Australian shares - the case for a new bull market
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1 with Australian Unity Personal Financial Services e-newsletter April 2014 Australian shares - the case for a new bull market by Don Williams^, Chief Investment Officer, Platypus Asset Management (reproduced with permission) While acknowledging there are divergent views in the marketplace, we believe the Australian stock market is in the early stages of a bull run that started in the middle of last year, and is set to continue through the remainder of 2014 and beyond. Our view is that the market is primed to reward investors that focus on quality and growth. In fact, we believe, there is lots of evidence in the market that remind us of Underscoring this view are current market fundamentals, in particular historically low interest rates and an improving residential property market, both of which have had a positive wealth effect on the hip pocket of Australian investors. Market fundamentals are solid Low interest rates are unambiguously positive for the Australian equity market, and we expect accommodative rates will remain for some time. This will be the case for as long as the Reserve Bank of Australia (RBA) looks to interest-rate sensitive segments of the market to take up the slack from the end of the mining investment boom. In our view, the RBA is unlikely to start raising rates until there is a substantial pick-up in employment or a significant inflation pulse threatens the broad economy. As such, we expect rates will remain below normal long run levels for some time. At its March 2014 meeting, the RBA all but confirmed this, saying the most prudent course is likely to be a period of stability in interest rates. 1 Interestingly, the dividend yield (including franking) of the market is above the yields of bank term deposits. While this situation persists it can be expected to provide a level of support for the current market prices as the price to earnings multiple is presently close to its long term average of 14.4 times, indicating the market as a whole is not considered expensive. Despite remaining historically high, the weakening currency is also providing a tail wind to the local economy, as a weaker Australian dollar acts as a quasi-easing monetary policy. A sustained lift in global growth, especially one that is driven by ongoing growth in the US, will continue to put downward pressure on the Australian dollar, significantly boosting Australia s competitiveness and export earnings. First stage recovery well underway The initial benefits of a low cash rate and lending costs can be observed in the residential housing market, which is often the first stage of a recovery process. Although investors have primarily driven recent price movements, Chart 1 shows building approvals are also up, which will improve supply. Private building approvals, which include renovations and new builds, saw a material pickup towards the end of Looking at the data in a historical context, it appears we are at the beginning of a new housing cycle that is no different to any other we have seen over the past few decades. All in all, we believe the risks of property prices dropping substantially in the short term are low, mitigating the negative flow-on effects to equities. Chart 1 + : Total private building approvals 19,000 17,000 15,000 Number of approvals 13,000 11,000 9,000 7,000 5,000 Page 1
2 Consumer confidence, too, is a leading indicator for equity market performance. While much of the initial spike upwards after the September 2013 federal election has now retreated, confidence has been boosted as personal balance sheets have been meaningfully repaired since the GFC. The effects can be seen in retail figures for early 2014 from the Australian Bureau of Statistics 2, which has shown discretionary retailing sectors outpacing the food-related (i.e. the nondiscretionary) sectors for the first two months of The Australian National Retailers Association noted the strength of the housing market is definitely helping performance at the moment 3. As such, it was encouraged by growth in spending for household goods, cafes and restaurants, clothing, footwear and personal accessory retailing. A new bull market One of the most obvious factors that support our thesis of a new bull market in Australian equities is the flurry of Initial Public Offerings (IPOs) coming to the market. A total of 49 companies listed on the ASX in 2013, compared to 46 in While the increase in absolute terms was slight, and even down on 2011, the amount raised from these new listings was just over $8.5 billion, compared to an average of $2.3 billion for the past five years 4. The issuance was also diverse by sector, suggesting broader market strength. Firms prefer to issue new equity during bull markets, as there is a greater chance of being successful and valuations tend to be higher has started with a strong pipeline of IPOs which we expect to continue throughout the year. Until six months ago the market had been caught in a fouryear technical trading range. The recent break-out (Chart 2) is positive, but it will need to be supported by increased volume and improved earnings expectations to be the start of something bigger. While volumes are still modest, there is mounting evidence the market is beginning to pay for earnings growth. Return expectations for 2014 and beyond With market yields continuing to be attractive when compared to the prevailing cash rate, we believe the hunt for income from Australian equities still has some time to run. And this benefit is further enhanced thanks to franking imputation credits. In addition, company earnings are steadily improving without large valuation expansion. The average forward price-to-earnings ratio (P/E) of the market since the early 1990s is 14.4 times, and at 28 February 2014 the market was trading on 14.5 times. This is not expensive by any means, especially in context of the current expected earnings environment. When companies recently reported their half-year results to the ASX (as at 31 December 2013), we saw the market move from a little over 5100 to just over 5400 in a three-week period. While pauses, such as that experienced in March 2014, are a part of any healthy bull market, the structure of the pullback was still supportive of our thesis. The volatility in the month appeared mostly driven by international events, such as the unfolding uncertainty in Ukraine and Crimea as well as comments from the new chairman of the US Federal Reserve, Janet Yellen. Looking ahead, our longer term view of the Australian stock market is that earnings conditions are continuing to improve. The market will likely grow earnings by low double digits in FY2014. This is a reflection of the broadly positive macro environment for companies, particularly the double impact of a lower currency and low interest rates. To us, the current outlook and trading market conditions feel a lot like 2004 and we believe we re well positioned to capitalise strongly on this for investors. ^This report was written by Don Williams, Chief Executive Officer at Platypus Asset Management, an Australian equities joint venture partner of Australian Unity Investments. 1. Reserve Bank of Australia, Media Release, 4 March Australian Bureau of Statistics, Retail Trade, Australia, February Australian National Retailers Association, Media Release, 3 April IPO Watch, The market for emerging companies, January 2014, HLB Mann Judd Australasian Associates + Source: Australian Bureau of Statistics * Source: Bloomberg, Platypus Asset Management Chart 2*: S&P ASX 300 index BREAKOUT year trading range 2000 Page 2
3 How does our Tipping Point Table currently rate Australian shares? The Australian Unity Personal Financial Services Tipping Point table is the output of our forecasting methodology which helps us assess the status of Australian shares (and other asset classes) based on the investment fundamentals of income and growth in earnings. As the table shows, the higher prices rise, then the lower the returns we should expect going ahead. Similarly, the lower the price you buy at, the higher returns you should generally expect in the future. So we aim to recommend buying when prices offer good returns, and sell slowly when prospective returns are not so attractive. Despite the continuing strong rally in Australian share prices we believe they still represent good value, as you can see by the circle in the Tipping Point table, right. In the long term, buying at these prices should produce attractive returns. We do not know what will happen to share prices in coming weeks or months and no outcome is guaranteed - but we anticipate that quality Australian shares bought at around these levels should show returns of around % per annum over the next decade. This is based on current high dividend yields and an expectation that companies will be able to grow earnings by 4% per annum over the period - notwithstanding that this rate would vary across shorter time frames. These are not lofty assumptions. Of these returns, over half are expected to come from dividends with just over 4% p.a. growth to provide the rest. Even if there is no growth, which would be unusual, Australian shares should provide a better outcome than term deposits and cash over the long term. Australian Shares All Ords Forecast Status Index 10 year return (p.a.) % Overpriced % Fully priced % Fully priced % Fully priced % Fully priced % Fully priced % Fair value % Fair value % Fair value % Fair value % Fair value % Fair value % Fair value % Cheap % Cheap % Cheap % Cheap + No guarantee is implied as to the accuracy of the specific forecasts provided. Data as at April What is our approach to asset allocation? The objective of our unique approach to asset allocation is to help you minimise investment risk and increase the long term return on your portfolio. Our approach is based on the philosophy that: Buying quality assets at reasonable prices is the best way to achieve competitive long term returns It is important to note we do not try to predict when an expensive asset class will begin to fall in price or when a cheap asset will rise in price. Cheap assets can become even cheaper. Expensive assets can become even more expensive. The turnaround may be just months away or it could be a few years away. No one knows exactly when that turnaround will be. For this reason we advise buying cheap assets slowly and selling expensive assets slowly. This gives you the chance to benefit from buying at even cheaper prices or selling at even higher prices. We do not recommend buying overpriced assets just because you have money to invest. Our goal is to buy at lower prices even if that means you have to wait before all of your money is invested. The benefits of our approach There are many benefits arising from our approach, including: Stronger, smoother and more predictable long term returns from your portfolio Reduction in your exposure to overpriced assets and therefore less exposure to significant market falls and bear markets Increased exposure to rising markets. Page 3
4 Shares: Invest for quality income and the capital growth should come A key to being a successful investor in the sharemarket over the long term is to focus on the potential for a growing income. Will your shares generate increasing profits most years? Will the dividends distributed to you grow most years? If the answers are 'yes', there's a good chance your shares will also deliver sound capital growth over time. Here's a case to show you why. As you can see in Chart 1*, the annual income generated by a $100,000 investment in shares since 1983 (with income not re-invested) started off low, but then gradually built up. In fact, last year s income was $44,747, or 44% on the initial $100,000 investment. The reason for the increasing dividends from shares is that quality businesses do not distribute all of their profits to shareholders. They retain some of their profit each year and use it to invest in the business to help it grow. If this is done well, it means they ll have more profit the next year from which they can afford to pay shareholders a higher dividend than they did the previous year. Plus they will again retain some profit for re-investment. So the next year their profits will hopefully be higher again, allowing the company to distribute an even higher dividend while still retaining more profit for re-investment. And even more the next year. And so on. Of course, the more the value of the company grows as a result of the re-investment of the retained profits, the more the market will recognise this and people will pay more to buy their shares. Hence the capital growth. Compare the income stream from shares to a well known income producing investment the term deposit. As shown in Chart 1, a $100,000 investment in term deposits since 1983 did well while interest rates were at historical highs, but then income dropped away to just $4,150 or 4.1% in Compare that to the $44,747 income from shares last year. In fact, since 1983, the $100,000 investment in term deposits generated a total income of just $229,650 compared to $1,084,165 from shares. Add to that the $1,032,961 in capital growth from shares as at 1 January 2014 and you have a total return of $2,117,126 from shares, compared to $229,650 from term deposits, as shown in Table 1. Table 1: Shares ahead by $1,887,476 since 1983* 1 Jan 83 1 Jan 14 Shares Term Deposits Total Income $1,084,165 $229,650 Growth $1,032,961 NIL Total $2,117,126 $229,650 Chart 1: Quality Shares Generate a Growing Income* ($100,000 invested from 1 Jan Jan Income not re-invested.) $100,000 Share Dividends (LHS) Share Value (RHS) $2,000,000 Term Deposit Income (LHS) Term Deposit Value (RHS) $80,000 $1,600,000 Income p.a. $60,000 $44,747 $40,000 $1,200,000 $1,132,961 $800,000 Capital Value $20,000 $400,000 $4,150 $ Year $100,000 * Assumptions and sources: Assumes $100,000 was invested in the relevant index at 1 January 1983 and income was not re-invested. Shares: These figures are derived from the All Industrials price and accumulation indices to 31/12/2001, and then the S&P/ASX XNJ and XNJAI price and accumulation indices. On an annual basis the percentage increase in the accumulation index less the increase in the price index reflects the dividend generated. Franking credits have been ignored. Term Deposits: 1 year Bank Fixed Deposits Reserve Bank Australia. Term Deposit is rolled over every year. Past performance is not an indicator of future performance. Page 4
5 Interest rates we are currently negotiating The tables below indicate the type of interest rates we are currently negotiating on behalf of our clients, as well as the monthly repayments for those loans. Home Loan rates as at Monthly repayments for 9 April 2014* 30 year loans (unless fixed term) for loan amounts of: Basic Rates From Comparison Rate $300,000 $500,000 $1,000,000 Basic Variable Rate 4.83% 4.85% $1,579 $2,632 $5,265 Offset Home Loans 4.74% 5.08% $1,563 $2,605 $5,210 Line of Credit 4.84% N/A $1,581 $2,635 $5,271 Professional Packages 4.74% 5.08% $1,563 $2,605 $5,210 1 Year Fixed Rate 4.49% 5.59% $1,518 $2,530 $5,061 2 Years Fixed Rate 4.64% 4.79% $1,545 $2,575 $5,150 3 Years Fixed Rate 4.74% 5.22% $1,563 $2,605 $5,210 4 Years Fixed Rate 5.44% 5.72% $1,692 $2,820 $5,640 5 Years Fixed Rate 5.69% 5.83% $1,739 $2,899 $5,798 Commercial Loan rates 9 April 2014* Rates From Notes New Business Investment 7.25% Subject to credit assessment Commercial Property Finance 6.1% Subject to credit assessment Agri Business Finance 6.1% Subject to credit assessment *Please note, basic rates do not include any fees and charges payable by the borrower. Not every product has a comparison rate. Whilst these rates are the lowest rates in each category, the product and lender may not necessarily be available for you or be suitable for your needs. A full analysis of your needs is required before suggesting a suitable loan product. WARNING: This comparison rate is true only for the examples given and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate. Are you paying the lowest rate you can for your home or car loan? Or your commercial loan? If you are buying a home or car, or borrowing for your business, or if the interest rate on your current loan is too high, we invite you to have your loan position health checked by us. All you have to do is give our mortgage broker the details about your financial objectives and loan position - we ll then analyse loans from the banks and other leading lenders to find you the most suitable loan we can. We ll call you with the result no later than five business days after you call us. It s quick, it s easy and it won t cost you a cent Our five-step loan process We help you work out how much you can borrow... and which type of loan is right for you We search the major lenders to find you the best rate we can We use our buying power to reduce interest rates even more We do all the paperwork for you You save on your new loan repayments and our service hasn t cost you anything Page 5
6 Why it pays to make sure you have the appropriate definitions for your TPD Insurance Total & Permanent Disability (TPD) insurance pays a lump sum on the insured becoming permanently disabled due to illness or accident. If you become permanently disabled, a TPD insurance payout can help free you and your family from financial worry by paying for things such as medical, pharmaceutical, specialised therapies and rehabilitation costs not covered by your health fund, paying for a carer, funding modifications to your home (e.g. replacing stairs with ramps), repaying debt, and topping up your Income Protection policy payments. Why TPD definitions are important Most TPD policies generally offer one of two definitions, either own occupation or any occupation. An own occupation definition means your claim will be paid if you are unlikely to ever return to your own occupation, which is the one you were engaged in at the time of the injury or illness. An any occupation definition means your claim will be paid if you are unlikely to ever return to any occupation that you may be suited to by experience or education. An own occupation definition is usually preferable, however its premiums are higher, and this option is not available for all occupations. Case Study Denise is a surgeon who has permanently lost the use of her hand and obviously can no longer continue as a surgeon. If Denise has an any occupation definition in her TPD policy, the insurance company could assert that although Denise cannot continue as a surgeon, she could still find suitable employment, for example as a hospital supervisor or university lecturer. Therefore the claim would most likely not be paid. However, if Denise has an own occupation definition in her TPD policy, her claim would be paid. And she could, if she wished, find suitable employment when she was ready. Denise could use the lump sum payout to help her top up her income, pay off her mortgage, and pay for medical and rehabilitation expenses. Note: Your financial adviser can answer any questions you have about TPD insurance, and then calculate how much TPD insurance you need to safeguard you and your family in the event something should happen to you or your spouse. And, if you wish, your adviser will use our sophisticated computer program to broker the major insurers to find you the right cover at a competitive price.* *Insurance cover is subject to eligibility criteria. Cap increase means you could contribute up to $690,000 into superannuation in the next 4 months on a non-tax deductible basis You are currently allowed to invest up to $150,000 p.a. in super as a non-concessional contribution (i.e. you do not receive a tax deduction on this contribution). If you are under age 65, you can bring forward up to two years of non-concessional contributions. This means you could currently contribute $450,000 in one financial year, but you would not be allowed to make non-concessional contributions in the following two financial years. From 1 July this year, the non-concessional contribution cap will be increased to $180,000, and the bring forward rule amount will be increased to $540,000. As a result, you could contribute on a non-tax deductible basis - $150,000 to super before 1 July 2014, and then $540,000 in the new financial year. A total of $690,000. But then, of course, you couldn t make another nonconcessional contribution for another two financial years after that. How much can you invest in super before 30 June 2014 on a tax deductible basis? Contributions which qualify for a tax deduction are known as concessional contributions and the annual contribution limit is aged based, as shown below. Generally you can only qualify for a tax deduction if you are self-employed. However employees can benefit as well by making a contribution through salary sacrifice. The limit includes any Super Guarantee your employer pays on your behalf. Age Tax deductible limit (2013/14) Up to 59 $25, $35,000 Please note that the concessional contribution limits will change next financial year as follows: Age Tax deductible limit (2014/15) Up to 49 $30, $35,000 Page 6
7 Considering entering an aged care facility? New rules could mean you might be financially better off by moving before 1 July 2014 The Living Longer Living Better aged care reforms which apply from 1 July this year will hopefully encourage greater investment in the sector and improve the sustainability of the aged care system. How will the new rules affect residents? The previous federal government claimed that new residents would be financially better off under the new rules due to the capping of fees with an annual indexed cap of $25,000 per annum (as at 20 March 2012) and a lifetime indexed cap of $60,000 applying to the means-tested fee. 1 But in all the scenarios we've compared between application of the incometested fee under the current rules and the application of the means-tested fee post-30 June 2014, the cost of care will generally be more expensive for residents under the new regime. Having said that, the fact that only a portion of the principal residence will be assessed (if not occupied by a protected person) will provide some opportunities to reduce the means-tested fee if the principal residence is retained. Residents will also have a little more choice about how they pay for their accommodation and those with lower means will continue to have their fees met in full or in part by the Government. Residents with greater means will have to pay more for their ongoing care but caps will be put in place to protect those who receive care over a longer period. The new rules do not apply to special residences such as retirement villages, granny flat rights or sale leaseback arrangements. To whom will the new rules apply? It is important to note that existing residents will be grandfathered under the current rules. The new rules will apply to individuals who enter residential aged care on or after 1 July Existing residents will be subject to the new rules if they leave care and re-enter after 28 days, or if they change facilities and decide to re-enter under the new rules. The means tested amount One of the critical changes under the new rules is the introduction of a means tested amount. Under the current rules, a resident s assets are used to determine how much they pay for their accommodation (accommodation bond and accommodation charge) and their income is used to determine how much they pay for their ongoing care (income-tested fee). However, the means-tested amount will replace the current income-tested fee and will use both a resident s assets and income to determine how much they pay for their accommodation (accommodation payment) and their ongoing care (means-tested care fee). The means-tested amount will be calculated by combining an incometested amount and an asset-tested amount. A new means-tested care fee will replace the income-tested fee and will be determined by a combination of the resident s assessable income and assets. Investment strategies As the means-tested care fee will be determined by a resident s income and assets, there will be a greater focus on whether to keep or sell the family home, how to structure accommodation payments and where to invest remaining funds. Investment strategies that reduce a resident s income and assets will continue to play an important role in reducing ongoing care fees and may even be more effective in some instances. The lead up to 1 July 2014 The upcoming reforms may provide a financial imperative to bring forward the decision to move into an aged care facility. There are several steps involved when moving into aged care and residents will only be grandfathered under the current rules if they move in before 1 July It may therefore be important for families with an elderly relative who is on the cusp of making a move to start discussions soon to allow enough time for their relative to be assessed for aged care, find an appropriate facility and move in. Of course, seeking quality financial advice can be a critical step in helping to ensure the best financial outcome for residents and their families. 1. Australian Govt. Productivity Commission An Ageing Australia: Preparing for the future, November 2013 Visit our Client Education Centre If you would like to find out more about financial and investment issues, please feel free to visit our 'Client Education Centre' at You'll find lots of information on a wide range of topics in each of the following items: Free Fact Sheets Free Webinars Calculators Investment Update Webinar Special Reports Latest client newsletter Page 7
8 Case Study: You get what you pay for... Let s compare the situations of Steve and Jim: Both are age 35 Both are married with 2 children Both earn $160,000 a year in the same job in the same company Steve pays a professional financial adviser to prepare a comprehensive financial plan which includes the consideration of risk insurance. As a result, Steve has full income protection insurance (which costs just $11.30 net a week) as well as a tailored plan to enhance his long term financial wellbeing. Soon after, Steve is diagnosed with a serious illness and can never work again. Steve s insurance pays him $120,000 a year (indexed) until he is 65 and he can therefore continue to support his family and almost maintain their lifestyle. Steve s total payout from insurance is $6,000,321 up to age 65. The fee Steve pays to his adviser is just $2,500 p.a. to monitor & manage his investments, optimise his tax position, ensure he is properly insured, and modify his financial strategies as his situation and the legislative & economic environments evolve. Jim doesn t want to pay for professional advice he would prefer to rely on his super fund for financial security in his retirement. And, as Jim feels fit and healthy, he doesn't think insurance is necessary. As a result, Jim doesn t have income protection insurance. Jim is diagnosed with the same serious illness as Steve and can never work again. Jim has no insurance backstop and he & his family are soon almost penniless and relying on Government handouts to survive. Jim got what he paid for If you genuinely want to be financially secure, you should seek advice from a professional financial adviser. We think you will find your adviser s fees are good value for money. Assumptions: Both have $150,000 in superannuation. Jim uses this to replace his lost income until it runs out in 16 months. Income protection insurance premium is tax deductible, and based as at 1 January on white collar worker A1, non-smoker, male age 35, 90 day waiting period, indexation 3% p.a., annual benefit $120,000 (indexed). 2013/14 tax rates used. If you no longer wish to receive Money Insights please send an Unsubscribe to the person who sent it to you. Contact us: You can contact us by calling your Australian Unity financial adviser or mortgage broker, or you can call Advisory Services on , or write to us at Level 8, 114 Albert Road, South Melbourne Vic 3205, or us at advisoryservices@australianunity.com.au, or visit our website Disclaimer: Unless otherwise indicated, the information in this newsletter is provided by Australian Unity Personal Financial Services Limited ABN AFSL & Australian Credit Licence No Any advice in this document is general advice only and does not take into account the objectives, financial situation or needs of any particular person. You should obtain financial advice relevant to your circumstances before making investment decisions. Where a particular financial product is mentioned you should consider the Product Disclosure Statement before making any decisions in relation to the product. Whilst every care has been taken in the preparation of this information, Australian Unity Personal Financial Services Ltd does not guarantee the accuracy or completeness of the information. Australian Unity Personal Financial Services Ltd does not guarantee any particular outcome or future performance. Australian Unity Personal Financial Services Ltd is not a registered tax agent. If you intend to rely on any tax advice in this document you should seek advice from a registered tax agent. This document produced in April Page 8 australianunitypfs.com.au
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