Investment news

Shane White

Superannuation Minister Bill Shorten ... he didn’t need a committee to tell him that the cumbersome and punitive system needed to be revised. Photo: Andrew Quilty

The federal government has taken aim at investors with superannuation balances of more than $2 million with plans to introduce a 15 per cent tax on investment earnings over $100,000 a year.

Ending a long week of speculation, Treasurer Wayne Swan and Superannuation Minister Bill Shorten announced the changes as part of a package of reforms that included the lifting of the concessional contribution rate and a revised approach to excess contributions tax.

Mr Swan said the changes were aimed at making super better, fair and stronger for all Australians.

“Why should someone who has millions of dollars in a superannuation account pay no tax on their earnings while someone on $80,000 a year pays a marginal tax rate of 37¢ in the dollar,” he said.

Mr Shorten said the reforms were targeted, made sense and were overdue.

The introduction of a 15 per cent tax on superannuation earnings above $100,000 is expected to affect 16,000 Australians. The government said the changes would affect member balances of more than $2 million (assuming a modest 5 per cent return).

The $100,000 threshold will be indexed to the CPI.

Transitional arrangements

The government has provided transitional arrangements for investors who have already purchased assets, saying they will have 10 years to decide whether they want to restructure their arrangements before their capital gains will be affected.

The changes will be prospective, not retrospective.

The strategy will see the government raise an additional $900 million over the forward estimates period while keeping Prime Minister Julia Gillard’s promise of no tax on withdrawals for the over 60s.

Mr Swan said that when combined with changes to taxation levels on contributions from people earning more than $300,000 the reforms would create $10 billion worth of savings over the coming decade.

The government has also responded the criticism about the architecture of the system by announcing a reprieve to the concessional contribution tax arrangements which were capped at $25,000.

Under the new arrangement, over 60s will be able to contribute up to $35,000 a year at the concessional rate of 15 per cent from July 1, 2013; the $35,000 cap will be extended to the over 50s from July 1, 2014.

Blindingly obvious

The excess contributions tax will also be reformed, with Mr Shorten saying he didn’t need a committee to tell him that the cumbersome and punitive system needed to be revised (under the previous system, super savers who breached the concessional and non-concessional contribution limits were hit with an effective tax rate of up to 93 per cent).

The new system will allow super fund members who breach the caps to withdraw excess contributions from their fund and tax them at the individual’s marginal tax rate plus an interest rate charge to recognise the interest lost.

Mr Shorten also announced the creation of a Council of Superannuation Custodians, which he said would provide an annual report to parliament on superannuation.

The council will ensure any future changes to the super system are consistent with a charter of superannuation adequacy and sustainability, which it hopes to develop in the coming weeks.

Other changes include a revision to the taxation of deferred lifetime annuities and an increase to the balance of inactive super funds considered to be “lost” accounts.

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Zoe Fielding

Wedged ... savers looking for income from cash deposits have been hoping that rates will start going up. Photo: Quentin Jones

It looks like we are getting close to the bottom of the interest rate-cutting cycle. But that might not be the good news that savers are looking for.

The Reserve Bank of Australia released the minutes from its March 5 board meeting on Thursday its decision to leave interest rates on hold again at 3 per cent.

Cash deposit rates have been falling as the RBA started to cut official interest rates in November 2011. People looking for income from cash deposits have been hoping for the situation to reverse.

However, the rates offered on deposits could actually have been much worse for savers: financial institutions have been competing for depositors’ money rather than going for cheaper wholesale funding.

The RBA noted that this situation would not continue.

Elevated

“Funding conditions for Australian banks remained as favourable as they had been for some months,” the minutes noted. “In time, this improved environment should see some moderation in banks' strong demand for deposits but, for the present, spreads between deposits and comparable wholesale benchmarks remained elevated.”

Rabobank’s chief executive in Australia and New Zealand Thos Gieskes said yesterday that he was yet to see evidence of falling competition for deposits, although he would not be surprised if competition started to ease soon.

Fixed mortgage rates (an indicator of where the banks expect rates to move) meanwhile, have started to climb.

Earlier this week, Westpac became the first major bank to lift its two-year fixed home loans to 5.19 per cent. It had cut the rate to a three-year low of 4.99 per cent in February.

Other banks have not yet moved their rates and CUA announced on Wednesday that it had cut its three-year fixed rate to 5.10 per cent. Interest-rate watchers are still expecting cuts to the official cash rate by the end of the year.

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Patrick Commins

Trouble in Europe is good for gold. Photo: Phil Carrick

As global sharemarkets have rallied strongly this year, the bears have retreated towards their cave and the price of gold has retreated with them. The precious metal finished 2012 trading at $US1675 an ounce, but had dropped 6.6 per cent to $US1564/oz by mid to late February, before regaining some lost ground between then and now (have a look at the chart below).

But recent reports of the death of the gold bull market may be exaggerated. For one, the bailout of Cyprus has reignited smouldering fears of a major blow-up in Europe. A Singapore-based fund manager recently proclaimed at a mining conference in Hong Kong that anyone “in Greece and Spain anyone who isn’t taking money out of the bank today and putting it in gold or a United Kingdom bank or German bank is frankly out of their mind”.

The investment case

Now a new report by HSBC’s commodities analysts further supports the investment case for the precious metal. They pin their argument on the fact they see no evidence of less money printing in developed economies – indeed Japan has joined the party. The US Federal Reserve’s Ben Bernanke has come out in recent statements strongly arguing in favour of further “quantitative easing”, as it’s euphemistically known.

Additional factors supporting gold are:

■ inflationary expectations may be on the rise;

■ “periods of competitive currency depreciation” (the current currency wars between big developed countries) are historically good for gold;

■ The rise of economic nationalism and assorted geopolitical risks (in Asia and the Middle East, for instance);

■ the bulk of gold selling through ETFs has run its course;

■ central banks will continue to buy the precious metal as a way to diversify away from the US dollar; and

■ the recent weakness in the price may stimulate jewellery demand and reduce scrap supplies.

HSBC’s analysts expect the average price for gold in 2013 to be $US1700/oz (ranging between $US1525 and $US1825/oz). The average annual gold price the following year, however, is estimated to only be $US1720/oz, and then $US1675 in 2015 – suggesting this year may well be the last hurrah for gold bugs.

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Patrick COmmins

Investors have right to fear what they can’t see. Photo: AFP

According to astronomy, a large part of the total mass in the universe is made up of “dark matter”, the existence of which can only be inferred by its impact on the observable mass of astronomical objects. You can’t detect it, you just know it has to exist because you can see its effects.

A similar phenomenon

Here on planet Earth, investors have been concerned that a similar phenomenon – trading in so-called “dark pools” – will allow institutions and back-room dealers to operate in the shadows, buying and selling away from the scrutiny and oversight of the regulators and other market participants. Their actions will only be able to be observed through the movement of share prices.

Now the corporate cop, the Australian Securities and Investments Commission, in a report has found there is evidence that the “quality of price information has been adversely affected” in some securities as a result of trading in dark pools.

As a result, ASIC is proposing a raft of new regulations, including enforcing a minimum size threshold in cases where it sees evidence of “degradation in the market quality of a security or group of securities”, and additional rules to enhance transparency in dark trading.

But in a finding that is likely to be controversial to many more traditional, “fundamental” style investors, the regulator also finds that concerns around high-frequency trading are overstated, even if there is evidence of some potential breaches of market integrity rules.

“High-frequency trading does not appear to be a key driver for changes seen in price formation, liquidity and execution costs,” reports ASIC, adding HFT “does not exacerbate market instability”.

That said, computer trading using automated algorithms does “in general contribute to excessive order messages, fleeting orders and market ‘noise’ [which] is disruptive to the market and has damaged investor confidence”.

Ordered to take a break

ASIC proposes to require a minimum 500 millisecond resting time for small orders of $500 or less. Apparently that is long-term investing at its worst in the world of HFT.

While many might see it as a fringe practice, the numbers around HFT are alarming: a small group of high-frequency traders account for 22 per cent of total equity market turnover, reports ASIC.

It’s unlikely that the regulator’s blase attitude on such practices will convince many shareholders, including super fund trustees and investors hoping that the market, while never perfect, is not excessively distorted by market participants with no interest in the traditional role of equity markets.

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Patrick Commins

Keep a sharp eye on three economic factors.

Confidence is back, but fundamentals need to catch up.

Measures of risk appetite are rising around the world while indicators of financial market stress are heading the other way, reports ANZ’s chief economist, Warren Hogan, in the bank’s newly released quarterly research compendium. That essentially explains the rallies in world sharemarkets in recent months.

US equities are up 15 per cent from November lows, Europe’s gained 12 per cent, while over the past four months China’s sharemarket is up 25 per cent and Japan’s an astonishing 40 per cent.

Feeling the pulse

ANZ’s measure of global growth momentum, its “inventory pulse”, has turned up, but is clearly lagging the improvement in risk appetite, says Hogan. In effect, financial markets are expecting - and pricing in - a strong economic recovery across the globe this year.

That means the Big Question for 2013 for Hogan and his team is: can the rebuilding of confidence evident in financial markets be replicated in real economies, particularly those in the industrialised world?

The ANZ economists outline three factors that will determine whether 2013 is a year to remember or forget:

■ An upturn in business investment in the developed economies is the key to the next phase of the global economic expansion;

■ A stable and supportive political leadership is as important as ever to economic prospects. The US debt ceiling debate will be a test of this; and

■ Inflation must remain contained in China if the economy is to broaden its recovery.

So keep a weather eye on those key economic indicators.

In other news, while many economists and sundry experts are paring back their expectations for further monetary easing, ANZ is still forecasting a 25 point cut in the RBA’s cash rate in the next three months and another cut in the final quarter of this year.

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Zoë Fielding

While many homes double in value, many sell at a loss. Photo: Gary Medlicott

Emotions often play into buying decisions more than the potential for capital growth when it comes to the family home. Even then, most people think housing is a pretty safe investment bet.

That bet that pays off handsomely for some, but proves costly for others.

More than a third of properties sold since late 2002 have gone for more than double their initial purchase price, RP Data’s figures show.

Source: RP Data Property capital markets report Summer 2013

The proportion has been trending slowly downwards since the around the time of the financial crisis, but there are still a considerable number of home owners making a tidy profit on their property.

RP data’s research shows that 45.1 per cent of homes sold over the December quarter sold at a price more than 50 per cent higher than their initial purchase price.

At the other end of the scale, a significant proportion (12.5 per cent in the three months to December 2012) of properties have sold for less than their initial purchase price.

Property values have been falling in some areas. Across the combined capital cities, values dropped by 0.6 per cent through 2012. Melbourne experienced the biggest fall, with values in Brisbane and Adelaide also falling.

Darwin residential property continued to boom, while Sydney and Perth registered smaller value increases.

Unsurprisingly, Queensland’s coastal areas have been the worst performers. Almost 40 per cent of properties on the Gold Coast, 34.5 per cent of Sunshine Coast homes and 33.8 per cent of properties in Far North Queensland sold at a loss in the December quarter.

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Patrick Commins

Analysts are searching for the missing link in markets. Photo: Brett Eloff

We have the confidence, we have a dwindling list of alternative investments, and we have a rising market. The only thing missing is for companies to start making more money. But there are positive signs that we may be approaching an inflexion point after years of falling top lines.

Tentative signs

For the past three or four years analysts have been forced to push the earnings recovery they slated for “next year” into the year after, points out Wilson HTM Investment Group analyst Damien Klassen. But there are “tentative signs” that this year could be different, reckons Klassen, as only three months out from FY2014 analysts continue to hold their nerve on an earnings recovery in the next financial year. Klassen’s chart below shows earnings per share expectations for the market over time.

The barriers to any recovery are the high Aussie dollar, weak government spending and declining capital expenditure plans, while supporting factors are low interest rates and the hope that a wealthier feeling consumer (as sharemarkets and house prices rise) will be happier to spend.

Over the cycle

Earnings estimates are a crucial consideration for valuing stocks (they are the “E” in the forward P/Es). But longer term investors may be more interested in the so-called “Shiller P/E”, after the famed American academic and author of the same name. It tries to give you a picture of how markets are valued through the cycle and also removes the effect of inflation.

You can see the Shiller P/E for the local market below. As Klassen notes on the chart, shares look cheap versus the 2000s, average versus the 1990s and average compared to the previous two decades.

Source: Wilson HTM

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Zoë Fielding

Higher rates for less of a lock-up. Jessica Shapiro

Banks want your cash and they’re getting creative in their approaches to attracting it.

In the past few weeks, RaboDirect and Westpac Institutional Bank have launched a new type of cash product, which is a hybrid of a term deposit and an high-interest savings account.

This type of account is known in Europe but they’re uncommon here, so far.

What’s in it for you?

Like high-interest savings accounts, these products allow account holders to add money at any time, and they offer a variable, rather than fixed, rate of interest, which is paid monthly.

The interest rate is typically higher than those offered by at-call cash accounts, as a reward for giving up the ability to immediately access the funds.

The products have no maturity date but account holders can only access their money after a notice period.

Westpac’s accounts are aimed at institutional savers, which own the cash in more than half of bank deposits.

The rest of the cash in bank deposits is owned by consumers, and RaboDirect is targeting this group with its product, called the Notice Saver.

The account pays 4.45 per cent interest to account holders who agree to give 31 days’ notice if they want to withdraw. People who give 60 days’ notice receive 4.55 per cent, and those who go into the product with a 90-day notice period receive 4.65 per cent.

The rates are variable, but in a term deposit, you’d have to lock your money up for five years to get a comparable rate at the moment.

What’s in it for them?

For the banks, these structures make it easier to meet new capital requirements rules, which are coming into force soon. That’s why the minimum notice period is 31 days – any shorter than 30 days and the bank would have to hold more capital to secure the deposit.

RaboDirect Australia and New Zealand group executive Greg McAweeney expects the new banking rules to change the products that banks offer.

“I can see all term deposits having a no-break within 30 days clause,” he says.

Other banks are also likely to launch similar products, both to avoid having to hold as much in their reserves, and also to compete for deposits.

McAweeny says the product helps people avoid making impulse purchases with their savings, but he thinks self-managed superannuation funds will also be interested.

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Patrick Commins

Investors should know what analysts think, but don’t believe everything you hear.

The horror eight months for listed mining companies has an upside – they now look the best value on a price to estimated 12-month earnings measure.

And analysts expect every sector aside from financials to log double-digit earnings per share growth in the coming 12 months, on Bloomberg data. Once again, the miners are leading the pack, but the high EPS growth estimate reflects the wide dispersion of forecasts in a sector that contains many juniors which, for example, may be making money for the first time.

Not obvious

Other than the resources sector, there’s not much obvious value on a sector-by-sector approach, with industrials trading at the next lowest median estimate P/E.

Financials and consumer goods are the least attractive sectors, on a consensus of analysts’ recommendations, rating a hold. But overall “the street” (as these consensus views are known) is broadly positive on the market, with oil and gas and mining companies the most attractive. Despite their strong run in the market, analysts still like healthcare and utilities – perhaps attracted to the defensive characteristics of both.

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Patrick Commins

For a company to deliver a strong performance, all of its metrics need to work in concert. Photo: Xiaojing Wang

One of the greatest challenges for investors is avoiding value traps. Many of the metrics – dividend yield, P/E ratios, book-to-value measures – can get more and more attractive as companies get deeper and deeper into trouble.

Robust ...

A University of Chicago accounting professor set out to come up with a formula to help identify companies in robust financial shape. If a stock looked a bargain and it also rated highly on his nine-point scale, then it was most likely a good investment.

The professor, named Joseph Piotroski, did some backtesting and proclaimed that investing in companies with a “margin of safety” (trading well below their net asset backing, for example) outperformed the market handsomely.

...yet simple

Piotroski’s method is simple. A company is scored against nine criteria that assess its performance over the past two years. It gets a point if it passes, otherwise nothing. A perfect score is nine, although a score of eight is considered good as well.

Here are the criteria:

1. Net Income: ‘1’ if last year’s net income before extraordinary items is positive, ‘0’ if not.

2. Operating Cash Flow: ‘1’ if last year’s operating cash flow number is positive, ‘0’ if not.

3. Return on Assets Increasing: ‘1’ if last year’s return on assets are greater than prior year, ‘0’ if not.

4. Quality of Earnings: ‘1’ if operating cash flow is greater than net income before XO, ‘0’ otherwise. This test can identify potential accounting issues, as cash flow is usually greater than net income due to depreciation and intangible asset amortisation (i.e. “non-cash”) charges.

5. Long-term Debt vs. Assets: ‘1’ if the long-term debt to assets ratio is lower than year-ago number, or if long-term debt is 0. Is the company reducing its debt relative to assets?

6. Current Ratio: ‘1’ if short-term assets / short-term liabilities ratio is greater than previous year. Is the company getting financially stronger?

7. Shares Outstanding: ‘1’ if outstanding shares is lower or the same as prior year, ‘0’ otherwise. Is management buying back shares and being reasonable with options grants?

8. Gross Margin: ‘1’ if gross margin from last year exceeds previous year, ‘0’ otherwise. Has the company been able to maintain pricing power against cost of goods?

9. Asset Turnover: ‘1’ if rise in revenues exceeds rise in total assets, ‘0’ otherwise. This can identify unprofitable investments by management.

As the table below shows, mining services company NRW Holdings rates highest of the top 300 ASX-listed companies using the measure of financial strength. Giants BHP and ANZ could only manage a three out of a maximum of nine on the same measure, our analysis reveals.

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Zoë Fielding

Dive in sooner to self-managed super. Photo: Kirk Gilmour

The size of the self-managed superannuation industry is increasing rapidly but service provision to the highly prized sector is fragmented, making it relatively expensive to run your own fund.

As the industry that services the DIY super sector develops, extra competition should mean a better deal for SMSF trustees, and this might lower the minimum balance at which it makes sense to run your own fund.

How much to start a fund?

The Australian Taxation Office says $250,000 is a minimum starting point for someone considering establishing a fund. If you have less than that, the costs for accounting, administration and the like are too high as a percentage of your balance. A pooled industry, retail or corporate super fund would be better value.

“Our view is that $250,000 is a bit low,” AMP’s SMSF managing director Paul Sainsbury said on Thursday, before the launch of a major campaign targeting would-be trustees.

AMP, which launched its SMSF business late last year, claims to be a market leader, but it administers accounts for only 9100 of the 945,207 people across Australia who are members of a self-managed fund, based on ATO figures.

The financial services giant has been working on a system that will help SMSF trustees manage their funds more efficiently. It does nifty things such as automatically producing minutes on changes to the investment strategy, and it allows you to flick a switch to shift the fund from accumulating wealth to drawing a pension at retirement.

More competition

Other financial institutions, as well as financial planners and accountants, are clamouring for their slice of the action too. They all want the chance to charge fees for assisting SMSF trustees to establish and run their own funds.

There are almost 500,000 self-managed superannuation funds operating in Australia, with the average balance almost $1 million, according to Tax Office figures.

The median balance, however, is much lower than that at $540,000, indicating that there is a relatively small number of funds with balances much higher than $1 million, and a fairly large number with balances under that sum.

That, coupled with the fact it’s wealthy people interested in their investments who are starting their own funds, makes it an enormously appealing target to businesses in the financial services industry.

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Patrick Commins

Surprising on the upside ... calculated by comparing the companies’ first-half profit results against a three-year average. Photo: Max Mason-Hubers

The five companies best placed to meet profit targets, and therefore more likely to surprise “on the upside”, as market boffins say, are Leighton Holdings, Southern Cross Media Group, Seven West Media, Emeco Holdings and NRW Holdings.

That’s according to the strategists at Credit Suisse, who compared the companies’ first-half profit results against a three-year average. Based on that, the analysts looked at how much ground each would need to make up in the second half to reach consensus expectations on full-year profits.

Under pressure

On the other hand, those most under pressure to pull out a strong second-half result if they are to meet expectations (in descending order) are GWA Group, Boart Longyear, Fairfax Media, The Reject Shop, and Fleetwood Corporation.

The investment bank’s analysis also suggest that the market is expensive across a range of measures. The S&P/ASX 200 is trading at a one-year forward P/E of 14.4, a standard deviation above the 10-year average of 13.1, and is similarly expensive on estimated earnings for fiscal 2014.

It’s the same story using Credit Suisse’s “preferred” P/E, which uses “trend”, or “through the cycle”, earnings in the denominator: 18.1 against the long-term average of 15.2.

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Zoë Fielding

Existing conflicted payments can continue after the ban. Photo: Andrew Quilty

There has been a trend away from financial service providers charging commissions on investment products they recommend to clients – but so-called conflicted remuneration methods are still relatively widespread.

The corporate regulator has finally released guidelines for financial companies on how to implement rules that will ban conflicted remuneration from July 1 this year.

Many financial planners – in the past commission agents of insurance and banking companies – have started charging “fees” to their clients rather than collecting trailing commissions direct from product providers.

Off switch

Asset-based fees are becoming a popular alternative for advice businesses charging their clients. Rather than collecting a 1 per cent commission on products sold, they will charge a percentage-based fee on the total value of the client’s assets on which they advise: perhaps an annual charge of 1 per cent of the amount that the client has invested.

The cost to the client is basically the same – but they can “turn off” the fee if they no longer use the adviser’s services, while a commission continues for as long as their money is held in the product.

Conflicted remuneration structures encourage advisers to steer clients towards financial products that will better line their own pockets.

A clear link

The Australian Securities and Investments Commission established a clear link between the quality of financial advice and conflicts of interest over remuneration in a 2006 report.

In a report in 2006, ASIC found that consumers were six times more likely to receive poor advice when the adviser had a conflict of interest, and three times more likely to receive poor advice when the adviser recommended a product that was associated.

The theory is that disconnecting the advice from the product will dissuade financial planners from recommending a product that pays a better commission over a product paying a lower commission.

Blacklist

From July 1, some of the conflicted practices that were once commonplace will be banned, but only on products sold in the future. Existing conflicted arrangements will be allowed to remain in place.

The practices banned from July 1 include:

■ Volume-based payments where product providers reward advisers for directing larger sums into particular products or strategies;

■ Performance benefits for employees, whereby employers reward staff members based on product sales;

■ Volume-based “shelf space” fees, where the providers of financial administration systems (called platforms) charge fund managers to include their products on the platform; and

■ Asset-based fees on borrowed amounts. These asset-based fees are acceptable under the new rules but the adviser can’t charge on money invested through a margin loan or other investment loan.

Hopefully, an explicit ban on these conflicted payments in future will help improve the quality of financial advice that’s available in the market. Hopefully in time, the long-standing backhanders that are being allowed to continue will fade out of existence.

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Patrick Commins

Investors all over the world hang on Warren Buffett’s proclamations. Illustration: Michael Mucci

There are more risks being out of the sharemarket than in it, and corporate bosses should stop wringing their hands and start investing in their businesses, writes investing super hero Warren Buffett in Berkshire Hathaway’s recently released annual letter to shareholders.

Buffett also discusses the recent mega-acquisition of Heinz, gives a tip on measuring a company’s capacity to repay its debt, and even provides some recommended reading.

Here are the highlights.

On Berkshire’s performance:

“When the partnership I ran took control of Berkshire in 1965, I could never have dreamed that a year in which we had a gain of $24.1 billion would be subpar ... But subpar it was. For the ninth time in 48 years, Berkshire’s percentage increase in book value was less than the S&P’s percentage gain.”

Berkshire’s book value per share (Buffett’s preferred measure of value) increased by 14.4 per cent in 2012, against the S&P 500’s total return of 16 per cent. He adds that BRK does better when “there’s a wind in our face”. Still, over the past 47 years BRK has grown book value per share at an annual compound rate of 19.7 per cent against the S&P 500 return of 9.4 per cent.

On ‘elephants’ and the Heinz acquisition:

“The second disappointment in 2012 was my inability to make a major acquisition. I pursued a couple of elephants, but came up empty-handed ... Charlie and I have again donned our safari outfits and resumed our search for elephants.”

“The other half [of Heinz] will be owned by a small group of investors led by Jorge Paulo Lemann, a renowned Brazilian businessman and philanthropist. We couldn’t be in better company. Jorge Paulo is a long-time friend of mine and an extraordinary manager.”

Buffett certainly raised some eyebrows with what was essentially a leveraged buy-out of the household brand name, and at high multiples. But the Oracle of Omaha points out that Berkshire also bought $US8 billion in Heinz preferred shares that pay a 9 per cent dividend, which certainly limits some risk. And, anyway, Buffett has always used leverage in his investing.

Advice for America’s corporate leaders:

(while pointing out that Berkshire is investing heavily in its own businesses)

“There was a lot of hand-wringing last year among CEOs who cried “uncertainty” when faced with capital allocation decisions (despite many of their businesses having enjoyed record levels of both earnings and cash). Of course, the immediate future is uncertain; America has faced the unknown since 1776. It’s just that sometimes people focus on the myriad of uncertainties that always exist while at other times they ignore them (usually because the recent past has been uneventful).”

Not-so-subtle subtext: start spending money and employing people, corporate America!

Advice for investors:

“Since the basic game is so favorable, Charlie and I believe it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of “experts,” or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it.”

Buffett has increasingly become America’s cheerleader when it comes to the US economy and the sharemarket. Understandably so - it has made him rich, after all.

The benefits of investing in the ‘regulated, capital-intensive businesses’

(of rail company BNSF and electric utility MidAmerican Energy)

“Our confidence is justified both by our past experience and by the knowledge that society will forever need massive investment in both transportation and energy. It is in the self-interest of governments to treat capital providers in a manner that will ensure the continued flow of funds to essential projects.”

Pundits were puzzled when Buffett spent $US44 billion in late 2009 buying the remaining 77 per cent of Burlington Northern and Santa Fe Railway, as it was once known. It seemed out of touch in a modern age. But Buffett is betting countries will always need freight rail services, and he’s probably right.

On measuring a company’s leverage (via its interest coverage):

“Our definition of coverage is pretax earnings/interest, not EBITDA/interest, a commonly-used measure we view as deeply flawed.”

No surprise there; Buffett’s offsider Charlie Munger famously referred to EBITDA as “bullshit earnings”.

His counter-intuitive bet on newspapers

Over the past 15 months Buffett has bought 28 daily newspapers, despite his belief that profits in that industry are “certain to decline”:

“Newspapers continue to reign supreme, however, in the delivery of local news. If you want to know what’s going on in your town – whether the news is about the mayor or taxes or high school football – there is no substitute for a local newspaper that is doing its job.”

“The main exemplar for local newspapers is the Arkansas Democrat-Gazette, published by Walter Hussman, Jr. Walter also adopted a pay format early, and over the past decade his paper has retained its circulation far better than any other large paper in the country. Despite Walter’s powerful example, it’s only been in the last year or so that other papers, including Berkshire’s, have explored pay arrangements.”

“Charlie and I believe that papers delivering comprehensive and reliable information to tightly-bound communities and having a sensible Internet strategy will remain viable for a long time.”

Some recommended reading:

“The Outsiders, by William Thorndike, Jr., is an outstanding book about CEOs who excelled at capital allocation. It has an insightful chapter on our director, Tom Murphy, overall the best business manager I’ve ever met. I also recommend The Clash of the Cultures by Jack Bogle and Laura Rittenhouse’s Investing Between the Lines.”

With a recommendation like that, they are sure to be best sellers!

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Zoë Fielding

Not enough jobs for tradesmen to do. Photo: Rob Homer

If you’re renovating or building a home, the Housing Industry Association’s trade report, released on Friday, has some good news.

More bricklayers, carpenters, painters, plumbers and a range of other tradesmen are looking for work than there are jobs to go around. The availability of tradespeople is increasing too, according to the quarterly HIA Trades Report.

That probably sounds great if you are looking to hire a builder, but it’s bad news for the economy more broadly and could have negative effects over the longer term.

Camouflage

The building industry is a major employer for a start. Fewer people actually working in the construction sector has consequences in other parts of the economy such as retail spending and, inconveniently, housing construction. It might mask the true picture of unemployment, too, as people in the industry may register as underemployed rather than unemployed.

The Australian Bureau of Statistics reported that in the September quarter of last year, 343,700 part-time workers across all industries were actively looking for more work. There were 655,500 people unemployed in December, so the number of under-employed added to that is significant.

Shortages

The HIA says the lull in building activity is discouraging builders from hiring apprentices, which will lead to shortages of skilled labour when the building cycle finally turns.

If you haven’t already, perhaps now is time to start those renovation - it might get harder to secure tradesmen in the future, and you’ll be stimulating the economy now, which is good for everyone.

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Patrick Commins

The key to export success is predicting what our big trade partners will want in future. Photo: Michele Mossop

The way to get rich in a gold rush is selling spades and shovels, not prospecting for the shiny stuff yourself. Australia has done a lot of digging in the past decade and has made a lot of money selling iron ore and coal overseas, particularly to China.

But with a maturing Dragon’s appetite for raw materials flagging, the big money in the coming decades will be in selling Australian mining expertise and advanced machinery to countries that are developing their own extraction resources industries, such as those in Asia, Africa and Latin America.

According to an HSBC report on future trends in global trade, industrial machinery exports will be the third most important contributor to Australia’s total export growth between now and 2020 after non-ferrous metals (such as copper and nickel) and mineral fuels (liquefied natural gas). And then it is expected to overtake mineral fuels to be the second-biggest export growth driver in the 2020s.

Most of that mining expertise tends to exist within the large mining companies, although there could be increasing opportunities for mining services businesses to sell to our region.

As Asia’s economic growth and urbanisation moves towards the next stage of industrialisation, base metals such as copper and nickel will be among Australia’s top export earners by 2030 and “will be used in the manufacture of higher-end goods like electrical equipment, stainless steel, batteries and electric motors for Asia’s growing consumer market”, the HSBC report says.

LNG exports are predicted to contribute 20 per cent to Australia’s export growth by 2020.

Our trade future will become ever more tied into our region, as developed world demand stagnates. By the end of the next decade China, Japan, Korea and India will remain our top export destinations, but Malaysia will have replaced the US as our fifth most important customer.

Patrick Commins

High-flying stocks can suffer the Icarus effect. Illustration: Christopher Nielsen

Select Harvests, ClearView Wealth and Australian Education Trust are the three ASX-listed companies trading at 52-week highs, according to S&P/Capital IQ data as at market close on February 26. (We limited the search for listed firms with a market capitalisation above $100 million.)

At $2 per share, Almond farmer Select is trading 45 per cent above its annual low of $1.10, despite announcing a $19.5 million loss at its recent interim results, including a $27.9 million write down of a West Australian almond orchard. Local agribusinesses have attracted interest from big global players, perhaps attracted to the low valuations that Australian investors place on the sector.

Stock in wealth management firm ClearView Wealth has been driven up courtesy of a private equity firm, which bought 80 per cent of the company late last year. The industry has had a strong year as the local market has roared back to life and reignited individuals’ interest in shares and building wealth.

Listed property vehicle Australian Education Trust looks to be back after copping a beating after the collapse of ABC Learning Centres – its biggest tenant at the time.

Other names in the high-flying club are CSL, Primary Health Care, truck and trailer parts company MaxiTRANS Industries, oil and gas explorer Sundance Energy, ophthamology services provider Vision eye Institute, engineering contractor Logicamms, and childcare centre operator G8 education.

Just as a stock trading at or near its 52-week share price lows can be great value or a great value trap, those flying high can either be on the up-and-up or on the verge of a nasty correction.

Price, after all, can only tell you so much about value.

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Zoë Fielding

Banks control their cash to get the best returns for themselves. Photo: Phil Carrick

If you’ve ever wondered what the Reserve Bank of Australia’s official cash rate has to do with the rate you pay on your mortgage or how much you get on your term deposit, RBA assistant governor, financial markets, Guy Debelle, explains it extremely well.

In an address at the business school at the University of Adelaide on Tuesday morning, Debelle set out the way the RBA controls the supply of money to enforce the official cash rate.

Funds take a trip

“Banks have deposit accounts with the Reserve Bank called exchange settlement accounts,” he says in the speech. “These are the accounts across which the myriad of transactions in the economy are settled each day. When you pay your electricity bill by direct debit, the funds are effectively transferred from your bank account, across the exchange settlement account of your bank to that of your electricity company’s bank and into the electricity company’s account.”

In simplistic terms, the RBA effects the cash rate it wants by controlling the interest paid on balances, and charged on borrowings, in these exchange settlement accounts. It also controls the amount of money available.

Anchor point

“The cash rate is effectively the anchor point for all interest rates in the economy,” Debelle says. “Banks fund only a very small part of their operations in the cash market, but ultimately all their funding can be arbitraged back to the cash market.”

That means that if the banks can get a better return on their money - accounting for risk - than they can by leaving their money in the exchange settlement account, they’ll take it.

“If this were not the case, a bank would be better off funding itself overnight and rolling that funding every day,” Debelle says.

Not that simple

Factors such as competition for deposits also influence the interest rates that banks charge and pay.

“Over the past five years, there has been quite a material change in a number of these [other influencing] factors, so that while changes in the cash rate are still the predominant determinant of changes in lending rates, the relationship between them is not one for one,” Debelle says.

Lending rates are influenced by the cost of other sources of bank funding, the banks’ assessments of the risk that the mortgage will not be repaid, and a profit margin for their shareholders.

These other factors have prevented banks from moving deposit rates in lock step with the cash rate in the past few years, Debelle says.

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Patrick Commins

Maybe you’ll love these stocks that are out in the cold. Eduard Kroniyenko

Sometimes you’re hot, sometimes you’re not; these are the stocks most out of favour today.

Two biotech companies are the least favoured stocks in the market right now: Nanosonics and Pharmaxis are trading at, or a whisker above, their 52-week trading lows.

Nanosonics develops decontamination and infection-control products for the healthcare industry. Its shares are trading at 47¢ – well below the 58¢ high for the year – which it recorded on May 3, 2012 (when it spiked briefly). The company is growing sales but is yet to turn a profit.

Analysts’ consensus

The consensus recommendation of the three analysts covering the stock is “buy”, according to S&P Capital IQ data. The contrarian investors at Orbis Investment Management increased their holding in the company by a quarter in early December, and now hold a little under 10 per cent of its issued stock.

Shares in Pharmaxis, another small biotech yet to make a profit, at 56¢ are going for only 40 per cent of the 52-week high.

The firm is developing products for the treatment and management of respiratory diseases, such as asthma and bronchitis. Institutional investors hold over 80 per cent of the stock, led once again by Orbis with 19.4 per cent of the issued shares, according to S&P Capital IQ data. The consensus opinion of the eight analysts covering the stock is “outperform” (one notch below buy on the Capital IQ scale).

Powerful bounce

Also out of favour are gold explorer Gryphon Minerals and consumer products manufacturer (of such as brands Sunbeam appliances and Oates) GUD Holdings. Traditional, long-term investment managers AFIC and Argo are the largest shareholders in GUD, with about 5.5 per cent of the issued stock between them.

More surprisingly, SAI Global is also on the least favoured list. The international standards firm is usually considered a defensive play, and so should be well in favour given the market’s current predilection for safety. That said, the stock has bounced powerfully since its midyear results announcement.

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Zoë Fielding

Shares in electronics and entertainment retailer JB Hi-Fi soared 17 per cent in a day. Photo: Glenn Hunt

The retail sector was unloved by investors through much of 2012 but there has been a marked turn around during the latest reporting season. Expectations are growing that better days are ahead for the sector.

Turnaround story

Super Retail Group this week reported a 74 per cent increase in net profit after tax to $60.6 million in the half year to December 29. It had earnings per share growth of 35 per cent for the half year and declared a 17¢ per share dividend, up 31 per cent compared to the previous corresponding period.

The company has been a turnaround story since October, when it acquired the Rebel Group. Its stock has rallied strongly since then.

Shares in electronics and entertainment retailer JB Hi-Fi soared 17 per cent in a day after it reported better than expected results at its half-year profit announcement. The company’s stock had been one of the market’s most heavily short sold.

Analysts at Commonwealth Bank increased their rating on JB Hi-Fi from “neutral” to “overweight”. JPMorgan lifted their rating from “underweight” to “neutral”. Meanwhile, UBS downgraded from “buy” to “neutral” and CLSA said the shares were now overvalued.

Luxury retailer Oroton’s share price has been rising steadily since mid-August, when it crashed after having lost its exclusive distribution deal for Ralph Lauren. Investors will be waiting to hear how it is travelling when it reports in March.

Rough seas

Surf brand Billabong is a notable exception. It posted a $537 million first-half loss on Friday, and cut its guidance. The retailer did not declare an interim dividend. It said in a statement to the ASX that it was facing difficult trading conditions in Europe and the performance of its Nixon business had not met expectations.

Members of the retail property sector (the shopping mall owners who make a living out of retailers) are optimistic about the coming year.

Michael Bate, head of retail at commercial property manager Colliers International, told a meeting of retail property specialists on Friday morning to expect a pick-up in retail sales.

Retail sales growth typically closely tracks consumer confidence levels. As sentiment falls, consumers spend less; conversely, when people feel more confident, they spend more at the shops.

Confidence returns

Retail sales rose by 2.5 per cent in December 2012 compared with December 2011, according to data from the Australian Bureau of Statistics. However, that was slow in comparison with longer term trends.

Bate says that, while spending is still sluggish, consumer confidence has lifted to the highest levels since 2009-10.

Subsequent interest rate cuts, while slow to have an effect, have finally started to encourage consumers to loosen their purse strings.

“On the back of money starting to come back into the economy, that gap [between rising consumer sentiment and sales] will start to narrow,” he says.

Resilient

Bate argues that the retailers that are now operating in Australia are more resilient than they were before the financial crisis. There have been 38 retail collapses in the past 18 months, leading to more than 500 store closures.

“Retailers are smarter and wiser,” Bate says. “The ones that didn’t adapt have been weeded out and the ones that are left are stronger and have strategies.”

The retail landlords are hoping that the strong results from retailers will flow through to their own shopping centres.

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Zoë Fielding

Saving for retirement is often a fast sprint after a sustained effort. Photo: Lionel Bonaventure

How long will your retirement savings last? Do you know how much you’ll have when you retire? Or how much you’ll spend?

Nearly 60 per cent of Australians expect their savings to run out just 11 years into their retirement, a survey by HSBC has found. That’s a scary statistic when the average person lives 21 years in retirement and many people live a whole lot longer than that.

A pittance

We’ve had compulsory super for more than two decades now but still, the average Australian expects their super to constitute just 20 per cent of their retirement income. Most people will rely on the government pension for 30 per cent of their income, while they’ll get the rest of their income from cash savings, property, shares and other investments.

It may or may not be a good idea to top up your super. It all depends on your own circumstances, but regardless of how you prepare, it’s a good idea to focus on the very long term – as in the rest of your life – when you’re making strategic investment decisions for yourself.

Long and small

Look for those long-term opportunities in share investing but remember to diversify your portfolio. And minimise fees and tax - they can erode savings very quickly and are often overlooked by people focusing solely on investment returns.

The pension may not be available forever. With an ageing population, there are big question marks over how sustainable it will be to have fewer working people supporting a larger population of retirees. That’s part of the reason why super was introduced in the first place.

The message seems to be getting across to the younger generations. Of the 25-34 year olds surveyed by HSBC, the average respondent expected 19 per cent of their income to come from the pension. In comparison, the average 45 to 54-year-old expected 45 per cent to come from the aged pension.

‘Never saved’

Unfortunately, many people are still not doing much about it. More than half of the Australians surveyed said they had never specifically saved for retirement outside of their compulsory super contributions. About half of those people said that was because high living costs were holding them back.

If that’s you, think small to begin with. You might find you can save more than you thought by making minor changes. Every little bit counts, especially when compounded over a number of years.

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Patrick Commins

Some markets, like our own, might cool this year. Photo: Pawel Kopczynski

The world’s most influential professional investors expect the Australian market to return 6 per cent including dividends to shareholders in 2013, according to a survey conducted by leading global investment consulting firm. With the S&P/ASX 200 already up 10 per cent so far this year (before dividends) that’s a pretty bearish figure.

But perhaps investors should temper their expectations a pinch. Many of us have effectively forgotten about the potential for another crisis in Europe, and the effect that would have on sentiment, which, let’s face it, remains a key determinant of sharemarket returns.

Guarded optimism

So while the global money men were “guardedly” optimistic, according to Towers Watson, a “significant number” of the 169 investment managers told Towers Watson they still expect a sovereign debt default in the eurozone and for weak fiscal conditions to continue in the US, UK and Japan.

This echoes similar warnings published in this blog from Vanguard’s chief economist for Europe.

The expected return from our market is the same as that predicted for investors in the UK or Japan markets, while the eurozone and US are expected to generate 7 per cent each (the strong preference, though, is for the US market). Chinese equities are the pick of the bunch with an expected return of 10 per cent.

Four-fifths of investment managers were “bullish” on emerging market equities in the coming five years, and “bearish” on nominal government bonds. The consensus is for Aussie government bond yields to be 3.3 per cent in 2013 (currently 3.61 per cent).

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Zoë Fielding

Even the experts don’t know how the cards will fall for Europe. Photo: Daniel O’Brien

The good news is that there’s an 80 per cent chance that conditions in Europe will keep on improving and the region’s sovereign woes will stay out of the headlines.

Vanguard’s chief economist for Europe, Peter Westaway (who is in Australia this week) says that, while the situation in Europe has stabilised, there are still considerable risks.

Westaway estimates there’s a 15 per cent chance that Europe will drag itself out of its crisis without any further hiccups along the way; and a 65 per cent chance of a “muddle through” outcome, where matters on the Continent are sorted out over the medium term, with a few false starts and detours.

Malign environment

However, there’s still a 20 per cent chance that it’ll all fall apart and the European recovery will (eventually) come out of what Westaway describes as a “malign” environment.

“[Any recovery] is always going to be fragile because of the politics. Politics dogs this crisis,” he says.

At the moment, all of the political parties in power in the region seem committed to the union but, with around 70 different parties making up the various coalition governments in Europe, there are a lot of different views that need to be aligned.

If one of the more “fringe” groups in Greece of Italy or even Germany that want their country to exit the European Union gains more power, that could throw the region back into a panic.

Any more jitters in Spain’s heavily indebted banking system would also cause instability.

Investment implications

If you subscribe to the view that Europe’s all on the mend, you might be thinking about investing heavily in equities in or exposed to the region. But then if it all goes bad, you might be sorry you did: remember what happened to equity markets last time investors thought Europe was getting close to the edge?

On the flip side, if you’re pessimistic about the prospects, you’d avoid Europe and perhaps equities altogether. But that risks missing a rally if the area does recover well.

Westaway says he looks at the data and considers the risks and outlook for Europe all day, every day. That’s his whole job – but he says he’s not sure what’s going to happen with certainty.

So what does he suggest investors do?

“The economic environment –whether you are talking about Europe or globally – is incredibly uncertain,” Westaway says. “We need to keep our options open and not have out portfolios too much on one or another. Stay diversified. Stay the course.”

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pATRICK cOMMINS

The Oracle of Omaha sees a bright future in agriculture. Photo: Scott Eells

Warren Buffett’s Berkshire Hathaway has increased its exposure to global food and foodstuffs with a new $US163 million investment in multinational agribusiness firm Archer Daniels Midland, or ADM.

Regulatory filings with the US Securities Exchange Commission for the three months to December reveal Berkshire bought close to 6 million shares at an average price of around US$27. Over the quarter, the famed investment company also increased its exposure to leading agricultural machinery firm Deere & Co (as did renowned hedge fund manager Jim Chanos). Berkshire had initiated its position in Deere in the previous quarter.

ADM is one of the world’s leaders in agricultural processing, servicing the globe’s increasing demand food, feed stock for animals, and alternative fuels.

From clinics to aircraft

In other movements, Berkshire increased its holdings in dialysis clinic operator DaVita (the fund’s ninth-largest exposure) by a third, satellite broadcaster DirecTV by 15 per cent (tenth-largest holding), and National Oilwell Varco (the US’s biggest maker of oil-field equipment) by 27 per cent.

Berkshire added to its holdings of Precision Castparts, whose castings are used in every jet aircraft engine program globally, and initiated a new position in Wabco Holdings, which makes braking and transmission products for the commercial truck market. Buffett’s already massive holding in General Motors was upped by 50 per cent, while big holdings in Wal-Mart and Wells Fargo Bank were also bumped up.

A different beast

On the other side of the ledger, Buffett slashed his long-time holding in Johnson & Johnson by 95 per cent and sliced a further 11 per cent off another stalwart, Procter & Gamble.

The “Oracle of Omaha” said he was only involved in the changes to the fund’s biggest holdings, but was the driving force behind the fund’s massive bet on IBM over the course of 2012.

Buffett is increasingly ceding control to two investment managers, Ted Weschler and Todd Combs. Another active trading quarter – relative to Buffett’s preference to “hold forever” preference – reflects the increasing influence of these two and suggests the Berkshire Hathaway of the future may be a slightly different beast once the 82 year-old Buffett leaves the firm.

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James Frost

SPAA chief executive Andrea Slattery ... ‘We believe super should have the same status as the family home’ Photo: Erin Jonasson

The growing political influence of the self-managed super fund movement was on display at Crown Casino’s Palladium last night, as more than a thousand professionals applauded a new push to keep super safe.

With the government hell-bent on winding back at least some of the concessions available, the SMSF Professionals Association of Australia (SPAA) launched a campaign to convince Canberra to keep its hands off Australia’s $1.4 trillion pool of super.

Marshalling forces

In a rousing speech, SPAA chief executive Andrea Slattery said that the group would not tolerate super being used as a honey pot and marshalled Australia’s 1 million SMSF trustees to keep super sacrosanct.

“We do have political clout” she thundered. “We believe super should have the same status as the family home,” she said to rapturous applause.

This new campaign follows hard on the heels of a minor win for super savers after the government ruled out removing tax concessions on superannuation for Australians over the age of 60.

SPAA is claiming the win for itself.

Despite the last-minute cancellation of Financial Services and Superannuation Minister Bill Shorten at last night’s event, it’s evident that SPAA has the ear of the government.

It would however be naive to think that the government had not already identified what measures the electorate would find more or less palatable after being softened up by the leaks splashed across the front pages in the preceding days.

A slight problem

SPAA does tremendous work in the space of professional accreditation, research and advocacy for SMSF sector.

The problem with this campaign as I see it is that SPAA doesn’t actually represent the 1 million self-managed fund members: SPAA is a professional services body that represents the accountants, auditors, financial planners, lawyers, actuaries and administrators.

SMSF members are by definition individuals with a range of different views.

There is no question that there are fund members out there who support the winding back of some of the more generous concessions available in super, which are expected to cost the government as much as the pension in forgone income in the next two years.

A view at direct odds with the SPAA campaign.

The interests of the two groups are, for the most part, aligned. But that won’t always be the case.

While SPAA is a fantastic body for the professionals who service the sector, DIY fund members might want to be cautious about hitching their wagon to this emerging and powerful group.

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Patrick Commins

Blue-chip stocks have charged ahead.

When investors’ appetite for risk returns, it’s the smaller companies that bounce the highest.

Not so this latest rally. The benchmark S&P/ASX 200 index ambled over the 5000 mark yesterday but – as a number of market watchers are pointing out – this bull market has a decidedly bluish tinge.

Yo-yo’s

With less durable business models and balance sheets, the market minnows’ share prices are more exposed to the business cycle and yo-yo’ing investor confidence. That translates into higher volatility in share prices – which works against you in bear markets and for you in bull markets.

But as the Bloomberg chart below show, the S&P/ASX Small Ordinaries Index is up 10 per cent since the market began its run in mid 2012. In contrast, the equivalent top 50 index is up 25 per cent, which has driven the All Ordinaries Index’s return of 22 per cent.

This lends support to the already consensus view that investors are returning to the equity market, but very carefully, and with a strong preference for blue-chip yield plays.

Risk ‘less-off’

This is not so much a “risk-on” rally as a “risk-less-off” one. We’ll need more than falling deposit rates and less scared investors for the rally to trickle down to the smaller end. Much will depend on the economy, and in particular commodity prices and the Aussie dollar.

Patrick Commins

Looks good... but it’s a trap! Photo: Gabriele Charotte

Young Australians beware: ticking that box to put your super into a “low risk” investment option is the riskiest thing you could do. This mind-bending piece of information comes from AustralianSuper, the two-million member superannuation behemoth.

The definition of “risk” is a many-splendoured thing in financial circles but, when it comes to investment options in super, it refers to the expected volatility of returns. In that way, shares can bounce all over the place and so are “high risk”. Term deposits, on the other hand, are clearly “low risk” on this measure.

More than volatility

But when it comes to saving for retirement, you shouldn’t be choosing where to invest your savings based on expected volatility alone. The boffins at AustralianSuper point out that there is another risk a super fund member should be thinking about: the risk that your returns won’t beat inflation. The associated worry is you won’t earn enough to provide the money you need in retirement.

Thus, a 25-year old going for the “low risk” investment option of term deposits will experience little volatility over the next 40-odd years, but will also experience very little in the way of returns. That could be a disaster for their retirement plans.

A bad skier

It’s natural that a young person with little experience with financial markets would gravitate towards an investment option labelled “low risk”. I am a very bad skier – it makes sense for me to head towards the low risk routes once at the top of the mountain.

No surprises, then, that of the 800 people surveyed by AustralianSuper, half would choose an investment option labelled “low risk”. What if it were labelled “low return”? Would they then?

New labelling

That’s why Aussie Super is “urging all super funds to ensure the labelling of risk for each of their superannuation investment options includes not only measures of volatility or short-term risk, but also inflation, which is the long-term risk”.

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Zoë Fielding

The turnaround in share market fortunes has come as a welcome relief for investors.

The S&P/ASX 200 Index added healthy capital gains of almost 15 per cent in 2012. And that was just a middle-of-the-road performance compared with other global markets.

Over the very long term, Australia’s markets have performed exceptionally well: the Australian share market has delivered a real return of 7.3 per cent a year over the 113 years since 1900, according to the Credit Suisse Global Investment Returns Yearbook for 2013.

The only other market that performed as well as that was South Africa’s. The world average over that time frame was a 5 per cent gain, according to the Yearbook.

Source: Credit Suisse Global Investment Returns Yearbook for 2013

Of course, past performance is no indicator of future performance, as the old saying goes.

Elroy Dimson, Paul Marsh and Mike Staunton (the academics at London Business School who put together the yearbook) believe we’ve been rewarded too well by equities.

“Six per cent has often been seen as the equity risk premium but they say it’s too high,” says Credit Suisse’s head of strategy and research Australia, David McDonald.

(The 6 per cent figure is widely accepted to be the annualised premium that equity investors have been rewarded with compared to Treasury bills, the risk-free rate over the long term. The academics note in the Credit Suisse Yearbook that this was influenced by research in the Ibbotson Associates Yearbook of early 2000.)

Dimson, Marsh and Staunton say the risk premium is closer to 5.3 per cent, as the Ibbotson research focused too much on the US share market’s performance. They believe the equity risk premium that investors should expect from now is more like 3.5 to 4.5 per cent over bills.

Given that cash rates are expected to stay lower for longer, the academics say many return projections by super funds and asset managers who promise to beat inflation by 6 to 8 per cent are unrealistic.

So what should investors do?

McDonald says investors should stick with shares anyway.

“You are getting close to a level where cash is a negative real return,” he says. “[The share market] fundamentals are attractive in the sense that it’s more attractive than the alternatives.”

Credit Suisse expects the Reserve Bank of Australia to cut interest rates by a further 75 percentage points, in three more cuts.

For fixed income, McDonald prefers corporate credit to bonds. Many major company balance sheets are in better shape than their governments’, says Stephen Cabot, head of investment consulting for Credit Suisse’s private bank.

Investors are still aiming for yield stocks. The private bank has started splitting its recommendations into “defensive yield” sources, which deliver predictable and reliable income, but are less likely to increase their distributions, and “dynamic yield” from companies that are expected to be able to achieve higher earnings over time.

Globally, stocks that fit the defensive yield category include GE (which yields about 3.5 per cent), McDonalds (3.4 per cent), Shell (which delivers 5.5 per cent dividends) and Vodaphone (with a yield of about 6 per cent).

Patrick Commins

Ready to rampage. Illustration by Simon Bosch

One in two investors say they will increase their exposure to Australian shares in the next month, according to a survey on investor intentions conducted by Investment Trends.

Investors are the most confident they have been since the monthly survey began in late 2009 – for the first time, more say they intend to reduce their cash pile than increase it.

This time last year, individuals were expecting a 2 per cent return from the market, excluding dividends. In 2012, the All Ordinaries Index rose 13 per cent.

The survey reveals shareholders are now expecting to earn 7 per cent before income this year, a big jump from the 5 per cent forecast only a month before. Expectations of 12-month returns have languished between 2 and 5 per cent since late 2011.

US individual shareholders are also feeling more confident of late, but have pulled in their horns a little over the past couple of weeks.

Every week, the American Association of Individual Investors (AAII) asks its members whether they are feeling “bullish”, “bearish” or “neutral”. Recently more than half said they were feeling “bullish” on the market – the highest in about a year.

But most striking about the survey is how volatile the results are: those declaring themselves bullish has dropped 10 percentage points in the past two weeks alone, to 42 per cent; two months earlier, it was 29 per cent.

Almost 30 per cent say they are bearish – pretty much spot on the long-term average (the long term average “bullishness” is 39 per cent).

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Investors can’t wait to find out what goodies reporting season will bring. Photo: Jacky Ghossein

Companies’ quarterly reporting season is now under way and share investors are watching for news of the market’s underlying performance and potential.

Analysts have warned that there could be setbacksfollowing the rally in shares over the past 12 months. Others point to success stories that will emerge.

What is clear is that consumer sentiment has been improving dramatically, albeit from a very low base.

A survey conducted by researcher Investment Trends at the end of December found regular investors expected the share market to gain around 5 per cent in the next 12 months.

Pleasant surprise

For the past 18 months, people have been expecting gains of between 3 and 4 per cent – they’ve been pleasantly surprised so far.

The S&P/ASX 200 has been up just over 6 per cent since the start of this year and about 4 per cent since the start of reporting season.

Telstra for one, described by institutional fund managers as one of the most important for this reporting season, has not disappointed.

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