30/10/2007 - 22:00

Boom's slow leak under way

30/10/2007 - 22:00

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Did you enjoy the boom?

Briefcase hopes so, because the evidence continues to flow in that, after five bumper years, we might actually have to start working for a living.

Easy money, the stuff made when property and share prices rise magically, has gone.

Regular readers might see this observation as repetition. Last week’s Briefcase rant was also along the lines of ‘watch out, the bears are on the way’.

This week, there is evidence that the bears are knocking at the front door.

Rising interest rates are the latest bogeyman to cause an outbreak of investor jitters. But the others issues to have caught the eye of Briefcase are:

• sharply lower forecast corporate earnings;

• slow strangulation of resource exporters (and new project developers) by the rising value of the Australian dollar;

• the drying up of institutional funds for high-profile resource-related investment proposals;

• worldwide aftershocks from the US sub-prime crisis which has even frightened the Bank of England; and

• stark evidence that, for 2008, cash looks like it will return a higher yield than shares.

Set against this is the enormously positive influence on Australia (and Western Australia in particular) of the China factor, and overall Asian demand for fuel, minerals, food and fibre.

But even with China there is a weight of evidence tipping the scales in favour of 2008 becoming one of those horrible years when values are re-balanced.

Consider what we saw last week.

•••

Interest rate jitters gripped the market as inflation rose. Over the next few months, base rates can be expected to rise by at least 0.5 per cent.

This scenario, on top of a housing affordability index that’s the worst it’s been for two decades, and it would be prudent to assume that the new homes market is in trouble.

In Perth, we might be saved from the worst effects of a downturn because of the strength of the resources sector, but to think that we are totally isolated from the rest of the country is foolish.

Interest rates, when everything else is stripped away, merely represent the cost of money, or the price an investor can expect.

Last week, Briefcase saw a table showing how cash, and even government bonds, represent a better return today than the yield on most property or shares.

When this happens, money migrates, and that’s exactly what is starting to happen as investors look at a share portfolio yielding an average of around 5.5 per cent when they can get 6.5 per cent on a cash deposit.

The extra 1 per cent doesn’t look much, but it’s a signal that is being detected by an increasing number of investors as they look at the year ahead.

•••

The second and third signals came directly from the resources sector, where the dollar is not only killing profit growth, but starting to kill plans for new projects.

Iluka, the big Perth-based titanium minerals and zircon miner, said everything necessary about the dollar when it issued its second profit warning for the year.

Rather than earn a top-of-the-range $65 million, Iluka now says it will pocket, at best, $50 million.

Where did $15 million go? Into thin air is the quick explanation. Into a black hole called ‘lost on conversion from US dollar sales into Australian dollars’ is the long explanation – plus the need to meet increased ship hire costs.

The dollar, a delight for Australians planning overseas holidays or buying plasma television sets, is a disaster for exporters, and a disaster for anyone planning a resource project.

George Jones, Perth’s unlikely iron ore hero after warning that investors should not accept a low-ball takeover bid from Cleveland Cliffs for Portman, and who now runs Gindalbie Metals, copped a sort of dollar blast last week.

His plan to merge Gindalbie with Sundance Resources was always a long shot, if only because African and Australian assets rarely mix well.

But when institutions looked at it they shied away, because Mr Jones is facing a big capital requirement if he is to deliver Gindalbie’s magnetite iron ore project. And there’s an equally big capital requirement for the Sundance haematite project in Cameroon – a place better known for its footballers than its attractions as an investment destination.

•••

The Bank of England warning, which surfaced late last week, attracted limited attention in Australia. This is a mistake.

Despite a historic animosity to most things English, one thing the Poms do rather well is marshal capital. If in doubt, ask yourself why London is the world’s financial capital (even if New York thinks it is).

What the Bank of England had to say last week was very much in the shot across the bows of a steamer trying to make its way up the Yangtze River.

In its latest ‘Financial Stability Report’ the Bank of England said first-time homebuyers and buy-to-let investors were most at risk of defaulting on their mortgages.

The bank also flagged a particularly disturbing message for equity (share) investors, saying that: “the financial system is more than usually vulnerable to further adverse shocks”.

The English translation of this coded message from the Bank of England is that share prices are set for a correction.

•••

Meanwhile, in Australia we sail on. The share market bobbles up and down, close to an all-time high. In Perth, we even have some people suggesting that property prices are set to boom again.

Perhaps Perth is different – that China factor which is so hard to decipher.

But one measurement Briefcase has learned to trust after many years of watching the stock market is that critical (in the absolutely critical category) of future earnings estimates.

Earnings, for novice investors, are the ‘E’ in the most fundamental of all stock market measures, the PE ratio. The P is price.

For readers unfamiliar with the PE ratio, shame on you for even calling yourself an investor.

For the half-a-dozen readers left, consider these numbers from the venerable house of Goldman Sachs JBWere. According to its assessment of next year, Australian shares are the worst place possible for your savings.

Why?

Because the earnings growth for Australian shares next year is expected to be 6.8 cents a share compared with 12.1 cents this year, 21.9 cents in 2006, 26.3 cents in 2005 and 14.1 cents in 2004.

The English translation of those numbers is that 2008 is shaping as the first year since the boom began when earnings per share growth will slip back into single digits.

Boom over?

You bet.

•••

 “Blessed is he who expects nothing, for he shall never be disappointed.” Alexander Pope, 1727

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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