain unchanged for now, adding that the most prudent course forward would likely be a period of rate stability.

At the moment, the RBA is reluctant to raise rates given uncertainty regarding the rest of the economy and the risk a rate hike would put upwards pressure on the Australian dollar, which is still too high for the RBA’s liking.

Final thoughts

We expect that investors could see further gains in house prices in the short-term, but at a more modest pace. This trend is likely to continue until the RBA starts to raise interest rates (possibly around mid-next year).

As a medium-term investment, residential property currently looks somewhat less attractive. The total return over the medium-term is expected to be around 4 to 5% per annum. This is currently lower than shares and commercial property.

In saying this, over the very long-term (almost 100 years) residential property has provided a similar return as Australian shares; both have delivered around 11 to 11.5% p.a. to investors since the 1920s.

About the Author

Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

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.

1. Price of iron ore has fallen dramatically

The price of the steel-making ingredient iron ore has been on a downward trend since 2011. The impact of this for Australian share investors is that a decline in commodity prices negatively impacts the profits of miners and adversely affects share prices.

2. China cools down

Concerns of inflated property prices have recently hit the headlines after a strong run up in prices and seemingly unceasing construction across China. The surge in prices and a threat to affordability saw Chinese policy makers implement measures to cool down property demand. This included controls such as limiting domestic housing purchases and raising down payment minimums. Another key factor in cooling the property market involved tightening monetary policy in China, which was aimed at slowing credit growth and lending for new properties.

China’s slowing economic growth is also a significant influence with some releases of economic data raising concerns that China’s economy may struggle to hit its +7.5% growth target in 2015. These factors translate into less ‘end-user’ demand for iron ore in China.

3. Significant ‘new supply’ is entering the market

To add to the complexity, there is a large amount of new supply of iron ore hitting the market provided by large miners such as BHP Billiton, Rio Tinto and Fortescue Metals as all the mining investment of the last few years has manifested in the completion of new mines. Less demand and more supply has driven a fall in the iron ore price and has weighed on the share prices of miners.

What does this mean for investors?

Large miners are better placed to weather suppressed commodity prices relative to smaller miners as they are better capitalised and have lower costs. An environment of depressed share prices for miners and balance sheet difficulties could set a backdrop for more mergers and acquisitions.

Corporate activity led by Chinese investors could be a support for many miners. For example, the last few weeks saw Chinese steel company Baosteel and Aurizon Operations offer a joint takeover to acquire 100% of the ordinary shares of Aquilla Resources.

The strength of balance sheets and average costs of production will be an important factor in determining the health and potential survival of miners.

About the Author  Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

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.

1. Compare this year’s annual report with last year’s annual report.

Check that the activities detailed in the current annual report are the same as what the company said it was going to do in the previous year's report. Consider whether the company has achieved the goals it set out for itself, and if this is a reason to be concerned about the company’s future.

2. Cash flow trends.

There can be a significant difference between what a company says it earned, using accounting standards, and the cash flow it generates. Cash is money in hand, not the result of accounting measurements and judgment calls, as is the case with earnings and net income. This line item is particularly important when making investing decisions. When a company's net income is much higher than cash flow, investors want to be aware and find out why.

Reflecting on the most recent reporting season, Michael Price, Portfolio Manager, AMP Capital Equity Income Fund said: “One of the key surprises was significantly stronger cash profit growth and thus high cash conversion rates, which were utilised to drive significantly stronger than expected dividend growth.”

 3. Earnings and revenue growth.

If you invest in a company, you want to know how much the company earns and whether it's boosting its sales. This can tell you whether a company is on a growth trajectory or in decline, key factors that determine how much the company is worth. A company's earnings and revenue can be compared with its stock price to tell you if a stock is expensive or reasonably-priced.

According to Phillip Hudak, Portfolio Manager/Analyst, Small Cap Equities at AMP Capital, Australia’s August reporting season saw a widening divergence in earnings growth rates being delivered across the market: “Many domestically-focused companies continue to find operating conditions difficult given Australia’s economic recovery remains sluggish. However, a number of offshore exposed companies outperformed due to the more advanced recovery of other developed world economies relative to Australia.”

4. Debt load.

It's critical for investors to understand how much debt a company has and how that debt compares with its ability to pay. This requires examining a company's balance sheet and income statement. Debt isn't detrimental for a company, so long as it can generate ample cash flow to service the debt payments.
There is so much information on financial statements because these documents are the most critical pieces of information investors will get from individual companies. Reading these documents closely is one of the best ways for investors to evaluate the performance of the company and gauge new developments that may affect its performance in the next few years.

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.

1. Price of iron ore has fallen dramatically

The price of the steel-making ingredient iron ore has been on a downward trend since 2011. The impact of this for Australian share investors is that a decline in commodity prices negatively impacts the profits of miners and adversely affects share prices.

2. China cools down

Concerns of inflated property prices have recently hit the headlines after a strong run up in prices and seemingly unceasing construction across China. The surge in prices and a threat to affordability saw Chinese policy makers implement measures to cool down property demand. This included controls such as limiting domestic housing purchases and raising down payment minimums. Another key factor in cooling the property market involved tightening monetary policy in China, which was aimed at slowing credit growth and lending for new properties.

China’s slowing economic growth is also a significant influence with some releases of economic data raising concerns that China’s economy may struggle to hit its +7.5% growth target in 2015. These factors translate into less ‘end-user’ demand for iron ore in China.

3. Significant ‘new supply’ is entering the market

To add to the complexity, there is a large amount of new supply of iron ore hitting the market provided by large miners such as BHP Billiton, Rio Tinto and Fortescue Metals as all the mining investment of the last few years has manifested in the completion of new mines. Less demand and more supply has driven a fall in the iron ore price and has weighed on the share prices of miners.

What does this mean for investors?

Large miners are better placed to weather suppressed commodity prices relative to smaller miners as they are better capitalised and have lower costs. An environment of depressed share prices for miners and balance sheet difficulties could set a backdrop for more mergers and acquisitions.

Corporate activity led by Chinese investors could be a support for many miners. For example, the last few weeks saw Chinese steel company Baosteel and Aurizon Operations offer a joint takeover to acquire 100% of the ordinary shares of Aquilla Resources.

The strength of balance sheets and average costs of production will be an important factor in determining the health and potential survival of miners.

About the Author  Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

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.

1. Compare this year’s annual report with last year’s annual report.

Check that the activities detailed in the current annual report are the same as what the company said it was going to do in the previous year's report. Consider whether the company has achieved the goals it set out for itself, and if this is a reason to be concerned about the company’s future.

2. Cash flow trends.

There can be a significant difference between what a company says it earned, using accounting standards, and the cash flow it generates. Cash is money in hand, not the result of accounting measurements and judgment calls, as is the case with earnings and net income. This line item is particularly important when making investing decisions. When a company's net income is much higher than cash flow, investors want to be aware and find out why.

Reflecting on the most recent reporting season, Michael Price, Portfolio Manager, AMP Capital Equity Income Fund said: “One of the key surprises was significantly stronger cash profit growth and thus high cash conversion rates, which were utilised to drive significantly stronger than expected dividend growth.”

 3. Earnings and revenue growth.

If you invest in a company, you want to know how much the company earns and whether it's boosting its sales. This can tell you whether a company is on a growth trajectory or in decline, key factors that determine how much the company is worth. A company's earnings and revenue can be compared with its stock price to tell you if a stock is expensive or reasonably-priced.

According to Phillip Hudak, Portfolio Manager/Analyst, Small Cap Equities at AMP Capital, Australia’s August reporting season saw a widening divergence in earnings growth rates being delivered across the market: “Many domestically-focused companies continue to find operating conditions difficult given Australia’s economic recovery remains sluggish. However, a number of offshore exposed companies outperformed due to the more advanced recovery of other developed world economies relative to Australia.”

4. Debt load.

It's critical for investors to understand how much debt a company has and how that debt compares with its ability to pay. This requires examining a company's balance sheet and income statement. Debt isn't detrimental for a company, so long as it can generate ample cash flow to service the debt payments.
There is so much information on financial statements because these documents are the most critical pieces of information investors will get from individual companies. Reading these documents closely is one of the best ways for investors to evaluate the performance of the company and gauge new developments that may affect its performance in the next few years.

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.

With share valuations in emerging markets looking relatively cheap compared to those in developed markets, we explore what investors need to look for before taking the plunge.

Be selective

While emerging market shares are relatively cheap, the current health and future prospects of individual countries within this segment can differ significantly. Therefore, while we expect investors will benefit from general exposure to emerging markets over the long-term, the short-term picture requires investors to be more discerning and pick and choose based on individual country and company fundamentals.

For example:

• Argentina’s problems are well-known and its ‘default’ reflects a problem with a hedge fund rather than broader emerging market debt problems.

• Tougher sanctions for Russia will harm it more than the West. However, Russia is unlikely to cut off gas supplies to Europe given the long-term damage it will do to what is a key export-earner for it.

• The softer trend in commodity prices is good for Asian emerging markets (as commodity users) unlike South America and Russia (commodity producers).

• China is looking relatively cheap at the moment and India is looking expensive however the reform-oriented Modi Government in India bodes well for the future.

• The Indonesian President is also reform-minded but there is uncertainty over the election results.

• Brazil is a bit problematic given the populist approach of the Dilma Government so a change in government would be required before we become more optimistic on Brazil.

Consider debt levels

Investors in emerging markets should focus on current account surplus countries as they are less vulnerable to foreign capital flows, for example China and Korea, and therefore less susceptible to volatility when the US Federal Reserve decides to start raising interest rates again.

Final thoughts

While a recession in emerging market countries is unlikely, we are likely to see slower growth than we have witnessed over the last decade. The trend in commodity prices is softer (working against Russia and South America) and the last decade has seen some backtracking on economic reforms.

After posting solid returns since May, emerging markets have improved since the start of the year. However, emerging markets still have a lot of catching-up to do on the ground lost to developed markets since 2010. More broadly while they are cheap and still have some catching-up to do, investors do need to be more selective than was the case, say a decade ago regarding the emerging world.

About the Author  Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

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.