The Chinese Dragon is still feasting on metals

When the Chinese economy began to slow at the start of this year, Australian investors had more reason to worry than most. Prices for mineral commodities soon fell and the mining boom was pronounced dead, along with the recovery in resources shares.

But the good news is that the Chinese Dragon is firing up and reports of the death of Australia’s mining boom were exaggerated. Recent economic news out of China confirmed that recovery is on the way, led by investment in infrastructure.

Chinese spending on new roads, rail and power plants grew by 20.7 per cent this year, retail sales rose 14.5 per cent in October compared with the previous year and industrial production climbed 9.6 per cent. Plus, inflation continued to ease in October, down to 1.7 per cent, which makes it easier for the nation to increase spending.

Good news for shares

The importance of these numbers is that China appears to have avoided the hard economic landing some feared. That’s great news for our economy.

China is Australia’s biggest customer of mineral resources. When demand for resources increases, commodity prices climb, boosting capacity to fund new mining projects. This in turn creates more jobs, consumption of engineering goods and services, more tax revenue and, in short, helps our economy grow.

China’s decade of astonishing growth pushed commodity prices to record levels, but when demand for its products slumped after the financial crisis, even the mighty Dragon was forced to draw breath.

Economic growth in China slid to 7.4 per cent in the September quarter from 9.2 per cent in 2011. While growth of 7.4 per cent outpaces a euro zone in recession, a Japanese economy suffering stagflation or a United States with modest growth of 2 per cent, it represents a large fall in income for resource-rich Australia.

The perceived threat of a Chinese ‘hard landing’ sent commodity prices tumbling and halted the recovery in mining shares. The Reserve Bank of Australia’s Index of Commodity Prices fell 16 per cent in the year to the end of October, led by major price slumps for metallurgical coal and iron ore – both key to China’s steelmaking and two of Australia’s biggest earners. Price instability for energy coal and base metals, such as copper - another two staples of our economy - also helped to subdue resources stocks.

The graph shows how closely these stocks follow global commodity price movements.

The power of one billion

This month, the Chinese Communist Party announced new leaders. In his first speech, incoming President Xi Jinping vowed to meet his people’s aspirations for material wealth, personal happiness and national power.

To understand the significance of the potential economic power of China’s one billion consumers, look no further than their love affair with the car.

In 2009, China assumed the crown as the biggest vehicle market on the planet. New car sales hit 18 million last year and experts predict this could double by 2018. That’s a lot of raw materials being sucked into the Middle Kingdom every year from just one industry.

China’s growth to continue

China’s outgoing President, Hu Jintao, announced a target to double economic output by 2020, implying annual growth of 7 per cent. AMP Capital senior economist Shane Oliver says that figure is below recent record levels, but is still strong and China’s catch-up potential remains immense. He adds China’s infrastructure is still well below levels enjoyed by Australians.

Whichever way you look at it, the Chinese Dragon - the world’s biggest metals consumer - still has an insatiable hunger. BlackRock Investment Institute recently forecast the country’s consumption of copper, aluminium and nickel will double in the next decade. It argues that current mines cannot hope to meet demand after 2015, opening up supply gaps for many metals as well as investment opportunities.

The challenge to meet demand for coal, gas and iron ore has sparked big plans for new mines, not just in Australia but also in Mongolia, West Africa and even China itself.

While this poses a risk of oversupply and depressed commodity prices in years to come, it is theorised that as under-developed nations modernise their economies, demand will remain constant for generations.

So, while the short-term outlook for commodity prices – and by definition Australia’s economic growth – faces some risks from a sluggish global economy, the longer-term view for resources appears bright in what has been labelled the Asian Century.

www.perthfinancialplanning.com.au

Property - is it really a safe haven?

It takes more than a global property slump to shake Australians’ love affair with bricks and mortar. And it’s to do with the myth that residential property always increases in value, while other assets – particularly shares – are less dependable.

Over the last 12 months, many capital cities have reported negative property returns. Depending on which city, suburb and type of property, returns have varied enormously.

An over-reliance on property

Australians have a special affection for property because it is an asset with which we are familiar. Home ownership levels have hovered around 70 per cent for decades, while a further 21 per cent of households own investment property.

Home ownership has many advantages, not least it prevents your landlord selling your rental property from under you, and forcing you to pack up and move.

A successful property investment on the other hand needs to deliver a sustainable rental yield and the potential for long-term capital gain. To be realistic, the rental yield needs to factor in agent’s fees, ongoing maintenance and periods where the property will be untenanted.

If we were to contrast the rental yield from property with the dividend yield from shares, property investors could learn a few things from the way shareholders receive their money.

Listed companies always retain a portion of their profits to reinvest in their business before paying out any dividends; this is critical to their long-term success. Too many property investors work on a ‘100 per cent pay-out ratio’ when it comes to their profit from rent. This leaves little for reinvestment in maintenance to keep their property in good shape.

Buying residential property as an investment can be expensive, making it difficult to achieve adequate diversification. While it’s possible to achieve this diversification by investing in a managed fund, very few property funds include residential property. But there are other advantages of managed property funds: small amounts can be invested regularly; they own blue chip commercial properties; tenants are often household company names; and, the properties are often spread across Australia.

Listed property funds and shares can be sold if necessary, but you can’t sell off your investment property one room at a time if you need to raise cash or take profits.
Property can take months to sell, compared with days for listed investments, and transaction costs are relatively high.

Tracking property returns

Part of the traditional appeal of property is the perception that bricks and mortar provide a safe haven from the wild swings of the sharemarket, but based on recent volatile returns, that may be changing.

For the first time, property investors can track daily movement in house prices across Australia in the same way share investors watch the All Ordinaries Index, thanks to a new home value index. And guess what? Property values go up and down, just like shares!

The other issue is transparency. Real house price growth figures are inflated - they include pure growth, but also growth as a result of expenditure on major home renovations and even more minor capital upgrades, such as new decks, kitchens and bathrooms.

Beating inflation
Short-term price fluctuations are not the only thing property and shares have in common. Both are classed as growth assets. This means they offer the potential for strong capital growth over the long run, unlike defensive assets such as bonds and cash, which are bought primarily for income. 

The chart below shows that in the two decades to December 2011 after-tax returns from shares and property comfortably beat annual inflation, though cash barely kept pace.

The main reason for investing a portion of your savings in growth assets is to prevent your investment returns being eroded by inflation.

The actual return you make on your investments will not only depend on the investments you choose but when you buy and how long you hold them. If another period had been selected, the actual returns may have been different, but history tells us shares and property would still deliver better returns than cash and bonds over the long term.

While property has been a source of wealth for generations of Australians, recent price falls demonstrate it should be just one of the building blocks needed for an all-weather investment portfolio.

www.perthfinancialplanning.com.au

Looking to the Future

‘Procrastination is the thief of time’ is a phrase that has been hijacked by the finance industry and reappeared as procrastination being ‘the thief of wealth’. If you are waiting for the right time to buy back into the market, then you may well be losing an opportunity to build your wealth.

‘Procrastination’ is a grand word but it has simple Latin origins, pro meaning ‘for’ and cras meaning ‘tomorrow’…for tomorrow. And that is what sharemarkets are all about. They don’t look to yesterday but focus on tomorrow.

Tomorrow in the market
Stock prices and sharemarkets are often forward-looking; a concept which is tricky to grasp. A company’s shares tend to rally on the expectation of a good result, rather than wait for the announcement of that good result. If the announcement does not meet expectations, the share price can drop.

And it’s much the same for the market overall. It is said the sharemarket generally runs six months ahead of the actual economy. With some commentators believing we will start to see a global economic recovery in 2013, these factors might well be underpinning recent rises in the major sharemarkets around the world, even though our local market has lagged behind the US.

Recent market performance
Since January, global shares have risen around 11 per cent, led by the US. The Australian All Ordinaries index has risen more than 5 per cent to around 4,400 although back in May it topped 4,500, underlining the continued volatility in the market. Either way, it’s nowhere near its November 2007 peak of 6,873 but still well off the bottom of 3,111 in March 2009.

These ups and downs reflect continuing uncertainty and the shakiness of investor confidence in the market. Indeed, a recent survey by the Melbourne Institute and Westpac showed only 5.5 per cent of Australians nominated shares as the wisest place for their savings.

The next move
Market sentiment does appear to be cautiously changing, reflected in recent media stories pointing to a more sustained market upswing. There are signs of support at key levels, suggesting an unwillingness to push prices lower. This, in turn, has reduced volatility in the market.
The International Monetary Fund has projected global growth for 2013 of around 3.75 per cent, despite Europe’s issues, a sluggish US and a slowdown in China.
In addition, as interest rates trend down in Australia, some of the money previously invested in shares, but now in bank deposits and fixed interest, should start to flow back into the sharemarket, lifting prices as it does.
Of course, positive commentary and optimism don’t fix major problems in Europe nor do they mean a bull run is just around the corner, but it would be fair to say most negative factors have already been priced into the market.
The latest move by the US Federal Reserve to buy $US40 billion a month in mortgage-backed securities has proved a welcome short-term boost as has the German constitutional court’s approval of the big rescue fund for troubled euro zone members.
But global markets are still wary of the slowing pace of China’s growth, while closer to home the high Australian dollar and falling iron ore prices cast a shadow.

Shares pay dividends
Some market pundits believe Australian shares are currently cheap, which in turn means the dividend yield is higher. Add to that the benefits of franking credits on Australian share dividends and the fact 63 per cent of companies increased their dividends in the latest reporting season, and the argument for re-entering the market gathers momentum.
Share investments often represent only one part of your asset allocation, as determined by your risk profile, needs and goals. Once you have set your share investment strategy, generally speaking, you should stick with it and look to the long term.
Indeed, if you had not needed to sell your shares to provide an income in the wake of the GFC, then the losses would have only been paper losses. In time, most shares will recover lost ground and while you may have seen no capital growth over the last few years, dividends have continued to be paid.
Warren Buffett is famous for saying you should be fearful when others are greedy and greedy when others are fearful.
With the wisdom of this famous investor in mind, maybe it’s time to stop procrastinating and start looking to tomorrow — today.

www.perthfinancialplanning.com.au

Changing with the Times

If variety is the spice of life, then most Australian investors have had their fill of excitement in recent years. While our economy has outperformed most of our traditional trading partners since the GFC took hold in 2009, Australians have remained concerned that an economic catastrophe is still lurking around the corner.

Despite solid growth and some areas of the economy shining, our outlook, as measured by consumer sentiment, has been in the doldrums. Positive drivers such as low interest rates and low unemployment were being overshadowed by negative news from Europe and uncertainty about the future strength of the local economy.

New realities
One reason for this uncertainty may be the extensive change Australians have been experiencing since 2009. With new realities like a strong dollar and dominant resource industries driving major changes in the economy, for some people the personal impact has been significant.

This ‘structural economic adjustment’ is not new of course. Changes occur to the structure of every economy for different reasons. The days when agriculture was our strongest sector have long gone, as we have moved towards an economy now dominated by the services and resources sectors.

More and more Australians are changing their lives – from where and how they live to the type of work they do – to be able to earn a living and prosper from these adjustments. Ebbs and flows in the economy can undoubtedly cause individuals and families considerable pain. People have their hours cut, or find themselves out of work and having to relocate or needing to re-skill themselves to take advantage of new opportunities. Any change can be difficult, especially if you are not prepared or lack the ability to adapt.

New opportunities

Similar adjustments are happening in the retail sector, as spending and buying habits change and increasing numbers of people shop online. Retailer and founder of Harvey Norman, Gerry Harvey, spent years resisting the online retail world before the opening earlier this year of harveynorman.com.au. But changes have also created opportunities for innovation and new ways of retailing, such as StyleTread. While shoppers are turning from bricks to clicks, they are helping grow new online businesses like shoe retailer StyleTread. The business is not alone in competing for Australia’s $2 billion shoe spend, but after less than two years they now have a warehouse holding 100,000 pairs of shoes and employ 20 people. They also generate new work for transport companies like Australian Air Express who deliver the shoes and pick up returns under StyleTread’s 100 day return policy.

Gaining from change
Many of the adjustments individuals and businesses have already made, as painful as they may have been on a personal level, actually add resilience in case of future economic shocks.

At an individual level, these changes include saving more and being more cautious about taking on high levels of debt, as well as weaning ourselves off easy capital gains from constantly rising property prices. Together with adjustments made by businesses such as redirecting banks’ funding away from short-term foreign borrowing, these responses give the economy stamina for the future.

One fact you can bank on — both the local and global economies face further change. While structural change is often beyond our control, you can be sure most well-managed businesses are actively working to position themselves for future growth.

It takes strength and stamina for Australians and Australian businesses to meet the challenges of our new economy. Although sometimes painful, the changes made today are designed to strengthen our position for tomorrow and for future generations to come.

www.perthfinancialplanning.com.au

The Perils of Short Term Trading

It was Friday 29 June 2012, the last trading day of the financial year, when department store group David Jones revealed it had received a $1.65 billion takeover offer. The market immediately went into overdrive, pushing up the price of David Jones shares by almost 20 per cent.

Then, over the weekend, doubts set in about the credibility of this offer from an unknown British outfit called EB Private Equity. The British corporate suitor was later unmasked as not much more than a website, but by then serious damage had been done. 

When the market opened on the following Monday, David Jones’ share price fell by 17.5 per cent to close to where it was before news of the offer broke. David Jones announced the offer had been withdrawn and its shares were placed in a trading halt. The next day, the Australian Securities and Investments Commission (ASIC) announced it had launched an inquiry into “potential issues regarding disclosure and trading in David Jones stock”.

Speculators who bought David Jones shares at the height of the buying frenzy were left bruised while sellers were smiling. But in the midst of all this sound and fury, the fundamental value of the David Jones business had not changed. 

What are the rules?
The case of the phantom David Jones bid raises serious questions for company directors and market regulators, and especially for investors. 

Under the continuous disclosure rules, listed companies must immediately notify the Australian Securities Exchange (ASX) if there is any information that is likely to affect their share price. The ASX makes this information publicly available on its website so all investors have access to the same information. 

With the advantage of hindsight, some market commentators questioned the decision by David Jones’ board to announce the takeover offer before it had checked the bidder’s bona fides. While continuous disclosure is designed to keep the market informed, in this case the information was not just incomplete but raised more questions than it answered. 

Other commentators argued the company should have requested an immediate trading halt on its shares until it could provide shareholders with all the information they needed to make informed decisions about their investment. A market fuelled by gossip and speculation increases the likelihood investors will make poor decisions in the heat of the moment. 

A takeover offer typically pushes up the share price of the target company, so the timing of the bid just as the financial year was closing off, raises the possibility of deliberate market manipulation. ASIC is now examining potential issues regarding disclosure of the bid and trading in David Jones shares. 

But even if there is wrongdoing for ASIC or other authorities to uncover, it is likely that people who lost money in the mayhem will have to wear most, if not all of their losses. 

Lessons for investors
There are important lessons for all investors in this David Jones episode.

One of the most important is to know and appreciate the difference between a company’s share price and the value of its business. A second is to have an investment plan that works for you, one that lets you focus on the long term so you can avoid ‘noise’ in the market . 

Legendary share market investor, Benjamin Graham, famously said that daily stock market activity is not a weighing machine on which the value of a business is recorded, but a voting machine where countless individuals buy and sell shares based on a mixture of reason and emotion.

It is only when you understand the true or intrinsic value of a company that you can tell if the market price is temporarily too high or too low. 

History shows us excessive trading doesn’t consistently produce better returns compared to that of a more passive long-term strategy. We also know short-term trading can prove a real distraction for people who have neither the time nor expertise required to crunch the numbers.

The best way to make money out of shares and sleep at night is to stick to your long-term plan, buy quality stocks and be patient. In the long run, the market will recognise the true value of a company and will price it accordingly, and that is where long-term investors become winners.

www.perthfinancialplanning.com.au

Financial Year 2011-2012

We are told the Australian economy is stronger than the rest of the world, but our share market fell 12.5% whilst the Euro area ‘only’ fell 6.9% and the US even managed to close the year with marginal gains.

Australians believe that the ‘resources story’ will continue to insulate Australia from the world’s economic troubles, yet the resources sector underperformed the wider market and fell 20%, with stalwarts BHP and Rio down a massive 30%.

Our July newsletter reviews yet another turbulent year in the performance of the world’s major economies and share markets. It takes a closer look at European weakness and the relative strength of the local economy, as well as key aspects like inflation, consumer confidence, the dollar, and interest rates. And it assesses what might happen in the months and year ahead. You can read our July newsletter online here.

Whilst the global risks to the world economy remain, I do believe the governments, and the majority of companies around the world are better placed to deal with these difficulties compared with four years ago when the GFC troubles started. As for resources, I am sure they will shine again, but the past financial year illustrates perfectly the necessity for a portfolio to be well diversified; both across sectors and regions. You may also be interested in an article I posted to the website in April of this year which attempts to explain why the Australian share market was underperforming the rest of the world. 

www.perthfinancialplanning.com.au

News of job cuts is sharing the headlines with the debt crisis in Europe and domestic political machinations, but what lies behind the job stories is what really matters.
Thanks to some tough decisions taken over recent decades, Australia is far from the global doom and gloom scenario some commentators write about. With risks hanging over the global economy, particularly from Europe, consumers and

businesses are understandably keeping a tight rein on spending, debt and costs. Retailers, along with the construction, aviation, manufacturing and fi nance sectors are finding things particularly tough. It is within these industries that many of the redundancies are occurring. At the same time, unprecedented global demand for commodities, particularly from Asia, means much of the mining sector has the opposite problem; it is struggling to find the workers with the skills it needs.

Good luck or good management?

Much of Australia’s success in getting through several global economic downturns, including the Asian Financial Crisis of 1997–99, the dot.com boom and bust in 2000, and the recent global fi nancial crisis, can be traced back to the decision in 1983 to “float” the Australian dollar and let it find its value in the world’s currency market. Once the dollar was floated, it was hard to turn back; Australia and Australians had to compete with the rest of the world, boost productivity and make some adjustments.

As a result, tariffs were reduced and trade was orientated towards the emerging economies in East Asia, well before China began to accelerate. The end of protection shifted Australia from being an uncompetitive manufacturer in areas such as clothing and footwear, to being highly competitive and successful in the education and services sectors, especially while our dollar was well below parity with the US dollar.

Professor and economist Tim Harcourt says, “Even in areas you’d least expect, the end of tariff walls and an inward looking culture unleashed Australian innovation. From sleepy surf towns such as Torquay in Victoria, companies like Rip Curl became international players, joining competitors like Billabong and Quiksilver on the world stage.”

Australia developed an education sector generating $16.3 billion in export earnings in 2010–11, as well as a professional services sector which is internationally focussed and competitive in areas as diverse as architecture, engineering, accounting, design, business logistics and management. It is no surprise that as Australia’s fortunes grew so did the need for a sophisticated, efficient financial sector to fund the country’s global expansion and engagement. Though still small, Australia has now made it into the top 10 securities exchanges in the world. Importantly, an open economy didn’t mean

having to dispense with notions of fairness in the labour market and employees have been somewhat protected through an evolving industrial relations system. The country’s unique industrial relations framework has helped to produce an

unemployment rate nearly half that of the United States and other northern hemisphere counterparts, says Harcourt.

Moving forward

Where Australia heads from here rests largely on its ability to remain competitive and innovative in key areas of the economy, particularly resources and education, and to learn from international best practice. Potential models lie with countries like Germany, the world’s third largest industrial power, which has forged a modern, highly skilled and well paid workforce and strong manufacturing industries, but not without painful adjustments. The Department of Education, Employment and Workplace Relations is predicting all industries, with the likely exception of manufacturing, will increase their employment over the next three years. Boosting the employment options in manufacturing will depend on our ability to innovate and to utilise our strengths in education and resources. Governments can help set the framework for a productive economy but it is largely up to Australian businesses to increase productivity and drive economic growth. Much of this will come from the ability of individuals and businesses to be flexible and use talent effectively, particularly with the right training and skills development. If history is anything to go by, opportunities for Australia in the global economy today will be very different from the opportunities in a decade’s time.

It is true that for people who have lost their jobs and struggled to find a new one, things might look bleak, but it is also true that the “lucky country” has a solid track record when it comes to changing with the times.
www.perthfinancialplanning.com.au

Today's cost of living: it's a mixed bag

Few dinner table conversations pass without some mention of the high cost of petrol at the local bowser, hikes in gas and electricity prices, or the cost of fruit and vegetables.

It is almost a national pastime to discuss the cost of living in negative terms, without feeling a need to refer to facts or fi gures! Rarely do you hear anyone talk about how much wages or salaries have risen, our houses have grown or cars improved. Other positives, such as increased savings, growing investments and superannuation are also often overlooked.

Looking at wages and prices

A key to working out whether you are better off is to look at wages and income against prices. For sure, the price of some items might be going up—it is hard to ignore the rising cost of utilities or fluctuations in fruit and vegetable prices. Yet the costs of many of the items we regularly buy including food, clothing and household appliances are actually decreasing.

To help put the cost of living into perspective, the economics team at CommSec looked at the cost and quality

of a range of goods 30, 40 and 50 years ago and compared them to what could be bought today. Whether you measure the cost in today’s dollars or compare the prices of goods with the value of wages, the study concluded Australians in 2012 are better off than their parents and grandparents. For example, according to CommSec, based on the average weekly wage for fulltime employees of $276.90 in 1982 it would have taken about 38 weeks to pay off the latest model Holden then priced at $10,633. Today it would take the average worker about 30 weeks to pay off a new Holden Commodore costing about $39,990. Most people agree the quality and accessories in today’s cars are better than they were 30 years ago. The same could be said of many household appliances from vacuum cleaners to televisions.
Housing: an exception

One of the few areas of affordability thathasn’t improved with time is housing.The median Sydney house price of $77,100in 1982 would have taken the average wageearner 23 years to pay off. Today it wouldtake the average worker about 42 years topay off an average-priced Sydney home.

According to the latest HouseholdExpenditure Survey from the Australian Bureau of Statistics, a record 36.2 per cent of Australian families are paying off a mortgage, with mortgage repayments dominating weekly spending. Mortgage repayments are among the biggest household weekly outlays, along with petrol and rent. ‘Mortgage stress’ occurs when homeowners are paying 30 per cent or more of their gross incomes on home loan repayments. Unfortunately, the number of Australians currently experiencing this type of stress is on the rise, particularly among lower income earners. The high cost of housing will impact many people’s spending on other items as well as their ability to save.
Competing forces

Economic changes and technology are key forces in making us adjust the way we use our money. For example, the internet and online purchasing are driving major shifts in the way we purchase the things we need or want.

Other key pressures leading to structural change within the economy include a booming resources sector and a high Australian dollar. All of these factors and competing forces are taken into account by the RBA as it manages monetary policy. The RBA’s challenge is to set interest rates at a level that keeps inflation under control and ensures stability in the overall economy. Understandably, any interest rate moves make a considerable difference to consumer ‘sentiment’ and how confident people feel about spending.

However, what the statistics show for the whole country is not necessarily reflected in individual experiences so it’s often hard to tell in real terms whether we are better off than we were in the past unless we do the sums as CommSec has. Certainly with higher comparative wages, many goods are cheaper to buy and there are more options available to make these purchases. At the same time, the cost of housing and everyday essentials such as electricity and petrol, coupled with a desire to save more money, can eat into your disposable income. If you would like to discuss the cost of living and what it means for your investments, or if you have any other concerns, please contact the financial planners at Cornish Wealth Management.

New tax rates and the government super co-contribution

In less than two weeks' time Australians will have new tax rates. The government has placed great emphasis on how these rates will "free over 1 million Australians from having to lodge a (tax) return".

My concern is that the ATO clearly states that to be eligible for the government super co-contribution you need to "lodge your income tax return for the relevant income year".
Does this mean that the current Labor government has just made 1 million of the lowest paid workers in the country ineligible to receive the very worthy government co-contribution?

Yet again another Union Super Fund (Industry Fund) is being investigated by Federal authorities for conflicts of interest by board members. http://avantfinancial.com.au/pdf/120519%20Officials%20called%20into%20Meatworkers%20Union%20Super.pdf

When higher wages are considered, the cost of living may have actually fallen over the past 20 or 30 years. http://ping.fm/4eYEg

Redundencies & unemployment are rising. Where to from here for Australia? http://ping.fm/YFNng

Industry Funds have demanded the most attention from the Australian Prudential Regulation Authority with regards to conflicts of interest and incorrect unit pricing and asset valuations
http://ping.fm/OjYDG

An analysis of 2011 share price performance and the influences likely to impact 2012. http://ping.fm/bcAxs

Interest rate cuts - not always a good thing.

http://avantfinancial.com.au/pdf/1201%20Newsletter.pdf

Lower interest rates might provide some welcome relief for home buyers and existing home loan customers in 2012, but they are not such good news for people dependent on income from their investments nor an indicator of a confi dent, growing economy.
The Reserve Bank (RBA) cut interest rates by 25 basis points, or one quarter of a per cent, in both November and December last year, taking the offi cial cash rate to 4.25 per cent. The majority of mortgage lenders followed suit, bringing home loan interest rates down to their lowest level in more than two years.

Bond yields and rate cuts
One of the best indicators of the future direction of interest rates is the yield on government bonds, and by this traditional measure the market clearly thinks rates have further to fall.

In 2011, 10-year government bond yields fell to 3.8 per cent, the lowest for 60 years. Normally, investors would expect to receive a higher rate of interest on long-term bonds than short-term cash as compensation for locking their money away for longer, but these are not normal times.

Interest rates in the US, Japan and other major economies are close to zero and this, coupled with Australia’s relative economic stability and prosperity, has caused a flood of foreign money into Australian government bonds, pushing up bond prices and reducing yields.

Expectations in 2011 were that local interest rates would rise to keep the lid on inflation caused by the mining boom. But with domestic inflation in check and the depth of Europe’s debt crisis even clearer, in November the RBA finally decided to loosen the reins on local interest rates. Europe’s woes may take years to remedy, hampering global recovery and the relatively strong Australian economy.

Australia’s economy may be the envy of many countries, but it is chugging along, not powering ahead. It grew by 2.5 per cent in the year to September, well short of the long-term average of 3.25 per cent. Inflation hovered around 3.5 per cent last year, above the RBA’s target range of 2–3 per cent, but most economists forecast inflation will fall slightly this year.

Future moves
Falling interest rates reduce the cost of borrowing for business so they are potentially good news for company profits and share prices. But the share market has also been spooked by the debt crisis in Europe and the lack of a clear political strategy to fix it. In this uncertain climate, Australian shares fell 12.7 per cent last year.

CommSec chief economist, Craig James, expects at least one more rate cut by the Reserve Bank in 2012. "Clearly with inflation under control and significant risks abroad, the Reserve Bank stands ready to cut rates and shore up Australia’s economy", he says.

However, home buyers should not celebrate too quickly as the banks look like moving the goalposts to cope with global pressure on their funding costs. ANZ chairman, Mike Smith, announced in mid-December that borrowers should no longer expect the ANZ to match official moves in interest rates.

Other banks are likely to follow his lead. This will break the strong link that has grown up between movements in the RBA’s official rate and bank mortgage rates. Whether it leads to more competition or more conformity among the major lenders is tomorrow’s question. For now it is a case of "watch this space".

www.perthfinancialplanning.com.au