The year ahead and beyond

With the holiday season finished and the kids back at school, this special edition of our Peach newsletter covers a range of financial topics relevant to the start of a new year as we look ahead through 2005 and beyond.

Minimise post-Christmas credit debt

Although Christmas now seems a distant memory, many Australians are facing daunting credit card bills from their Christmas expenses. The Federal Treasurer and various welfare groups called on consumers to avoid racking up large credit card bills before Christmas. It’s wise advice which I endorse, especially given the record levels of household debt in Australia.

It’s always best to avoid any credit card debt if possible, by paying the card off fully each month. But if you need to keep using your credit card, then try to reduce the Christmas debt as soon as possible.

Credit cards attract much higher interest than home loans and personal loans. So my advice is if you can't pay off the credit card balance from your salary, then look to use equity in your home loan to reduce the debt – and maybe make a note that it’s better to save in advance than play ‘catch up’ in the future.

Many home loans have redraw facilities to allow borrowers to utilise equity in the home. It's all about paying off debts at the lowest possible interest rate (though keep your eye out for fees on your redraw.)

It could even be worth some consumers refinancing their current loan to a product offering a redraw or line of credit facility. Remember if the interest on your home loan is not deductible – if for instance the money was borrowed to buy the house you live in rather than investments – this strategy is OK, because the interest on the additional lending for Christmas spending is also not deductible. If the loan is otherwise for investment purposes, it may be best to open a new account to redraw the money or at least to keep close track of what you do so interest can be apportioned. Ring us if you have any questions.

Of course, it's much better not to have too much debt on the credit card to begin with. I recommend consumers currently facing a post-Christmas financial shortfall to plan early for next Christmas. Credit card interest is no joke, so it’s best to try to save enough cash to pay off your post-Christmas credit card bill immediately. Others prefer spending cash for Christmas, but I like picking up all the extra frequent flier goodies – then I always pay the card off immediately it’s due, even after Christmas.

And if you’re finding it difficult to curtail credit card spending, you should consider reducing your credit limit or closing your credit card accounts completely.

Review finances

We tend to let financial planning and investments roll along during the year without regular review. So now is an ideal time to have a check-up of these things.

Consumers should undertake systematic planning of their finances and investments. I suggest that homeowners and investors take the opportunity to address short-term cost factors (like credit card expenditure, as discussed above) and then to think about long-term strategies.

In many cases, borrowers are paying more in interest than they need be. By switching loans or refinancing, they may be able to offset future rate increases. A simple review of mortgage loans could save borrowers thousands of dollars.

Many borrowers who have had the same loan for some time are paying too much. There’s a good chance you’re being taken for a mug if you’re currently paying more than 6.5% interest. Borrowers can easily get flexible loans with all the bells and whistles at interest rates below 6.25% today – with the additional possibility of honeymoon periods. 

All homebuyers and investors should check their interest rates and fees to see if they could benefit from a change of loan product. Contact us at Peach to have a free no-obligation loan check-up. We may be able to find you a better loan. You can call us seven days a week between 7.30am and 9.30pm on 1300 13 75 86 or visit www.peaches.com.au.

Superannuation can be a tax-effective investment and many Australians are now directing a higher proportion of their income into “super”. However, there have been constant changes to the superannuation system, which should be taken into account when considering long-term financial planning. Indeed, just in the past year or so, a total of 60 superannuation Acts, regulations and other legislative pieces were passed by parliament. 

Many of these new regulations take effect in the current financial year. They apply to such areas as:

• income tax;
  
  
• prudential supervision of superannuation funds and retirement savings accounts;
  
  
• the superannuation guarantee;
  
  
• the superannuation contributions surcharge and termination payments surcharge; and
  
  
• public sector and military superannuation schemes.

Our message is to check with your financial and taxation professionals to see how these changes impact on your situation. You can also find an overview of these changes at http://www.aph.gov.au/library/pubs/RB/2004-05/05rb06.htm

In late 2003, homebuyers and investors were hit with two interest rate rises and most commentators said there would be more to come. Throughout 2004 I argued that rates did not need to rise and I have gradually been proved correct.

My predictions to Peach clients as far back as 18 months ago have proven to be remarkably accurate – even though they often went against the forecasts of many other “experts”.

Over the past year and a half, we often saw media reports of predicted big interest rate hikes during 2004. My forecasts have always been much more moderate, and this has been borne out by what actually happened last year. My (so far unblemished) record of forecasting can be attributed mostly to luck I expect, as predicting the future is a hazardous game. 

This time, I am happy to hold my prediction of ‘no change’ for a good while yet. There are some strong signs that the economy is slowing – certainly the national accounts suggest that.

In the wake of the housing boom, we’ve been having a party. While demand for our exports was low – for instance, after the Asian crisis and the 2001 recession in the US - that was a good strategy. If no-one would buy our exports it was best to keep people employed and keep the economy growing with domestic consumption – a party. 

But for three years now the Federal Treasury has been predicting strong export growth to take over from the consumption-led economy. In fact export volumes have been pretty flat, even though export prices have gone through the roof (thanks to the Chinese buying anything we can dig up out of the ground and send their way).

The fact that export growth is not picking up is both good news and bad news. If exports don’t pick up substantially soon, there will be little short-to-medium-term pressure on interest rates. Indeed, assuming consumption growth continues to slide with lower house prices, there will be slack in the economy, which is a reason for lowering rather than increasing rates.

So my guess is that rates won’t go anywhere for the next three to six months and it’s pretty difficult to predict beyond that point. After that, if I had to guess I'd say rates will fall a little – in the context of a possible substantial slowdown in the Australian economy.

On the other hand it’s difficult to read the economy at present. National accounts point towards at least a mild slowdown. As Chris Caton from BT – now owned by Westpac – says, reviving his comments on an earlier period in the dim dark past, “if you’re not confused about the current state of the Australian economy, then you clearly don’t understand what’s going on.”

Though national accounts and the Treasurer’s predictions show the economy slowing, job growth and business confidence suggest continuing strong growth. Our economy is running large and possibly growing current account deficits which will ultimately reduce our exchange rate and - if there is a serious loss of confidence - produce a case for increased rates. If these forces play themselves out smoothly, then a decline in the exchange rate could occur gradually and without increases in our interest rates. However, such adjustments may not be smooth. 

And smoothness may not be the order of the day if these adjustments coincide with similar adjustments in the US economy. Not only is the US running a current account deficit of the same order of magnitude (as a share of GDP) to our own, but this is being driven by a government budget deficit of a similar size (where we’re running a surplus). When foreigners – particularly the central banks of Asia – stop buying American debt, world interest rates are likely to rise. 

Looking further ahead...

In terms of the economy beyond the current year, I provide the following general comments and predictions. I preface them by saying that they are not backed up with lots of research, but rather by my own investment philosophy which is ‘contrarian’. I like to invest where there is clear value and against the grain of where the money is.

• Property has peaked or, if it continues to rise, it will do so slowly. There should be no hurry to invest in property in the next few years unless you have good knowledge that you’re betting on something special. If you do want to invest in real estate, or perhaps rebalance an existing portfolio, I think you explore parts of regional Western Australia like Karratha where it is exposed to mineral exports.  Export prices have gone through the roof and there will be export expansion from WA for a long time to come. (Even if prices fall, reducing the export earnings it produces, production will expand, drawing in employment and driving up prices.)  We are organising a large loan for someone seeking to invest in a couple of homes in Karratha.  He’s achieving yields of over 7% on houses that are leased long term to large mining corporates.  I asked him to look out for a house for me to invest in.
  
  
• Gearing to invest is almost always a good idea – so long as it’s moderate (getting caught overexposed and forced to sell into a buyer’s market is a great way to lose money);
  
  
• it doesn’t stretch your budget; and
  
  
• you’re in it for the long term.  If you’re under 55 with lots of equity in your home and a good job, borrow some money, invest it and review each couple of years for seven to ten years.  It’s very unlikely you’ll be worse off for it and you may make a good killing.  If you do lose money in the short term the Government will subsidise your losses with negative gearing tax deductions. Then you’ll get concessional capital gains tax on your winnings later.  It’s not very fair or very efficient for the Australian economy, but no politician has the guts to change the system, so you may as well benefit from it.
  
  
• Australian shares have gone for a good run but they still look reasonable value and  dividend  imputation effectively makes your dividends company tax free.
  
  
• Take the opportunity presented by the high value of the Aussie dollar to buy some international assets. For a ‘contrarian’ trying to avoid the herd (or rather to get there before the herd arrives) a diversified portfolio of Asian shares seems like a good idea to me. The Asian economies look like growing strongly in the long term (though the strength of China may represent something of an investment ‘bubble’), but owing to investor shyness since the Asian Financial meltdown of the late 90’s, prices are still reasonable. 

I’ve been putting my money where my mouth is, pulling back property investment to my own home, gradually reducing Australian share exposure and I’ll probably put a big chunk of the proceeds of recent property and share sales into International equities managed by contrarian investors.  A favourite of mine is Platinum Capital. 

All the best for a successful 2005 and beyond !

Until next month,

Nicholas Gruen
(AKA Dr Peach)

January 2005

The observations made here are general and indicative. They are not warranted as free from error in any respect whatsoever. We are not financial or tax advisers and you should not rely on any aspect of these comments without taking independent financial advice relating to your own specific circumstances. We suggest you obtain advice on a fee for service basis rather than from someone who earns commissions from investments they recommend.