an investment roadmap key investment themes michael karagianis investment strategist mlc investment...

An Investment RoadmapKey Investment Themes

Michael KaragianisInvestment StrategistMLC Investment Management

May 2011

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Any opinions expressed in this presentation constitute our judgement at the time of issue and are subject to change. We believe that the information contained in this presentation is correct and that any estimates, opinions, conclusions or recommendations are reasonably held or made as at the time of compilation. However, no warranty is made as to their accuracy or reliability (which may change without notice) or other information contained in this presentation. To the maximum extent permitted by law, we disclaim all liability and responsibility for any direct or indirect loss or damage which may be suffered by any recipient through relying on anything contained in or omitted from this presentation.

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Opinions expressed constitute our judgement at the time of issue and are subject to change. The presenter is a representative of MLC Investments Limited. MLC Investments Limited ABN 30 002 641 661 105-153 Miller Street, North Sydney NSW 2060 is a member of the National group of companies.

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General advice warning and disclaimer

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Michael Karagianis Investment StrategistMLC Investment Management

• Michael joined MLC Investment Management as an Investment Strategist in July 2010. Prior to that, he was Head of Asset Allocation at UBS Global Asset Management in Australia and Global Head of Asset Allocation and Investment Strategy at Aberdeen Asset Managers in London.

• He graduated with a BEc from the University of Adelaide, and subsequently joined the Department of Treasury in Canberra as a research officer.

• At MLC, Michael is part of the capital markets research team, and is responsible for communicating MLC’s Manager of Managers Investment process to the market place as well as involvement in the formulation of the Strategic Overlay for diversified funds including the LTAR and Horizon series of funds.

• Michael has written numerous articles, as well as undertaken presentations and training to a wide range of clients and audiences, on topics related to the investment outlook, asset allocation and risk management. He has worked and presented in Asia Pacific, the Middle East, North America and, Europe.

• Michael is a member of the Morningstar Regional Expert Panel on Asset Allocation.

MLC Investment Insights & Viewpoints

September 2010 – The post-GFC investment environment. What can history tell us?

February 2011 – An Investment Roadmap. Key investment themes for 2011

December 2010 – The rise and rise of the Australian dollar – stretching the friendship

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Proverb:

I am an optimist, sure ……..

But I am an optimist that carries an umbrella !

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Key Investment Themes for 2011

Some of the key themes that may impact over the coming year

1. The “muddle through” global recovery continues . . .

2. China - a slowing juggernaut ?

3. Those sovereign debt blues keep rolling along . . . .

4. Long live the asset bubble !

5. 2011 – the Year of the Rabbit Equity ?

6. Australia – a two or three speed economy ?

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85

90

95

100

105

110

115

120

125

130

135

Q1 2008 Q1 2009 Q1 2010 Q1 2011

China Australia

US Germany

UK Japan

Ireland Greece

Cumulative real GDP indexQ1 2008 =100

Source: Datastream

Asia booming – US economy gradually recovering post GFC

1. The “muddle through” global recovery …

Two tiered

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US housing market still a problem

Source: Financial Times

One in 9 housing mortgages in the US not being serviced – prices still falling

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Negative equity remains major overhang

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Recent bumper stickers in the US

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Geopolitical Tensions

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Middle East – Fight for Democracy or Jobs?A dangerous combination of high unemployment and young

demographics

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2. China – a slowing juggernaut?

Source: Datastream

Chinese leading indicators weakening ?

97

98

99

100

101

102

103

104

105

106

107

Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

5

10

15

20

Leading indicator (lhs)

Industrial production (rhs)

% change oyachange oya

14 Source: Datastream

Now “tapping the brakes” to slow things

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3. Those sovereign debt blues keep rolling along . . .

Source: IMF

What debt ?“Zone of Worry”

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Probability of default at some stage is high European peripheral government & US municipal debt the

main concern

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4. Long live the asset bubble !

Source: Datastream

1970’s commodity boom

GFC

China super- cycle

Bubble ?

Are commodities experiencing a bubble ?

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RBA Commodity Price Index vs Australian dollar

20

40

60

80

100

120

140

160

Jul-00 Jul-04 Jul-08

0.5

0.6

0.7

0.8

0.9

1

1.1

Commodity Index US $ A$/US$ (rhs)

Index

Australian dollar reflects terms of trade boost

Source: Datastream

Could this also be a bubble?

GFC

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Asian housing prices booming – a bubble?Residential prices up 30 - 80% since 2008 on easy credit

conditions

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An Australian housing price bubble?

Source: Marc Faber “gloomboomdoom.com”

Australia has one of the most expensive housing markets globally

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End of QE2 could produce market volatility

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Global Bonds have outperformed Global Equities over 5 years

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75

100

125

150

175

01-Dec-05 01-Dec-06 01-Dec-07 01-Dec-08 01-Dec-09 01-Dec-10

Bonds (Barclays Global Agg Index)

Equities (MSCI World Index)

Total Return Indices Dec 2005 = 100

5. 2011 – the Year of the Rabbit Equity?Bonds are more expensive now – shares are relatively

attractive

Source: Datastream

?

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US corporate profits rebounding strongly

Source: Datastream

0

10

20

30

40

50

60

70

80

90

Mar-85 Mar-90 Mar-95 Mar-00 Mar-05 Mar-10

$ EPS

Weaker US$, improving profit margins and reduced write-downs all helping

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Australia

0

20

40

60

80

100

120

140

160

May-85 May-90 May-95 May-00 May-05 May-10

EPS

Australian earnings more muted recoveryNegative impact of rising AUD & interest rates and tight

labour market

Source: Datastream

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6. Australia- catching the “Dutch Disease”?

Mining booming but a high AUD hurts retail, tourism, manufacturing

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Australian Labour Force by Industry(March 2011)

Manufacturing10%

Construction10%

Wholesale4%

Retail12%

Accommodation8%

Transport6%

Government7%

Education8%

Health13%

Cultural2%

Personal4%

Electricity2%

Communication2%

Finance4%

Property2%

Mining2%

Agriculture3%

Total employed 11,457,000 (March 2011)

Manufacturing & Retailing big employers

Source: Australian Bureau of Statistics

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Impact of floods / storms . . . . . . .

• Near term - 2011 H1• Reduce growth & raise inflation

• Disrupt mining & agricultural exports

• Impact negatively on affected farmers, businesses and households

• Interest rates on hold

• Longer term - 2011 H2 onwards• Major reconstruction effort - concentrated in certain regions

• Qld a major beneciary

• Boost economic growth by up to 1-1.5% but not spread evenly

• Support construction industry – shortage of skilled workers?

• Industry recovery? Agriculture & tourism – wait and see

• Tax levy & other spending cuts to pay the bill

• Interest rates to rise further

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2

3

4

5

6

7

8

9

10

11

12

13

Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11

Selected interest rates (%)

Small/medium business loans

Official cash rate

Std. variable mortgage rate

Loan rates are starting to bite – heading up

Source: RBA, Datastream

Expect another 1-2 moves by the RBA later in 2011

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Housing affordability is poor nowPotentially dangerous for households with significant

mortgage debt

Source: RBA

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2011 Budget – where is the vision?Deficit > $49.4 bn in 2011 FY, $22.6 bn in 2012 FY, surplus $3.5 bn in 2013 FY

Growth > 2.25% in 2011 FY & 4% in 2012 FY

Inflation> 3.25% in 2011 FY, 2.75% in 2012

Sources of Growth

booming mining investment and disaster reconstructionmoderate consumption and weak residential construction

Positives > Spending on Labour force training and migration to boost workforce

Concerns > Very slow recovery in budget deficit despite the mining boom> Many of the measures not impacting for 2-3 years> No sovereign wealth fund to bank the benefits of the mining boom> No tax reform

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Dividends make up the majority of returns

Source: Datastream

Australian Equity Market Returns

0

200

400

600

800

1000

1200

1400

Q2 1986 Q2 1989 Q2 1992 Q2 1995 Q2 1998 Q2 2001 Q2 2004 Q2 2007 Q2 2010

All Ordinaries Accumulation Index (incl dividends)

All Ords Price Index (excl dividends)

Index = 100 at Q2 1986

9.9% pa

4.5% pa

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Dividends offer stable returnsDividends relatively more important in a “muddle through”

environment

Source: Datastream - All Ordinaries Accumulation Index

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What can you do about it?Equities preferred - valuations fair (not cheap) with reasonable earnings growth

Dividends matter - bigger share of total equity returns vs capital gains

- more reliable than capital gains and, - more tax effective than term deposits

Residential Property - beware because of poor affordability and rising interest rates

Diversification - crucial in a highly volatile, uncertain environmentglobalisation of portfolios - reduces risk !alternative asset classes - for diversification or illiquidity premia

Dollar cost averaging - systematically buying (not selling) cheap assets

Active management - active asset allocation & stock selection important for risk management not just return enhancement

Risk control - don’t take any more portfolio risk than you really need to !

Get good advice from a financial planner !

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