The Experts

Local doomsday merchants got a statistical kick in the pants this week when the OECD gave the Aussie economy a big tick, claiming that our economy will contract by only 0.3 per cent this year but will roar back to solid growth next year, with a 2.4 per cent figure tipped.

But the even better news from the Paris-based think tank is that unemployment in Australia will peak at 7.9 per cent next year, rather than the 8.5 per cent predicted in the Budget.

All up, recent economic and business news is telling me that long-term investors should be thinking about having a look at shares as a way to build their wealth bottom lines.

Update on America

Let’s have a look at the latest revelations from the place where most of our economic and market problems began — America.

In the USA, the big news was that the Federal Reserve is not jumping to raise interest rates too soon. Despite the fact that the world’s biggest economy is starting to free itself from recession, the central bank thinks there is still some time to go before the Yanks are out of the woods, and that means interest rate rises will have to wait.

The power of ‘can do’

That’s great news, however, an old carpet watcher says the US recovery will happen and warns everyone not to underestimate this country of ‘can do’ merchants. He also warns that inflation will come, which always forces up interest rates and hurts economic recoveries, but he thinks this unwanted development could be some time off.

Buffet’s predictions

Typically, most news outlets preferred to run hard with Warren Buffett’s prediction that the US will have to face inflation down the track, but if you go to his interview on Fox Business, you’ll find he suggests this could happen in three years time. He thinks the US is on the mend and that the Obama Administration is doing the right thing by the economy but the housing sector, which is crucial for the recovery, has not yet turned the corner.

The Dunny Index!

Buffett says he is a big watcher of carpet sales as this is a great indicator of how housing is going — a new house needs new carpet.

(In Australia, I look at my own creation — the Dunny Index — and this looks at the orders for Portaloos, which builders need on site at the start of a project.)

Not a big US slide

Back to America, and while it is expected that a pullback will happen for the stock market on Wall Street after the latest 30 per cent plus rally, few think the market index will fall by anything more than 10 to15 per cent. By the way, this could be overdone negativity.

In case you are wondering, Wall Street is bound to keep leading the local market, though I think over time our shares will do better than our US counterparts because of our link to China, and Asia generally.

Short term and long term

For the short-term investor jumping into shares, now is a gamble after such a big rally, though I do think the market will be higher by Christmas. On the other hand, the long-term investor, who has a three- to five-year horizon, has a great opportunity to buy stocks that are bound to do well from these still beaten-up levels. Remember, shares fell over 50 per cent during the crash and have since risen about 30 per cent, however that doesn’t mean we’re only down 20 per cent on the market.

Free lesson

Let me give you a little lesson, which surprises novices to stocks.

When the market started to slump, the All Ords index was around 6,700. If this lost 50 per cent, it fell to 3,350. If we have risen 30 per cent, that takes us to 4,355 but this is still 35 per cent short of 6,700. This means someone’s portfolio of shares could still be 35 per cent lower than it was before the crash.

How come?

The 50 per cent fall was from a bigger amount — 6,700 — while the rise of 30 per cent was off a smaller amount of 3,350.

My favourite stocks are those in the top 30 or 40 in terms of market value. These are some of the best business names in Australia. Some great miners will be good value and so are those with a history of paying dividends.

The beauty of the dividend

You know, some experts say that shares average returns of around 10 to12 per cent, but history shows that half of the returns from shares comes from dividends. That’s why I look for good dividend payers.

Switzer on TV

Over the next few months, I’m going to create my favourite portfolio of stocks using some of the country’s best stockbrokers. These people are coming on my new TV show called SWITZER on Sky Business — from Monday to Thursday at 7 to 8pm and repeated at 9 to10pm.

Hope you can join us to see how we build the portfolio, but I’ll make sure it will also be here on my website. Good luck with your money life ahead!

The question I am fielding all the time right now is — how do I play this rally? A related one is about whether the worst is behind us and is it time to buy shares?

Regular readers know I have pointed out that the US stock market has a history of bouncing around 26% after the world’s biggest economy hits rock bottom on its consumer sentiment reading.

In hindsight

The tricky thing is you don’t know when the low has been hit until you have seen a month or two after it has happened. And even then it can be wrong. The Lehman Brothers collapse in September last year created a false dawn on consumer sentiment.

The Reuters/University of Michigan consumer sentiment index gave up 5 points in mid-February to 56.2 after January recorded 61.2. The US record low for consumers is 51.7 from May 1980.

March was a tad better but April made the point more emphatic with the reading going to 61.9 — the highest since the 70.3 level in September.

Brave call

In March I reported that Sydney economist from Kinetic Securities Clifford Bennett had called an end to the bear market, which was the call of the brave.

This coincided with some better economy-fixing policies from the Obama Administration, some ‘green shoots’ showing the US economy was getting better and then better than expected company results.

By April the March lows on the stock market were being left behind but technical experts said we had to break through important levels on the S&P 500 and they have been broken with this very broad measure of the health of US shares now over the 900-hump at 942.

Barring another Lehman Brothers shock, it looks like the worst on the US stock market, and therefore ours, is behind us.

Global recovery follows US recovery

There is a growing belief that 2009 will be the year of the US recovery, which lots of cynics said was a naïve claim when some made it last year (OK, sometimes I like to rub it into my critics). And 2010 will be the year for the global economic recovery.

In Australia, our market plays follow the leader with Wall Street — historically and generally — but there can be exceptions. I suspect this isn’t an exception.

As the belief in economic recovery grows, so will the demand for commodity stocks and that helps the likes of BHP-Billiton, Rio and other miners.

Long-term strategy

But now as I have started naming names, let me warn that my views are for long-term investors. The short-term play is gambling, and it can be sensible gambling, but you have to be good on your timing.

I have confidence that I want to hold our best banks, best retailers, best miners and best property businesses in my portfolio. They go into my self-managed super fund, as it gives the best tax treatment, and that’s where I collect the best of Australian industry. That’s a line from Warren Buffett, who recommends to his compatriots that buying US industry for the long-term is a strategy that has underpinned his wonderful run as a stock picker.

John Bogle, the founder and former CEO of The Vanguard Group recently told CNBC that people should not buy stocks.

“You’re betting on prices — you’re betting on buying them from those who don’t know how much they’re worth and selling them to somebody who thinks they’re worth more,” he said.

“That’s speculation and it’s short term. It’s influenced and driven by supply and demand, and not by the worth of those companies whose value lies underneath that stock price.”

Two things

He’s saying two things. First, the wise investors learn how to measure a company’s value and then compare it to its price. As most people can’t do that or won’t do it, then you should buy an index fund that buys the entire market.

That’s what Vanguard sells but for many investors I think Bogle has a point and index funds are used by many cautious investors and financial planners. Also, they are not expensive compared to other funds.

Answer the question

To answer the initial questions, I think it’s safe to say that the worst is behind us on the stock market barring a massive shock, which looks less compared to six months ago. That’s why the rally has topped 30%.

The US economy is on the mend and Australia is surprising the doomsday merchants with one-time disaster spruikers now falling into the mild recession camp. We could get a technical recession over June and September, as business investment has been very weak, but I doubt it.

The latest NAB business survey added more positives to my rosy picture.

This is how CommSec’s Craig James greeted the news: “Business confidence rose by a substantial 11.6 points in May to a reading of minus 2.2,” he said. “Apart from the rebound after the September 11 2001 terrorist attack, it was the biggest monthly improvement in confidence on record.”

An opportunity

This market could go sideways for a few months until we get the next US company results and then could rise again or fall a bit — that’s the short-term investor’s gamble.

For the long-term investor, with the March market lows behind us, this is a buying opportunity of a lifetime, even if you missed the latest rally.

It’s the stuff made of nightmares, nevertheless it does need to be taken into consideration. I’m stating the obvious here, but children are just as susceptible as adults to debilitating diseases or injuries that may result in permanent disability or death. What many parents don't realise until it’s too late is that it’s just as important to insure their kids as it is themselves in order to be prepared financially should something happen.

According to the Australian Institute of Health and Welfare, during 2002 and 2003, there were over half a million hospitalisations recorded for children aged 0 to 14 years old. You can imagine the specialist medical costs involved for the hospitalisation of a child – it’s not cheap.

Here’s an example from ING of how chid insurance was used after tragedy struck a family:

Ross and Anne, who are both farmers, have two children – Emily, 5, and Matthew, 9. On the advice of a financial planner, Ross took out a child insurance policy for each of the children a couple of years ago to the amount of $100,000. His financial adviser also assisted him in arranging his own life cover with optional trauma as well as total and permanent disability covers.

One night while the family were asleep, an electrical fire started in the kitchen and quickly spread throughout the house. Ross and Anne managed to get Emily out, but couldn’t get to Matthew’s bedroom quickly enough.

Matthew suffered third degree burns to 40 per cent of his body and had to remain in hospital for some time to receive extensive treatment for his injuries. Ross, Anne and Emily’s burns weren’t as severe and they recovered after a few weeks.

Ross made a claim on the child insurance policy he had taken out for Matthew two years earlier. The insured amount of $100,000 was paid as a lump sum and was used to pay for immediate and future medical expenses as well as rehabilitation and any home modifications that may be needed when he returned to the farm later down the track.

As Anne often travelled to the hospital in the city to visit her son, the accommodation benefit also came in use. Life for the family will never be the same, but the financial burden was met because Ross took out a child insurance policy to prepare for this scenario.

This is just one example where the child insurance policy came into use. Other trauma conditions covered under the child insurance policy include: benign brain tumour; cancer; deafness; encephalitis; loss of limbs or sight; major head trauma; meningitis and/or meningococcal disease; quadriplegia; stroke; and terminal illness.

Child insurance is basically life insurance for kids. If an insured child suffers from a specified trauma condition, or dies, the insured amount is paid as a lump sum to the parent or guardian. It is designed to be an extension of your own insurance, so it’s taken out as a part of a parent or guardian’s policy.

There is also the option with some policies to convert it to life insurance with optional trauma insurance once the child becomes an adult.

Of course, you need to do the research before settling on a particular policy. In order to make an informed decision, you should speak to a financial adviser, and Switzer Financial Services would be happy to discuss your needs and circumstances.

The big news during May was of course the Federal Budget. On June 3, we got ‘great’ economic growth figures, but I will leave that until later.

A lot of the Budget information was leaked before the actual night, so most were prepared for what was in store. I did an economics wrap-up for PriceWaterhouseCoopers at a Budget breakfast up on the Gold Coast where 900 people attended to find out how the Budget would affect their business and personal lives. This year I began my speech with: “On a historical basis, this is a very irresponsible Budget – thank God, we needed an irresponsible Budget!”

As I discussed in my Yahoo article in May, creating a $57.6 billion budget deficit is so big it puts us back on track to over $300 billion of debt in ensuing years and around six years of more deficits down the track.

It’s the weekend after the Budget that I look forward to after some of the smartest guys and gals in accounting firms and financial institutions have had a while to digest it.

Changes to rules surrounding salary sacrifice will affect a lot of people. If you’re under 50, the amount you can put into super will be reduced from $50,000 to $25,000. If you’re 50 or over, the amount will be taken from $100,000 to $50,000. These changes don’t come into effect until the start of the new financial year, so your deadline is June 30 if you want to make a larger payment.

There were also a few other changes to come out of the Budget that you may have missed if you blinked. One of these is changes to income tax paid by people working overseas. At the moment, these people may pay income tax in the countries they are working, but under the new laws, if they are a resident of Australia and work for 91 days or more, they may have to pay income tax based on the Australian tax scales, and will receive a rebate to the amount of income tax they paid in the foreign country. Those affected or think they are affected should give the Australian Tax Office a call to get the details.

There were a few winners to come out of the Budget – single pensioners will get $32.49 extra a week, while couples will get $10.14. The First Home Buyers Grant will continue at $21K for new homes until October. Following this, it will go to $14K, and existing home grants will fall to $10,500.

One of the big controversies of this Budget has been the private health insurance rebate. For those earning between $75K and $90K, the rebate has been cut from 30% to 20%. If you earn between $90K and $120K, the rebate fall to 10%, and if you earn over $120K, there is no longer any rebate. For two income families, these income levels double.

On the markets, May was a big month for the bulls. CNBC says the Dow was up 4.1% and more than 20% since the start of March. This is the biggest three-month gain since late 1998. The S&P 500 had the biggest three-month gain since 1933 and as for the Nasdaq, it was the biggest three-month gain since late 2001. There are quite a few economists out there who believe we are headed for a second half of 2009 recovery in the US.

Interest rates stayed as they were, and the pressure has been on for banks to pass on further cuts.

Australia’s GDP figures were released on 3rd of June, and we actually expanded 0.4% during the first three months of the year.

This means we have avoided a technical recession and while we are still struggling to grow, most comparative economies are deep into recession. This outcome will help contain bankruptcies and the length of the dole queue. In addition, it will bring the economic recovery closer and make it stronger.

As someone who has promoted both economic and market optimism in face of the massive challenges of the past 18 months, it’s good to see that both the global economy and the Australian economy are heading in the right direction. This is great for long-term investors.

It’s official — Australia is NOT in recession! And no matter what negative, doomsday merchants want to say to justify their incorrect calls, there’s no official recession here.

This is great news and will help a recovery in consumer and business confidence. This in turn will boost business investment sooner rather than later and that’s a great thing for the economic recovery that lies out there, as well as the people who now won’t lose their jobs.

More caution required

If we had to bear newspapers, radio stations and television news services all saying we’re in recession, this would have sent both business and consumer confidence down. It would have also deepened the recession and lengthened it, adding more to the numbers in the job queue.

This is why I get angry about economists and commentators warning us that things will get worse. They could be right and they could be wrong, but being too cocky about an economy is fraught with danger.

I am an economist but I know the impact of China’s recovery, the 4% cut in interest rates and the Rudd Government’s stimulus packages are hard to calculate and that’s why being certain about our economic destiny puts a so-called expert on precarious footings.

Economic debate in Australia

For those wondering about the link between the rise and fall in real Gross Domestic Production and why it defines a recession and ultimately what happens to jobs, now is the right time to clear up the matter.

By the way, I believe Australia is one of the most economically literate countries in the English-speaking world, but it’s up against very little opposition. Inexplicably, most countries’ newspapers I encounter around the world, do not conduct economic debate at the same level as we do.

Keating’s lessons

I blame Paul Keating who really engaged the Australian public between 1983 and 1996 in what was what about deregulation of the financial system, tax reform, micro-economic reform, reduced protection, workplace reform linked to productivity, a floating dollar and even concerns about foreign debt.

These terms and issues were his stock-in-trade as he set about getting us ready for the 21st century.

His early work, which was carried along by the Howard-Costello team between 1996 and 2007, partly explains why our economy has held up well with the relentless winds from the global financial crisis.

He crystallised our challenges and what we had to do when he made the famous ‘banana republic’ comment talking to John Laws on Sydney radio in 1986. This comment sent the dollar down to record lows and forced Australians to embrace better work practices, tax changes and more productive attitudes.

All of these changes helped our real GDP grow so strongly for 17 years in a row and helped us avoid a recession — just as we have now.

Our Gross Domestic Product measures our total Australian production. As we produce more goods and services, we increase the incomes of the Australians who make the goods and services — the business owners and the workers who pocket profits or wages.

Do the maths

To understand what lies behind how the Australian Bureau of Statistics calculates our GDP, imagine our total production was measured in 2008 at $100, just to keep it simple. If in 2009 it rose to $102 when they counted the goods and services produced, then we would say there was 2% economic growth.

As there’s more production, then there would be more demand for raw materials, buildings, etc, as well as a need for workers. That’s the link between rising GDP and employment.

Alternatively, if we move into a deep recession, then our GDP falls and demand for workers falls and unemployment rises.

Still to come

The news on June 3 - remember that date, Prime Minister Rudd and Treasurer Wayne Swan definitely will - suggests that our economic downturn will be milder than most economists and commentators have been predicting.

So, what lies ahead for our economy?

The one big negative is that the surveys for business investment have been pretty poor, and it’s this that determines whether we grow quickly, slowly or contract.

The better news from Wall Street, the American economy, the Chinese economy and the current level of interest rates could save us from going into a recession in the future. We now have to hope that consumers make a comeback and the economy starts creeping back into more convincing positive growth territory.

The outlook

I believe that will happen gradually and many Aussies will be more likely to spend up at the end of the year — a plasma TV Christmas is certainly on the cards.

The experiences of high interest rates in 2008 followed by the fear of losing your job over 2009 will not be erased from the minds of local consumers very easily and this will keep a lid on economic growth.

However, by 2011 the global recovery will be really kicking in and that means the Rudd Government’s predicted 4% plus economic growth in 2011-12 looks very believable. That’s when Australian life as we knew it before the credit crunch will get back to something that looks like normal.

For those in a quandary over whether they should be fixing their home loan interest rates or gambling on the more volatile variable rate of interest, this is your chance to see what’s going on in my head about this thorny, hip-pocket dilemma.

A reader called Jessica recently sent me an interesting question, which I am sure many other Aussies are scratching their heads about. Given the questions she raised, and to do the issues justice, I have decided to dedicate a full story to the answer rather than the usual shorter Q&A treatment I give to reader enquiries.

First homebuyer query

Here’s the question: “My partner and I are applying for a home loan for our first home, which we plan to live in for around five years. People around us have mentioned some advantages and disadvantages of both interest only and principal and interest loans, but the more we hear the more we are confused. How does each work and what are the pros and cons? And does the fact that we will only be in this house for a few years make any difference?”

Time makes a difference

Let’s take the time period first. As you plan to live there for only five years, it makes sense to consider a fixed rate option. If you were there for a long time, there could be a case for going for a variable, as it’s often argued that it’s swings and roundabouts.

On the other hand, I know many experts who believe that fixers usually get it wrong. However, I would say when interest rates are rising, the panic merchants often fix their rates at the point of maximum fear and that’s often close to the top of the interest rate cycle.

Low interest rates

We are now closer to the bottom of the interest rate cycle and it makes more sense to think about fixing. Also, with big government spending now, many economists think we will have inflation problems in two-years time or even before.

That means rates could fall 0.25-0.5% before starting to rise again, possibly in 2010. But I wouldn’t expect a massive rise for quite awhile, say in three to four years time.

When I checked, the best variable interest rate was at HomeStar at 4.82%. Banks are charging around 5.15%. Here is a word of warning — always look for the comparison rate of interest as this adds in all of the other charges. Don’t get fooled by the advertised rate.

Compare and contrast

On interest rate comparison websites, it was easy to find three-year fixed rates and they are around 5.49% to 5.79% at the banks, but Better Option home loans have a 5.19% product.

I found it’s really hard to find current five-year fixed rates, which might be the best bet as interest rates will rise over five years for sure, but the rates I saw were around 6.64%. These were advertised rates, so the comparison rate could be close to 7%.

So for two years you might be paying 7% while those on variable rates could be paying 5.19% or a bit higher or lower, depending on what happens over the next year.

If we go into a deeper recession than expected, then variable rates will fall.

I don’t think we will slump badly but I could be wrong. Now you are seeing the gamble.

By the way if you lock in for three years, when your loan matures you might have to look for a new loan in a much higher interest rate environment.

Loans explained

On how each works, the principal and interest loan sees you pay off interest and a little bit of principal with repayments but it’s mainly interest in the early years and that’s why interest only might suit you. Also, interest only repayments should be smaller, so it can help cash flow and may mean you can buy a more expensive house.

With interest only loans, you simply pay interest. These loans are often used by landlords as the interest is tax deductible, but it would not be deductible for you unless you rented the place out.

Lock it in?

Locking in the rate can give you peace of mind that your repayments won’t go through the roof.

However, it can be annoying if rates fall, though I can’t see many more falls.

If you were going to live in the place for three years, the fixed rate option might seem pretty sensible but as you plan for five years, the last two years could be tricky.

Smarties might say in the fourth year you could go for a home loan that has a one-year low introductory rate but switches to a higher rate in year two. That way you would only have one expensive year of interest rates, but as you can see, it’s a very big gamble.

Bit of this and a bit of that

For people planning to stay in their house, a cocktail of part fixed and part-variable can mean you pay off the variable part as fast as you can and the part fixed portion can soften interest rate rises.

Pay more off when you can

Paying off your home loan with bigger repayments and throwing your tax refund cheque or any other windfall at the principal can save heaps of interest and time off your home loan.

Good luck with your decision — it’s a tough one! Hope this helps.