Alliance Investment and Retirement Services Pty Ltd

From the MD's Desk....

What a difference a year can make.  While there is no guarantee that the global economy is totally out of the woods yet, most indicators are suggesting that a solid turnaround is underway.  This is in total contrast to the outlook 12 months ago, when the world was completely engulfed in doom and gloom.  As mentioned in the past, the share market is generally a leading indicator, usually changing direction somewhere between six and 12 months before the economy does.  This has happened again, with the Australian share market rebounding significantly, despite the real economy not looking particularly strong.  The Dow Jones in the USA has also recovered significantly despite the US economy having experienced a much deeper and longer recession and facing a less positive outlook.

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As usual, our investment committee spent a considerable amount of time over the past few weeks processing and filtering information from the most recent ASX company reporting season (financial results mostly for the six months ending 31 December 2009).

Below is a summary of our thoughts:

1. Few significant surprises

From our perspective, there were very few significant surprises (positive or negative) within this round of company reporting.  Generally, businesses have reduced their costs where needed, have addressed any balance sheet concerns and are now well placed for a longer term economic recovery.  In some instances businesses are also now facing less competition than in the past which may prove very beneficial over the long term.

2. Revenue growth remains the challenge

Despite the generally more positive view on the economic recovery (particularly in WA) and the significant jump in both consumer and business confidence, revenues clearly remained under pressure.  However in many instances cost reductions and reductions in impairments offset weaker revenue and drove increases in earnings.  Once revenue growth returns, businesses should be well placed to grow earnings more significantly with their leaner cost bases.

3. Debt funding costs remain a headwind for small to medium business

Access to capital (bank funding) for small to medium business clearly remains very tough with banks charging high interest rates, establishment fees and significant fees on undrawn debt.  This will continue to be a drag for these businesses unless banks are able to significantly increase lending in this area.  This may prove to be a significant competitive advantage to larger businesses with strong balance sheets and access to alternate sources of capital.

4. Non-discretionary food, healthcare  and utilities businesses well placed

Pre reporting, many investors were clearly focussing their attention on companies with the greatest potential operating leverage to an economic recovery.  In some instances the share prices of such companies declined after reporting as the results (whilst solid) somewhat missed overly inflated expectations.

Defensive (non-discretionary) businesses generally fared well post reporting season as many investors had under estimated their ability to achieve solid results in a period of gradual economic recovery.  Many of the "defensives" (in food, healthcare and utilities in particular) remain very reasonable long term buying as their share prices have not matched earnings growth in recent years.

5. Australian share market unlikely to match previous twelve months

With the gradual unwinding of economic stimulus, rising interest rates and noise around sovereign credit issues remaining; our expectation in the medium term is the Australian share market is unlikely to continue rebounding as sharply as it has in the previous twelve months (off a low base). We believe returns over the medium term are more likely to revert to longer term averages.

Our efforts continue to be focussed around businesses with a clear track record of performance, solid management and in industries with sound long term economics.

Presentation Summary

Alliance recently held an "economic outlook session" with guest speaker and economist George Tharenou from UBS Australia.  Feedback from the session suggested that the evening was very informative and was a great opportunity to mix with other clients of Alliance and our staff.  We now turn our minds to attracting an appealing guest speaker for our next event!

Below is a summary of George's views and comments from the presentation.  

If you would like a copy of George's slides, please click here.

The global economy has just experienced its largest downturn since the Great Depression.

The United States has seen a severe recession where extremely tight credit conditions led to a significant depreciation in asset prices. Only now have credit conditions begun to stabilise allowing for gradual improvements in consumer confidence. While markets have recovered significantly, the next 2 to 3 years are likely to be characterised by further volatility.

The focus has now shifted from providing emergency credit liquidity to central bank policy exit strategies and sovereign risk issues.

Dubai and more recently, Greece, Portugal and Spain have illustrated the difficulty some countries face in the GFC aftermath. Despite much publicity, Australia's indebtedness (when compared to GDP) is insignificant when compared to the European area, Japan and United States. UBS expect Australia to move back to a current account surplus by 2013-14.

Key developing economies, China and India are likely to lead the world economy out of recession.

While UBS expect credit conditions to become tighter in the near-term, they don't expect this to significantly impact the country's overall growth profile. Australia appears as one of the very few developed economies well poised entering the new growth phase. The country's economy ties with China have helped indeed and UBS expects this to continue.

The Reserve Bank of Australia has now removed much of the emergency policy implemented thought the GFC.

UBS still expect another 0.75% - 1.00% in cash rate rises this year.

Commodity prices remain a significant driver of the Australian dollar.

Given UBS' favourable outlook for commodity prices in the near to medium-term, UBS expect the Australian dollar to continue trading above 90 US cents.