Opportunities from QE3?

Chairman Bernanke and the FOMC have acted strongly in their announcement of “QE3” overnight.  An immediate share market rally is expected by many, some argue that it’s been already priced in.  A complex web of domestic and international influences should be considered by Australians in making their investment decisions.

Commentators vary in their response to the Fed’s announcement ranging from Goldman Sachs’ view that “further stimulus represents a clear signal that economic growth remains stalled” to UBS’ strategic view essentially ignoring QE3 and taking steps to position for a pullback in stock prices post-easing and as the fiscal cliff approaches toward the end of the year.

Karen Maley writing in the AFR said today:

Critics argue that QE3 will undoubtedly affect the prices of assets, such as shares and commodities, but will have no effect on US employment. The Fed is able to affect asset prices because when it buys US Treasuries and mortgage-backed securities, it effectively removes these assets from the market. That pushes up the price (and reduces the yield) on those ‘safe haven’ assets. (Incidentally, it also pushes up the price, and reduces the yield of other ‘safe haven’ assets, such as Australian government bonds, which boast a triple-A rating.)

But QE3 won’t encourage businesses to borrow more money to invest and hire new workers, because companies are worried about feeble demand for their products. And QE3 won’t encourage consumers to spend more, because they’re worried about their job prospects, and banks remain extremely reluctant to lend to debt-laden households.  By pushing up their cost of living, QE undermines the living standards for millions of low- and middle-income households. The wealthy – who own large share portfolios – get a benefit from rising equity markets, but most people end up worse off financially.

By targeting mortgage bonds in his latest round of QE3, Bernanke is clearly trying to spread the benefits of QE3 to the US middle classes – for whom their house is their important asset. But with an estimated one in seven US households underwater on their mortgages, and with a mountain of foreclosed houses yet to hit the market, it’s unlikely that a marginal reduction in US mortgage rates will provide much of a boost to home prices, or spur activity in the embattled housing sector.

Back in March 2012 we wrote about Investing in a QE World.  In that piece we explained what QE is and how it has been implemented by the major central banks.  Since that time we have observed the European ECB and Bank of England response.

The Economics editor of the Guardian reflected on 6 September 2012:

In one important respect, QE did the trick, because without it there is no telling what would have happened to the global economy in the winter of 2008-09. By the summer of 2009 there was clear evidence that the decline in output had bottomed out. Fears of a Great Depression 2 were scotched.

And yet, QE was supposed to be a temporary measure, with the process reversed once the global economy returned to normal. Far from that happening, central banks kept on buying bonds. The Bank of England is on its fourth round of QE; the Fed is about to embark on its third. Despite an unprecedented stimulus, the global economy is losing momentum

Is it all bad, though? Before answering this question, Australian investors need to consider the following six interlinked areas:-

1. The Australian dollar:  Our earlier post set out the critical issues for our dollar including commodity prices and demand from foreign sovereigns.  Devaluation of the US Dollar inflates the value of ours – this correlation must be watched closely mindful of the negative effects on Australian producers & exporters of a high dollar.
2. Commodities prices: (especially iron ore) but also metals including gold and silver – to a very large extent these are determined by demand for our commodities from China.   Slowing global demand for our commodities particularly iron ore and other mining exports will be the greatest influence on our domestic economy for the near future.  The recent price falls in the iron ore price and its partial recovery will be pivotal.   The speed with which change in this sector can occur is exemplified by Fortescue  this week which is now in a trading halt as the company approaches its banks to waive lending conditions.  Watch this space – China is key.
3. Shares: There will undoubtedly be winners in equity markets in Australia and overseas.  The challenge is in picking suitable stocks (or ETFs) which sit happily with your risk profile and your proposed holding time.  We all know a trade is different from an investment.  Our summary of the current position is: Expect market volatility between now and the start of 2013 as global issues dominate including further chapters in the European debt crisis, Arab political instability, US presidential elections and dealing with the “fiscal cliff”. Traders may wish to consider income producing stocks including global ETFs. Traders may wish to consider diversification into natural resources funds as a potential hedge against future inflation (see more on inflation below).  Longer term investors may prefer to remain prudent in the face of continued volatility  and uncertainty and stay out of stocks until the start of 2013.   US equities may appear more attractive than Australian shares if you can manage the currency issues.
4. Inflation:  How do you protect your investments against this?  Protecting yourself against future inflation is going to be an increasingly important consideration now.  There are a number of options to consider – ranging from investments in gold, hedged equities, commodities, inflation protected bonds and ETFs.   We consider these options at length and propose specific strategies suited to our clients’ investment profiles and needs.  This is a sophisticated and complex area and we do not make any general recommendations at this point in time.
5. House prices: Australian house prices continue to be considered overpriced by international and historical standards.  Overseas commentators remain negative about future capital growth in the Australian real estate sector.  Domestically, there are mixed messages coming from different markets across the country.  However, the overall trend is that things are tracking sideways, with risks to the downside.  This is no environment in which to recommend investment properties with enthusiasm.  Yet we continue to receive multiple calls weekly from property spruikers wanting to put our self funded retirees into residential real estate investments.  We are currently resisting this trend and do not recommend Australian residential investment to our SMSF clients generally at this time.   We mention house prices now as we are going into a new spring selling season, mindful that supply of housing stock is at record highs, the time it takes to sell a house is also very long in Melbourne and Sydney and the recent volume of mortgage transfers reported by government is at historic lows.  We would not be surprised to see a flat or negative selling season ahead.  This has an effect on the Australian banking sector and bank stocks in particular given the huge focus they have had on domestic mortgage lending over the past decade.  Their massive profitability has ridden the “house price increase” wave and all commentators seem to agree that this ride is over: see Gail Kelly’s recent comments here.
6. Australian interest rates: Expectations are that the RBA will lower interest rates again, and that the immediate future looks like a lower rate environment. This is a further blow to self funded retirees looking to live off their super pensions and those for whom a large part of their super is currently held in bank deposits. Lower returns on investments are the “new normal” and the only thing that will change these returns at this time is increased risk in investments – and that brings greater risk to the downside as well.  Speculative investment within super is not good if you want to rest easy at night.  It may prove good for the hip pocket but then again it may not go well at all.  That’s the risk. Lower rates are reflected in the Australian Bond yield curve, to which we have made reference before.  It continues to be in a negative yield curve – a negative portent for our economy generally.

We haven’t talked in this post about other economic indicators such as unemployment, GDP and PMI.  Neither have we mentioned industrial unrest, wages pressure, political issues such as funding for government spending programmes such as the NDIS, Gonski and the Dental Scheme which are looking like blowing a big hole in the Commonwealth Budget.  These issues are all bubbling away in Australia and whilst we have no doubt on the scale of relativities that we are indeed a fortunate country, there remain risks to our domestic economy which provide significant challenges ahead for us all.

The major message coming from the Fed today is that the US Central Bank is going to continue its active and open ended interventions for as long as it takes to improve the employment market in the USA.  There are big consequences for global trade in all this.

Superannuation - in the Budget

The Australian Commonwealth Budget was handed down this week and in amongst the detail there are two matters relevant for our clients.

Concessional Contributions
The government has deferred until 2014 its proposed raise from $25,000 to $50,000 in the concessional contributions cap for individuals over 50 with less than $500,000 in super.  This is a 50% reduction on the cap available this tax year.


It has been noted by industry commentators that this saving to the budget will come from the pockets of older taxpayers with relatively small superannuation account balances, the ones needing to boost their savings to ensure a comfortable retirement.

The lower $25,000 annual cap is likely to result in more taxpayers incurring penalty tax bills for exceeding the annual contribution cap. Even with the larger caps applying currently there are employees who are receiving penalty tax bills as a consequence of exceeding the annual contribution cap.  

Thomson Reuters comment:

The deferral of the start date for this measure will have significant implications for salary sacrificing arrangements and deductions for personal contributions and transition to retirement pension strategies.  Taxpayers will need to review their strategies before 1 July 2012 when the concessional contributions cap for those aged 50 and over will drop from $50,000 to $25,000 for 2012-13 and 2013-14.

A taxpayer aged 50 or over on the top marginal tax rate who is currently making full use of the $50,000 concessional contributions cap will effectively pay an extra $7,875 in tax if she or he has to restrict concessional contributions to $25,000 from 1 July 2012, and take the remaining $25,000 in cash salary.

Contributions tax rate rise
From Thomson Reuters' Budget Summary:

From 1 July 2012, individuals with income greater than $300,000 will have the tax concession on their concessional contributions reduced from 30% to 15% (excluding the Medicare levy).  This means that the tax rate on concessional contributions will effectively double from 15% to 30% for very high income earners from 1 July 2012.

It is noted:

Precisely how (and from whom) the Government will collect this additional 15% tax on concessional contributions for very high income earners will be determined following consultation with the superannuation industry. No doubt the Government may consider reintroducing a superannuation surcharge tax regime to collect this additional contributions tax directly from the superannuation fund holding the contribution on behalf of the very high earner.

We hope not as the cost to administer would significantly nullify the benefits of additional tax received.  The Government will be collecting a maximum of $3,750 from a taxpayer who contributes $25,000 into super where their taxable income plus super contributions exceeds $325,000 in the year.  This is an overall tax increase of 1.15%.  It is estimated it will affect approximately 180,000 taxpayers.

An easier way to collect this tax would have been to increase the personal tax rates for the high income earners and this option would not erode the desirability for retirees and those nearing retirement from boosting their super contributions.

The above changes to superannuation make negative gearing for high income earners outside super more attractive.  Treasury would be aware of this and the next "tax grab" from this group may be a limit on the amount of interest deductions.

For more information on the Budget read

Super Contributions: how can Australians be helped to retire with enough super?

Super Contributions - the future

A report from actuaries at Deloitte released 2 November studies the future of Australia's superannuation industry.

Dynamics of the Australian Superannuation System: the next 20 years 2011 – 2030, explores a range of scenarios that show the comparative growth in superannuation assets by market segment, in the demographic makeup of post and pre-retirement funds, and what longevity means for retirement adequacy.

To put the average balance at retirement in context, the authors turned to the current Association of Superannuation Funds of Australia (ASFA) Retirement Standard, which suggests that a single male requires $22,000 per annum for a modest lifestyle in retirement. That means to retire on a modest lifestyle a male will require a balance of $280,000. A female will need the higher amount of $310,000 due to greater longevity. But...the average balance for a male at retirement in 2030 will only be $217,000 in today’s dollars, and the average amount for a female will be even less - $139,000.

Given that 50 percent of the population is expected to live beyond the standard 85 years of age for a male and 88 years for a female...a single male retiring with an account balance of $217,000 and taking an income stream of $22,000 per annum has a 78% chance of outliving his retirement benefit.

The Report projects that recent strong growth in industry funds, master trusts and Self Managed Super Funds (SMSFs), will continue at the expense of corporate and public sector funds.

The Deloitte model projects that SMSFs will continue to remain a popular superannuation option overall with its assets reaching $2 trillion by 2030. This is however almost one trillion dollars lower than in their 2009 projection, which is almost entirely due to the introduction of lower concessional contribution limits.

Generational change is significant.  The report finds over the next 20 years, the share of assets held by Generations X and Y will grow from about 46% in 2010 to become the dominant superannuation customers with 84% of all assets in 2030.

The combination of longer life expectancy and volatility in the investment markets is raising the risk that retirees will run out of money before they die. The Deloitte report finds this presents an opportunity for the industry to think innovatively and find new solutions to what will become an increasing challenge.

The Australian Superannuation system is still dominated by lump sums, but we are seeing an increasing proportion of retirees opting for an income stream. It is expected that this trend will continue, presenting a challenge for funds to provide services and pension benefits for members as they approach and  transition into retirement.

The decision to increase the Superannuation Guarantee to 12% and lift the qualifying age for the age pension to 67 years, are intended to help Australians provide for their own retirement – by saving more and working longer.

Addressing adequacy in retirement is described by Deloitte as "a work in progress" see here.

A significant factor under consideration by industry about which the ATO/Government is aware is the possibility of increasing the limits for concessional contributions when a person is nearing retirement. 

This would go some of the way to resolving the question of adequacy of superannuation.