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The case for overseas Investment exposure

Written and accurate as at: Nov 26, 2013 Current Stats & Facts

Written by Geoff Steer, Partner Matthews Steer Chartered Accountants

The end of the year is a good time to reflect on the previous 12 months and what the future holds.  To try and look through the short term noise and get an understanding of the medium to longer  term trends and the implications for Australia and all of us as Australians.

This is no better example of the short term focus of the media and economic commentators than the concern around any US Fed action to progressively reduce the extremely accommodative monitory policy currently in place. For any medium to long term investor a tapering of the policy is positive news as it reflects the fact that the US economy is showing good signs of recovery and should not be forever dependent upon the current massive levels of monetary stimulation.

The hypersensitivity to very rational announcements about policy objectives and the current state of play sees an almost panic like reaction in investment markets. A classic case of ‘good news is bad news’.

Most of the economic data coming out of the world’s largest economies, primarily the US and China over the last few months confirms they are travelling reasonably well. In particular, consumer spending, employment and house prices in the US are all moving in the right direction. Even Japan produced a solid growth rate in 2013.

It should be noted that the US, Japan and China make up 40% of the World’s GDP. This is equivalent to the next 24 largest economies in the world. Asia and particularly, of course, China continues to be incredibly important to the rest of the world and Australia in particular. China is experiencing massive internal change. The economic miracle of the last 30 years now has to face the economic and social challenges of a more normalized economy.

However, three major themes will continue to be a positive for the world economy and have many years to run:

  1. The continuing urbanisation of the Chinese population.
  2. The rise of the middle class and resultant transition to a more consumer driven economy.
  3. The massive increase in the availability of education, health services and utilities over the last 20 years means that China is now a healthier, smarter and more productive country, and not just a source of low labour cost production.

Of course, Europe continues to be a basket case. However, it does at least appear to be stabilising on the back of a more positive and proactive approach by the European Central Bank. This should see Europe being less of a drag on global growth over the next year or so.

Whilst growth may be slower it should ultimately prove to be more sustainable.

Whilst there are no doubt risks and uncertainty I think it can be asserted, quite positively that world economies are stabilising and gradually recovering, from what was, for many, a near death experience.

Since the onset of the GFC, Australia has managed to avoid recession and to continue to grow. This has largely been on the back of growth in exports (predominantly mining commodities.)

Whilst Australia’s GDP has grown by approximately 12% in this period, the US has grown by 4%, Japan has hardly grown and Europe has declined.

So where does Australia sit?

For a number of years now, commentators have described the Australian economy as “Two speed” i.e.: mining in top gear and the rest of the economy mostly stalling or in reverse. The best way to understand the two speed economy is to think of a line drawn between Brisbane and Adelaide. The economic growth of the section that is Northwest of the line is actually faster than China’s, while we are all too familiar with the economic growth of the area Southwest of the line.

However, as mining investment tapers off quite quickly over the next couple of years, the economy is reverting back to one speed. The question is, will that speed be slow (growth) or reverse (recession).

There is no question that Australia has become one of the most expensive countries in the world in which to live and invest. The list of impediments, many self imposed, to productive investment include:

  • The high cost and (inflexibility) of labour
  • Rising Government changes and policy taxes. (e.g.: carbon  and mining)
  • High  relative energy costs
  • Infrastructure bottle necks
  • Skilled labour shortages
  • Strong Australian dollar

Overlaying this we have had an election campaign to endure and a political environment which did nothing to inspire any degree of confidence or direction.

Of the above list, we are placing an extraordinary degree of hope that a falling dollar will cure our ills. Concerningly this is the one that we are least able to influence.

Historically low interest rates have been the only lever being pulled to try and prevent the stalling of the economy (in part also to try and devalue the $A).

Despite the low interest rates, lending remains subdued with little appetite for productive investment. Anecdotally, within our client base we have seen just in the last few weeks some signs of the banks being more accommodative and looking for opportunities to lend.

So where to from here? 

Australia continues to be extraordinarily dependent upon China and broader Asia. With Asia being the high growth region of the world. There in continues to lie the opportunity, provided we can identify our natural place in the region (other than as a commodity exporter to China).

We have much to offer apart from resources in financial services, healthcare, education, tourism and not least agriculture. To a degree, these opportunities have been impeded by the strength of the $A. Going forward it is critical that we harness these opportunities.

What does all this mean from an investment perspective?

In summary we must continue to broaden our investment horizons. There are always opportunities, but going forward, a more global perspective will be required. There will, of course, continue to be good opportunities in Australia, particularly if we can harness our strengths in asset’s the world needs such as food, agriculture, energy, commodities and water.

However, increasingly we are just a small part of a global world and the opportunities won’t all be in our own backyard.

We know that investing overseas can seem a daunting prospect for clients who have always invested in Australian markets, and overseas investment may not be appropriate for some client’s portfolios, so the first question is to determine the relevance of overseas investment to an individual investment strategy, and only then how best to access and incorporate such investments in a portfolio.

Perhaps a theme for another day.

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