Different Investment Types

Growth Pick up

After a dip in growth last year thanks to the softer housing market and weak consumer spending, 2006 has seen the economy head back up to growth up to 3.1%. There's been continued strength in business investment and export volumes are rising.

While consumer spending has been reasonable at around 3% per annum, it has been constrained by high petrol prices and the interest rate hike in May. Inflation is within the RBAs comfort zone at around 2.75%. Although the Federal Budget tax cuts will put more money in peoples' pockets, the increase in housing construction market has been falling although not as hard as in the past. Activity is not expected to pick up until we move into 2007.

The main driver of the economy has been business investment on the back of the mining boom. However, Profitability and business confidence has been high right across the economy fuelling business capital spending. It is expected to continue over the next year along with an increase in state government spending on infrastructure.

World growth

Resources have been rocketing along however a correction in commodity prices in May has brought volatility to the sector. In spite of this, economists believe commodity prices will remain high for the next few years, possible even decades, given that China and India are growing in a similar fashion to Japan and South East Asia in the post World War II period. The difference between the industrialization of Japan and what is happening now in China and India is scale - China and India are much larger, with billions rather than millions of people.

Furthermore, if China continues to grow at its current pace, it will still take 30 years to catch up to our living standards. It is a similar story with India and this should contribute to upwards pressure on commodity prices for some time to come. That said, there will still be ups and downs in the cycle but the longer term trend is one of continuing strength. We are looking at weighting portfolios to this international sector

Federal Budget

At the time of the May Budget there were concerns that the latest round of tax cuts would drive consumer spending, adding inflationary pressure. However, many consumers have high debt levels and when faced with higher interest rates and petrol prices, it is believed a significant proportion of the tax cuts will be saved rather than spent.

From an economic perspective, the superannuation changes announced in the budget are being viewed as appositive for the economy as they will encourage further savings.

Jobs and interest rates

Unemployment has been sitting in the range of 5.1 - 5.3 % for the past 18 months, although the most recent data has seen a jobs surge in May with unemployment dipping just below 5% to 4.9%, seasonally adjusted. The unemployment rate is expected to stay in that range in the months ahead.

Sectors which have experienced an upward pressure on wages include mining and engineering, non-residential construction and financial services, particularly the accounting profession where there is nationwide shortage of accountants.

Interest Rates

Any interest rate rise these days has a powerful impact as it is mainly the debt laden household sector not eh corporate sector which is affected. In early May the RBA raised the cash rate a quarter of a percent to 5.75%, the first rate rise since March 2005. The hike may slow parts of the economy particularly the housing sector as buyers become more cautious.

As the rate rise is not fully offset by the budget tax cuts and other concessions, it is expected to assist in keeping inflation under control.

In theory rising interest rates help to push up the value of the Australian dollar but, as other countries around the world have also been increasing their rates, the interest rate differential has been narrowing. It is becoming less attractive for investors to park their money here, which is acting as a negative for the Aussie dollar. The dollar has been bouncing up and own between 70 and 80 cents since early 2004 and the trend is expected to continue.

International economies

Overall the global economy has performed better this year than most people thought it would, with growth running around its highest level in 30 years.

Asset class performance
Up until the May/June correction and ensuing volatility, the share market was the star performer of the asset classes for 2006. The Australian market had huge gains, rising around 25% percent from the last correction in October 2005 to its peak in early May. Other markets rose further than that and suffered larger falls in the correction. Over the course of May the Australian market fell 4.9% but from its peak early in the month to its low in late May, the Australian share market fell 8%, similar to the October 05 correction. Also in May, the US market had a 6% top to bottom fall, Europe sank 8-10% and the Indian market, which had the biggest drop, fell 22% from its peak.

The share market shake up is the correction we were looking for. The risks on the horizon were being ignored and after huge jumps in the market and prices for commodities such as copper, zinc and gold, a pull-back was inevitable. Uncertainties over global inflation and growth risks remain and will add to continuing market volatility.

Where to now

After the phase of volatility ends, the market is expected to resume an upwards trend. There is room for further growth in the Australian share market down the track. Corporate profits are tracking well, interest rates are not likely to rise significantly and there is a lot money earmarked to go into the share market from superannuation and the Future Fund.

While the resources sector has shot up more than 30% and outperformed the broader markets by a wide margin this year, a period of consolidation is to be expected. However, unlike the IT boom of 2000, the surge in resources stocks has been backed by profit growth. Furthermore, the assumptions built into current share prices regarding metal prices are below current market levels, so even if the price of metals edge back in the short term, profit forecasts may need to be revised up. This means that while there may be uncertainty in the short-term, there is still a lot more upside in resource stocks.

International Shares

After a couple of years of the Australian share market leading the world, this year international shares have outperformed the Aussie market, although, as mentioned earlier, global equities have also been hit by a correction.
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The past few months has seen the emergence of a new acronym, BRICs, referring to economies of Brazil, Russia, India and China which are driving much of global growth. While the outlook is for further growth in the BRIC economies, they are emerging markets which tend to be very volatile. The BRICs story will be covered in a future Newsletter.

Fixed interest

Talk of higher interest rates has pushed up bond yields around the world, although they are still low in comparison to other asset classes. In Australia yields are around 5.5 - 6%, just over 5% in the US and 1.9 - 2% in Japan. Although bonds may be considered a somewhat dull asset they can't be ignored as they provide stability and portfolio diversification.

Residential Property

A diverse situation is occurring across the country with residential property. The Western Australian and Northern Territory markets are still surging on the back of the mining boom, while there are average conditions in South Australia and Tasmania and the east coast is flat to negative.

In the most recent data for the year to March:

Sydney has had average capital growth of minus 1%
Melbourne, Canberra and Brisbane are up a couple of percent
Adelaide has had gains of 7%
Hobart 8 - 9% and
In Perth and Darwin there has been growth of 28 - 29%. In March alone the Perth market jumped 8%.
For investors, the rental yields in all property markets, including Perth, are very low. The national average is a gross of 3%, falling to a 1% return after taking costs into account. In Sydney the net yield is more like 0.5%.Residential property is not the preferred asset class for the next 2 years In fact the ratio of house prices to wages is almost double what it was 15 years ago

Non-residential property

There is increasing investor demand for non-residential property due to the attractive yields of 6-7% and a similar level of capital growth on top. After a big run-up last year, the listed property trust sector has been flat this year, however unlisted property funds have been generating returns of around 13-14%.

Summary

International Shares: continuing long term growth trend.
Australian shares: volatility over the next few months upward trend stick to strategy.
Residential property: flat for 18 months - 2 years
Unlisted property: must be very project selective too risky at present
Listed Property: Pick the bigger ones with track record.
Cash: stay in for the next 4- 6 months if you need the money at that time. However always better places for money long term.