November Market Commentary

November Market Commentary

Monthly Economic & Investment Market Commentary

November 2012

As mentioned last month, we are going to spend some time discussing China and their new leadership now that a few weeks have passed since the transition, but we will also briefly visit the United States where there looks to be a different dynamic to the current debate after the election. At home in Australia, we will review the latest GDP results, and the Reserve Bank’s thinking that led to a further rate cut. We start however in Europe, where the Greeks have recently secured the next stage of their bailout.


The latest agreement extends the maturity date by 15 years on the loans Greece has received from the European Financial Stability Fund (EFSF), and also includes a deferral of interest payments on these loans for 10 years. This means that while their level of debt remains very high, there has been a very significant effect on Greece’s ability to service that debt. In fact it is now estimated that the interest payments as a percentage of GDP have come down to just 3% for Greece, compared with about 5.5% of GDP prior to the latest agreement.

In a research note following the announcement Credit Suisse1 note that about 80% of Greek debt is held in the official sector. Importantly, this means that with the long term maturities now in place on this debt, the likelihood of a crisis triggered by being unable to rollover loans is now largely off the agenda. The Greek economy in the long term still needs to recover, but consistent with the views we have expressed in recent times, this latest deal seems to provide further confirmation that the disastrous disorderly disintegration in Europe looks to be only a remote possibility at this time.

A little over a year ago we included a significant downgrade in our expectations for earnings growth in Europe and in the time elapsed since then we have essentially seen that decline of around 30% come to be. As a result, and on the basis that we believe the disaster scenario mentioned above is unlikely, we are starting to see reasonable expected returns over the next ten year period for Europe in our forecasting. We have not yet made any adjustments to the International Equities model holdings, though we will continue to monitor developments in the region closely.


The Americans are weeks away from the automatic spending cuts and tax increases coming into effect in January. On the balance of probabilities it would still seem most likely that the new year comes around without a deal having been reached. Should that happen, then the contractionary impact to the American economy is expected to see a recession in 2013, though exactly when depends on the timing of any compromise measures agreed by House Republicans and the President.

The concept of the fiscal cliff, whilst widely reported, remains a mystery to many Americans, as evidenced by a recent survey2 where for every person who correctly said the measures would reduce the deficit, four times as many thought the effect would be to actually increase the deficit.

What has been noticeable in recent weeks is a different approach to the negotiations from President Obama. In his first term the President started with what he thought was a position that both sides could accept, and was then forced to make further concessions to the brinkmanship of the Republicans. Now, buoyed by a strong election result and not having to run for office again, the President has made his initial offer and demanded the Republicans submit their counter proposal.

It is fair to say there is presently a substantial gap between both sides, however the Democrats would seem to have the stronger position, as come January tax rates move higher on all levels of income. In the New Year the Democrats could then propose restoring lower tax rates for the bottom 98% of households, and force Republicans to block the move in defense of the wealthiest 2% of households. This will be a distraction for weeks and likely months to come, as will the next round of ludicrous debate about increasing the debt ceiling come February or March. Meanwhile, the best case scenario looks like the American economy continuing at around 2% annual GDP Growth, with any spurt above that level likely thwarted in the name of deficit reduction and long term debt management.


In the middle of November the transition in China to the new leadership of Xi Jinping and Le Keqiang was confirmed, and the Standing Committee of the Politburo they will lead as President and Premier respectively has been widely categorised as centrist in character. This is to say that the policy course already in place under the 12th Five Year Plan is likely to continue. As we mentioned last month, in his speech at the National People’s Congress outgoing President Hu Jintao committed to the goal of doubling China’s 2010 GDP by 2020.

Importantly he also committed to a goal of doubling the per capita income of both urban and rural residents over the same period. The attached chart3 shows that in recent years the growth in per capita income (light blue) has lagged the rate of economic growth (dark blue), including in the years post the global financial crisis when the Chinese embarked on an investment driven stimulus program of some US$640 billion. This is the first time the party has explicitly set such an objective and confirms the recent emphasis on the quality of economic growth, not just the quantity.

In annual terms the goal of doubling in ten years comes back to average yearly growth of 7%, and given that the actual growth rate for both 2011 and 2012 will be comfortably above that figure, the growth rate required to achieve the 2020 objective will naturally be lower and should be readily achievable. The challenges for the Chinese economy lay in the medium to longer term when it will become apparent if the current attempts to rebalance their economy have been successful.

The Chinese have an extraordinarily high savings rate, surpassing 50% of GDP in recent years, due in no small part to the lack of an adequate social safety net. The development of programs such as a national pension system, and strengthening of medical insurance programs is in time expected to lead to higher consumption and lower savings.3 In other words, as we have been saying for some time now, the Chinese (and other Asian and Emerging Markets consumers) will spend more and save less in future. These challenges will be brought into sharper focus in the coming years as the initial relatively easy growth to be had from a huge supply of cheap labour and seemingly insatiable consumers in the west, gorging themselves on cheap credit, move further into the past.

In 1979 the Chinese implemented the one child policy, which was deemed necessary at the time to ensure that population growth did not outpace the ability of the Chinese to feed themselves, and came on the back of a near doubling in size from 540 million in 1949 to 940 million people.4 The result of course was to slow the population growth rate substantially, to an annual average rate of just 0.57% between 2001 and 2010. The proportion of the population made up by 30 to 50 year olds is forecast to fall from 50% to 40% between now and 2030, while the number of elderly citizens will increase to more than 25% over the same period.

As a relative latecomer to the scene, the Chinese economy has enjoyed the benefits of a rapid uptake in technology and from government directed investment in fixed assets such as infrastructure. The next phase of growth will necessarily be slower, but still well in excess of what Europe and North America will experience. We have been expecting Chinese growth of around 7% as far back as 2010, as a natural consequence of the rapid expansion in the Chinese economy over the last couple of decades, and we have also consistently said that the Chinese will face challenges in managing the next phase of their growth. They have the financial capacity to deal with these challenges, including the usual range of potential calamities that are predicted such as defaults on non-performing loans and an overheated housing market in tier one cities.


We wrap up with a quick discussion on Australia, where we have just seen another cut in interest rates from the Reserve Bank in early December. Following the decision the ABS announced that our economy grew at 0.5% in the September Quarter, providing an annual growth rate of 3.1%. The Reserve Bank did mention that in the short term global growth was expected to remain below average, and that there remained risks to the downside to that outlook. The breakdown of the GDP numbers did also confirm that we continue to need some rebalancing in our economy, with growth continuing to be led by mining related business investment.

The Bureau of Resources and Energy Economics releases a report twice yearly on the status of major projects, and breaks down the projects into four main categories; publicly announced stage, feasibility stage, committed stage and completed stage.

In their October5 report the numbers were as follows:

  • Publicly announced  106 projects      > $91 billion
  • Feasibility stage          171 projects      $292 billion
  • Committed stage         87 projects       $268 billion
  • Completed stage         24 projects        $12 billion

The committed investments are dominated by 11 mega projects (value greater than $5 billion) which account for more than $200 billion of the above total, and the publication provided the following analogy to give some context to the scope of investments being made.

“if just one of the large LNG projects currently at the Feasibility Stage were to receive a positive FID [Final Investment Decision] in the next twelve months, there would be more invested in LNG, gas and petroleum projects in Australia than the total amount spent by the US Government on the Apollo Moon Program (in 2012 prices).”5

Elsewhere in our economy, the imbalances have been correcting for several years now, including the household sector to continuing to pay down debt and the banks continuing to reduce their reliance on offshore funding arrangements. Affordability in the housing market has been improving for some time and the unemployment figures continue to show resilience in the labour force.

The first signs of our government softening their commitment to deliver a budget surplus have appeared in early December, and the opposition reaction will likely be shrill and completely out of proportion to the magnitude of the decision. As you are subjected to the squabbles in Canberra, providing yet another example of the importance of long term forecasting, be reminded that our long term outlook remains very much linked to the growth engines of the global economy in Asia and Emerging Markets.


The table below shows our long term (10 year) expected returns from four asset classes; Australian shares (represented by All Ordinaries index), international shares (S&P 500), Emerging Markets (represented by the FTSE Emerging Markets Index) and listed property (ASX 200 Property). The four valuation ranges, represented by the different colours, are determined by comparing the return we forecast, to a risk free rate of return (Term Deposit rate).


1. Credit Suisse, European Economics. 28-Nov-12.
2. Walter Hickey, 47% Think The Deficit Would Increase If We Go Over The Fiscal Cliff. Business Insider. 4-Dec-12
3. Li-Gang Lui & Raymonf Yeung, China’s New Leadership. ANZ Research Quarterly. Q4 2012.
4. China’s Downward Spiral. Stratfor Global Intelligence. 29-Nov-12.
5. Aust. Govt. BREE. Major Projects 2012. Oct-12.

DISCLAIMER: The information in this commentary has been provided for publication by Implemented Portfolios (ABN 36 141 881 147. AFSL Number 345143). The information has not been verified by Implemented Portfolios or Adapt Wealth Management Pty Ltd (ABN 76 821 231 362 Corporate Authorised Representative of CHPW Financial Pty Ltd AFSL 280201) but is believed to have come from reliable sources as noted in the acknowledgements. No Liability is accepted by Implemented Portfolios, or Adapt Wealth Management Pty Ltd, its Directors, officers, employees or contractors for any inaccurate or incorrect information. The information is a broad commentary and there is no intention that a client should act on the information without seeking professional assistance from their own advisers (legal, tax, accounting, financial planning) for suitability in respect of their unique circumstances.


About Reuben Zelwer


Reuben Zelwer established Adapt Wealth Management in 2011 to help time poor clients achieve financial freedom. For over 15 years, Reuben has helped professionals, executives, business owner and those approaching retirement make the most of their circumstances by making good financial decisions. Reuben’s professional practice is complemented by substantial voluntary work, which has included setting up financial literacy and savings programs in the local community.