Likely impact of Trump Victory


The market initially reacted sharply as the likelihood of Trump victory increased. However the market settled down as realisation of the policy implications of a Republican controlled Senate drove the market. Below we analyse the expected market impact of a Trump Victory.


We had initially expected the market to prefer a Clinton victory given the greater certainty. However the markets have been weak over the past month and begun to factor in the uncertainty. Reviewing the policy agenda reveals a mixed outcome but overall an inflationary / growth driven agenda.

The longer-term impact on the market will be dictated by the performance of his economic policies. In terms of the major policy implications we need to consider Trump’s ability to get his policies through the Senate and the House. While these will be controlled by Republicans many Senators and Congressman will be hostile towards Trump and so it is not a foregone conclusion that his policies will pass. The economic policies will likely be influenced by Speaker of the House, Paul Ryan who sees economic management as one of his specialist areas.

Ultimately a number of questions are going to remain. Does a Trump victory impact confidence? Can Trump drive his policy agenda through both houses? Does he push policies that are negative for his own business interests such as more aggressive trade deals with Asia?

Key Economic agenda


Protectionist Policies

It is safe to assume the trade agreement with the Pacific will not pass. However it is not clear that Trump will be able to pass more of his aggressive protectionist policies that harm US allies. This is the largest risk area from a Trump Presidency but also the area that he likely face the most opposition from other members of the Congress and the Senate. His policies in this regard are more closely aligned to left wing Unions than a conservative, free trade Republican Senator.

Tax Cuts

Trump plans to reduce corporate taxation to a rate of 15% (which was borrowed from Paul Ryan’s economic policies and therefore likely to pass the House and the Congress). The purpose of this reduction is to make sure that US multinational companies bring their funds back to the US and reinvest it domestically in the US economy. Tax cuts would be a positive for companies operating in the US (increasing earnings by 20%), and would be positive for the US$ as we would be likely to see cash repatriated to the US.

Infrastructure Spending to increase

There are plans to revitalise airports, roads and build a wall. The US corporate tax rates proposed within the Trump program would increase US private fixed capital investment in the US economy. We see the likelihood of greater funds being invested in the US as positive for infrastructure companies.

Other considerations

Less regulation of banks and healthcare and repeal of Obamacare is positive for banks and healthcare companies operating in the US.

Promote energy independence which will further support infrastructure investment in the US.

Investment Implications


Higher Interest rates

Trump policies appear inflationary—lower tax rates, lower deregulation, higher infrastructure and defence spending. This is further enhanced if he is successful in forcing protectionist policies though. We believe this will drive higher interest rates over time.


US$ will strengthen on the back of repatriation of capital, and inflationary / growth policies. The uncertainty that he creates from a global perspective also leans towards a safe haven trade.

Higher risk premium

The markets are likely to adopt a higher risk premium to allow for the uncertainty that Trump’s rhetorical bluster provides. Will he damage US relations with Japan and South Korea? Will he start a trade war with China? Will he butt up against Putin? There are numerous uncertainties which will provide an overhang.


Global trade is on the decline and future trade deals will be under threat. This is a negative for Australia but potentially be offset by the resource intensive growth agenda in the US. Furthermore a growing US would be favourable to major exporters to the US such as Japan and South Korea (which would be helpful as they are major export destinations for Australia).

Wall Street to Main Street

One of the political consequences from the Trump victory as well as Brexit is that economic policies are likely to swing towards the masses. US manufacturing salaries have not increased faster than inflation for 30 years. Margins in the US are high and are likely to be squeezed. This can be fine if the top line is growing faster however we believe it favours buying quality companies which can pass on inflation to their customers.


Companies exposed to infrastructure spending such as Macquarie Group and Lendlease should be assisted by the infrastructure agenda that is being adopted in the US and by the likely adoption by other markets.

US Corporate earnings

Higher US corporate earnings as a result of the tax cut will be helpful for companies operating in the US.


The impact of a Trump victory is significantly lower risk than Brexit. We are not dealing with a leading nation having to unravel a complex economic agreement. Further the tax cuts will provide a significant boost to earnings and stimulus in the largest economy in the world. We see US earnings higher off the back of tax cuts however the impact on markets will be offset by a higher risk premium and higher interest rates which will impact the multiple.

Please do not hesitate to contact me should you wish to discuss anything in greater detail.


Reporting Season Wrap


The reporting season was mixed this year with FY16 largely in line with expectations, but FY17 being downgraded by 1.7%. The confession season in May had been unusually quiet with fewer negative surprises, which lulled the market into a false sense of security heading into the reporting season. The actual results produced a similar number of disappointments as per usual, but fewer positive surprises which left the market a little underwhelmed.

Key observations

Large companies look notionally cheap and offer good yields, but in our view reporting season didn’t suggest much in the way of improvement in the earnings per share growth backdrop.

  • Banks are under margin pressure as competition and political scrutiny increases. * General insurers are facing competition from new entrants and the cycle remains challenging. * Telstra faces an earnings hole and is reinvesting to improve its competitive position. * Food retailers continue to have a competitive market with price deflation. * The outlook for a market darling like CSL (ASX:CSL) looks a little more difficult in the short term. * However the outlook for resources looks a little better with costs coming out and improved balance sheets. If commodity prices were to hold then there is significant leverage. * From an investment perspective we think the issues above are now well known and are factored into market forecasts, and as a result some investment opportunities are presenting themselves.
  • The domestic economy has held up well. The consumer environment has been reasonable (unemployment and interest rates are low) although some players experienced a slowdown late in the year during the election cycle,

  • Despite fears on the housing market, the sentiment was generally positive with defaults on settlements lower than expected.

Key growth areas in the market

While large companies are generally struggling, we see a range of growth areas in the market. These include the following:

  • Those companies exposed to an ageing population such as the hospital groups—Healthscope (ASX:HSO), Ramsay Health Care (ASX:RHC).
  • Those companies offering Software as a Service (SaaS). There continues to be rapid growth in this area as companies look to outsource IT functions and utilise the efficiency benefits that arise from using the cloud to deliver their IT services. Companies such as IRESS (ASX:IRE), MYOB Group (ASX:MYO), Aconex (ASX:ACX) all displayed strong growth.
  • Online market places continue to grow. Realestate. (REA Group, ASX:REA), Domain (Fairfax Media, ASX:FXJ), SEEK (ASX:SEK), (ASX:CAR) continue to deliver strong growth and are reinvesting to drive further growth. 
  • Global leaders such as Brambles (ASX:BXB), Macquarie Group (ASX:MQG) and CSL ASX:CSL) that have products or services in demand across the globe. * We are expecting a bounce in infrastructure spending this year as government spending kicks in. A range of infrastructure companies highlighted an increase in their workbooks and for our portfolios Lendlease (ASX:LLC) highlighted the strong growth expected in this regard. 
  • The lower A$ means a range of sectors like tourism, agriculture and export services continue to grow.
  • There are also opportunities for companies in traditional industries that invest in technology to drive improved productivity. Significant investment in digitisation is being undertaken by large companies like AGL Energy (ASX:AGL), Tatts Group (ASX:TTS), banks and Telstra Corporation (ASX:TLS) with the aim of driving stronger customer engagement and more efficient service delivery.

Please do not hesitate to contact me should you wish to discuss anything in greater detail.


Interest Rate Cut

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** Interest Rate Cut

** The RBA announced a further 0.25% rate cut today. Low inflation and slowing housing growth provided the RBA the flexibility to lower interest rates to support growth. While the market was anticipating the rate cut and therefore the reaction is muted, we note the following implications:

1. The cut provides broad support for equities given the gap between dividend yields and cash rates remains wide. 2. A cut places further pressure on the currency given interest rate differentials are narrowing. This is positive for stocks with offshore earnings and for exporters but might limit enthusiasm from offshore investors for the Australian market. Positive for Treasury Wine Estates (ASX:TWE), SKYCITY Entertainment Group (ASX:SKC), SEEK (ASX:SEK), Macquarie Group (ASX:MQG). 3. Commonwealth Bank (ASX:CBA) has announced they will only pass on half the rate cut to mortgage holders. While this initially looks positive for the banks we note the banks funding costs will be higher as they will need to retain attractive TD rates to grow deposits. Lower interest rates will reduce risk of bad debts, so overall it is mixed from a banks perspective. 4. Domestic cyclical stocks and small business should benefit. There will be more money available for consumers (Tatts Group (ASX:TTS), Woolworths (ASX:WOW), other retailers) and it might extend the property cycle (or at least assist with settlements).

Low inflation suggests a further rate cut is likely.

Mando Valley Pty Ltd ATF Anderson Family Trust T/A Solidity Private Wealth, (ABN 13 791 903 550), is a Corporate Authorised Representative of The Advice Exchange Pty Ltd (ABN 55 107 629 194) who holds an Australian Financial Services Licence (No.278937).

The information contained in this document is general information only. It is not intended to be a recommendation, offer, advice or invitation to purchase, sell or otherwise deal in securities or other investments. Before making any decision in respect to a financial product, you should seek advice from an appropriately qualified professional on whether the information is appropriate for your particular needs, financial situation and investment objectives.

We believe that the information contained in this document is accurate. However, we are not specifically licensed to provide tax or legal advice and any information that may relate to you should be confirmed with your tax or legal adviser. Solidity Private Wealth and The Advice Exchange Pty Ltd (The Advice Exchange) their officers, employees and agents make no representations or warranties and, to the extent permitted by law accepts, no responsibility for any loss or damage whatsoever arising in any way for any representation, act or omission, whether express or implied.

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Market Update- Brexit


Market Update – Brexit

The outcome of the Brexit has clearly come as a shock to markets which had been following polls and betting markets to expect the UK to remain in the EU. Markets will often over-react in situations such as these and as such it is important to analyse the situation calmly. We analyse the potential economic impacts and market impacts below.

Economic Impacts

Short Term

We would expect consumer and business confidence to take a hit especially in Europe and the UK. The extent that confidence remains low will depend on leadership across Europe and central bank statements which we would expect will try to firstly provide some certainty regarding the process that will be undertaken to enable the UK to exit Europe and secondly we would expect further liquidity injections to support the economy. We would expect the Pound to remain under pressure, the US$ to rally as a safe haven currency and interest rates to remain low globally.

Long Term

The longer term impact on the global economy will depend on the deal negotiated by the UK with Europe. In some respects globalisation is in retreat which is a negative from a global growth perspective. Nonetheless, early comments from European leaders suggest a rational course of action will be followed, and we would expect self-interest to drive a rational outcome (which would have a modest impact on global growth).

A further risk that will continue to overhang confidence is that geopolitical risk will remain heightened and fears of further EU countries exiting Europe will create some uncertainty, although the U.K. is an outlier in terms of Euroskepticism. We would not expect another EU country to vote to leave the EU, though tail risks are up.

Market Impacts

Given the shock of the vote it is not surprising to see markets react sharply in the short term. Despite the direct trade, investment and earnings consequences for Australia of Brexit likely being relatively modest (3.5% of Australian exports are to the UK), the immediate moves in the local equity, bond and currency markets have not been dissimilar to those offshore. While risk assets might recover some of these losses in coming days, we would expect damage has been done to the rating of the market which will take some time to recover. In assessing the outlook for the market we consider the potential earnings impact and the potential market rating.

Earnings Impact

Clearly companies exposed to the Pound will suffer from a translation impact of the currency. In addition there is some risk to stocks exposed to Europe should the economy suffer from a downturn. Of greater uncertainty is the broader impact on global growth and global credit markets. We tend to think the market is likely to over-react on the broader implications which is likely to create some interesting opportunities. We note that parallels are sure to be drawn to 2008 and we would think the level of debt among corporates and consumers remains substantially below 2008. Furthermore central banks are in a position to inject liquidity so the risks of a credit crunch remain low.

Market Rating

The greater impact on markets can come from a permanent de-rate to accommodate heightened geopolitical risk. A de-rating towards the lows earlier in the year seem possible in the short term. However with interest rates likely to be moved lower, we would think this would provide support for the market. Ultimately this type of volatility can create significant stock opportunities and we will remain alert to these.

Please do not hesitate to contact me should you wish to discuss anything in greater detail.



Market Update – Brexit

It appears increasingly likely that the UK has elected to leave the EU with over 70% of the vote counted. The pound has come off ~10% against the US$ and UK equity Futures are also pointing down ~10%. The ASX200 has closed down -3.17%.


The UK’s decision to leave the EU is a surprise for the market which has seen increased volatility over the course of the day as polling and voting results were revealed in what has been a tight contest.

Implications for the ‘leave’ vote include new trade agreements between the UK and EU which need to be negotiated, a potential 2nd Scottish referendum on independence and potential for further exits from the EU (eg. Denmark, Sweden), however it is likely that this will take time to be resolved (perhaps years).

In the meantime, volatility is expected to continue in the short term. Stocks hit the hardest include those exposed to the UK on currency concerns, Financials on potential credit implications and Resources on global growth uncertainty.

We will be actively monitoring the market and will seek to be opportunistic over the coming weeks as greater certainty emerges.

Please do not hesitate to contact me should you wish to discuss anything in greater detail.


Budget 2016- Superannuation

Last night the Federal Government handed down the Budget for the 2016-17 year that includes some of the biggest changes to the superannuation system since 1 July 2007.

As expected, superannuation tax concessions have been heavily tightened, however we are surprised and disappointed by the extent and retrospective nature of some of these measures and believe them to be a backward step in enabling people to adequately save for their retirement.

Some of the major announcements that may affect clients include:

  • the lowering of the concessional contributions caps
  • the introduction of a lifetime non-concessional cap
  •  changes to the taxation of concessional contributions for high income earners
  •  limits to how much can be transferred into pension phase
  •  restricting tax-concessions associated with transition-to-retirement pensions
  • removal of work tests for contributions between age 65 and 74
  • extending eligibility to claim deductions for personal contributions

We briefly examine each of the above proposals:

The lowering of the concessional contributions caps.

The Government will reduce the annual cap on concessional superannuation contributions to $25,000 (currently $30,000 under age 50; $35,000 for ages 50 and over).

Comment: For a nation facing a major problem of how to fund a growing generation of retirees we find a measure that inhibits the ability of people to fund their own retirement particularly puzzling.

Strategy: The reduced concessional contributions cap does not apply until 2017/18. Clients should consider taking advantage of the current higher concessional caps in the current and 2016/2017 financial years.

Clients will need to review existing salary sacrifice arrangements and personal deductible super contributions to ensure they comply with the reduced concessional cap.

The introduction of a lifetime non-concessional cap

A lifetime non-concessional contributions cap of $500,000 will be introduced effective 7.30 pm (AEST) on 3 May 2016. The lifetime non-concessional cap will replace the existing annual non-concessional contributions cap of up to $180,000 per year (or $540,000 every 3-years under the bring-forward rule for individuals aged under 65). The $500,000 lifetime cap will take into account all non-concessional contributions made on or after 1 July 2007. Contributions made before commencement (ie 7.30 pm AEST on 3 May 2016) cannot result in an excess of the lifetime cap

Comment: We are disappointed with the retrospective nature of this measure and believe it unfair on people who in good faith made contributions under the existing rules.

Strategy: To determine how much of the lifetime non-concessional cap has been utilised with prior non-concessional contributions clients will need to add their non-concessional contributions since 1 July 2007 from all funds to determine how much counts towards their lifetime non-concessional cap. Clients will need to carefully review their situation to determine whether they have exhausted their lifetime cap.

Changes to the taxation of concessional contributions for high income earners

Currently those who earn over $300,000 (taxable income plus superannuation contribution) are required to pay an additional 15% contribution tax on their concessional super contributions (i.e. total of 30% contribution tax).

From 1 July 2017, this threshold will reduce to $250,000.

Strategy: The overall impact of this measure will be to increase the tax burden by up to $3,750 (i.e. 15% of $25,000) on concessional contributions. However concessional contributions still offer a tax concession of 19% for those paying Division 293 tax so it is unlikely to significantly reduce the level of concessional superannuation contributions.

Limits to how much can be transferred into pension phase

From 1 July 2017, the Government proposes to introduce a $1.6 million limit on individuals' superannuation balances that can be "transferred" from accumulation phase to retirement phase. Subsequent earnings on retirement balances will not be restricted. Individuals that have amounts in excess of $1.6 million will be able to maintain those amounts in accumulation phase where earnings will be taxed under the current 15% treatment. Superannuation fund members already in the retirement phase that have balances in excess of $1.6 million will be required to reduce their retirement balances to $1.6 million by 1 July 2017. They will either be able to retain excess amounts in accumulation phase or withdraw them from superannuation.

Strategy: This proposal will allow couples to have a combined pension balance of up to $3.2 million. However, where most of a couple’s superannuation savings are in one spouses name the $500,000 lifetime non-concessional cap will restrict a couple’s ability to equalise their benefits to take full advantage of the transfer balance cap. The requirement for member’s with balances already in excess of $1.6 million to either withdraw or transfer the amount in excess of the cap back to superannuation means that people with pension account balances in excess of $1.6 million have not been grandfathered from these changes.

Restricting tax-concessions associated with transition-to-retirement pensions

From 1 July 2017, the tax exemption for earnings on assets supporting ‘transition to retirement’ income streams will be removed. These are income streams where the member has reached preservation age but not yet retired.

Earnings will then be taxed at 15 per cent. This change applies irrespective of when the TTR income stream commenced, ie. no grandfathering applies.

Strategy: Taxing earnings on TTR income streams significantly reduces the tax effectiveness of strategies such as TTR and salary sacrifice. For clients aged 60 or over, TTR strategies may still be worthwhile as pension payments are tax free and allow tax effective salary sacrifice contributions. However for clients under age 60, the tax benefits are minimal.

Removal of work tests for contributions between age 65 and 74

From 1 July 2017, individuals under the age of 75 will no longer have to satisfy a work test and will be able to receive contributions from their spouse.

Strategy: Clients are currently required to work 40 hours within 30 consecutive days in the financial year they make a contribution over the age of 65. This proposal will remove this requirement and make it easier for older clients to contribute to super.

When combined with the life-time non-concessional cap this proposal could allow non-working clients aged between 65 and 74 who were previously ineligible to contribute to make non-concessional contributions of up to $500,000 after 1 July 2017.

Extending eligibility to claim deductions for personal contributions

From 1 July 2017, individuals up to age 75 will be able to claim an income tax deduction for personal superannuation contributions. This will apply regardless of employment status (i.e., wholly employed, self-employed or a partially employed/self-employed).

Strategy: This announcement will dramatically simplify the eligibility requirements for a member to qualify to claim a deduction for a personal super contribution. The requirement to not be an employee during the financial year or to satisfy the 10% test will be replaced with a simple requirement to be under age 75.

We wil be in contact with clients in the coming days/weeks to discuss how these changes will impact them and any required changes to existing strategies. In the meantime please do not hesitate to contact us if you have any queries or wish to discuss your individual circumstances.

Surprise Rate Cut

After months of explaining why the market has been weak, it is nice to report on a positive news event. The RBA has determined that housing prices are abating and this has given them room to lower interest rates.


Implications for portfolios are as follows:

  • Banks. Will the banks pass on the rate cuts to consumers? They run the risk of incurring the wrath of Governments during an election year so I suspect they will pass most of it onto consumers. Banks yields look attractive compared to cash rates.
  • Consumer stocks. Clear beneficiaries from this decision. Consumer spending has slowed this year with a warm start to winter so these companies will be pleased with the relief offered by lower interest rates.
  • Offshore exposures stocks. The currency has dropped and those stocks earning foreign currency will benefit. It will also be of benefit to those sectors whose competitiveness will improve with a lower currency—tourism, education, agriculture, other exporters.
  • Yield payers will benefit from the comparison to low interest rates.

Over the past few months there has been a number of positives which is supporting the market (now up for the year).

  • We have seen commodity prices bounce which has supported resource stocks.
  • Economic data from the US has turned positive reducing concerns regarding a potential recession or slowdown. 
  • Chinese economic data has improved off a low base as stimulus bites.
  • Now the RBA has lowered interest rates. Our largest concern has been the potential for the currency (which has been nudging 80 cents) to strangle the recovery that has been evident in a range of export sectors. This was coming at a time when housing was slowing so presented a risk to the economy. So we welcome this decision as providing support for the economy over 2016 before infrastructure spending kicks in to support the economy in 2017.

The budget might provide further stimulus via infrastructure projects although this will be balanced by tax increases and the usual political machinations in an election year.

Please do not hesitate to contact me should you wish to discuss anything in greater detail.


2016 Budget Predictions

With the Federal Budget imminent, speculation as to what superannuation measures will or won't be in the Budget increases. It has been clear since late 2015 that the Coalition Government's moratorium on changes to superannuation was not going to hold for the 2016 Budget. While crystal ball gazing is never easy when it comes to forecasting Government tax policy decisions, we have landed on four possible changes to superannuation that the Government may announce in the Federal Budget due on 3 May 2016.

Reducing the Division 293 tax threshold to $180,000

As reported in media this week, the forthcoming Budget may see the Government pare back superannuation tax concessions for higher income earners by reducing the threshold for Division 293 tax from $300,000 per annum to $180,000 per annum. Division 293 tax levies an extra 15% tax on concessional contributions for the taxpayers it applies to. We would expect such a change to apply to the 2016-17 income year going forward.

Strategy tip: Higher income earners, especially those earning between $180,000 and $300,000 should look to maximise the current concessional contribution arrangements for the 2015-16 income year.

Reducing the concessional contribution cap to $20,000

Another possible route to reducing the concessions for superannuation would be for the Government to decrease the general concessional contribution cap from $30,000 per annum to $20,000 per annum. This has been a rumoured approach but may not be pursued if the Division 293 tax option above is followed.

Strategy tip: Again, maximising the $30,000 concessional cap (or the $35,000 cap for those aged 50 and above) in the current income year is key. As we would expect a smaller concessional contribution cap to apply from the 2016-17 income year onwards, this should allow time for SMSF members to maximise contributions for the current year.

Reducing the non-concessional contribution cap

The generosity of the existing $180,000 non-concessional contribution (NCC) cap and $540,000 bring forward rule may be targeted by the Government, especially on the grounds of equity and preventing super being used for estate planning. A reduction in the concessional cap would see a smaller NCC as a consequence (i.e. a $120,000 NCC cap and $360,000 bring forward rule) but the Government may also choose to independently reduce the NCC cap.

Strategy tip: SMSF members planning to make large contributions to superannuation in the coming years may want to bring those contributions forward to the current financial year to use the existing NCC cap and bring forward rule. It is unclear how the Government would treat taxpayers who have triggered the bring forward rule in 2015-16 but not used the entire $540,000 amount if a lower NCC cap was to apply from 2016-17 onwards.

Tightening transition to retirement pension rules

The use of transition to retirement (TTR) pensions as part of recontribution strategies has caught the attention of Government as a "loophole" of the superannuation rules. Policy makers have been concerned that TTRs are not being used for the original policy purpose of transitioning people from work to retirement by allowing them to drawdown on some of the retirement savings while still working. Instead the prevailing view is that TTR pensions are being used for tax planning purposes. This concern may see the TTR rules tightened to achieve their original policy intent (e.g. by applying a change of work hours test or raising the preservation age for TTRs) or at worse repealing the TTR rules.

Strategy tip: Changes to pension rules are generally introduced with extensive grandfathering for existing pensions. Accordingly, the Government may seek to limit a rush into TTR pensions by making any changes effective from Budget night. This means for TTR pensions to have grandfathered treatment (i.e. continue operating under the current rules) they would need to be started before the Budget announcement at 7.30pm on 3 May 2016. Starting a TTR before the Budget may be a prudent move and if it is not needed going forward, the TTR pension can be commuted after the pro-rata minimum benefit payment is made and the amount supporting the pension can be simply rolled back to accumulation phase.

Please do not hesitate to contact me should you wish to discuss anything in greater detail.

Market Update- Banks


The reporting season is under way and given the increased market volatility, we provide further information in addition to our recent market update. With banks occupying a prominent position in most client portfolios we thought it worthwhile focussing on this sector.



Portfolio valuations have been impacted by weakness in financials this year. The sector has been influenced by sentiment associated with global events but appears to be overshooting in our view. We have met with management of Bank of Queensland and attended the CBA result briefing which has provided us with further insights into the sector.

The two key concerns globally include:

1. The potential for bad debt deterioration especially associated with mining and oil and gas exposure.

2. Higher funding costs.

In relation to these two issues we note the following:

1. We expect bad debts to rise for banks in coming years (given they are at a low point).

2. However there are no signs at present in a sharp deterioration. Asset quality remains sound.

3. CBA’s troubled loans continue to fall.

4. Mortgage Insurers are not reporting any significant deterioration in housing delinquencies.

5. Bank of Queensland’s (BOQ) impaired loans and past dues have improved by 2% in the past quarter and they are not seeing any deterioration (at this point).

6. We would expect bad debts to increase from mining exposures. However we suspect global investor’s perceive our banks to be more exposed to this sector than in reality. The major bank’s exposure is around 1.5–2% of total loans. Much of this is investment grade. CBA has fallen circa $40b in market value in the past year yet has only $18b in mining lending. A conservative assumption is 10% of this lending is lost (50% of non investment grade lending). This would allow for a loss of $1.8b compared with $3.7b that CBA holds as provisions for potential problem loans.

7. CBA and BOQ were both upbeat about the economy. While everyone couches their commentary with some caution given the global volatility and uncertainty regarding whether some problem loans will arise, there was also unambiguous commentary regarding the improvements being observed on the ground. CBA stated that “global volatility warrants caution, but overreaction also a threat”. Both banks noted the transition the domestic economy is making from being resource dependent with tourism and other export sectors picking up the slack. While risks remain the economy appears to be handling the downturn in mining capex surprisingly well.

8. Higher funding costs will have a small impact on profits by reducing margins however we would expect the banks will seek to manage this impact. We have already seen some price increases on mortgages and more recently business lending.


Bad debts are at a low point in the cycle and will increase from here, however the market is anticipating a significant deterioration of which there is no evidence to support. Valuations on the banks look attractive.

Key positives:

  • PE’s look attractive relative to the market at 10.8x—a 25% discount. 
  • Dividend yield grossed up is trading at a large premium to cash rates. We allow for a 10% haircut to dividends but the yield is still 8.6% (grossed up). 
  • Historically when the banks have moved sharply negative on a one year basis it has proven an attractive entry point. See the WBC momentum chart below. 
  • Earnings outlook remains solid. * The banks have been heavily impacted by regional selling / shorting which we see as a contrary indicator.


  • Global bank peers have been sold off and are generally trading at lower PE’s than domestic banks (albeit this is justified by lower capital levels, lower returns and greater historic volatility). 
  • While money is exiting the Asian region, pressure will remain on domestic financials.
  • There is the potential for lumpy problem loans to emerge in the mining space which can cause negative sentiment (particularly for ANZ).
  • There is some potential for dividends to be reduced (but suspect the banks will be reluctant to take this course and allow profit growth to chip away at the payout ratio).

Please do not hesitate to contact me should you wish to discuss anything in greater detail.

Market Update


This month we discuss the poor start to the year. While sentiment remains weak, the reasons for the market fall are not particularly obvious from our perspective. The Chinese economy remains soft (but this is largely known to the market). The US economy has slowed a little but remains reasonably robust. The market has been reacting to the fall in the oil price but this should be positive for global growth. Nonetheless the weakness has remained persistent and in some pockets, such as tech stocks, it has accelerated. While individually the reasons for the correction do not seem particularly convincing, a range of factors are contributing to the weakness including the following:

  • US Federal Reserve tightening. We asked ourselves last year whether the beginning of US Federal Reserve tightening would add to volatility or whether it was already reflected in markets. The price action this year suggests the removal of this support has left the market more vulnerable to volatility (the market no longer has the confidence that the US Federal Reserve will step in with quantitative easing to support markets).
  • US market strength last year. The US market had held up well into the end of last year despite some evidence that the economy was softening. Further we had seen excessive valuations in tech stocks which left them vulnerable to a pull-back were sentiment to turn (which we have seen).
  • Chinese policy mistakes. The Chinese authorities have been undertaking the delicate task of rebalancing their economy away from investment and doing a reasonable job. We are seeing service sectors grow and heavy industry investment decline. However their handling of the market has been ham-fisted over the past year which has undermined confidence and encouraged outflows from the Asian region. We see two major mistakes—limiting the ability of investors to sell stocks that were up 80% and the signal that they were to devalue the currency only encouraged capital outflow. Our major stocks have been caught up in this selling.
  • Lower oil price driving credit concerns. While the lower oil price is yet to have a positive impact on global growth, the correlation of lower oil price with the stock market is more to do with deterioration in high yield credit markets given there is a significant amount of debt exposed to oil companies. We note from an Australian bank perspective exposures to resources as a whole remain around 1.7% of book (this compares to 12% for Singapore banks and 17% for Indonesian banks).

The key questions we are asking from here include:

  • How does the pull-back compare to other corrections?

The market is off nearly 20% from its high. Of the previous 12 episodes when Aussie equities crossed the 20% peak-to-trough threshold, index levels were higher in a year's time in eight cases and they were lower in four. The determining factor is whether the decline in equities preceded a recession and the level of valuation support post the fall.

We tend to think this pull-back will prove to be one of the better times to buy the market. Certainly sentiment is negative as noted below and in the Asian region we have seen significant outflows (which is a contrary indicator). 

  • What is the risk of recession and where are the growth areas of the economy?

Globally we have seen a slowdown in growth rates but nothing to suggest a recession. The outlook for growth remains around 3%. It may surprise many that the G7 has experienced the fastest drop in unemployment on record. The US economy has experienced a slowdown in the oil states as well as a seasonal slowdown in activity levels. Yet consumer confidence is strong, home sales are robust as is unemployment.

China clearly has its challenges (unwinding excess construction investment) and leading indicators remain soft. We would not rule out a further slowdown in the Chinese economy, but note they have been stimulating the economy for some time and there has been some improvement in service sectors, car sales and house sales. The Chinese economy remains one in transition where incomes are growing at 7% pa, household debt is low and savings are high which provides a good base for further growth. However excess capacity remains in industries tied to construction. Within China we are seeing strong growth across a range of consumer service sectors and this represents opportunities for Australian businesses.

  • Ecommerce/internet—growing ~30–40% yoy
  • Healthcare—growing ~15–20% yoy
  • Travel services—growing ~15–20% yoy
  • Entertainment/Movies—growing ~40% yoy
  • Environmental services—growing ~20% yoy * Sportswear—growing ~15% yoy

Even allowing for a further 2% slowdown in Chinese growth rates, the impact on Europe and the US is only around 0.2% of GDP (given modest export levels to China). The most negative scenario would be a messy devaluation of the currency which could have a spill over into Australia but even in this scenario global growth should be positive.

The Eurozone continues to recover with business confidence solid and leading indicators supportive of further growth

Recent economic data from Australia has been encouraging. Job ads were up 1% in January and 11% on the previous year. Unemployment has held up well and while we are cautious on the outlook for housing we see opportunities in areas such as tourism, agriculture, and education. Once we move beyond 2016 then a number of non-residential construction projects should begin to offer support to the economy. So while the global economy continues to have some growth challenges and sentiment remains soft, we continue to expect the economy to grow. As we cycle through the decline in energy capital expenditure then the benefit of a lower oil price should begin to become apparent. 

  • Are valuations compelling yet?

Valuations remain attractive relative to interest rates with a grossed up yield of 6.7% and are beginning to trade below long term average PE’s at 14.5x. We see this as attractive but not especially cheap. However if we peel back the onion on valuations we see more compelling opportunities. There has been a divergence between companies with earnings certainty (which the market has chased) and those without. We are seeing some stock specific opportunities emerge in the current environment. Key areas where valuations look attractive include:

  •  Financials. Financials have been sold down with global markets yet capital levels are strong, asset quality appears sound (albeit some potential pockets of resources stress). They are trading on a long term average PE (11x) and an attractive dividend yield. We see Macquarie Bank as offering significant value with the market selling it off in line with global investment banks when its earnings have a greater proportion exposed to annuity like earnings streams (such as funds management). 
  • Anything resource related is being heavily discounted although some caution is warranted especially for companies with stressed balance sheets. 
  • Domestic exposed companies taking costs out can enjoy positive leverage as the domestic economy improves.

When considering the earnings of the market we note that earnings growth has been flat for the past few years as the market cycles the deterioration in resource earnings. The outlook should begin to improve (5-7% growth) from here given:

1. Resource earnings have already fallen (law of small numbers applies).

2. Currency will continue to provide a tailwind for exporters.

3. A small improvement in domestic demand will have outsized impact on profits given the level of cost cutting that has been occurring.

4. Offset by a slowdown in housing related activity.

Further a trend analysis suggests the market is trading significantly below trend.

  •  What are the major risk areas for portfolios?

The major risks we identify include the following. 

  • Credit spreads. Clearly the main concern of the market is the lift in high yield credit spreads. The credit market seems to be following equities rather than the other way round however there are pockets of issues within the oil debt markets. 
  • Geopolitical concerns. A further possible cause of weakness might be associated with geopolitical instability. A low oil price is causing a substantial deterioration in the strength of budgets in the middle east and adding to an already volatile political climate. Furthermore extremist politics is on the rise in Europe and elsewhere (Trump, Sanders) as the global political structure deals with the aftermath of the GFC. The central bank response to the GFC (quantitative easing) has boosted asset prices (which has a positive impact on the wealthy) but has not resulted (or not yet) in an increase in investment (which would provide a greater impact on jobs). 
  • Australian housing. From a top down perspective the Australian housing market contains risk. High levels of consumer debt, high house prices and a deteriorating terms of trade is not an attractive mix. It is difficult to see consumer confidence bouncing strongly in an environment of deteriorating house prices so creates some risks for the domestic economy. We note only 6.5% of the ASX 200 has exposure to this issue (if there is no credit event as we expect). 
  • Inflation. Given valuations have been supported by low interest rates, any sign of capacity tightening driving up inflation would be a negative for the markets. There are some pockets of capacity tightening in the US but the world continues to be awash with excess capacity (so it would seem to be too early to be overly concerned with this risk).

Portfolio positioning

We have seen an opportunity to start building some contrarian positions as the market polarises between some heavily in favour sectors and out of favour sectors. 

  • De-rated quality stocks which have de-rated in recent years (Woolworths).
  • Improving quality. We see opportunities in those companies turning around their businesses—Clydesdale, NAB
  • Sustainable earnings growth has been identified in a range of areas including: 
    • Stocks benefiting from a low A$— Macquarie Bank, Brambles. 
    • Domestic exposures benefiting from cost out and improving demand—Healthscope, Tatts. 
    • Business models with strong structural growth—IRESS, Dulux, SEEK.

Market Update

The start of 2016 has seen market volatility increase with the ASX200 pulling back to levels last seen in 2013.


What has caused the pull back?

Soft Chinese manufacturing data and a devaluation of the yuan has sent shock waves through global markets with fears that the Chinese economy may be in a much weaker state than previously thought. These fears have flowed through to equity and commodity markets with steep falls across the board. Compounding the size of the moves has been the lack of market activity given January is traditionally a low month for volumes.

While the soft manufacturing data has direct implications for the Chinese economy, the decision to devalue the yuan has more global implications. By devaluing their domestic currency the Chinese government is trying to stimulate the manufacturing sector. Such currency adjustments impact all of China’s trading partners. Given the importance of the Chinese economy to global trade, the concern is that this has the potential to drag on the economic growth of China’s trading partners.

Since the initial falls we have seen concerns spread into other sectors/countries. Bond yields have fallen as investors place bets that interest rates will stay lower for longer than previously expected and credit spreads have increased as more risk is priced into debt markets.

What are the Implications the Australian Economy?

China is a significant trading partner to Australian and so any weakness will impact the Australian economy and in particular, the commodity sector. Major miners such as BHP are trading at 10 year lows reflecting the expectation that commodity demand and prices will remain lower for longer. More generally, stocks with any direct exposure to China have also been sold off as investors look to offload any China exposure they can.

Domestically the economic data has actually been quite strong with retail sales over Christmas looking reasonable and recent unemployment data continuing to show positive signs (Unemployment under 6%). Job creation in the services sector continues to be a standout with the falling A$ stimulating tourism and manufacturing. The housing market has definitely cooled in the last 6 months, however approvals are still well above average and there has been no signs of significant price weakness or settlements not being completed.

Overall, while global issues will impact the Australian economy, we are generally still seeing solid economic data suggesting that the outlook remains positive. In the event external forces do start to impact the Australian economy, the RBA is one of the few central banks globally that does have room to stimulate via cutting rates. The Australian fiscal position is also robust and the new coalition leadership team does seem more open to fiscal stimulus in the event the economy softens meaningfully.

How are we responding to the Volatility?

We have been encouraging clients to underweight portfolios to commodities for some time and have only bought those companies with strong balance sheets with high quality projects that are low on the cost curve. While these companies have not been immune to the selloff we continue to see value in the medium to long term and are reluctant to join the exodus when current prices are already reflecting very bearish scenarios.

Outside of the commodity related stocks, we have for certain clients using the volatility to selectively increase exposure to some high quality businesses which have been sold down along with the rest of the market. We will continue to search the market trying to find more opportunities to buy quality businesses that are over sold. At the same time we recognise that the global environment is volatile and we will continue to monitor the situation and should our assessment of the situation change we will look to advise clients to adjust portfolios accordingly.

Market Update


The market sold off aggressively yesterday on little news. The driver appeared to be a negative broker report on Glencore, which triggered a wave of hedge fund shorting across energy and resource names.

The hedge funds are targeting two key areas:

  1. Commodity stocks with significant amounts of debt (e.g. Origin Energy and Santos). These stocks appear to offer significant value but this will not be realised until they address their balance sheet while the hedge funds are targeting the stocks. We have no exposure to commodity stocks with large amounts of debt. Rather we have targeted those stocks with good balance sheets that can potentially acquire distressed assets and emerge from the current uncertainty in a stronger position.
  2. Stocks with exposure to Australian housing. The hedge fund view of the world is the Australian economy will face pressure from the resources slow down and this will impact housing. We believe the hedge funds are once again over playing the risk. Banks have not lent aggressively, Australian’s have been repaying loans faster than necessary in a low interest rate environment and only pockets of the housing market have experienced large price rises. The RBA retains the flexibility to lower rates.

Looking at simple multiples and yields the major banks and major resources appear to offer significant value. We note the grossed up yields below.

Of course there is an argument for both of these sectors that the dividend payout ratios are perhaps unsustainable. Banks The banks will face a higher share count following capital raisings, stronger growth in risk weighted assets and a likely steady deterioration in bad debts. To offset this pressure we expect them to further increase interest rates on mortgages and more aggressively cut costs. We are anticipating circa 5% EPS increases and flat dividends. We note even if the banks needed to cut the dividends by 10% the yields would remain attractive (which we doubt). As a consequence we see the market as overly focused on the downside risks rather than a balanced outlook. Resources Dividend yields are typically not a great measure of value within resources given the volatility of earnings depending on the commodity prices. BHP and Rio Tinto have adopted a progressive dividend policy where they attempt to maintain or grow their dividend through the cycle. At this low point the dividends appear somewhat stretched but we expect the major resource companies to continue to run their businesses aggressively to try to support the dividends. The major resource players have been removing costs and cutting capital expenditure to support their dividend. We note that one factor the market does not fully appreciate is that the payout ratio can remain above 100% at this point in the cycle given capex is running below depreciation levels.

Our preferred valuation method is using a net present value and running a sensitivity over commodity prices. The market is currently pricing into the major resource players an expectation that iron ore prices will fall towards the low $40 range (from $57 currently), that other commodities will continue to trade around spot levels and that oil will rise towards US$60 a barrel. That is the negative sentiment towards China and commodities appears to be largely reflected in current share prices and it will not take much improvement to drive a re-rating.

Market Update


We thought it was worth expanding on our commentary from Friday given the weakness in markets over the weekend / today.


Firstly the current move appears to be liquidity driven as money exits emerging markets equities and risk assets following the Chinese currency adjustment. Essentially the move in the currency has forced some changes in global asset allocations as investors anticipated further deflation in the emerging market currencies. This has then begun to feed on itself. In much the same way the move up in markets in February / March were a little hard to reconcile, so these falls seem a little removed from fundamentals. The market’s relentless focus on negative news at present was highlighted by the fact equities sold off early last week when Chinese housing data was too strong (on the basis that it signalled China would not undergo a stimulus program) and later in the week sold off on weak manufacturing data. The Chinese economy is weak and this is well known by markets.

From Australia’s perspective there are a range of reasons to be more optimistic.

1. The size of the fall of 15% is quite a substantial correction especially given the economic outlook has not changed substantially. Sentiment indicators have turned sharply negative (which is a bullish indicator) and investors are heavily underweight emerging market positions.

2. Valuation and yield is supportive. The PE of the market is now 14.7x which is slightly below the past 15 year average. However the yield at 6.8% grossed up (5.1% without franking) looks very attractive relative to low interest rates and relative to global comparatives.

3. The risk for markets appears to be in the resource related sectors. However resources represent only 15% of the market (was 30% a few years ago) and the declining A$ will provide a cushion for the non-mining sectors of the economy (and their earnings).

4. Corporate balance sheets remain in good shape. Net debt to equity sits at 40% compared to 55% pre GFC. There are some pockets of stress in resources and mining services but it is not widespread.

5. Australia has greater ability to stimulate the economy with interest rates at 2% (high compared to other markets) and Government debt at 23% of GDP.

In a liquidity driven market we are looking for events that could trigger an end to the selling. We see the following possibilities:

1. A Chinese stimulus package would be helpful but it would need to be large enough to restore some confidence to Chinese investors. There is speculation of the liquidity injection this week.

2. Markets become absolutely cheap enough. We are probably close in this respect although we do not think the US is there yet. However given the speed of the falls it is not that far off causing valuation support to cause a change in asset allocations and money back into equities.

Overall it is important to separate out the noise of the market during these types of selloffs and focus on the fundamentals of the companies in the portfolio. Those companies with good balance sheets and quality businesses can emerge stronger from these types of disruptions.


Market Update


The market weakness has continued this week with a devaluation in the currency of Kazakhstan causing the concerns. We highlight the following factors as driving markets at present:

  • The devaluation of the Yuan and the concern of other emerging market currency devaluation have triggered uncertainty in the market. It would appear that this uncertainty has come at a time with the market still grappling with a potential US Federal Reserve rate hike and so the market response has been to sell into this uncertainty.
  • One of the consequences of the Yuan fall has been to raise further questions regarding the potential demand from China for commodities and we have seen speculative selling in that space. It would appear that we are seeing a capitulation in much of this selling and it will continue until high cost supply exits the market. We remain very cautious towards resource exposed companies with debt but opportunities can emerge for those with stronger balance sheets to pick up distressed assets.

  • Bank capital raisings have sucked demand and buyers from the bank sector. Simply, the buyers are participating in the capital raisings but not buying on market which is causing weakness.

The market valuation has corrected and is now trading on 15x earnings. This remains cheap relative to interest rates and alternative assets but in line with fair value from a historical perspective. The question we are asking is what will provide a circuit breaker for the market. A more aggressive policy response from China would be helpful and greater clarity regarding the US Federal Reserve interest rate decision would also be helpful. Beyond that we do not see too much froth in markets, corporate gearing levels are modest and domestic savings rates are high so there does not seem to be too much reason for undue concern.


Monthly Investment Review- July 2015

Monthly Investment Review- July 2015

The S&P/ASX 200 Accumulation Index rallied to end the month up 4.4%, following a soft period for markets as Greece made its attempts to reach an agreement with the Eurozone. This was achieved despite falling commodity prices that saw oil and iron ore fall 21% and 10% respectively. A sharp fall in long-term government bond yields supported the defensive sectors and a 5% fall in the domestic currency aided companies with a large offshore exposure. Internationally the Chinese market closed down 14.3%. This is the worst monthly loss in six years and occurred despite extraordinary measures taken by the government to calm investor nerves.


Market review

A recovery following the resolution of the crisis in Greece (at least for now) has given way to some unease in the market and weakness in commodities. Key drivers of this unease include: 

  • US profit results to date have struggled to inspire markets therefore not providing a catalyst.
  • Markets remain wary of emerging markets (China in particular) following some soft economic data (flash PMI) and the risk averse attitude of investors following the equities sell off. This is feeding into commodity markets and resource stocks resulting in these sectors hitting lows


We are becoming increasingly cautious about the outlook for the Australian economy based on the following logic.

  •  We have known for some time that the resource capex spend is about to roll over and that we need other areas of the economy to come to the rescue.
  • But housing, especially apartments, is hitting a peak and banks are tightening lending into this segment. At the same time government regulations are affecting the opportunity for foreign investors.
  • That leaves service industries like tourism and education as well as infrastructure and the consumer to make up the difference. With national incomes static it is difficult to see the consumer providing too much of the gap and, with the exception of NSW, government urgency on infrastructure is poor.
  • This outlook supports lower interest rates and a lower currency.

The implications for our portfolios are that we:

  • continue to look for currency-exposed stocks, particularly those that report in A$
  • continue to look for quality opportunities in service industries
  • minimise domestic cyclical exposures (which thankfully make up a smaller and smaller component of the market).

Hard landing for China

The Chinese equity market volatility has seemingly fed into concerns regarding the economic outlook for China, driving risk aversion and a selling of commodities. There were numerous newspaper reports describing the fall as ‘China’s Great Depression’. We make the following comments: 

  • The Chinese equity market has corrected, but the only people who have lost money are those who have bought since April of this year. 
  • The market was very ‘frothy’, having almost doubled from March to June. This move up was speculative, with margin lending increasing as investors chased the returns. Global investors barely raised an eyebrow at this market movement. 
  • The real economic impact comes from those who had geared up losing real wealth, and any future impact there may be on confidence. Actual economic data has been soft (but it has been soft all year) and the Chinese Government continues to stimulate the economy. 
  • The size of the Shanghai Index is small and represents only a small proportion of the Chinese economy relative to the size of markets in other developed countries.

The key enduring concern we have is that the steps authorities have taken to protect equities may undermine confidence in the asset class. The movement in commodities has clearly stepped down and this has been reflected in equity prices. The key question is whether this selling is now capitulation and begins to represent an opportunity, or whether it signals a hard landing for China. We think the odds of further government stimulus for China are increasing, which could provide a circuit breaker for the situation. Results for BHP and Rio Tinto that confirm dividends might also create a circuit breaker for these stocks.

Portfolio positioning

We continue to focus on those companies that are best placed to deliver growth via: 

  • strong business models with structural competitive positions
  • exposure to offshore markets so that profits will benefit from the lower A$ 
  • exposure to growing segments of the economy (housing, finance and infrastructure)


Market Update- Greece & China

 Market Update – Greece & China

When markets are nervous they have a habit of interpreting all news negatively and of course the reverse occurs when markets are bullish. At present nerves have taken hold primarily due to the uncertainty with respect to Greece. However further nervousness has emerged over a recent share market correction in China. We thought we would provide some context to the discussion.

The markets have generally reacted benignly to the potential for a Greek exit from the Euro however this has still created some uncertainty and added volatility. As we have written, a Greek exit is unlikely to have a significant economic impact given its small contribution to European GDP and the mechanisms in place to handle the contagion impact on other markets. The bigger risk is the potential political risk. If Germany was to roll over to Greek demands then this would likely encourage other groups in Italy, Spain and Portugal to make similar claims for debt relief. The lack of panic in European financial markets increases the pressure on the Greeks to make a deal in our view (if the Greeks behave rationally). However there is still a reasonably high possibility they will exit the euro. If this were to occur, we would anticipate the economic impact as modest. However European confidence could be impacted and market uncertainty might well linger for a while longer. However we do not see it as having a lasting impact on the global economy (so long as the political fallout is contained).

The Chinese market has had a strong correction in recent days. There are numerous newspaper reports describing the fall as “China’s Great Depression” etc. We make the following comments:

  • The market has corrected but the only people who have lost money are those who have bought since April.
  • The market was very frothy nearly doubling over March to June. This move up was speculative with margin lending increasing as investors chased the returns. The move up barely raised an eyebrow from global investors.
  • The real economic impact comes from those who had geared up losing real wealth and any future impact on confidence. Actual economic data has been soft (but it has been soft all year) and the Chinese Government continues to stimulate the economy.
  • The size of the Shanghai Index is small and represents only a small proportion of the Chinese economy relative to the size of markets in other developed countries.

Market Update


Market Update – Grexit Mark II

Further to yesterday’s short note on the on-going Greek situation, we highlight that the market’s initial reaction to the potential Grexit has been relatively benign. European markets fell 2% and there did not seem to be the panic that has been associated with other disturbances.


We raise a number of questions:

  • Have the markets become a little too blasé with respect to the risk or has the risk of contagion reduced?
  • Will the Greeks exit the EU and if so will this cause greater volatility in the market?
  • Is value being presented by the market?

Greek exit is not assured, as negotiations will continue until the Greek central bank is instructed by the government to physically print a new currency. Credit controls, default, even the issuing of IOUs are all simply steps that take Greece closer to a euro exit, but are not by themselves critical. In this volatile context, it is essentially impossible to properly price each new item of information, which should, by definition, lead to higher volatility and reduced risk appetite.

Have the markets become a little too blasé with respect to the risk or has the risk of contagion reduced?

The market reaction was reasonably subdued. See for instance the Italian bond yields which spiked reflecting some concerns of contagion yet the yields remain at historically low levels.

While volatility has picked up and could remain elevated while we deal with the uncertainty created by the Greek vote, we think the subdued reaction reflects the fact the contagion impact from a Grexit appears containable relative to the uncertainty in 2011/2012. This is due to the following factors:

  • Private cross-border debt exposures are now very small. Greek public debt is 80% owned by official lenders such as the IMF and the ECB. Bank exposure is $46b compared to $138b in September 2011.
  • Greece is less than 2% of the Eurozone and falling. The EU’s share of Greek imports is only 0.5% of total EU trade or 0.15% of GDP. So the economic impact is not significant.
  • The European economy is in better shape with significant reform paying dividends in economies such as Spain (with GDP growth expectation lifting recently to 3%).
  • The ability to contain contagion exists. ECB now has the mechanisms to provide liquidity support and increase quantitative easing.

Will the Greeks exit the EU and if so will this cause greater volatility in the market?

Like most things in Europe there remains uncertainty as to what will be the clear trigger for a Greek exit. A missed payment to the IMF on 30 June will not necessarily mean an exit. A ‘no’ vote at the referendum will significantly increase the likelihood but will also not be the trigger. The ECB will need a two-thirds majority to end Greek access to the liquidity assistance.

The bottom line is that nothing is set in stone in Europe. Even rules that are technically written down in treaties can be overruled and modified in times of crisis. The most we can say with certainty is that the ECB is unlikely to see a late payment to the IMF as a clear signal of insolvency. A similar default on a redemption to the ECB itself, however, may be taken differently. That is why the €3.5b redemption due to the ECB on July 20 is the key date for the Greek exit. A ‘no’ vote at the referendum will obviously increase the likelihood of exit because it will empower the Greek Government to withhold payment to creditors.

Is value being presented by the market?

The market has fallen 10% which is a typical size correction in a bull market. The question is whether this has restored value to the market.

A 10% pullback means the PE of the market is on 15x which is still slightly above long-term averages but is not extreme and continues to look attractive in a low interest rate environment. The grossed up dividend yield of the market is now 6.3% which will also attract investors in the low interest rate environment.

The missing ingredient for the Australian market has been growth. FY15 will be another year without growth thanks to the poor performing resource stocks. The market is currently forecasting 4% growth for FY16 which reflects more conservative expectations but growth forecasts look a little more optimistic for Industrial only stocks (with 8% growth forecast). We continue to focus on those companies which are best placed to deliver growth via:

  •  Strong business models with structural competitive positions. 
  • Companies exposed to offshore markets whose profits will benefit from the lower A$. 
  • Companies exposed to growing segments of the economy (housing, finance and infrastructure).



Market Update

Market Update – Grexit

In a surprise move the Greek government called a referendum for Sunday 5 July asking if Greece should accept the latest bail-out proposal by its creditors. The current government will be campaigning for a 'No' vote.

The European Central Bank (ECB) has capped Greek banks' emergency funding at €90b, but not withdrawn it yet. The Greek government has announced capital controls which would limit bank activity and the closure of the stock market. Capital controls are expected at least until the referendum. A 'No' vote in the referendum could mean the withdrawal of ECB emergency funding and higher probability of Grexit.

Market impact

In the short term we expect volatility to increase as markets do not like uncertainty and will re-treat to safe havens. We expect strong US$, lower bond yields and lower equities in the short term. The initial risk-off mode will take markets lower, the potential for an aggressive policy response will propel them higher. We would regard a 5% pullback in markets as a significant buying opportunity.

Potential policy response

The ECB will be watching for signs of funding stress or bank runs in the periphery and may accelerate purchases of assets. A major difference now versus the Greek crisis of 2011–12 is that the ECB has a facility in place to intervene, if required. The ECB will be looking to protect the fledgling recovery in European confidence following the Russia/Ukraine conflict last year. Market expectations of Fed lift-off will be pushed out further. Expectations of an RBA rate cut will be brought forward.

Market Update

Market Update – Budget

Last night the Abbot government handed down their second budget. In contrast to their first, policymakers sacrificed ambitious savings in a bid to win back voters and as a result produced a softer budget. However while the budget only trims the deficit and delays fiscal repair, this is a good course to take for an Australian economic repair. Business not government generates wealth, creates jobs and grows the economy so we agree with measures taken by the government to stimulate business with a "have-a-go budget".

From a macro point of view, the overall budget is fairly bland with no real push or pull of the economy in either direction. However, if anything, with the intention of fiscal policy to do some of the work to stimulate the economy, it may place less pressure on the RBA to cut rates. Additionally consumer and business confidence should pick up as a result of a more measured budget, while measures to level the playing field on online purchased goods will also favour local companies.

We were relieved that the superannuation system or the taxation of superannuation was barely mentioned in the 2015 Budget Papers with the Government sticking to its pledge for "no unexpected, detrimental changes" to the superannuation system in its first term of Government.

Focusing on portfolios, we do not see any real tail or headwinds that necessitate major adjustments to portfolios. However, we focus on a few key implications: * Consumer stocks (JB Hi-Fi, Super Retail Group, Flight Centre Travel Group)—Budget aiming to stimulate economy and bring forward consumer demand. Instant write-off of capital investment under $20k for small business on any items with no limitation on use. There has also been an adjustment to FBT to abolish electronic devices used for work such as mobile phones, laptops and tablets.

  • Infrastructure & Construction stocks (Lend Lease Group, DuluxGroup)—The government have outlined a one-off payment of $499m to WA and up to a $5b loan facility to northern Australia to construct infrastructure. This should create jobs and increase productivity.

  • Employment stocks (Seek)—Policymakers are focusing on increasing the number of people looking for work. Increased family childcare benefits and encouraging employers to hire older workers should increase the participation rate.

  • Healthcare stocks (Sonic Healthcare)—Backing down from last year’s GP co-payment should support high volumes and subsequent referrals. This should remove some of the regulatory concerns around some of our healthcare stocks.

In conclusion, a plain budget should be received well by the market with many participants ranking the need for growth and strong economy over reaching a surplus. Additionally by saving on pensions, the government was able to avoid taxes on superannuation which should bode well for equities. Last year confidence took a major tumble and the Consumer stocks suffered downgrades. The outlook appears much better and this is clearly being reflected in the market today with Consumer stocks bouncing.

Please do not hesitate to contact me should you wish to discuss anything in greater detail.