04 August 2011

Dear Investor,


What strange times we live in. Economists and commentators say that Australia is in the midst of an unprecedented resources boom that, if properly managed, will propel us into prosperity for at least the next generation.

The Reserve Bank of Australia remains firmly in this camp. In the minutes of its July interest rate meeting, the members of the Reserve Bank of Australia considered that, notwithstanding some recent headwinds, the continuing strong economic performance of the Asian economies means that the medium-term outlook for the Australian economy remains strong. Demand for our commodities remains high and strong growth in investment, particularly in the resources sector, is still expected over the next couple of years.

But Australians are not living the high life. Indeed, Australian households seem instead to be battening down the hatches. Australia is becoming a nation of savers, with households locking away more of their disposable income than they have for 20 years. The Reserve Bank says people are banking their money or paying down mortgages because of a "change in households' attitudes towards debt and financial vulnerability". Indeed, the latest Reserve Bank figures show that the household saving ratio as a percentage of disposable income has climbed more than 11 per cent - to levels not seen since the 1980s.

At a recent presentation to the Anika Foundation, the Reserve Bank Governor, Glenn Stevens presented a series of figures and statistics to back up this assertion. One of those charts is extracted below. It shows that, although disposable income has continued to rise in recent years, consumption has decreased significantly. Thus, since about 2007 (around the onset of the GFC), gross savings rates have increased to well above 15%.

These numbers are borne out by survey. An ING Direct household financial wellbeing index released last month in "The Australian" showed that Australian households are saving an average of $313 per month. More than half of survey respondents said they feared the economy would worsen and a third said they were earning more. Concerns about the rising cost of living is turning families of spenders into savers.

With all of this saving, bank deposit rates have hit all-time highs. According to the Australian Bankers' Association, banks held $496 billion in deposits from households at the end of May. These savings have increased by 8.5% or $39 billion, in the past twelve months. Furthermore, they have grown 59% or $189 billion since the beginning of the global financial crisis in August 2007.

The effects of this high level of saving on the economy as a whole are mixed. No one denies that a general deleveraging puts Australian household balance sheets in a stronger position than before. But the increased savings rate has also led to a slump in retail spending, which has devasted shop owners (with the exception, perhaps, of online stores, which are predominantly based overseas in any case). If taken to extremes, a refusal of households to spend can be as damaging as a debt binge, resulting in job losses across the economy.

The challenge for investors in this environment is the perennial one: making properly disciplined investment decisions and avoiding the temptation to simply join the herd. If additional funds are being saved, they should also be invested with care.

At first glance, a bank deposit seems to be a reasonable way of investing surplus funds. After all, banks offer security and reasonable rates of return. However, that is not the whole picture. With inflation levels expected to remain high into the medium term at least, prices rises will eat into these returns, pushing investors to seek alternative investments that pay a premium to cash. Many commentators have also observed that interest rates paid on bank deposits are beginning to decline, making it even more imperative for investors to be mindful of alternatives.

As always, in the quest for appropriate returns on their investments, investors will benefit from observing the immutable law of investment: never put all of your eggs in the one basket - even if that basket is a bank deposit. Diversification of investments is the key to navigating the current challenging investment environment.

Best regards,
Chris Andrews

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Chris Andrews
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e  candrews@latrobefinancial.com.au

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