Investment Newsletter May 2010

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Investment Newsletter May 2010 Powered By Docstoc
                                         Investment Newsletter
AFS LICENCE NO. 226360                                                                  MAY 2010

                          From th e Ed   From the Editor….            VOLUME 8,              ISSUE 5

                     Market Update                               bearish at the beginning of this year was
                                                                 “regulatory risk” as governments used the
                     It has become very obvious to us that       GFC as an excuse to increase the
                     Australia has done itself some very seri-   breadth, depth and influence of govern-
                     ous and not easily fixed damage in the      ment in business. This is somewhat stun-
                     eyes of global investors. This is exactly   ning because the “real world” business
                     what we thought would occur. From           experience in Government has never
                     what we can see there is no likelihood of   been lower. As far as we can see the
                     a short-term compromise, despite the        combined “real world” business experi-
                     Rudd Government’s approval rating col-      ence of the Prime Minister, Treasurer and
                     lapsing.                                    Treasury Secretary is the two year stint
                                                                 Mr Rudd did at accounting firm KPMG.
                     The recent war of words between the
                     government and the resources industry       There is a real potential upside to the do-
                     is genuinely damaging foreign investors     mestic equity markets that they will rally if
                     perceptions of Australia. What on earth     they get even a sniff that the Rudd Gov-
Market Update        does an advertising battle achieve other    ernment could be on the way out.
                     than to cement the view of foreign inves-
                     tors that we have completely lost our       Despite overwhelmingly bullish broker
                     way in this country?                        and analyst sentiment at the beginning of
Spain in trouble?                                                this year, we have remained concerned
                     With absolutely no sign of a compromise     with the major macro issues of rising EU
                     on this resource super profits tax          sovereign debt and a potential slowdown
                     (RSPT), let alone any genuine consulta-     in Chinese growth. In addition, we have
                     tion process with the mining industry, we   remained cautious on the outlook for the
                     should continue to see Australian mining    Australian economy due to the stimulus
                     stocks locked in their new lower trading    fade, regulatory intervention from Can-
                     ranges. The same goes for the Austra-       berra, and the heavy handed monetary
                     lian dollar. This is unfortunate but we     policy of the Reserve Bank of Australia.
                     just struggle to believe that governments   We have also been sceptical of the very
                     can allocate capital better than the pri-   bullish consensus earnings forecasts for
                     vate sector. We also struggle to believe    domestic shares for financial year 2011.
                     that governments act in the true long-
                     term National interest; they act in the     In the meantime, investors have now ac-
                     interests of what they believe will get     knowledged the uncertain macro environ-
                     them re-elected. Interesting, the RSPT      ment with a sharp rise in risk aversion
                     has backfired on them in the opinion        and a global equity market correction.
                     polls and rightly so in our view.           Subsequently the ASX 200 index has
                                                                 fallen around 12% from the recent peak.
                     Whilst we are disappointed by the RSPT      As a result, after the correction we be-
                     debacle we shouldn't be surprised. One      lieve equity markets are now more rela-
                     of the key reasons we were outright         tive of the risks to the global economy/

         domestic regulatory risks.                         of over 2-3 billion Euros in outstanding
                                                            commercial paper. This is a bad sign.
         The downgrade of Spain’s coveted AAA               There has been massive inter-government
         rating by one notch to AA+ is a clear indica-      loans within the EU countries. The PIGS
         tion that major macro issues remain. It            have been the major recipients of credit via
         would be easy to believe that the recent           inter-government EU loans from France,
         global equity correction has signalled the         Germany and the UK. However, it appears
         end of the EU’s problems. The reality is           that the amount of short term government
         however, that the sharp fall in equity mar-        IOUs or commercial paper issued by banks
         kets have merely signalled a belated inves-        in Spain, Portugal and Italy has fallen sig-
         tor willingness to finally acknowledge that        nificantly. The implication is that the
         “yes” we have a problem. Of course, the            stronger EU banks are refusing to buy
         ratings agencies will be the last to the party     PIGS paper or to further extend credit to
         as usual.                                          PIGS banks.

         The Spanish sovereign downgrade is a so-           In addition the European Central Bank
         bering reminder that the EU sovereign debt         (ECB) is now attempting to sterilize the po-
         crisis is far from ’resolved’. It is interesting   tentially inflationary effects of its massive
         to note, that while Spain has a 12% budget         rescue program of buying distressed PIGS
         deficit, its ratio of national debt to GDP is      government bonds, by lifting deposit rates.
         approximately 60%. This is relatively low          As a result, EU banks are now lodging
         compared to the rest of the PIGS which             cash with the ECB rather than lending to
         have sovereign debt levels of 100%. How-           other banks. The recent data reveals that
         ever, the difference is that Spain holds 40%       bank deposits with the ECB are increasing
         of Portugal’s sovereign debt. Therefore we         rapidly with a rise of 7% in the past week.
         think the key issue from the Fitch ratings         Consequently the move to pledge deposits
         downgrade is the acknowledgement by rat-           with the ECB is having unintended conse-
         ings agencies of a genuine contagion risk to       quences for EU inter-bank lending and ex-
         other EU nations. Importantly, Spain repre-        acerbating the recent trend of EU bank
         sents the first AAA– rated nation to have its      cash hoarding.
         credit rating downgraded. Make no mistake,
         this is massive news and confirms our ex-          Spain in trouble?
         pectations that further downgrades to AAA
         credit ratings are possible this year.             The EU banks, particularly the PIGS, re-
                                                            main heavily dependant on short term fi-
         The problems of the European Union (EU)            nancing which renders them very vulner-
         and the Euro are both structural and long          able to any reduction in bank lending. As a
         term. While it appears a Lehman-style EU           result, there is a possibility of a major EU
         financial meltdown has been averted, we            credit crunch similar to the height of the
         believe a secondary sovereign debt effect—         GFC when world bank lending ground to a
         a long period of stagnant EU economic              standstill. More importantly, in contrast to
         growth is now becoming a real possibility. In      the US banks, the true health of the EU
         this regard, the Fitch downgrade was sup-          banking system remains very unclear. As
         ported by an expectation that Spanish              evidenced by the Spanish debt downgrade,
         growth would remain anemic given the gov-          the inter-related nature of EU indebtedness
         ernment’s pledge to cut government spend-          heightens the risk of contagion. We do
         ing by a massive 7.7% in 2011.                     need to keep a close eye on these events
                                                            as they unfold.
         More importantly however, it appears the
         EU is now lurching towards a potential             There have been fears recently that Span-
         credit crunch. The latest data from Dealogic       ish banks are struggling to raise funding,
         reveals that EU banks are shunning govern-         and the country could soon be forced to
         ment paper and hoarding cash. In the past          request a Greece-style emergency bailout
         month, the PIGS banks have posted drops            package.

VOLUME 8, ISSUE 5                                                                             PAGE 3

     According to the French newspaper, Le Monde,         budget deficits under control should be penal-
     Spain’s Treasury secretary, Carlos Ocana,            ised, and perhaps even be expelled from the
     strongly denied rumours that Spain was negoti-       eurozone, an idea that France is resisting.
     ating for a bailout package, saying that Spain
     did not need any additional financing from inter-    Spain is the fourth largest economy in the eu-
     national institutions. However, Ocana did con-       rozone, and any problems in Spain would
     cede that some Spanish banks were being re-          quickly impact France and Germany. Accord-
     fused loans in the international inter-banking       ing to the latest report from the Bank for Inter-
     market; “It’s definitely a problem”, he said. “The   national Settlements, French banks have
     way to restore confidence is to introduce reso-      $248 billion in exposures to Spain, while the
     lute and concrete measures”.                         exposure of German banks is $202 billion.
                                                          The French banks are heavy lenders to Span-
     Worries about a Spanish debt crisis were also
                                                          ish non-bank companies, while more than half
     fuelled by comments from Francisco Gonzalez,
                                                          of German bank loans were to Spanish banks.
     chairman of Spain’s second largest banks,
     BBVA, who said that Spanish sovereign debt           Concerns over Spanish debt also overshad-
     worries were impacting private borrowers. "For       owed figures that showed eurozone industrial
     the majority of companies and financial institu-     production grew for the 11th consecutive
     tions in Spain, the international financial mar-     month in April, with year-on-year growth rising
     kets are closed," he said.                           to 9.5%. But the growth was concentrated in
                                                          the stronger economies. Greece’s industrial
     Concerns over the Spanish banking system
                                                          output has dropped 6.4% in the past year,
     have been simmering since last month when
                                                          while Ireland, Portugal and Spain still have
     the Bank of Spain took control of CajaSur, a
                                                          lower output than a year ago.
     small Spanish savings bank which was con-
     trolled by the Catholic Church. This drew atten-     Spain had previously argued that its debt is
     tion to the precarious financial state of other      not a problem, as government debt only ac-
     Spanish savings banks, many of which are             counts for around 55% of the country’s GDP,
     heavily exposed to the ailing Spanish property       compared with more than 115% for Greece. In
     market.                                              addition, the Spanish government has intro-
                                                          duced additional austerity measures to reduce
     And markets are likely to stay on edge in com-
                                                          the budget deficit by a further $18.3 billion and
     ing weeks, as they wait to see whether Spain
                                                          has proposed measures to reform the coun-
     can raise the $US20 billion it needs to refi-
                                                          try’s labour markets.
     nance debt that matures next month. Increased
     jitters over Spain’s financing problems have         ****************************************************
     come at a time when relations between the two        Information in this Newsletter is drawn from vari-
     most important eurozone economies – Ger-             ous sources, including extensive and comprehen-
                                                          sive research by Southern Cross, Bloomberg and
     many and France – appear to be deteriorating.        the local press.
     German Chancellor Angela Merkel and French           ****************************************************
     President Nicolas Sarkozy met recently in a bid
     to hammer out a joint approach to eurozone           PLEASE NOTE THAT THIS IS NOT ADVICE TO BUY
     debt crisis. France is pressing strongly for a       OR SELL SECURITIES IN ANY OF THE COMPANIES
                                                          MENTIONED IN THIS NEWSLETTER AND WE
     common European economic government for              STRONGLY RECOMMEND THAT YOU SEEK OUR
     the 16 eurozone countries, which would have          SPECIFIC FINANCIAL ADVICE BEFORE MAKING
     its own administration.                              ANY DECISION.

     Germany is deeply opposed to introducing a
     new layer of administration. Instead, it wants       Doug Henderson
     eurozone members to introduce tough austerity        Authorised Representative
     programs to reduce budget deficits, and it has       UPA Investments Pty Ltd
     proposed that countries that fail to get their

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