Month: October 2013

By Chris Vermeulen, GoldAndOilguy.com

My Stock market trend analysis is likely different from what you think is about to unfold. Keep an open mind as this is just showing you both sides of the coin from a technical stand point. Remember, the market likes to trend in the direction which causes the most investor pain.

Since the stock market bottom in 2009 equities has been rising which is great, but this train could be setting up to do the unthinkable. What do I mean? Well, let’s take a look at the two possible outcomes.

The Bear Market Trend & Investor Negative Credit

The S&P500 has been forming a large broadening formation over the last 13 years. The recent run to new highs and record amounts of money being borrowed to buy stocks on margin has me skeptical about prices continuing higher.

Take a look at the chart below which I found on the ZeroHedge website last week. This chart shows the SP500 index relative to positive and negative investor credit balances. As you can see we are starting to reach some extreme leverage again on the stock market. I do feel we are close to a strong correction or possible bear market, but we must remember that a correction may be all we get. It does not take much for this type of borrowed money to be washed clean and removed. A simple 2-6 week correction will do this and then stocks will be free to continue higher.

Monthly Bearish Trend Outlook

Below you can see the simple logical move that should occur next for stocks based on the average bull market lasts four years (it has been four years) and the fact the negative credit is so high again.

Also, poor earnings continue to be released for many individual names across all sectors of the market. While corporate profits may be holding up or growing in some of the big name stocks, revenues are not. This means the big guys are simply laying off workers and cutting costs still.

Overall the stock market is entering its strongest period of the year. So things could get choppy here with strong up and down days until Jan. After that stocks could start to top out and eventually confirm a down trend. Keep in mind, major market tops are a process. They take 6-12 months to form so do not think this is a simple short trade. The market will be choppy until a confirmed down trend is in place.

Monthly BULLISH Trend Outlook

This scenario is the least likely one floating around market participant’s minds. It just does not seem possible with the global issues trying to be resolved. With the Federal Reserve continuing to print tens of billions of dollars each month inflating the stocks market this bullish scenario has some legs to stand on and makes for the perfect “Wall of Worry” for stocks to climb.

The US dollar is likely to continue falling in the long run, but I do not think it will collapse. Instead, it will likely grind lower and trade almost in a sideways pattern for years to come.

Major Stock Market Trend Conclusion:

In summary, I remain bullish with the trend, but once price and the technical indicators confirm a down trend I will happily jump ships and take advantage of lower prices.

Remember, this is big picture stuff using Monthly and quarterly charts. So these plays will take some time to unfold and within these larger moves are many shorter term opportunities that we will be trading regardless of which direction the market is trending. As active traders and investors we will profit either way.

Get My Reports Free at: www.GoldAndOilguy.com

Chris Vermeulen

By Michael Lombardi, MBA

According to the just-released annual Wells Fargo & Company Middle Class Retirement Study, about 60% of middle-class Americans say that getting monthly bills paid is their top concern. This number stood at 52% in the 2012 study. (Source: Wells Fargo & Company, October 23, 2013.)

But there are more depressing results of the survey…

34% of middle-class Americans say that they will work until they are 80 years old, because they will not have enough money saved up for retirement! In 2012, the number of respondents with a similar opinion stood at 30%; and in 2011, this number was at 25%. While the U.S. economy is supposed to be in recovery mode, the trend shows more Americans will need to work after retirement.

Based on the results of the study, the Wells Fargo Institutional Retirement and Trust issued a statement saying, “We do this survey every year and for the past three years, the struggle to pay bills is a growing concern and the prospect of saving for retirement looks dim, particularly for those in their prime saving years.” (Source: Ibid.) No kidding.

While the stock market has more than doubled since 2009, while real estate prices are rising again, while Washington and the mainstream are telling us the U.S. economy is improving, Americans are becoming more “doom-and-gloomish.” According to the results of the CNN/ORC International poll released late last week, only 29% of Americans say that economic conditions are good right now—the lowest level of the year. (Source: CNN Breaking News Text, October 22, 2013.)

The chart below of the University of Michigan Consumer Sentiment Index is very important. This is a key indicator of consumer confidence in the U.S. economy.

Chart courtesy of www.StockCharts.com

Since July of this year, consumer confidence has been plunging, having now fallen to the same level it was at in early 2012! Weak consumer confidence has always been a signal that consumer spending in the U.S. economy will pull back.

But looking at the retail stocks, it’s like they don’t care how consumers are feeling in the U.S. economy. The Dow Jones U.S. General Retailers Index just hit a record high! What does that tell me? It tells me the same thing I have been telling you, dear reader, for months now. This stock market is rising on easy monetary policy, not fundamentals—and that’s dangerous.

Michael’s Personal Notes:

Even amateur economists will agree with me on this: when supply declines and demand remains the same, prices increase. Well, it wasn’t too long ago when I said that if gold bullion prices remain suppressed for long, we will see the supply decline. This phenomenon has started to happen.

According to the U.S. Geological Survey (USGS), in June of 2013, the total production of gold bullion from mines in the U.S. was 19,400 kilograms (kg)—about four percent lower than the same period a year ago. (Source: U.S. Geological Survey, Mineral Industry Survey, September 2012 and October 2013.)

The table below compares U.S. mine production in the first six months of 2012 to the first six months of 2013.

But as the supply of gold bullion falls, we see consumer demand for gold bullion increase.

In India (the biggest consumer of the precious metal), demand continues to rise in spite of the efforts of the Indian government and the Indian central bank to curb demand for the yellow metal. The director of the All India Gem and Jewellery Trade Federation, Bachraj Bamalwa, recently noted, “Demand is picking up and supplies have dried up.” (Source: “Gold premiums near record levels on lack of supply,” Reuters, October 22, 2013.)

In China (the second-biggest gold bullion consumer), we are seeing something very similar. According to the Hong Kong Census and Statistics Department, in August, 110.5 metric tons (Mt) of gold bullion was imported from Hong Kong into China. It marked the fourth straight month that imports of the precious metal exceeded 100 Mt. (Source: Reuters, October 8, 2013.) Why is this so important to even mention? China keeps the country’s gold bullion production for internal use; importing from Hong Kong shows how much more is needed to fulfill the demand.

Other than the consumer demand for the precious metal, we are still seeing buying for gold bullion from central banks, especially in Russia and Turkey.

After hitting a bottom in June, gold bullion prices haven’t declined to that level again. In fact, they have been trending higher since. This trend can continue, but you have to keep in mind that we are in a market where irrationality prevails. Time will draw a better picture, but as it stands, I see many opportunities in the mining sector.

This article New Retirement Trend: One-Third of Americans Need to Work until 80 is originally publish at Profitconfidential

By Mitchell Clark, B.Comm.

The stock market typically reacts quite positively when a company beats Wall Street consensus. But in a considerable number of cases, a company’s share price after-earnings bounce isn’t really warranted, considering the run-up in anticipation.

Many stocks go up in value after beating expectations, but many numbers this quarter actually reveal a contraction in business conditions.

Western Digital Corporation (WDC) is the Irvine, California-based maker of hard drives and solid-state hybrid drives for desktops and personal computers (PCs). The company beat the Street on earnings, but the company’s numbers actually represented a decline from the comparable quarter last year.

The company said that in its most recent quarter (fiscal 2014 first quarter), sales dropped six percent to $3.8 billion; earnings fell to $495 million, or $2.05 per share, compared to $519 million, or $2.06 per share, in the same period a year ago; and adjusted earnings came in at $2.12, while Wall Street was looking for a consensus of $2.05.

Naturally, the position moved higher on the stock market. The company did experience an improved gross margin, but it wasn’t a good quarter. The stock is up about 70% so far this year to an all-time record high.

There are countless other stories similar to Western’s, and investors have to be very careful with this so-called outperformance by Wall Street standards. Business conditions are not improving for a lot of companies. Earnings are slightly improving, but only through continued pressure on costs and a slight improvement in pricing.

Of course, the monetary backdrop continues to be very supportive for stocks as we know. The S&P 500 Index has broken out of what looked like the perfect head-and-shoulders pattern. It’s still an ominous-looking chart, but the breakout pattern is significant. It’s as if the index is returning to its modern era mean. The S&P 500’s 35-year chart is featured below:

Chart courtesy of www.StockCharts.com

Investment risk is always high with equities, but there are very few alternative investment classes with interest rates sitting so low, especially for those investors who rely on dividend income.

Given the monetary situation and the expectation that the Federal Reserve will continue to be highly supportive to equities, this is very much a market that can still tick higher. But there is absolutely no need to chase stocks, or play the momentum gain, especially with companies that aren’t actually growing.

Wall Street’s expectations for a company are both useful and irrelevant at the same time. Stocks didn’t advance this year on the expectation of better growth rates of revenues and earnings; the marketplace just went all-in with the Federal Reserve’s grand attempt at reflation.

For investors, I like existing winners that pay growing dividends in an era of very slow real corporate growth. Companies like NIKE, Inc. (NKE), Johnson & Johnson (JNJ), PepsiCo, Inc. (PEP), Canadian National Railway Company (CNI), E. I. du Pont de Nemours and Company (DD), and Colgate-Palmolive Company (CL) are just a few examples of growing dividend payers with excellent long-term track records of wealth creation. (See “Equity Market Super Stock Adding Up to Solid Returns.”)

And energy is not to be excluded as a great income provider. It’s one of the economic bright spots with staying power for the rest of this decade.

If a company beats the Street, that’s great. But when it beats the Street without actually growing comparatively, it’s not worth chasing.

This article My Six Favorite Growing Dividend Payers is originally publish at Profitconfidential

EURUSD is bullish for the last few weeks but now also sideways around 1.3800 area which is nothing else than just another corrective pause within larger uptrend. We suspect it’s wave (iv) that is part of incomplete five wave rally in wave 3 from 1.3470. As such, sooner or later pair should accelerate to a new high, which be a fifth wave of 3 that may reach levels around 1.3860/1.3900 later this week. Meanwhile we also need to keep an eye on 1.3700 level where our impulsive bullish count would become invalid as wave (iv) must not trade into the territory of a wave (i).

EURUSD 4h Elliott Wave Analysis

Written by www.ew-forecast.com | Try Ew-Forecast.com’s Services Free For 7 Days at http://www.ew-forecast.com/service * No Credit Card Required.

By WallStreetDaily.com

We’re long overdue for a correction. At least, that’s the latest cry emanating from the bears as they try to dissuade us from investing.

Total hogwash!

I’ll concede that it’s been a while since the S&P 500 Index suffered a 10% setback – 521 trading days, to be exact. But we’re nowhere near record territory.

Heck, we’ve witnessed two streaks without a correction in the last 25 years that were twice as long as the current one, according to Bespoke Investment Group. From March 2003 to October 2007 (1,153 trading days) and from October 1990 to October 1997 (1,767 trading days).

That means, for us to set a new record, the current bull market would need to continue uninterrupted until October 2018!

So, again, we’re certainly not long overdue for a correction.

That’s the good news. Now for the possibly troubling news – and, of course, what it means for our investing strategy…

Third-Quarter Earnings Update

The only way the market is going to keep chugging higher is if companies keep increasing earnings at a healthy clip. As I shared at the beginning of the month, analysts certainly expect that to happen, with record profits projected for 2014.

I’m sorry, but after looking at the latest earnings seasons stats, I have my doubts that conditions will be that rosy.

Sure, the headline numbers convey strength.

With nearly half the companies in the S&P 500 Index reporting results, 75% beat earnings expectations. That’s above the average for the last four quarters of 70% and the average for the last four years of 73%, according to FactSet.

Here’s the rub, though…

The rate at which companies are beating expectations is hardly impressive.

Earnings came in a mere 0.8% above expectations. That compares to an average surprise of 3.7% over the last four quarters and 6.5% over the last four years.

Either analysts suddenly got really good at predicting earnings (fat chance!) or business conditions aren’t as strong as executives originally expected.

Beyond that troubling development, there’s also an unsustainable discrepancy between earnings and sales growth rates.

So far this quarter, actual earnings are on track to increase 2.3% in the third quarter. Yet third-quarter sales are only on pace to grow 2%.

We don’t need to be math whizzes to realize that companies can’t keep growing profits faster than sales indefinitely. Or, put another way, cost cutting isn’t a permanent profit-boosting strategy.

At some point in the very near future, we need meaningful increases in demand to propel profits higher.

Run to Strength, Not Cash

Forget running for cover into cash like most of the bears want us to do. Instead, we need to keep an eye on the surprise margin for earnings and sales growth rates in the coming quarters.

We should also focus on investing in the pockets of strength in the market. And there’s no better example than the technology sector.

• The earnings and revenue “beat rates” for the tech sector are much higher than the market’s right now – at 87% and 66%, respectively.

• Unlike the broader market, tech companies continue to report better-than-expected earnings by a wide margin, too. The average earnings surprise is 11.4% above expectations.

• If we exclude the undue influence of Apple (AAPL), the sector’s earnings growth rate is the fastest in the market, at 11.2%. If we include Apple, the sector ranks second (7.2%), behind consumer discretionary (8.2%).

Most importantly, tech companies remain reasonably priced…

The S&P 500 trades at 14.7 times forward earnings, which is a 14% premium to its five-year average. Tech stocks only trade at 14.1 times forward earnings, which is only a 3.7% premium to the sector’s five-year average.

Bottom line: The smartest bet right now is to bet on tech stocks – not a correction.

Ahead of the tape,

Louis Basenese

The post An Uncomfortable Truth About Earnings appeared first on Wall Street Daily.

Article By WallStreetDaily.com

Original Article: An Uncomfortable Truth About Earnings

By www.CentralBankNews.info     India’s central bank raised its policy rate by another 25 basis points to 7.75 percent to “curb mounting inflationary pressures and manage inflation expectations in a situation of weak growth,” while it cut the marginal standing facility (MSF) rate by 25 basis points to 8.75 percent to “infuse liquidity into the system to normalise liquidity conditions.”
    It is the second consecutive rate rise by the Reserve Bank of India (RBI), which raised its policy rate by 25 basis points in September, thus reversing cuts earlier this year and leaving the policy rate 25 points below its level at the start of 2013.
    “It is important to break the spiral of rising price pressures in order to curb the erosion of financial saving and strengthen the foundations of growth,” the RBI said, quoting Raghuram Rajan who took over as governor in early September.
    The RBI cut its MSF rate, or the overnight borrowing rate, in September by 75 basis points as part of its move to unwind exceptional tightening measures taken in July.
    “With the reduction of the MSF rate and the increase in the repo rate in this review, the process of realigning the interest rate corridor to normal monetary policy operations is now complete,” Rajan said.

    The MSF rate was raised by 200 basis points in July as part of the central bank’s defense of the rupee which plunged as capital started to flow out of India and other major emerging markets in expectation that the U.S. Federal Reserve would start to reduce its asset purchases.
    At today’s second quarter policy review, the RBI kept the cash reserve ratio (CRR) steady at 4.0 percent but also increased the liquidity provided through 7-day and 14-day repos from 0.25 percent of  Net Demand and Time Liability (NDTL) of the banking system to 0.5 percent. The bank also adjusted the reverse repo and bank rates to 6.75 percent and 8.75 percent, respectively.
    Looking ahead, the RBI said it would “closely monitor inflation risk while being mindful of the evolving growth dynamics.”
    The decision by the RBI was widely expected given the continuing rise in inflation.
    Inflation, as measured by wholesale prices – India’s preferred gauge – rose to 6.46 percent in September, the fourth month in a row of rising prices, from 6.1 percent in August, well above the RBI’s medium-term objective of annual inflation of 3.0 percent and the short-term goal of 5.0 percent WPI inflation by March 2014.
    Rajan said the pass-through of rupee depreciation into prices of manufactured products is partly offsetting the disinflationary effects of low growth and while food prices may ease with the harvest “overall WPI inflation is expected to remain higher than current levels through most of the remaining part of the year, warranting an appropriate policy response.”
    In its policy report, the RBI said a study of professional forecasters expect the average WPI inflation to rise to 6 percent from an earlier expectation of 5.3 percent.
    Although the depreciation in the rupee is impacting inflation, the rupee has recently stabilized as capital flows have resumed following the Fed’s decision to postpone the tapering of asset purchases.
    Since early September the rupee has rebounded and been stable in the last month, rising to 61.51 to the dollar today from 68.15 on September 4, a rise of almost 10 percent. But compared with the end of last year, the rupee has still lost almost 11 percent, putting upward pressure on inflation.

    But industrial activity in India has weakened, reflecting the ongoing downturn in both consumption and investment demand. Stronger export and signs of a revival in some services, along with an expected pick-up in agriculture, could support higher growth in the second half of financial year 2013/14 from the first half, raising real GDP growth to 5.0 percent for the year as a whole from 4.4 percent in Q1, Rajan said, adding that a revival of large stalled projects may also buoy investment and activity.
     India’s Gross Domestic Product expanded by 4.4 percent in the second quarter of the year, down from 4.8 percent in the first quarter and continuing a trend since the first quarter of 2010 of declining growth rates.

    www.CentralBankNews.info

USDJPY is facing the resistance of the downward trend line on 4-hour chart. A clear break above the trend line resistance will indicate that the downtrend from 99.00 had completed at 96.94 already, then another rise towards 100.00 could be seen. On the downside, as long as the trend line resistance holds, the rise from 96.94 could be treated as consolidation of the downtrend from 99.00, one more fall to test 96.57 support is still possible after consolidation, and a breakdown below this level will signal resumption of the longer term downtrend from 100.60.

Provided by ForexCycle.com

By www.CentralBankNews.info     Angola’s central bank held its policy rate steady at 9.75 percent, citing a drop in September’s inflation rate, an increase in credit to the economy and depreciation in the kwanza’s exchange rate.
    The National Bank of Angola (BNA) has cut its policy rate twice this year by a total of 50 basis points as inflation has continued to decline.
    In September Angola’s inflation rate eased to 8.93 percent from 8.97 percent and last week the BNA’s deputy governor said he was convinced the country would meet the goal of inflation at 9 percent at the end of the year.
    The BNA”s goal for many years was to get inflation below 10 percent and this was achieved in August last year and inflation has continued to decline slowly since then.
    In its statement, the BNA said the interest rates on credit in local currency fell in September to an average of 14.09 percent from 14.95 percent the previous month while credit extended has risen by 5.7 percent since the beginning of the year to an outstanding stock of 2.816 trillion kwanza.

    The LUIBOR overnight rate also continued to fall to 5.52 percent, the BNA said.
    The kwanza’s average exchange rate against the U.S. dollar was 97.39 at the end of last month, a depreciation of 1.54 percent from the end of August.

    www.CentralBankNews.info

By MoneyMorning.com.au

It looks like being another bumper day for stocks as Australia & New Zealand Banking Group [ASX: ANZ] reveals its full year results.

What have we been telling you for the past year? Buy stocks. Hopefully you already have and so today you can focus on day two of ‘Retirement Week’ rather than worrying about whether to buy into this rally.

Yesterday we left you in no doubt about your options for saving for retirement.

If you missed yesterday’s Money Morning we’ll give you the five-second version of our thoughts on risk-taking: You don’t really have a choice. You have to take risks.

Although as Nick Hubble showed subscribers of his Money for Life Letter this month, there is one way to kick risk to the kerb.

But for the most part you can’t avoid taking risks. That’s why we say you should acknowledge it, plan for it, and then do something about it. Here’s how…

For two years we’ve recommended a fairly simple approach to risk taking and investing.

In fact it’s so simple some have said it’s simplistic (childish even) and obvious. Saying that, whenever we’ve asked those people how they approach risk taking and investing we get little more than a few ‘ums’ and ‘ahs’.

It seems our approach is so obvious either they hadn’t thought of it or if they had, they haven’t done anything about it. We don’t know what kind of investor that makes them – not very good investors, we guess.

But that’s fine. We make no apology for keeping things simple. To be honest, we’d say our approach is so simple you could teach it to your kids or grandkids.

And as far as investing goes, handing down your investment knowledge to the next generation is a key part of building and preserving family wealth. We know our retirement expert Vern Gowdie would agree with that.

Don’t be a Lazy Investor

You may have seen us discuss this strategy before. But there’s no harm in going over a bit of old ground. Besides, sometimes it takes more than once to get the message across.

So perhaps today’s issue of Money Morning will jog your memory.

As you know by now, we don’t like diversified investments. We see diversification as a cop-out. It’s the opposite of making a committed decision.

So instead of diversifying investments, we like to compartmentalise our investments. What do we mean by that? And how is it different to diversification?

Well, diversification is lazy investing. It involves sticking our money in a broad range of investments and then not paying much attention to how those investments perform.

The way we approach investing is different. Compartmentalising your investments involves making a decision about where you’ll invest. In short, it’s not a scattergun approach. It’s a well thought out and executed approach.

Let’s show you an example of how we do it…

Long Term Investing Doesn’t Mean Buy-and-Hold

Our first step is to split our liquid and investable assets into two blocks. We call one block ‘Safe Money’ and the other block ‘Punting Money’.

Remember, this is how we do it. You may come up with a different way to compartmentalise your money and assets into a way that suits you. This isn’t to say ‘this is how you have to do it’, it’s about getting you to think more about how you manage your money.

In the ‘Safe Money’ block we include our long-term investments. Right now this includes cash, gold and silver bullion, and dividend paying stocks. Now, just because this is ‘Safe Money’ doesn’t mean it’s ‘buy and hold’ money.

If a stock you’ve bought doesn’t appear to be living up to expectations, sell it. There’s nothing wrong with that. Things change. Revenue and profit growth can slow. Businesses can ‘go bad’.

In the ‘Punting Money’ block we include speculative investments. That includes small-cap growth, small-cap income, and blue-chip growth stocks.

From time to time we assess the weighting of each asset and investment in the portfolio. So when we have cash flow to invest we look at the outlook and decide whether we want to add more to the ‘Safe Money’ pot or the ‘Punting Money’ pot.

See, we told you this is simple.

Once we’ve decided in which ‘pot’ to put the money we then decide which specific investment. For example, if we had to allocate capital today we wouldn’t hesitate to allocate part of it into speculative small-cap stocks.

The important thing to remember is that this is active portfolio management.

It involves taking an interest in financial markets and asset prices. It doesn’t mean you have to become an expert, but you do have to show at least a minor interest in investing.

Wishing Won’t Get You Far

Active investing (which doesn’t necessarily mean trading, it just means taking an interest in your investments) is the side effect of a volatile and unpredictable market.

If the market was predictable and with low risk it’s arguable you wouldn’t need to be an active investor. You could just buy an asset and then forget about it.

But as long as interest rates stay at record low levels and investors remain uncertain about the outlook for the local and global economy, it will be essential for you to actively manage your investment portfolio.

This is the only way to make sure you have enough savings to see you into retirement. If you have a positive outlook you can direct cash flow into strong dividend paying stocks or speculative stocks to take advantage of a rising market.

On the other hand, if you’re cautious about the short to medium term outlook for stock prices you could increase your cash exposure.

We wish investing didn’t have to be so involved. It would be great if you could just set money aside knowing that it will be enough to fund your retirement. But wishing won’t get you far in this market…or in retirement. You’ve got to be decisive and active.

By following this simple approach (or coming up with your own) you can do everything in your power to save for retirement without putting an excessive amount of your capital at risk.

Cheers,
Kris+

From the Port Phillip Publishing Library

Special Report: UNAVOIDABLE: Australia’s First Recession in 22 Years

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By MoneyMorning.com.au

It’s a hot topic in the mainstream media right now.

Hardly a day goes by without SMSFs being implicated in the Sydney & Melbourne property bubble.

It’s also an issue causing some of my Gowdie Family Wealth members concern as well. Here is an email I received from George T.

‘Hi Vern,

‘Like you I have three daughters, two of whom are trying to get into their own homes. As is the norm these days, they are looking to borrow $300,000 to $400,000. Even with deposits of their own savings of $100,000 plus, in Melbourne, this puts them in the ‘first home-buyers’ end of the market.

‘Last year as executor for a deceased estate, the residential property I had to sell was purchased by a SMSF. Today I read about the concerns of some authority (forget who) suggesting that this SMSF market is well and truly into the property market utilizing the gearing strategy opened up by the government a few years ago.

‘So, apart from the issues as to whether SMSF’s should be allowed to ‘gear’, the issue concerning me is that the young new generation, trying to get their first home, have a fresh, access to funds, new competitor, in their market.

‘Apart from the potential social issues (between the haves and the have not’s) and the dangers that this new market player is adding financial fuel to the housing pricing bubble, my personal question is: What is the right advice to give to my two daughter’s? Enter this potentially overheated market or stay renting, stay cashed up and stay saving??

‘Life was not meant to be easy. I would very much appreciate your thoughts and input.

‘Kind Regards,

‘George T‘

Before addressing George’s concerns, here’s a general overview of borrowing to invest within a SMSF… 

Borrowing to Invest Within SMSFs

Until late 2007, legislation prohibited SMSFs from borrowing to invest. The borrowing rules were amended in 2007, and again in 2010. This opened up a whole new world to a myriad of SMSF advisers/consultants/planners/property developers/financiers etc. to eagerly market this opportunity to investors.

Not surprisingly the take up rate has been phenomenal.

However, for those not familiar with the machinations of borrowing within a SMSF, it’s not quite the free-for-all it has been portrayed to be.

Borrowing is restricted to limited recourse borrowing arrangements (LRBA).

The LRBA together with available funds within the SMSF are used to buy a single asset that is held in a separate trust.

Should the loan default, the provisions of the Superannuation Industry (Supervision) Act 1993 (SIS Act) are intended to protect the assets of the superannuation fund, and member entitlements.

The LRBA limits lender’s rights to the asset held in the separate trust. The lender cannot seek recourse against any of the other assets within the SMSF.

Any losses are quarantined to the asset the borrowed funds were used to purchase. This safeguards the remainder of the SMSF assets (if there are any).

SMSFs are also restricted to using LRBAs to purchase a ‘single acquirable asset’. If the SMSF wishes to acquire more than one property, then separate LRBAs and trusts need to be established for each additional property. Again, losses are contained within the individual trust.

In 2009, the Government launched the Cooper Review into the Australian superannuation industry.

One of the findings of the Cooper Review was ‘the amount of borrowing within SMSFs is excessive and poses a potential risk to retirement savings.‘ This finding was four years ago. Borrowing levels have only increased since then.

Another finding of the Cooper Review was:

‘The 2007 relaxation of the borrowing provisions and the consumer protection measures that have recently been announced should be reviewed by Government in two years’ time to ensure that borrowing has not become, and does not look like becoming, a significant focus of superannuation funds.‘

The Government’s response to the finding was:

‘gearing can magnify investment losses and reduce liquidity [and] given the significant role SMSFs play in Australia’s superannuation system, it is important that there is appropriate oversight of SMSF service providers; that fund investments are consistent with the purpose of superannuation; and that fraudulent activity is curbed.’

The ATO has also voiced its concerns about the level of gearing in SMSFs.

In November 2012, the ATO issued a Taxpayer Alert TA 2012/7 ‘Self-managed superannuation funds arrangements to acquire property which contravene superannuation law’. The alert was a warning to SMSF trustees and advisers to exercise care when investing in property. This was a shot across the bow.

There is approximately $440 Billion in SMSFs. Of this, around 15% ($66 Billion) is invested in direct property.

No surprise property is the major asset class borrowed funds have been used to purchase.

Given the recent press from the Reserve Bank of Australia, my guess is the new government will look to eventually tighten the SMSF borrowing rules. Possibly:

– increase the amount of equity the SMSF has in the property purchase
– an SMSF must have $200,000 before it can be established
– trustees to sit a multiple choice test to ensure they are aware of their responsibilities

Squashing property speculation and naïve investor exploitation from SMSFs would, in my opinion, be a step in the right direction.

OK, so what about this bubble?

From an outsider’s perspective, the Australian property market is in a bubble. In a recent interview, Jeremy Grantham said:

‘America is a very, very optimistic-biased society, as I believe, incidentally, Australia is, for whatever that means. We’re the two great optimistic societies. You can have a conversation about a housing bubble in England, and they’ll say, ‘oh, is that right? Let me see the data.’ If you have one in Australia, you have World War III! They hate you. They hate you for years! The idea that you could suggest that they were having a housing bubble.‘

Here’s what Quartz had to say in August 2013 about Grantham’s ability to spot a bubble:

‘Jeremy Grantham, the 74-year-old chief investment strategist of Boston-based investment fund Grantham Mayo van Otterloo (GMO), has made his career forecasting market bubbles- with remarkable success. When writing an article on the slowing pace of global growth last week-for which Grantham’s ideas provide significant fodder-my colleagues and I were spellbound by one statistic: of the 36 major bubbles GMO says it tracks, 33 have completely popped, or returned to their prior trends.‘

One of the three bubbles yet to pop (according to GMO) is the Australian property market. Rarely does someone have a 100% forecasting record, so Grantham could be wrong on this one.

However all markets have certain mathematical metrics – yield, price to earnings, etc. When these metrics move well away from the average and the collective thinking is ‘it’s different this time’ or ‘it’s different in Australia’, then this sends up a red flag to experienced bubble watchers.

The following graph is from macrobusiness.com.au and shows the real (after inflation) price movement of the Australian housing market since 1880.

Click to enlarge

Note the kick up in prices began in earnest after 1980. No coincidence that this also corresponds with the beginning of our love affair with debt.

If we step back a bit further and view the house price graph with the knowledge of the following graph on US long-term interest rates, we can see the 1950 spike in prices was influenced by the extremely low rates that applied at the time.

Some constraints on house prices at that time that do not exist today, were:

1. Higher deposit required
2. One income household

After the initial spike in 1950, house prices moved slightly upward over the next thirty years. During this period interest rates rose from their post-Second World War lows to over 16%.

The higher servicing costs acted as a handbrake on house prices. Another factor during the 1970s was government-capped home loan interest rates at 13%, irrespective of how high the cash rate went to.

A measure designed to relieve pressure on households that had borrowed at the lower rates in the 1960′s.

Rates peaked in 1980 and as rates fell (money became cheaper), debt levels grew.
Admittedly this is the US interest rate experience. However, our rates trended in the same direction (give or take a percent or two) over these periods.

The point I’m making is that cheap money has filtered into asset prices. The current low interest rates + SMSFs borrowing + Chinese buyers are the reasons being cited for a fire being lit under the property values in Sydney and Melbourne.

As mentioned above there are mathematical metrics that apply to all markets, and Australian property isn’t immune to the laws of math.

From an investment point of view, if price rises aren’t matched by equally strong rental increases then the yield on the property decreases. For example, a property valued at $800,000 with a weekly rent of $800 per week (say $40,000 per annum) is yielding 5% before expenses (rates, insurances etc).

If the property price increases to $1 million and the rent remains at $800 per week, then the yield is 4% ($40,000/$1 million).

When you deduct expenses (of 1-2%) from the gross rent, the net income is getting a little skinny. Now this is OK while interest rates are low, but what happens if interest rates rise (as they inevitably will from their historic lows)?

If we look at the US property market pre-2007, a whole lot of new buyers (sub-prime borrowers and home equity withdrawals) were introduced to the concept of owning a house or three.

Sure this surge in demand drove prices up and those who ‘missed’ out lamented the fact they were left behind. No different to the current argument about SMSFs and foreign buyers crowding out the Australian market.

Why did sub-prime implode? The sweetheart low interest period expired and borrowers faced with the higher rates folded.

There certainly appears to be heat in the major property markets at present. However unless there is a corresponding increase in rents (and this is unlikely with unemployment tipped to rise) prices will hit the outer edge of their mathematical metrics.

So, to sum up, the short answer to George’s question at the top of this essay is that I would advise my daughters to continue saving, exercising patience, avoiding the hype, and do the math on renting versus buying if interest rates tick up 2+% or more.

Vern Gowdie+
Chairman, Gowdie Family Wealth

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