- Do not rule out the likelihood of a 2.00% cash rate and 75 US cents Australian dollar.
- This year was all about asset allocation and 2015 will be all about asset allocation.
- Take lessons from the Future Fund’s allocation to international shares.
What needs to be remembered with the clearly disappointing Q3 Australian GDP data is the iron ore and oil price rout only really gathered steam in Q4. The Q4 GDP print could be negative when it is released next March.
Nominal GDP contracted for the first time since 2009. In per capita terms real net disposable income fell 0.8% in the third quarter. This measure of living standards is now down -2.1% in two years.
The chances of interest rate cuts in 2015 are rising and DO NOT rule out the likelihood of a 2.00% cash rate and 75 US cents Australian Dollar. That is becoming my base case forecast.
Down, down, the dollar goes down
I am in danger of boring you all to wealth with my short Australian dollar macro strategy, but the Aussie dollar is a basic commodity currency being priced as a yield instrument. The concept of buying a commodity currency for yield will prove as flawed as buying a resource stock for yield.
The absolute and relative yield of the Aussie dollar will fall in 2015, particularly versus the US dollar, and that will cut its legs off. The first stop will be 80 US cents and the next stop 75 US cents. Sell it while you still can with an “8” in front of it. As an Australian, being short Australian dollars (or long US dollars, US equities or ASX listed US dollars earners) is one way of hedging yourself against a decline in GDP per capita.
Quite frankly this morning after the Australian Q3 GDP miss yesterday I am even more convinced my broader macro and sector strategy is correct. My conviction is increased and I am putting the foot to the floor in US Dollar earners, non-bank industrial yield, transport, inbound tourism, shopping mall owners, international fund managers and selected discretionary retailers.
Key stock specific recommendations include:
Westfield Corporation (WFD)
QBE (QBE)
Crown Resorts (CWN)
Resmed (RMD)
Brambles (BXB)
Telstra (TLS)
IAG (IAG)
AMP (AMP)
Wesfarmers (WES)
Transurban (TCL)
JB Hi-Fi (JBH)
Super Retail Group (SUL)
RCG Corporation (RCG)
Automotive Holdings Group (AHE)
Qantas (QAN)
Platinum Asset Management (PTM)
Magellan Financial Group (MFG)
NAB (NAB)
ANZ (ANZ)
Forecast for 2015
At this time of year, those of us who make forecasts for a living feel the pressure to make prognosis for the year ahead.
Here is mine: 2014 was all about asset allocation and 2015 will be all about asset allocation.
Australian investors need to lose the home bias. That was the key to 2014 and it will be the key to 2015 as the Australian dollar reverts to its natural place as a commodity currency.
A 100% exposure to Australian assets in Australian dollars was the worst relative and absolute positioning in 2014 and I expect that to be the case again in 2015.
I encourage you to think and act more like the Future Fund who is leading the way in Australian based global asset allocation.
While most SMSF’s probably haven’t changed their asset allocation despite the growing underperformance of Australian assets, what is of interest to me is that Australia’s largest pension fund, the Future Fund, has.
In its latest update the Future Fund confirms US dollar exposure is now at 30%, up from 15.1% in June 2013, while 70% of the $100 billion portfolio is invested overseas.
But where it gets far more interesting is in sub-asset allocation. The fund holds 9.8% in cash, 24.4% in developed world equities, 13.8% in hedge funds, 11.3% in debt securities, 9.7% in emerging market equities, 9% in Australian equities, 8.8% in private equity, 7.4% in infrastructure and timberland, and 5.8% in property.
I doubt there is a single SMSF in Australia with an asset allocation like that, but I think it is the future. For example, with volatility increasing and Australia underperforming, the Future Fund has more in hedge funds than it does in Australian equities. Now that is interesting and would have generated the fund genuine outperformance if they have picked the right global hedge fund managers.
The median Australian SMSF would be 100% weighted to Australian equities, Australian property and Australian bank CMT’s/Hybrids. The Future Fund and the median SMSF are driving in completely different asset allocation lanes, despite the fact the Future Fund can value franking credits.
If you are in the pension phase of super (tax free) and all you care about is reliable tax effective income streams that you will spend in Australian dollars then there’s no need to change your asset allocation. You can happily clip dividends and collect the franking credits, but be prepared for somewhat stagnant capital growth.
Follow the Future…Fund
However, if you are in the accumulation phase of super your focus should be capital growth (compound then protect) in Australian dollars. The way to maximise capital growth will continue to be via asset allocation to offshore asset classes and offshore fund managers. You need to lose the home bias as I have said all year. Simply investing in an unhedged Platinum (PTM) or Magellan (MFG) fund is a sensible first step.
Let’s just remind ourselves of CY2014 year to date performances (excluding dividends) in Australian Dollar terms of leading global and regional equity indices.
These are returns from basic index investing. With the right fund manager or via successful high conviction stock-picking, alpha beyond these returns should have been generated.
With speculation increasing about rate cuts in 2015 in Australia the impetus to increase offshore asset allocation increases. As the Australian dollar loses its absolute and relative yield advantage to the world, it will revert to being the commodity currency. It’s that simple in my view and having a simple view on the Australian dollar has worked very well for the last two years. I set all my medium-term asset allocation decisions from a 75 US cent target on the Aussie dollar, a further -11.2% fall in the currency from here.
Interestingly, I note yesterday as domestic rate cut forecasts increased for 2015 that a few of my key USD earning ideas did every well. Westfield Corporation (WFD 2.15%),QBE Insurance Group (QBE 2.61%), and Brambles (BXB 3.44%) all performed well and I expect that to continue. Resmed (RMD) has done well in ADR’s overnight.
The way forward
Either way, I believe the Future Fund has the future of asset allocation right. For those who care about the maximum available risk adjusted return on Australian dollar capital it is well worth considering. If you are bearish on the prospects of the Aussie dollar you need to act with more urgency. 100% asset allocation to Australian assets in Australian dollars is not the way forward, particularly in a world of highly divergent currency and asset class performance.
And finally consider this chart. It’s the S&P500 (blue line) and ASX200 (red line) on a common raw monthly performance base (not currency adjusted, not dividend adjusted) over the last 20 years. It actually shows you it is not unusual for Australian equities to underperform US equities. In fact you could argue it is structural underperformance with the only re-correlation coming during the peak of the GFC.
Click here to view larger image [1]
Go Australia, Charlie
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.