We now have the New Year well and truly behind us. When we look at the year ahead, it is easy to get lost in things outside of our control, and most of these issues are not new. This is particularly debt problems in Europe, which have been with us for some time and are likely to be here for decades. I believe the two main factors that will impact us in the coming year are tapering in the US Quantative Easing program and Federal Politics in Australia.
The US Quantative Easing (QE) program is in effect the US Government lending themselves billions of dollars a month. This is a technical mechanism and there is lots written in the media and by experts on what will happen when they stop this. If I read this correctly this has not happened before, so by definition the outcome is unclear.
QE can’t go on forever so it is not a matter of if they will slow and stop it but when. If you listen to the statements from the US Fed, they will do it when the US economy is improving. From what I can see the US is improving and we have seen the start of reducing QE. As we have not seen Quantative Easing at this level before then this also means we haven’t seen is slowing (tapering) or stopping. So this creates some uncertainty, and as a result we can probably expect to see market volatility and noise in the media during this period.
Probably the main issue for us is the change in direction in Australian Government Policy following the change from Labor to the Abbott led government last year.
There are a number of issues which gives us an indicator as to the Abbott Government’s priorities, being;
– Reducing government intervention in business and give business more flexibility;
– Stop spending more than the government is earning;
– Stopping throwing good money after bad on ventures that add little or no value to Australia.
We saw the Rudd/Gillard government add policy and services, then look for ways to raise taxes to fund the policies and hence we ended up with Government debt and an annual budget deficit. We have been wary of tax rises, which we have seen in areas such as reduced Health Care rebates, lower super contributions etc. Whilst this is not off the table for the current government they have shifted focus to reduced spending which means fewer services.
The catch cry is end to “era of entitlement” and moving from “equal outcomes to equal opportunity.” As they do not control the senate we can expect to see significant horse trading with Labor and the minor parties.
We can reasonably expect changes in the free safety net that has risen in recent years looking at big spending areas such as health, unemployment, disability and age pensions and throwing good money after bad at industries that should have died long ago.
I expect a significant amount of public debate in this area in coming years and will be interested to see what is proposed in Federal Budget in May.
Looking at investments, low interest rates mean cash is expensive, houses are still expensive and share market has moved from cheap to fair value. We have also seen a rise in the value of house prices in most capital cities in the last year. We want our house to go up in value so we are better off, but we also want houses to be more affordable for our children, clearly a dichotomy. Sydney house prices on a global measure appear to be 30-50% more expensive than they should be. There are a number of factors which have driven this and we do not know is how long will this continue and if it doesn’t what will it look like.
The Australian Stock market has largely been trading sideways for the last year. We had a rally in 2012 when the market was cheap and it has been bouncing along in the fair price range ever since.
In the long run company values are based on profits: share prices rise with company profits, and conversely fall with falling profits. One way to answer these questions is look at the valuation of the stock market.
Whilst it is not possible to pick the top or bottom of markets, it is possible to determine valuation. I attach our current view of the Australian Share Market (Graph 1 below).
Graph 1. ASX 200 Share Price Valuation
Source: Equitas Wealth, 2014
As you can see in the last 18 months by our valuation the share market has been priced fairly which means it is no longer cheap but not overpriced either.
We are seeing improved profits in some sector such as Banks and Telco’s. We have started to see companies moving from a focus on cost management to looking for revenue drivers in the last year which is a positive sign. This typically happens when conditions are more stable and companies see opportunities, this may be in internal investments or ideas such as we saw in the last few week of Myer having a go at David Jones.
Interest Rates are at a low most of us have never seen before and from statements Australia’s Reserve Bank made earlier this month then we can expect to see rates stay roughly where they are for the coming year. Great for those borrowing money, not so great for those with interest bearing investments such as Term Deposits.
Graph 2. Sydney House Prices 1988 – 2013
In summary, my perspective on 2014 looks like this:
Interest rates will remain at current low levels for the foreseeable future.
The Australian Share Market is still fair value but cannot grow dramatically without company profits growing, and there are early signs of this.
The Federal Government will be looking for ways to do things differently and we can probably expect each of us to bear some of the burden in reduction in services or having to pay extra for them. The Abbott Government’s philosophy is to spend less than you earn and allow everyone to take responsibility for themselves, so if your strategy if heavily reliant on narrow government legislation then it may be worth looking at the risks.
The residential property market is still expensive. Sydney house prices have risen at less than 3% compounding for the last 10 years. At that rate it will take over 20 years to double, so the old adage that property doubles every 10 years is now a thing of the past. Ultimately affordability and lack of new home buyers will dampen growth.
Our outlook continues to remain positive, Australia is in good shape. We have a government intent on supporting those who want to look after themselves, which I think will bring rewards in the mid-term.
As always if you want to discuss this or any other matter, please call me on (02) 9492 0444.