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(26 May 2010) - The New York Stock Exchange
opens and closes to the sound of a bell but as
many share investors have lamented, no-one rings
a bell at the top or the bottom of the market.
So far this month, Australia's benchmark S&P/ASX200
index has slumped 11.7%, mostly on justifiable
concerns about the ability of Europe and other
developed nations to service their debts.
But investors have also been pondering a raft
of other negatives.
Whether justified or not, there is a danger that
the Resource Super Profit Tax (RSPT) will scare
off overseas investors and will result in mining
projects being shelved. There are also concerns
that the Chinese regulatory authorities will not
be able to dampen speculative activity in the
housing sector without hurting the overall economy.
Likewise, most blue chip stocks in the local market
are not cheap on key valuation yardsticks - a
situation that might become worse if short-term
interest rates rise another 0.75% over the next
two years as the futures market is implying.
But perhaps the biggest problem is one of simple
arithmetic: namely, that it's impossible to keep
piling up debts indefinitely. In economics, saving
is often described as deferred consumption. It's
the portion of your income that you could spend
now but have held back for future use. Debt, of
course, is the other side of the coin. It allows
you to spend more than your earn and to bring
consumption forward from the future.
The sting in the tail with debt is that you have
to allocate future income to meet your repayments.
Greece and several other European are now barely
able to do this and bondholders are staring at
losses of potentially trillions of dollars. The
usual solution to this kind of economic mess is
to grow your way out of the problem - i.e. generate
more income and pay down your debts. Unfortunately,
Greece has little chance of doing this. Its three
main industries are tourism, shipping and manufacturing
- none of which have great upside. It will therefore
have to cut future consumption for years, and
possibly decades, to come. It's a similar story
for Portugal, Spain, Ireland, Italy and a host
of other European countries who will struggle
until the Euro sinks to a level that makes the
region competitive again.
Questions for local investors
Of course, the critical question for local investors
is: what does all this mean for us? The answer
is probably not that much. Although the Europe
accounts for 15.2% of world GDP, it only accounts
for 6.8% of our exports. Australia's biggest individual
export market in Europe is the U.K. which has
a 2.6% share. On a dollar basis, that makes it
less important than Singapore and about the same
as Thailand. The other G7 countries - France,
Germany and Italy - collectively account for just
1.8% of Australia's export sales. China, Japan,
India and South Korea constitute nearly 58% of
the total.
The reality is that Europe is a relatively minor
contributor to Australia's economic growth and
has a limited presence in Asia. Any fallout from
Europe in terms of weaker growth or sovereign
debt defaults is unlikely to have a significant
impact.
Worries about China need to be kept in perspective
too. While there are legitimate concerns about
speculative activity in the Chinese housing market
and newly-announced curbs on lending, you need
to bear in mind that 30 of China's 32 biggest
banks are state-owned. Twelve are owned directly
by the central government and another 18 generally
smaller lenders are owned by local governments.
Unlike most Western countries, the Chinese regulatory
authorities don't have to cajole their commercial
banks to rein in spending; they can instruct them
what to do.
Moreover, the government has made it clear that
it is targeting second homes and high-end properties
in tier one and tier two cities, not the low-end
real estate which dominates the industry. As long
as inflation stays reasonably contained, the odds
are that the residential property boom in China
will deflate with a hiss not a bang.
With the Resource Super Profits Tax (RSPT), it's
hard to untangle the information and misinformation.
According to Fortescue Metals CEO Andrew Forrest,
the RSPT is "equivalent to the nationalisation
of the mining industry." Yet Treasury Secretary
Dr Ken Henry argues that "the RSPT should have
little impact on mining investment. Overall mining
investment is encouraged in this package." BHP
has threatened to cut its dividend, Rio Tinto
plans to 'review' all its projects, the Wall Street
Journal says the tax will make Australia 'one
of the most burdensome places to mine in the world,'
there have been threats to target marginal seats
in Western Australia during the Federal election
and everyone is getting frustrated that others
can't see their point of view.
It is not hard to understand why mining companies
and share investors don't like the tax but they
seem to be swimming against the tide. The wider
business community is not rushing to back them
up on the issue with most industrial and service
sector CEOs expressing ambivalences or even guarded
support for the RSPT, the Federal Government is
not keen to negotiate a compromise and the weight
of research is starting to confirm that the mining
sector is not as heavily taxed as it was a decade
ago.
It is hard to weight up these competing claims
but perhaps the best arbiter is the stock market.
Since the RSPT was announced, the ASX Metals &
Mining Index has actually outperformed the All
Ordinaries Index by 1.7%.
Not all bad news
With all the drama surrounding the RSPT, European
debt and world growth, it's easy to get caught
up in the gloom of the moment. But to keep a balanced
perspective, it's important to be aware of other
trends that just don't fit the doomsday scenario.
- To begin with, most
commodity prices are strong, especially
in $A terms. This is surprising given
that commodity prices and the US$ tend
to move in opposite directions and world
growth is supposedly at risk from an implosion
in Europe.
- Mining stocks appear
to have under-reacted to the weak $A.
During the past month, gold shares have
slumped 6% yet the A$ gold price has surged
14.8%. Since the collapse of Sons of Gwalia
from hedging losses in 2004, most gold
miners have steadily unwound their hedging
arrangements so the higher $A bullion
price should quickly flow through to their
bottom line.
- Dry cargo shipping
rates are up 28% so far this year which
suggests that world trade is strong. While
this is by no means a perfect indicator,
it is useful because it is hard to fudge.
No-one leases a 50,000 long ton ship just
for the heck of it.
- ASX trading volumes
are up 67% on last year. This must be
making inroads into the supply of panic
sellers in the stock market.
- While Australian
corporate earnings are only expected to
grow 1.7% this year, they are forecast
to climb by 12.9% in FY11.
- The S&P/ASX 200
index is nearly 29.6% below its long-term
trend.
- Job ads on seek.com.au
and other online websites are continuing
to grow strongly which indicates that
labour demand and business trading conditions
remain positive.
- Dividends plus franking
credits are yielding more than short-term
interest rates.
Conclusion
There will undoubtedly be plenty of turbulence
on the financial road ahead but the local
share market looks closer to a buy than
a sell. While the fears about Europe's fate
are of concern, the punishment meted out
to Australian equities and the $A over the
past month is excessive.
Warning: While all care
has been taken in the preparation of this
document (using sources believed to be reliable
and accurate), we do not accept responsibility
for any loss suffered by any person arising
from reliance on this information. This
document is not financial product advice
and does not take into account any individual's
objectives, financial situation or needs.
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