Investing in tough times

With the turmoil in investment markets over the course of 2008, many investors will be asking “when will it all end?” or “when will we see a return to more stable markets?”

Back in November 2007, the Australian All Ordinaries Index peaked at 6873 points. At the time of writing this article, as at 7th July 2008 it is at 5091 points, almost the lowest point in the current cycle. Many headlines will be screaming out the news that the sharemarket has “crashed” or “plummeted” by 26% since last November!

Very emotive sentiments. If you invested in the All Ordinaries Index back in November 2007 and sold your investment now, you would certainly have lost money. You would receive back around 74% of what you had invested (before taking into account any fees and charges), however that loss will only occur if you actually sold your investment. If you are still holding the investment you made back in November, then you haven’t lost anything in real terms. You may have a “paper loss”, but an actual loss does not arise until such time as you actually sell your investment.

Let’s look at a simple example: If you bought a house five years ago for $300,000 and you now believe is worth $500,000, and you put it on the market, how much money have you made? You will probably say $200,000. Actually, you have not made anything until such time as a buyer comes along and purchases the property. If you believe the house is worth $500,000, but the best offer you receive is $450,000, would you sell? Perhaps you will, in which case you have still made a profit of $150,000. But you may decide to reject the offer and hold out for more. It is your decision.

The point is, you haven’t made or lost money until you accept the offer and have the money in your hands. For those who believe they are smart investors, perhaps it is now time to be "counter cyclical." That is, to go against the trend and do what everyone else is not doing. With the sharemarket being at a relatively low point, perhaps now is the time to consider going back into the market. The sharemarket is having a “sale”. Shares are cheaper than they have been. We don’t know how long the “sale” will last, or if prices will fall further, but perhaps this is time for the astute investor with some cash available to start re-entering the market. Perhaps it is time to start an orderly approach to investing by “dollar-cost averaging”, making smaller investments at regular intervals (say each month).

Remember, investing in the sharemarket is a long-term investment. Know your investment time horizon and invest accordingly.

Most importantly, before embarking on any investment strategy, take professional advice and ensure that the steps you take are relevant for your overall situation.

A counter-cyclical investment approach is perhaps best summed up in the words of Rudyard Kipling “If you can keep your head when all about you are losing theirs…”

Source: Peter Kelly – Professional Investment Services

Economic update

Inflation in Australia is now above the target band - both headline and preferred underlying measures.

That is why the Reserve Bank of Australia (RBA) has said a period of slower growth is necessary to ensure inflationary expectations remain anchored and can trend back down through next year.

The RBA has tightened official rates 1% since last August in spite of all the events unfolding elsewhere. The credit/liquidity crisis has seen retail bank funding costs rise and so more than the official 1% has been passed onto borrowers.

The medium term fundamentals remain excellent, but the next 6 - 12 months may well be more difficult.

The US economy has slowed appreciably, and whether it will technically go into recession is hardly important. The housing market weakness persists, consumption has taken a step back, confidence measures have fallen and job losses are coming through.

The European Central Bank remains concerned about the inflation outlook. The mix of a strong Euro and stubbornly high inflation make any near term ECB rate cut difficult. If the hard economic numbers weaken further, the ECB may be in a position to forecast a lower CPI profile and then potentially cut rates.

With Japan’s official cash rates at just 0.50%, policy makers continue to point to the very accommodative nature of policy, but the recent weaker growth profile probably means an extended period of no policy change.

Source: Navigator

Government’s assistance for working families

When Treasurer Swan brought down the Government’s budget on 13th May 2008, two of the announcements included the introduction of an Education Tax Refund to assist working families, and changes to Child Care benefits.

Education Tax Refund

This scheme, which takes effect from 1st July 2008 represents a $4.4 billion investment by the Government.
Eligible families will be able to claim a refund of up to 50% of the cost of certain education expenses, subject to a maximum cost of $750 for each primary school child, and up to $1,500 for each child in high school. The maximum refunds are therefore $375 for each primary school child and $750 for those children in high school.
Expenses that are eligible to be claimed include laptop computers, home computers and associated costs, home internet connection, printers, education software, trade tools for use at school, school text books and stationery. To be eligible to claim the Education Tax Refund, means testing applies to the parents. In essence, parents who are eligible to receive the Family Tax Benefit Part A (FTB A) will be able to claim the refund. Parents who would have been entitled to FTB A, but for the fact their child receives Government payments such as Youth Allowance, Disability Support Pension or ABSTUDY Living Allowance, will also be eligible to claim the Education Tax Refund. Whilst the Education Tax Refund will be administered through the tax system, parents who are not required to lodge a tax return will be able to claim their refund on a separate form to be issued by the Australian Taxation Office.

Child Care Benefits

The payment of Child Care Benefits has changed from 7th July 2008. Previously, Child Care Benefits reduced to a minimum level once income exceeded a prescribed threshold. The changes have seen the removal of the minimum payment. In general terms, once a family’s income exceeds $126,793 (higher income levels apply for families with more than one child in approved child care) the Child Care Benefit will no longer be payable. To be eligible for the Child Care Benefit, the claimant for the benefit must meet a work, training or study test along with other criteria. Even though families may no longer be eligible for Child Care benefits because of their income, they may qualify for the Child Care Tax Rebate.

Child Care Tax Rebate

The Child Care Tax Rebate is designed to assist families with the costs of child care.
From 1st July 2008, the Child Care Tax Rebate will cover up to 50% (up from 30%) of out-ofpocket child care expenses for approved child care. The maximum rebate is $7,500 per child per year. In the 2007/08 financial year, the maximum rebate was $4,354 per child.
The payment frequency of the Child Care Tax Rebate has also been increased effective from 1st July 2008. Where previously a payment was made annually, the Rebate will now be paid to eligible recipients each quarter.
The Child Care Tax Rebate is not income tested.
The Government provides a number of benefits to assist families with costs associated with raising children. Some of these benefits can be significant in financial terms. If you are raising a family, speak to your financial adviser about the additional financial assistance that may be available to you and your family.

Source: Peter Kelly – Professional Investment Services

The BIG questions

Members of the Colonial First State investment team answer some of the big questions when it comes to the current market climate.

Have we seen the bottom of the market?

Look, I’d like to put my hand on my heart and say the market will not fall from here. I can’t honestly do that. The market has seen a good recovery since mid March. You remember in January and February as interest rates rose, the share market fell. In mid March investors came back into the market. What happened? The US authorities took actions to help protect their financial system. That gave investors a fair degree of confidence that the crisis was over and as that confidence increased, people started moving back into the share market and prices have risen. There are still some potholes, there are risks out there, but maybe we have seen the bottom.

Are interest rates likely to keep rising?

Trying to forecast interest rates is a difficult job, it’s almost a fool’s job trying to work out all the forces that impinge upon interest rates and inflation. Let’s keep in mind that the Australian economy has been growing solidly for 15, 16 years now. That’s starting to see inflationary pressures and to counter those inflationary pressures the Reserve Bank raised interest rates, most recently in late 2007, and early 2008. They were the real crunches that have hurt consumers and businesses. The aim of those higher interest rates is to slow the economy. The purpose of slowing the economy is to ease the inflationary pressures. So if those rate rises work and the economy does slow then there won’t be a need to raise them further. But if the economy keeps booming ahead and we see more inflationary pressures, then the Reserve Bank might be forced to raise interest rates again. We can’t be sure until we see the full impact of the last round of interest rate rises.

When is the share market likely to recover?

I get asked the question “When is the share market likely to recover?” a lot. By that I assume that people mean when will it get back to the highs that we saw late in 2007. The truth is, parts of the market are already there. The resources sector led by BHP, Rio Tinto, Fortescue and so on is already back at the levels of last year. We’ve also seen a strong recovery in the banks - they’re not quite there yet, but confidence has come back into the financial sector. What’s holding us back are the consumer related companies - the Woolworths, the Harvey Normans, the Nick Scalis of this world. Because of higher interest rates, their customers aren’t buying as much. I always try to keep these things in perspective - markets go up, they go down a touch, but they grow with the Australian economy, it moves in cycles. Over time, as the Australian economy adjusts to the interest rates that we have, those consumer stocks will pick up as well. Keep things in the long-term context; ask yourself where will the Australian economy be in three, five years time? Will those companies that are the laggards now have picked up by then? The probable answer is yes. There’s a lot of strength in the Australian economy, the resources sector is booming, the consumer sector now needs to catch up. It’s hard to put a precise date on it but we will probably look back in a few years time and wonder what the fuss was, because markets do set new records over time.

Source: Colonial First State – Hans Kunnen - Head of Investment Markets Research

How should investors react to these market conditions?

Investors should actually just think about why they originally invested in these funds. People invest in fixed interest funds and bond funds, because they want the income stream that these funds offer. When we buy a bond, we’ll lend money to somebody, lend money to a bank as with a term deposit, they will undertake to pay us an agreed rate of interest and give us our money back at the end of the day. So the income that we earn from these bonds is fixed. The only real risk you face is that of defaults. If they were to default and therefore not pay you the interest, or not pay the principal back on maturity, then clearly that’s a loss that you will incur. What has happened now is that interest rates have gone up and there’s been a capital value adjustment in the bonds. Despite this, cash flow, the actual interest that’s being earned on those bonds, and the probability of those bonds being repaid at maturity, has not radically changed. In fact, we invest in a lot of banks bonds, so you know they’re the same as a term deposit in that the bank has undertaken to pay us an agreed amount of interest over a certain period of time and give us our money back at the end of the day. So the bottom line for investors is, if you invested in these funds for the income stream they’re going to offer you, that income stream is intact. What it does offer is some further opportunity for the future.

Source: Colonial First State – Tony Fitzgerald Co-Head of Global Fixed Interest & Credit

The information in this newsletter is current at the time of publishing. Contact us for updates.

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