2016 August Newsletter

As August gets underway Australia’s iconic wattle trees are beginning to bloom, the annual signal that winter is almost over. On the economic front, there is still a chill in the air but encouraging signs that investors have put the uncertainty of the federal election and Brexit behind them.

 

Australia’s annual rate of inflation fell from 1.3 per cent to 1 per cent in the year to June, the lowest level in 17 years. This puts inflation well below the Reserve Bank’s 2-3 per cent target band and increases the likelihood of a rate cut to stimulate growth and consumer spending. Consumer confidence sagged in July amid uncertainty surrounding the federal election and Brexit, before making a slight recovery late in the month. The ANZ/Roy Morgan consumer confidence index lifted 0.5 per cent to 115.5 in the week to July 26, down 1.3 points over the month. The Australian dollar remains stubbornly high at around US75c, after rising above US76.5 mid-July. This is higher than the Reserve Bank would like and is another factor pointing to a rate cut to improve the nation’s competitiveness.

 

Against this sluggish economic backdrop, global sharemarkets provided some good news for investors over the past month. The US market hit a new all-time high, UK shares posted a string of weekly gains in the aftermath of the Brexit fallout while the Australian All Ordinaries Index was up around 6 per cent.

 

“Everything you’ve ever wanted is one step outside your comfort zone.” 
“Outside of the comfort zone is where the magic happens.” 

Sound familiar? We’ve all heard the phrase before – in a book, on a motivational poster, in a meme, as part of an ad. It’s the ubiquitous, go-to idiom for motivating people to do things that, well, they don’t really want to do. But it’s used so often that it’s almost lost its meaning.  So what does it really mean to ‘get out of your comfort zone’? 

 

You may be surprised to learn that your comfort zone is a real thing – something you can observe, measure and manipulate. To put it simply, your comfort zone is a psychological state in which you feel familiar, at ease, and in control of your circumstances. A state in which you feel little (if any) stress and anxiety. 

Psychologists, along with other scientists and academics, have been studying the phenomenon for over a century, usually in reference to performance management. In other words, what happens to your capacity to get things done when you’re pushed beyond what you’re used to. 

A 1907 US study claimed that the anxiety (induced from going beyond what is familiar and easy) improves performance – up to a certain point.i Beyond that point – in the ‘danger zone’ – performance shoots back down. More recently, in 1991, Dr. Judith Bardwick wrote a comprehensive tome ii where she defined the parameters of the comfort zone; what’s ‘too comfortable’ and ‘too stressful’ for achieving anything worthwhile. 

 

There are plenty of good reasons to push yourself beyond what you’re comfortable with. For example, at work, setting higher goals and tighter deadlines can make you more productive. Trying a new way of doing something – a creative way – can give you and your colleagues the confidence to overhaul methods and protocols that have a real measurable impact on both qualitative and quantitative outcomes (like profits). 

Outside the workplace, taking controlled and measured risks can help prepare you for unexpected life events, such as the loss of a loved one or a serious career hurdle. Repeatedly taking on small challenges builds your coping mechanisms, resilience, self-teaching skills, and other capabilities. The key is picking something small, where you know and can accept the boundaries of the risk. For example, try taking a different route to a destination you visit often. You’ll be forced to think of good alternatives, but you’ll still be able to budget for travel time and prepare for what could happen if you get lost or are late. 

 

 

 

 

With the government still lacking a majority in the Senate, both ratings agencies cited parliamentary gridlock as their main concern, along with rising levels of national and household debt. Without a clear majority in the Senate, they argue, the government will find it difficult to get its spending cuts and other budgetary measures passed by the upper house. 

Standard and Poor’s has changed Australia’s credit outlook to ‘negative’ and says it will keep a close eye on Parliament and its efforts to narrow the budget deficit over the next six to 12 months before downgrading Australia’s AAA credit ratingi. Moody’s has adopted a less formal wait and see approach. 

 

Australia is one of only three members of the Group of 20 (G20) leading industrial nations with a AAA rating, the others are Canada and Germany. 

A AAA (or Triple-A) rating indicates to lenders that the government or institution so rated is highly likely to repay their loans. The three main global ratings agencies – S&P, Moody’s and Fitch – have similar grades, with AAA the highest and C the lowest. Anything below BB is considered ‘junk’. 

Ratings are determined after looking at things such as assets, liabilities, income and expenditure. Like households, governments can improve their budget position by cutting spending and paying down debt. But unlike households, governments can also raise taxes and print money to boost their coffers. 

The main benefit of a high credit rating is the ability to borrow at lower rates of interest because we are seen as low risk; the main way governments borrow money is by issuing bonds. But to maintain the highest rating governments must keep a lid on debt. 

Australia’s debt is currently around 15 per cent of GDP. If we were to lose our AAA rating, the government would have to pay slightly higher rates of interest on bonds it issues in future. The higher our national debt, the more the government pays out in interest. 

A ratings downgrade could have flow-on effects for the Big Four banks which also had their outlook cut to ‘negative’. This is because the banks’ AA- credit rating is linked to the government’s high rating and the implicit understanding that it would support the banks in a crisis. 

Like the government, the banks could also end up paying higher rates of interest to global bond investors who are a major source of bank funds. While this might be good for bond investors, an increase in the banks’ funding costs may not be so good for local borrowers who could end up paying more for their loans. 

The composition of the newly-elected Senate could make it difficult for the government to achieve budget cuts or balance the budget by 2021, while weak commodity prices will reduce projected revenues. 

In this environment, most economists expect the Reserve Bank to cut interest rates to stimulate economic growth. In practice, it is the Reserve Bank that has the biggest influence on domestic interest rates, not ratings agencies. 

The interest rate on Australian government bonds is currently around 2 per cent and falling, along with rates around the world. While low interest rates are bad news for savers and anyone who relies on income from their investments, there is a silver lining. 

Low rates make it easier for the Australian government to pay down debt and lock in finance for investments that benefit the nation. While the warning of a credit downgrade focuses attention on the job ahead, it is unlikely to have a material impact. 

 

 

Despite record low interest rates, getting a foot on the property ladder has become increasingly difficult. In the year to June 2016, average house prices across major capital cities grew by 8.3 per cent, more than four times faster than wage growth of 2 per cent.i 

Against this backdrop, it’s hardly surprising that the proportion of first home buyers has fallen to less than 14 per cent of all home buyers, the lowest level in more than a decade.ii 

As the numbers of first home buyers fall, many younger Australians are focusing on buying an investment property instead. A recent survey by Mortgage Choice found 50.8 per cent of investors who purchased a first investment property were 34 or younger, up from just 33.8 per cent three years ago.iii 

So which is best - buy, rent or invest? 

 

One of the best arguments for buying a home is that it forces you to save. Most of us find it difficult to save money today for long-term goals, but that is what paying the mortgage forces us to do. The pay-off is eventual ownership of an asset that enjoys favourable tax treatment when you sell or when seeking eligibility for the age pension and other means-tested benefits in retirement. 

Unlike rents, which rise along with the cost of living, mortgage payments are fixed to the initial cost of the property and tend to fall relative to rents for similar properties over time. 

Buying also provides the security of being your own landlord and the flexibility to renovate. After building up equity in your home you may choose to borrow against it to kick-start an investment portfolio. 

On the downside, saving for a home deposit and transaction costs is a major hurdle for first timers. Ongoing costs for rates, maintenance and insurance can also be significant. While mortgage interest rates are currently at record lows, buyers also need to factor in the possibility of higher rates over the term of the loan. 
 

Renting has the potential to free up money to invest in assets with a higher return than residential property. For this strategy to work, your rent must be less than you would otherwise spend on mortgage repayments. You also need the discipline to invest the savings if you want to get ahead. 

Renting rather than buying can be a profitable strategy when other asset classes provide higher returns. Yet over the past 10 years residential property has been the best-performing asset class with an average annual return of 8 per cent a year compared with 5.5 per cent for Australian shares.iv 

While this is no guarantee of future performance, it helps explain why many would-be first home buyers are taking a new approach to the old rent or buy equation. 

First time buyers often find they can’t afford to buy in an area where they want to live. So to get a foot on the property ladder they continue living in rental accommodation - or at home with Mum and Dad - and purchasing an investment property. 

The advantage of this strategy is that your tenants help pay off the mortgage. And unlike a home you live in, costs such as mortgage interest, repairs, rates and insurance are tax deductible. 

At the end of the day, the decision to buy, rent or invest will depend on your personal financial situation, the state of the housing and rental markets, the returns available on other investments and lifestyle. The important thing is to have a long-term housing strategy that won’t disadvantage you in later life.

 

If you or your children are weighing up whether to buy, rent or invest in property, give us a call to discuss the options in the context of your overall investment strategy. 

 

 

Please click here to access the PDF version of our August 2016 newsletter.

  

Please note this information is of a general nature only and has been provided without taking account of your objectives, financial situation or needs. Because of this, we recommend you consider, with or without the assistance of a financial advisor, whether the information is appropriate in light of your particular needs and circumstances.

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