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Has Australia really had three recessions in the last 28 years?

Posted On:Sep 30th, 2019     Posted In:Rss-feed-oliver    Posted By:Provision Wealth

The claim that Australia has gone 28 years without a recession since the early 1990s recession ended in 1991 has been subject to some criticism in recent times with the economy sliding into a “per capita recession” where economic growth has been below population growth. Some have latched on to a recent Federal Reserve Bank of St Louis analysis that

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The claim that Australia has gone 28 years without a recession since the early 1990s recession ended in 1991 has been subject to some criticism in recent times with the economy sliding into a “per capita recession” where economic growth has been below population growth. Some have latched on to a recent Federal Reserve Bank of St Louis analysis that noted the 28 year claim should be “taken with a grain of salt” because “Australia has had three recessions since 1991 when looking at GDP per capita, the most recent one being from the second quarter of 2018 to the first quarter of 2019.”

GDP per capita

It’s true that Australia’s relatively strong population growth helps grow the economy. And in terms of living standards it’s GDP per person or per capita that really matters and the recent slowdown in GDP growth to 1.4% year on year which is below 1.6% population growth is a big concern. I even wrote a note after the release of the December quarter GDP data entitled “Australia enters a per capita recession” (which can be found here). But it does not measure up as a conventional recession.

Recession definitions

The conventional definition of recession is two or more consecutive quarters of falling real GDP. 


Source: ABS, AMP Capital

On this basis Australia’s last recession ended back in 1991, ie 28 years ago.

However, if GDP per capita is looked at then Australia has had three per capita recessions since 1991 using the two or more consecutive quarters of decline approach – in the September and December quarters of 2000, the March and June quarters of 2006 and the September and December quarters of 2018. There was also a per capita recession in 1985-86.


Source: ABS, AMP Capital

However, while it may be reasonable to call them “per capita recessions” they don’t compare at all to the scale of the conventional recessions in 1981-83 and 1990-91 that saw far deeper and longer falls in GDP and per capita GDP.

* Because there were two periods of consecutive quarterly declines in per capita GDP in each of the 1981-83 and 1990-1991 periods broken by one quarterly rise the Fed Reserve Bank of St Louis note ascribes two per capita recessions in each period although for all intents and purposes they were really each just one big recession. Source: ABS

Wider definitions of recession

Nor would the per capita recessions of 1985-86, 2000, 2006 and 2018 comply with wider definitions of recession such as that of the US National Bureau of Economic Research that defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.

For example, the next chart shows employment growth and unemployment since 1980 with per capita recessions shaded.  


Source: ABS, AMP Capital

Only the per capita recessions of 1981-83 and 1990-91 which were also conventional recessions saw a significant slump in employment (both of around 4%) and sharp rises in unemployment (with both seeing around a 5 percentage point rise). The other per capita recessions saw very little or no fall in employment and only small or no rises in unemployment. In fact, through the last per capita recession of 2006 jobs growth remained solid and unemployment fell, which makes a non-sense of calling it a recession particularly given it was in the midst of the mining boom! The recessions of the early 1980s and 1990s were horrendous events in terms of mass job losses, corporate collapses and financial failures. The per capita recessions of 2000, 2006 and more recently do not compare.

Which brings us to the smell test. For Australians like myself who lived through the early 1980s and early 1990s recessions it’s doubtful that they would recall the per capita recessions of 1985-86, 2000 or 2006 as real recessions. Which is why they are often just referred to as slowdowns. The 2000 slowdown occurred because of the pull forward of spending due to the start up of the GST and also the end of the Olympics and the 2006 per capita recession can hardly be seen as a recession given it was in one of the biggest booms in Australian history, ie the mining boom. And a common question in relation to the recent episode is “things aren’t that bad, so why is the RBA cutting?” (The answer being that waiting for a real recession is likely leaving it too late.)

Consistent with this, consumer and business confidence was bouncing around average levels in 2000, 2006 and more recently in contrast to the slump of the early 1990s.


Source: NAB, Westpac/MI, AMP Capital

It’s not just strong population growth

While strong population growth helps grow the Australian economy as the Fed Reserve Bank of St Louis notes, it didn’t stop real recessions in 1981-83 and 1990-91. Going into the early 1980s recession population growth was 1.8% year on year and going into the early 1990s recession it was 1.5% year on year. So, if strong population growth didn’t stop conventional recessions in the past, other factors must have been playing a roll in heading off conventional recessions over the last 28 years. These include:

  • economic reforms of the 1980s and 1990s that made the economy more flexible;

  • the floating of the $A that has seen it fall whenever there is a major economic problem providing a shock absorber for the economy;

  • desynchronised cycles across industry sectors and states;

  • strong growth in China that helped export demand through the GFC;

  • counter cyclical economic policy – like stimulus payments and monetary easing that helped in the GFC; and

  • good luck – which can never be ignored lest hubris set in!

But what about through the GFC?

To be sure, Australian confidence had a recession-like fall through the global financial crisis (GFC) reflecting the dyer global news at the time and annual growth in GDP per capita fell, but there was only one quarter of contraction in both GDP and GDP per capita and there was no recession like slump in employment or rise in unemployment. What’s more the fall in per capita GDP at the time of the GFC was trivial compared to that in the US, Europe and Japan suggesting again that other things must have helped Australia beyond strong population growth.


Source: ABS, Bloomberg, AMP Capital

Concluding comment

The slowdown in Australian growth to below the level of population growth at a time of weak wages growth and high underemployment is a real concern and highlights the need to boost growth and productivity. However, a per capita recession on its own is not the same as a real recession, and the three seen over the last 28 years do not compare to the recessions of the early 1980s and early 1990s in terms of their impact on jobs, economic welfare and confidence. Which is why they are normally just referred to as growth slowdowns as opposed to being recessions. To be sure the risk of conventional recession in Australia has increased – although for the reasons noted here I think it remains unlikely. But there is clearly more to Australia’s 28 years without a conventional recession than just strong population growth.

 

Source: AMP Capital 30 September 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)  (AMP Capital) 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 and must not be provided to any other person or entity without the express written consent of AMP Capital.

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Investment returns have been good, but they are likely to slow over the next five years

Posted On:Sep 25th, 2019     Posted In:Rss-feed-oliver    Posted By:Provision Wealth

The past 10 years have seen pretty good returns for well-diversified investors. The median balanced growth superannuation fund returned 7.3% pa over the five years to July and 8.2% pa over 10 years and that’s after fees and taxes. This is impressive given that inflation has been around 2%. 

Source: Mercer Investment Consulting, Morningstar, AMP Capital

Shares and growth assets have literally

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The past 10 years have seen pretty good returns for well-diversified investors. The median balanced growth superannuation fund returned 7.3% pa over the five years to July and 8.2% pa over 10 years and that’s after fees and taxes. This is impressive given that inflation has been around 2%. 


Source: Mercer Investment Consulting, Morningstar, AMP Capital

Shares and growth assets have literally climbed a wall of worry this decade with a revolving door list of worries around public debt, the Eurozone, deflation, inflation, rate hikes, Trump, North Korea, China, trade wars, growth, house prices, etc. But returns benefitted from the recovery after the GFC and a search for yield as interest rates have collapsed depressing yields on most assets. But – while it sounds like a broken record – the decline in yields points to eventually more constrained returns ahead.

Declining yields = falling medium-term return potential

Investment returns have two components: yield (or income flow) and capital growth. Looking at both of these components points to lower average investment returns over the next five years compared to the last five years. It’s basic to investing that the price of an asset moves inversely to its yield all other things being equal. Suppose an asset pays $10 a year in income and suppose its price is $100, which means an income flow or yield of 10%. If interest rates are cut resulting in increased demand for the asset, as investors search for a higher yield, such that its price rises to $120 given the $10 annual income flow its yield will have fallen to 8.3% (ie $10 divided by $120) as its price has gone up by 20%. So, yield moves inversely to price. But as yields decline it means a lower return potential going forward.

Since the early 1980s investment yields have collapsed. Back then the RBA’s “cash rate” was around 14%, 1-year bank term deposit rates were nearly 14%, 10-year bond yields were around 13.5%, commercial and residential property yields were around 8-9% and dividend yields on shares were around 6.5% in Australia and 5% globally. This meant that investments were already providing very high income so only modest capital growth was needed for growth assets to generate good returns. So, most assets had very strong returns and balanced growth super fund returns averaged 14.1% in nominal terms and 9.4% in real terms between 1982 and 1999 (after taxes and fees).

Over the last four decades, investment yields have mostly fallen quite sharply. See the next chart.


Source: Bloomberg, REIA, JLL, AMP Capital

Today the cash rate is 1%, 1-year bank term deposit rates are 1.5%, 10-year bond yields are 0.9%, gross residential property yields are around 3%, commercial property yields are just below 5%, dividend yields are still around 5.5% for Australian shares (with franking credits) but they are 2.5% for global shares. This points to a lower return potential for a diversified mix of assets.

What’s more, the capital growth potential from growth assets is likely to be constrained relative to the past reflecting more constrained nominal economic growth. Several megatrends are likely to impact growth over the medium term. These include:

  • Continued slower growth in household debt. 

  • An ongoing retreat from globalisation, deregulation and small government in favour of populist, less market friendly policies.

  • A shift in corporate focus from profit to “balanced scorecards”.

  • Rising geopolitical tensions – notably as the US attempts to constrain the rising power of China as evident in the trade war.

  • Aging and slowing populations – resulting in slowing labour force growth and rising pressure on public sector budgets.

  • Technological innovation and automation.

  • Continuing rapid growth in Asia and China’s middle class. 

  • Pressure to slow emissions & the impact of global warning.

  • A large shift to sustainable energy as its cost continues to fall.

Most of these will constrain economic growth & hence returns.

Medium-term return projections

Our approach to get a handle on medium-term return potential is to start with current yields for each asset class and apply simple and consistent assumptions regarding capital growth reflecting the above-mentioned megatrends. We also prefer to avoid forecasting and like to keep the analysis simple.

  • For bonds, the best predictor of future medium-term returns is current bond yields as can be seen historically in the next chart. If a 10-year bond yield is held to maturity its initial yield (0.93% right now in Australia) will be its return over 10 years (ie 0.93%). We use 5-year bond yields as they more closely match the maturity of bond indexes.


Source: Global Financial Data, Bloomberg, AMP Capital

  • For equities, current dividend yields plus trend nominal GDP growth (a proxy for capital growth) does a good job of predicting medium-term returns.1

  • For property, we use current rental yields and likely trend inflation as a proxy for rental and capital growth.

  • For unlisted infrastructure, we use current average yields and capital growth just ahead of inflation.

  • In the case of cash, the current rate is of no value in assessing its medium-term return. So we allow for some rise in cash rates over time.

Our latest return projections are shown in the next table.

Projected medium term returns, %pa, pre-fees and taxes

 

Current
Yield #

+ Growth

= Return

 World equities

2.6^

4.1

6.6

 Asia ex Japan equities

1.6^

6.9

8.5

 Emerging equities

1.9^

6.9

8.9

 Australian equities

4.3 (5.7*)

3.2

7.5 (8.9*)

 Unlisted commercial property

4.9

1.7

6.6

 Australian REITS

4.6

2.3

6.7

 Global REITS

3.6^

1.6

5.5

 Unlisted infrastructure

4.6^^

3.0

7.6

 Australian bonds (fixed interest)

1.1

0.0

1.1

 Global fixed interest ^

1.3

0.0

1.3

 Australian cash

2.0

0.0

2.0

 Diversified Growth mix *

 

 

5.6

# Current dividend yield for shares, distribution/net rental yields for property and duration matched bond yield for bonds. ^ Includes forward points. * With franking credits added in. Source: AMP Capital.

The second column shows each asset’s current income yield, the third shows their 5-10 year growth potential, and the final column their total return potential. Note that:

  • We assume inflation averages around or just below central bank targets.

  • For Australia we have adopted a relatively conservative growth assumption reflecting slower productivity growth.

  • We allow for forward points in the return projections for global assets based around current market pricing.

Key observations

Several things are worth noting from these projections.

  • The medium-term return potential has continued to fall due largely to the rally in most assets and fall in investment yields. Projected returns using this approach for a diversified growth mix of assets have fallen from 10.3% pa at the low point of the GFC in March 2009, to 8.6% five years ago, to 6.2% a year ago and to now just 5.6%.


Source: AMP Capital

  • Government bonds offer low returns due to ultra-low yields. Yes, bond returns have been strong lately as yields have collapsed pushing up bond prices. But this is no guide to future returns, particularly if bond yields stop falling.

  • Unlisted commercial property and infrastructure continue to come out relatively well, reflecting their higher yields.

  • Australian shares stack up well on the basis of yield, but it’s still hard to beat Asian/emerging shares for growth potential.

  • The downside risks to our medium-term return projections are that: the world plunges into a recession driving another major bear market in shares or that investment yields are pushed up to more normal levels as inflation rebounds causing large capital losses. Just allow that drawdowns in returns tend to be infrequent but concentrated and it’s been a while since the last big one. See the first chart. 

  • The upside risks are (always) less obvious but could occur if we see improving global growth but inflation remaining low.

Implications for investors

  • First, have reasonable return expectations. Low yields & constrained GDP growth indicate it’s not reasonable to expect sustained double-digit or even high single digit returns. In fact, the trend decline in the rolling 10-year average of both nominal and real super fund returns since the 1990s indicates we have been in a lower-return world for many years – it’s just that it only becomes clear every so often with bear markets and then strong returns in between.

  • Second, remember that responding to a lower return potential from major asset classes by allocating more to growth assets does mean taking on more risk.

  • Third, bear markets are painful, but they do push up the medium-term return potential of investment markets to higher levels and so provide opportunities for investors.

  • Fourth, some of the decline in return potential reflects very low inflation – real returns haven’t fallen as much. 

  • Finally, focus on assets with decent sustainable income flow as they provide confidence regarding future returns.

 

Source: AMP Capital 25 September 2019

1Adjustments can be made for: dividend payout ratios (but history shows retained earnings often don’t lead to higher returns so the dividend yield is the best guide); the potential for PEs to move to some equilibrium level (but forecasting the equilibrium PE can be difficult and dividend yields send valuation signals anyway); and adjusting the capital growth assumption for some assessment regarding profit margins (but this is hard to get right). So, we avoid forecasting these things.

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) (AMP Capital) 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 and must not be provided to any other person or entity without the express written consent of AMP Capital.

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Will the world slip up on oil again? – after oil prices spike as attacks disrupt Saudi production

Posted On:Sep 17th, 2019     Posted In:Rss-feed-oliver    Posted By:Provision Wealth
Introduction

World oil prices have spiked since last week following weekend drone attacks on oil production in Saudi Arabia. This has naturally raised questions about the threat to economic growth, particularly if oil prices spike further, flowing on to petrol prices.

 

Why the spike?

Since last Friday world oil prices are up by around 13%. Tensions have been escalating in the Middle East

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Introduction

World oil prices have spiked since last week following weekend drone attacks on oil production in Saudi Arabia. This has naturally raised questions about the threat to economic growth, particularly if oil prices spike further, flowing on to petrol prices.

 

Why the spike?

Since last Friday world oil prices are up by around 13%. Tensions have been escalating in the Middle East for a while now following President Trump’s decision to re-impose sanctions on Iran after the US withdrew from the nuclear deal with Iran. This has shown up in several attacks on oil shipments through the Strait of Hormuz, but the attack on Saudi oil production by drones takes it to a new level. Roughly 5.7 million barrels per day (mbd) of Saudi production is impacted and this is around 6% of global oil production. It also comes at a time when OPEC’s spare capacity of around 4mbd is reasonable but less than the outage from Saudi Arabia and there are ongoing issues in terms of supply from Venezuela and Libya.

View larger image

Source: Bloomberg, AMP Capital

Of course, the 13% spike in the last few days needs to be seen in context and so far it’s a bit of a non-event with prices still below levels seen in April and a year ago.

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Source: Bloomberg, AMP Capital

However, the concern is that oil prices could go higher and listed here are the key uncertainties involving:

  • how long takes Saudi production to return to normal – latest indications are that it may take weeks and months;

  • the extent that the outage can be covered by stockpiles, reserves and spare capacity elsewhere – this should help but is unlikely to cover the full outage;

  • whether there might be more similar attacks – with drone attacks posing a new threat in multiple areas;

  • the retaliation Saudi Arabia and the US undertake with President Trump saying that the US is “locked and loaded” – which may worsen the conflict with Iran.

The 5.7mbd disruption makes it the worst in history – worse than the Iranian revolution (5.6mbd) that saw a roughly three-fold increase in oil prices and the Iraqi invasion of Kuwait (4.3mbd) that saw oil prices briefly double. So, a further spike in prices is likely if the threat continues to escalate.

Working against this though: some of the disruption may be brief; OPEC’s share of world oil production has fallen from around 50% in the 1970s to below 40%; President Trump was elected after campaigning against never-ending wars in the Middle East and he may not want to risk further pushing up oil prices just over a year out from next year’s Presidential election so the US response may be limited to say taking out the drone bases where the attacks came from, albeit the risk of wider conflict has increased, and the US today is less reliant on global oil imports given a sharp spike in shale oil production. See the next chart.

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Source: Bloomberg, AMP Capital

Impact on global growth

What happens if tensions in the Middle East between Iran & its proxies and Saudi Arabia & the US continue to escalate resulting in a further threat to supply and a further spike in oil prices? Past oil price surges have clearly played a role in US & global downturns – in the mid 1970s, the early 1980s, the early 1990s, early 2000s and even prior to the GFC. See the next chart. They weren’t necessarily the driver of these recessions as other factors (like interest rate hikes and the housing downturn prior to the GFC) often played a much bigger role. But they made things worse because a rise in oil and hence broader energy prices is effectively a tax on consumer spending which leads to lower growth in retail sales, car sales, etc.

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Source: Thomson Financial, AMP Capital

It’s not so much the oil price level that counts as its rate of change, as businesses and consumers get used to higher prices over time. Trouble normally ensues if the oil price doubles over 12 months. From where we were last week at around $US55 for West Texas Intermediate this would imply a rise to around $US110 a barrel (more for Brent and Tapis) and right now at around $US62 a barrel we are nowhere near that.

The situation in the US is also complicated because the surge in US oil production means that there is a huge boost to energy producers from higher prices providing some offset to the drag on consumers and businesses that use energy. Ultimately the negative impact on US consumers from rising oil prices would still dominate the positive impact on US energy producers so net its probably still a negative for US growth but just less so than in the past.

So, a further spike in oil prices that ultimately saw them double last week’s levels would be a significant threat to global growth. Particularly at a time when global growth has slowed, and trade wars pose an ongoing threat.

While higher oil prices boost inflation, central banks will ultimately look through this as it’s seen as a one off and ultimately less consumer spending power weighs on underlying or core (ie ex energy and food prices) inflation. So, a spike in oil prices is unlikely to stop further central bank easing as we saw in the early 1990s, early 2000s and through the GFC.

Impact on Australia

As can be seen in the next chart, Australian petrol prices track the Asian Tapis oil price in Australian dollars pretty closely because our prices are largely set globally (absent the GST, fuel excise, distribution costs and retailer margins). So spiking world oil prices will flow though to Australian motorists. Prior to the attacks in Saudi Arabia, Australian capital city petrol prices were around $1.40 a litre. The rise in oil prices since then implies a rise to around $1.46 a litre. This is not great for those of us who have cars, but would still see average petrol prices below the levels seen last October.

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Source: Thomson Financial, AMP Capital

The real issue would come if world oil prices double as in past major Middle East crises. This would push petrol prices up to around $1.95 a litre. Such a rise in petrol prices would push the typical Australian family’s weekly petrol bill up to around $68 compared to $49 last month.

View larger image

Source: AMP Capital

This extra $19 a week impost would act as a significant tax on consumer spending and almost offset the recent tax refunds for low and middle income households. This in turn would act as an additional drag on consumer spending. Again, while higher energy prices would temporarily add to inflation the RBA with its focus on underlying inflation would look through this, particularly given the reduction in spending power – and hence underlying inflation pressures – that sharply higher petrol prices would result in. So, it would be another reason to expect further monetary easing from the RBA.

Implications for investors

The surge in oil prices is great for energy shares, but not good for the rest of the market given the impact on profit margins and consumer demand. It has also come at a time when global economic growth is fragile. Our base case is that tensions around Iran will be contained and the oil price won’t rise too far from here so it will be broadly neutral for global and Australian growth. But the risks have clearly increased and the situation regarding the Middle East and oil prices could trigger more volatility in the next month or so.

If you would like to discuss any of the issues raised by Dr Oliver, please call on |PHONE| or email |STAFFEMAIL|.

 

Source: AMP Capital 17th September 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) (AMP Capital) 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 and must not be provided to any other person or entity without the express written consent of AMP Capital.

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Australian house prices back from the abyss – seven things you need to know about the Australian property market

Posted On:Sep 11th, 2019     Posted In:Rss-feed-oliver    Posted By:Provision Wealth
Introduction

After the biggest fall in at least 40 years – with a 10.2% top to bottom fall between September 2017 and June this year – average capital city home prices have turned up again. I thought prices would fall further with a 15% top to bottom fall led by around 25% falls in Sydney and Melbourne. But the facts changed

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Introduction

After the biggest fall in at least 40 years – with a 10.2% top to bottom fall between September 2017 and June this year – average capital city home prices have turned up again. I thought prices would fall further with a 15% top to bottom fall led by around 25% falls in Sydney and Melbourne. But the facts changed from May – with the election removing the threat to negative gearing & the capital gains tax discount, earlier than expected interest rate cuts & a relaxation of APRA’s 7% interest rate test all pushing prices up again. So, where to from here?

 

Extreme property views

There are basically two extreme views amongst “property experts”. On the one hand, some real estate spruikers still wheel out the old “property will double every seven years” line. On the other hand, property doomsters say it’s hugely overvalued and overindebted with massive mortgage stress and so a 40% or so crash is inevitable. The trouble with the former is that implies home price growth of 10.3% pa, so even if wages growth picks up to 3.5% (a big ask!) it implies that the average price to income ratio of Australian housing will rise to around 9 times over the next 7 years from around 6 times now and in 14 years’ time it will be 14 times! The trouble with the doomsters is that they’ve been saying that for 15 years and we’re still waiting for the crash. In between, first home buyers are wondering why it’s so hard to do what my and my parent’s generation took for granted: be part of the Aussie dream with a quarter acre block. The reality is it’s far more complicated than these extremes. Here’s seven stylised “facts” regarding Australian property.

First – it’s expensive

This has been the case since early last decade and remains so despite the recent correction in prices:

  • According to the 2019 Demographia Housing Affordability Survey the median multiple of house prices to income is 5.7 times in Australia versus 3.5 in the US and 4.8 in the UK. In Sydney, it’s 11.7 times & Melbourne is 9.7 times. 

  • The ratios of house prices to incomes and rents relative to their long-term averages are at the high end of OECD countries.

 

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Source: OECD, AMP Capital

  • The surge in prices relative to incomes has seen household debt relative to household income rise from the low end of OECD countries 25 years ago to the high end now.

These things arguably make residential property Australia’s Achilles heel. But that’s been the case for 15 years or so now.

Second – it’s diverse

While it’s common to refer to “the Australian property market”, in reality there is significant divergence between cities. This divergence has been extreme over the last five years with Perth and Darwin seeing large price falls in response to the end of the mining investment boom, as other cities rose.

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Source: CoreLogic, AMP Capital

The divergence is also evident in gross rental yields that range from 8.7% in regional WA units to 3.1% in Sydney houses.

Third – talk of mortgage stress is overstated

Headlines of excessive mortgage stress have been common for over a decade now. There is no denying housing affordability is poor, household debt is high and some households are suffering significant mortgage stress. But most borrowers appear to be able to service their mortgages. And despite some seeing negative equity and a significant proportion of borrowers switching from interest only to principle & interest loans (which has seen interest only loans drop from nearly 40% of all loans to 23%) there has been no surge in forced sales and non-performing loans. Non-performing mortgages have increased but remain low at around 0.9%. While Australia saw a deterioration in lending standards with the last boom, it was nothing like other countries saw prior to the GFC. Much of the increase in debt has gone to older, wealthier Australians, who are better able to service their loans. Low doc loans are trivial in Australia and the proportion of high loan to valuation ratio loans has fallen as has the proportion of interest only loans.

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Source: APRA, AMP Capital

Fourth – it’s been chronically undersupplied

Annual population growth since mid-last decade has averaged 373,000 people compared to 217,000 over the decade to 2005, which requires roughly an extra 75,000 homes per year. Unfortunately, the supply of dwellings did not keep pace with the population surge (see the next chart) so a massive shortfall built up driving high home prices. Thanks to the surge in unit supply since 2015 this is now being worked off, but it follows more than a decade of accumulated undersupply which is the main reason why housing has remained relatively expensive in Australia. Not tax breaks or low rates – all of which exist in other countries with far more affordable housing!

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Source: APRA, AMP Capital

Fifth – house prices go up and down

After several episodes of price declines ranging from 5 to 10% across various cities over the last 15 years and 15%, 21% and 31% for Sydney, Perth and Darwin respectively in recent years home buyers should be under no illusion that prices only go up.

Sixth – the housing market remains rate sensitive

While it varies from city to city, despite much scepticism recent rate cuts have helped push up the property market again.

Finally – house price crashes are not easy to forecast

The expensive nature of Australian property and associated high debt levels have seen calls for a property crash pumped out repeatedly over the last 15 years. In 2004, The Economist magazine described Australia as “America’s ugly sister” thanks in part to soaring property prices. Property crash calls were wheeled out repeatedly after the Global Financial Crisis (GFC) with one commentator losing a high-profile bet that prices could fall up to 40%. In 2010, a US newspaper, The Philadelphia Trumpet, warned that “Los Angelification” (referring to a 40% slump in LA home prices around the GFC) will come to Australia. Similar calls were made a few years ago by a hedge fund researcher and a hedge fund: “The Australian property market is on the verge of blowing up on a spectacular scale.” Over the years these crash calls have often made it on to 60 Minutes and Four Corners.

But our view remains that to get a national housing crash – as opposed to periodic falls in some cities – we need much higher unemployment, much higher interest rates and/or a big oversupply. But while the risk of recession has increased it remains unlikely, aggressive rate hikes are most unlikely and while property supply still has more upside it’s unlikely to lead to a big oversupply as approvals to build new dwellings are now falling. As we have seen for years now overvaluation and high debt on their own are not enough to bring on a crash.

So where to now?

The rebound in buyer interest since May has seen auction clearance rates in Sydney and Melbourne rise to around 75% and prices lift nearly 2%, albeit other cities are mixed.  

View larger image

Source: Domain, CoreLogic, AMP Capital

This has so far come on low volumes, but they now look to be rising. Our base case is that house price gains will be far more constrained than the 10-15% implied by current auction clearance rates. Compared to past cycles debt to income ratios are much higher, bank lending standards are tighter, the supply of units has surged with more to come and this has already pushed Sydney’s rental vacancy rate above normal levels and unemployment is likely to drift up as economic growth remains soft. So, we don’t expect to see a return to boom time conditions and see constrained gains through 2020 – eg around 5% or so. There are three key things to watch:

  • The Spring selling season – if auction clearances remain elevated as listing pick up then it will be a positive sign that the pick-up in the property market has legs.

  • Housing finance commitments – these have bounced but will have to pick up a lot further to get 10-15% price rises. 

  • Unemployment – if it picks up significantly in response to slow economic growth then it will be a big constraint on house prices and could result in another leg down in prices.

We don’t see the rebound in the Sydney and Melbourne property markets as a barrier to further monetary easing, but it may reduce the need as it turns the wealth effect from negative to positive. And if it continues to gather pace then expect a tightening of the screws again from bank regulators.

Implications for investors

Over long periods of time residential property provides a similar return to shares (at around 11% pa) but it offers good diversification as it performs well at different times to shares so it has a role to play in investors’ portfolios. The pull back in prices in several cities in the last few years provides opportunities for investors, but just bear in mind that rental yields remain relatively low in Sydney and Melbourne and be wary of areas where there is still a lot of new units to hit. There is probably better value to be found in regional centres and Perth, and Brisbane looks attractive in offering reasonable yields, a low vacancy rate and improving population growth.

If you would like to discuss any of the issues raised by Dr Oliver, please call on |PHONE| or email |STAFFEMAIL|.

 

Source: AMP Capital 11th September 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) (AMP Capital) 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 and must not be provided to any other person or entity without the express written consent of AMP Capital.

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Nine reasons why recession remains unlikely in Australia

Posted On:Sep 05th, 2019     Posted In:Rss-feed-oliver    Posted By:Provision Wealth

Australian economic growth has slowed to the weakest since the GFC. Talk of recession remains all the rage. And economists don’t have a great track record in predicting recessions globally – with an IMF study finding that of 153 recessions seen in 63 countries around the world between 1992 and 2014, economic forecasters only predicted five in April of the

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Australian economic growth has slowed to the weakest since the GFC. Talk of recession remains all the rage. And economists don’t have a great track record in predicting recessions globally – with an IMF study finding that of 153 recessions seen in 63 countries around the world between 1992 and 2014, economic forecasters only predicted five in April of the year before they started – so why should they pick one this time? As someone who forecast two of the last one recessions in Australia I am a bit wary. Perhaps the best way to predict recessions would be to forecast one every year and then you would have a perfect track record in predicting them! Some actually do this. But they are totally useless because they miss out on the 90% or so of the time that countries are not in recession and the positive lead this provides for share markets and other growth assets.

 

Recessions come along when there is a shock to the system (usually high interest rates), invariably at a time when the economy is vulnerable after a period of excess (such as rapid growth in spending, debt or inflation). The shock causes a loss of confidence, lots of little spending decisions are delayed and excesses are unwound. But given the natural tendency of most economies to grow given population growth and new innovations, increasing economic diversity, counter cyclical economic policies and the rise of the more stable services sector recessions are relatively rare at around 10-12% of the time globally. In Australia the last one was 28 years ago.

Why there has been no recession for 28 years

The absence of an Australian recession – whether defined by two quarterly GDP contractions in a row or negative annual growth – for 28 years is instructive. Many forecast recessions at the time of the 1997-98 Asian crisis, 2000-2002 tech wreck, the GFC and from around 2012 as the mining investment boom ended. But it didn’t happen. There are seven reasons why:

  • economic reforms made the economy more flexible;

  • the floating of the $A has seen it fall whenever there is a major economic problem providing a shock absorber;

  • desynchronised cycles across industry sectors;

  • strong growth in China that helped through the GFC;

  • strong population growth; 

  • counter cyclical economic policy – like stimulus payments and monetary easing that helped in the GFC; and

  • good luck – which can never be ignored lest hubris set in!

But is our luck running out?

June quarter GDP growth was just 0.5%. And annual growth has fallen to 1.4% which is the slowest since the GFC and below population growth of 1.6%. Housing and business investment fell, and consumer spending remains very weak. Were it not for public spending and net exports the economy would have gone backwards in the June quarter. 


Source: ABS, AMP Capital

Going forward, the housing downturn has further to run with building approvals pointing to a further fall in home building.


Source: ABS, AMP Capital

This is likely to amount to a 0.5-0.6 percentage point pa direct detraction from growth. This along with low property turnover (less people moving) and lagged negative wealth effects from the earlier fall in house prices will all act as drags on consumer spending. In total the housing downturn is likely to detract around 1-1.2 percentage points from growth in the year ahead.

The drought will likely also act as an ongoing drag on growth with a “mild” El Nino hanging around although this may be modest at around a 0.2 percentage point growth detraction. The threats to global growth from trade wars also suggests downside risks to export growth.

The weakness in relation to the economy is clearly evident in soft profit results in the recent June half year profit reporting season. The ratio of upside surprise to downside was the weakest since 2009, only 58% of companies saw profits rise from a year ago and the proportion of companies raising or maintaining their dividends fell to the lowest since 2011 suggesting a lack of confidence. Earnings growth slowed to 1.3% and excluding resources stocks was around -2.4%.


Source: AMP Capital

Slow growth but probably not recession

Since last year our view has been less upbeat on growth than the consensus and notably the RBA. This remains the case as the housing construction cycle turns down and weighs on consumer spending. As a result, it’s hard to see much progress in reducing high combined levels of unemployment and underemployment, and hence wages growth and inflation are likely to remain low. But there remains a bunch of positives that should help the economy avoid a recession even though growth will remain weak for a while yet. Here are nine.

  • Rate cuts and tax cuts should provide some growth boost – while July retail sales were disappointing, the experience from the GFC stimulus payments is that the tax cuts will provide some lift to growth in the months ahead and various retailers have expressed optimism about this recently.

  • The threat of crashing property prices looks to be receding – while it’s so far been on low volumes, buyer interest has returned to the Sydney and Melbourne markets and we never saw the much-feared surge in non-performing loans or forced selling. This has helped remove the threat of a debilitating negative wealth effect on consumer spending.

  • Infrastructure spending is booming – recent state budgets saw the projected peak in infrastructure spending pushed out yet another year to 2020. And it’s likely states will seek to take even greater advantage of ultra-low long-term borrowing costs to further push out the peak in infrastructure spending.

  • The low $A is helping to support the economy – the $A is down 39% from its 2011 high and is likely to fall further and this provides a boost to Australian businesses that compete internationally by making them more competitive.

  • The business investment outlook is slowly improving – the big drag on growth as mining investment fell back to more normal levels as a share of GDP is over and mining investment plans are rising. This is driving some pick-up in the outlook for overall business investment.


Source: ABS, AMP Capital

  • Australia has a current account surplus – the June quarter saw the first current account surplus since 1975. The slide since then in iron ore and coal prices suggests it may not be sustained, but the reasons for the improvement are more than just commodity prices so the deficit is likely to be well below the norm of recent decades going forward. What’s more there has been a significant improvement in our foreign liabilities with a less short-term debt and a growing net equity position. This all means that our reliance on foreign capital inflow has declined. So much for the boiling frog!

  • There is scope for extra fiscal stimulus – the Federal budget is nearly back in surplus and while we have had a long run of deficits our public finances are in good shape compared to the US, Europe and Japan. As a result, there is scope to provide more fiscal stimulus and this is probably more important than a narrow focus on the surplus.

  • Population growth remains strong – Australia’s population growth at around 1.6% pa remains strong. Of course, strong population growth is not without issues and in terms of living standards it is economic growth per person (or per capita) that matters. But solid population growth also has significant benefits in terms of supporting demand growth, preventing lingering oversupply and keeping the economy dynamic. 

  • Finally, cyclical spending (consumer durables, housing and business investment) as a share of GDP remains low – suggesting that apart from bits of the housing market there’s not a lot of excess in the economy that needs to be unwound.


Source: Bloomberg, ABS, AMP Capital

Concluding comment

Our assessment remains that growth will remain soft and that the RBA will have to provide more stimulus – by taking the cash rate to around 0.5% and possibly consider unconventional monetary policy like quantitative easing. Ideally the latter should be combined with fiscal stimulus which would be fairer and more effective. While Australian growth is going through a rough patch with likely further to go, recession remains unlikely barring a significant global downturn.

If you would like to discuss any of the issues raised by Dr Oliver, please call on |PHONE| or email |STAFFEMAIL|.

 

Source: AMP Capital 5 September 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) (AMP Capital) 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 and must not be provided to any other person or entity without the express written consent of AMP Capital.

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Negative rates, QE & other measures the RBA may deploy- why? will it work? what would it mean for investors?

Posted On:Aug 28th, 2019     Posted In:Rss-feed-oliver    Posted By:Provision Wealth
Introduction

Since the RBA started cutting interest rates again back in June and in the process taking them closer to zero there has been increasing debate that it will deploy so-called “unconventional monetary policy measures” such as negative interest rates and quantitative easing. This debate has hotted up in recent weeks after the escalation in the US-China trade war posing a

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Introduction

Since the RBA started cutting interest rates again back in June and in the process taking them closer to zero there has been increasing debate that it will deploy so-called “unconventional monetary policy measures” such as negative interest rates and quantitative easing. This debate has hotted up in recent weeks after the escalation in the US-China trade war posing a rising threat to global growth, numerous central banks cutting interest rates this month in a so-called “race to zero”, the Governor of Reserve Bank of New Zealand saying that negative rates are possible and RBA Governor Lowe saying that its “prepared to do unconventional things if the circumstances warranted it” even though he also said that QE was “unlikely”. News of a Danish lender offering negative mortgage rates has only added interest to the issue. But what exactly are these unconventional monetary policy measures? Do they work? Would they work in Australia? Are there better options? Will they be deployed and when? What will it all mean for investors?

 

What’s behind talk of unconventional monetary policy

Put simply Australian economic growth has slowed sharply below its long-term potential reflecting the housing downturn and weak consumer spending. While house prices may be bouncing back in Sydney and Melbourne and there are anecdotes that the tax cuts are helping retailers, the downturn in housing construction has further to go and other factors from drought to the threat from the US trade wars cloud the outlook with increasing talk of recession globally. Slower growth has seen the outlook for unemployment deteriorate – at a time when there is still a high level of unemployed and underemployed (at 13.6% of the workforce). Which in turn threatens to keep wages growth and inflation lower for longer. So, with the cash rate approaching zero the question naturally arises of what to do next? Of course, Australia is not alone – with talk of recession globally, other central banks ramping up or considering the use of unconventional monetary policies and all of this being reflected in record low bond yields. Basically, there is an excess of global savings and this is driving ultra-low interest rates.

View larger image

Source: Global Financial Data, AMP Capital

What are unconventional monetary policy measures>

They refer to a bunch of policies which have been deployed by major central banks in the aftermath of the GFC. They are:

  • explicit forward guidance – where the central bank indicates the cash rate is not expected to rise for some time period;

  • very low and negative policy interest rates;

  • quantitative easing (QE) – which has involved using printed money to purchase public and private securities;

  • providing cheap funding to banks to support lending; and

  • intervening to push the Australian dollar lower.

But do they work?

A common comment is that “QE etc hasn’t worked in the major economies so why should it work here?”. In reality such policies do appear to have helped notably in the US and Europe where they were progressively deployed from the time of the GFC once interest rates hit zero and then became the lone stimulus measures as fiscal austerity took hold. Since its high in 2013 unemployment in the Eurozone has fallen from 12% to 7.5% and in the US it fell from 9% in 2011 to 4% in 2017 enabling the Fed to start unwinding unconventional monetary policy. Inflation has not been returned to 2% targets, but wages growth has lifted and at the start of last year it looked like the global economy was getting back to normal. So unconventional measures have helped. Of course, Trump’s trade wars have provided a big threat since then.

The main lessons look to have been that different measures are appropriate depending on the issues facing a country, that a range of measures are preferable to just one and that central banks need to go early unlike Japan which left it too late.

Will it work in Australia?

Our assessment is that unconventional monetary policy measures may help in Australia, but it will depend on the measure deployed and their impact will be limited particularly compared to overseas. We now look at the issues around each.

Explicit forward guidance – the RBA has already started this with its comment this month that “it is reasonable to expect that an extended period of low interest rates will be required”. If the US and ECB are any guide this is likely to morph into a specific time period through which rates will remain low. This can help keep bond yields low, but the low yields in other countries dragging our yields down will arguably do this anyway.

Zero or negative interest rates – while the Fed stopped cutting rates in the GFC and its aftermath at 0-0.25% and the Bank of England stopped at 0.25%, the Bank of Japan and several European banks led by the ECB have taken rates negative. This negative rate applied to the deposit rate banks get for leaving deposits at the central bank and was motivated to encourage them to lend out cash which was building up as reserves due to quantitative easing. There is some evidence that negative rates in Europe have boosted bank lending but cut into bank profits because banks are reluctant to take interest rates on bank deposits (which are used to fund lending) below zero and so further falls in lending rates lead to reduced profit margins which may crimp lending. The thought of negative rates may also scare people. Sure a 10% bank deposit rate and 12% inflation is really no different to a -1% deposit rate and 1% inflation – but the former would feel a lot better!

For these reasons it would make sense for the RBA to call a halt to cash rate cuts around 0.5% (which we expect to see by year end) or maybe 0.25%. There would be little point in going to zero or negative as the banks will be unlikely to pass it on in lower mortgage rates as they won’t want to take deposit rates negative. So negative interest rates will hopefully be avoided.

Asset purchases under quantitative easing – QE in the US, Europe and Japan involved pumping printed money into the economy by central banks buying government bonds, high-rated private debt and, in Japan’s case, some shares. This was aimed at pushing long-term bond yields and hence borrowing costs even lower, boosting narrow money in the economy with the hope that it will be lent out, pushing investors into more risky assets to make more capital available for investing and (although they don’t admit it) pushing their currencies down. It tends to be what you do once interest rates have hit zero.

In Australia, QE may provide less help because there are less Government bonds for the RBA to buy given relatively low public debt in Australia, bond yields are already low anyway and in any case 85% of mortgage borrowing is linked to short-term interest rates and so there would be little benefit to the household sector from lower long-term bond yields.

What’s more it’s not clear that QE as practiced in other countries is the most efficient or fairest way to boost growth. There is no guarantee that the cash pumped into the economy is lent out and spent and a lot of it has just helped share markets (which is good for the better off) at a time when interest rates are low (which is not so good for lower income earners who rely more on bank deposits). More on this later.

Cheap funding for banks – the RBA did this around the time of the GFC and the ECB and the Bank of England have provided cheap financing to banks tied to them boosting lending. It’s not really an issue at present in Australia as banks are not facing difficulties in terms of funding and the recent slowdown in credit growth in Australia owes more to tighter regulatory oversight around “responsible lending”. However, following the UK experience the provision of cheap funding to banks may be a way for the RBA to ensure that cash rate cuts are continued to be passed on to lower mortgage rates and that lending holds up as the cash rate gets closer to zero.

FX intervention – this is a return to old fashioned RBA intervention in the foreign exchange market to push the $A down by selling Australian dollars and adding to its foreign exchange reserves with the aim of helping growth. It seems unlikely though as it would be criticised by other countries as competitive devaluation and the $A is already low anyway.

A better option – helicopter money?

Given the issues with some of the unconventional monetary policy measures – notably negative interest rates and quantitative easing – there may be a better way. This would be for the RBA to work with the Federal Government to use printed money to provide direct financing of government spending or “cheques in the mail” to households with use by dates. While some might say this is just “Modern Monetary Theory” in reality there is nothing “modern” about it at all (although support for MMT may help clear a path toward it). Such an approach was referred to decades ago as a “helicopter drop” by Milton Friedman. I was taught at university that government spending can be financed by tax, issuing bonds or printing money. So it’s nothing new. It’s been eschewed because of the worry that politicians will misuse it and cause hyper-inflation. But a lack of inflation is the issue now. Such an approach would be guaranteed to boost demand and eventually inflation and the spending could be targeted in a way that is seen as fair. To provide a lasting boost to inflation without running out of control it could be set up to continue until certain objectives are met then gradually phased down. Hopefully, it won’t come that, but it’s a preferable option to the hit and miss of just relying on alternative monetary policy measures. In the meantime, more fiscal stimulus could take some pressure off the RBA.

Will the RBA deploy unconventional policies?

The RBA is likely to exhaust conventional easing by cutting the cash rate to 0.25-0.5% before doing unconventional measures beyond forward guidance. The probability of other measures next year is rising. Negative interest rates are unlikely but quantitative easing would likely be included. Ideally this would involve working with the Government to provide a fiscal boost.

Implications for investors?

There are a number of implications for investors. First, bank deposit rates are likely to fall even further and remain unattractive for a lengthy period yet. Second, the low interest rate environment means the chase for yield is likely to continue supporting commercial property, infrastructure and shares offering sustainable high dividends. The grossed-up yield on shares remains far superior to the yield on bank deposits. Investors need to consider what is most important – getting a decent income flow from their investment or absolute stability in the capital value of that investment.

View larger image

Source: RBA, Bloomberg, AMP Capital

Third, the continuing low interest rate environment will support Australian residential property prices, but still high debt levels, tight lending conditions and rising unemployment mean that it’s unlikely to set off another full-blown property boom.

Finally, easy monetary policy in Australia will likely help keep the $A lower than it otherwise would be.

If you would like to discuss any of the issues raised by Dr Oliver, please call on |PHONE| or email |STAFFEMAIL|. 

 

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

Source: AMP Capital 28th August 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)  (AMP Capital) 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 and must not be provided to any other person or entity without the express written consent of AMP Capital.

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