A round-up of the current state of the global and Australian economies. We focus on the the energy boom in the United States, the issues facing Europe and the challenges China faces in dealing with a property and credit bubble. We also highlight recent events with regards to the Australian stock market, In particular we discuss recent market fall, which are related to a weakening Australian dollar and the prospect of higher interest rates in the United States.

1. Slide 1
Baiocchi Griffin Private Wealth
Economic and
Investment Markets Update
24th September 2014

2. Slide 2
General Advice Warning
This presentation and the associated discussion is
general in nature and does not take your individual
situation into account. You should not act on
anything contained herein, or discussed as a
consequence of the contents of this document,
without receiving personal financial advice from a
suitably qualified person such as a financial advisor.

3. Slide 3
What will be covered
A look at the global economic environment
&
Australia: the State of the Nation
&
An update on investment markets

4. Slide 4
The Global Economy

5. Slide 5
Revisiting an old theme…

6. Slide 6
Firstly, the ‘Good’…
The world’s largest economy is firmly in recovery mode, with falling unemployment, rising
home prices and increases in business investment

7. Slide 7
The recovery has been led by energy gains
The timely development of new oil
and gas drilling technologies and
discovery of new shale oil reserves
have underpinned the recovery
The US now produces more oil
and gas than Saudi Arabia

8. Slide 8
Increased production = lower prices
Note the disparity in US gas
prices with the rest of the world
(Australian prices are $6 to $7)
A natural gas glut forced US gas
prices down to record levels

9. Slide 9
US energy self-sufficiency is close
Energy self-sufficiency levels are back to the same level as 1987
– total self-sufficiency is expected to occur by 2035 (IEA)

10. Slide 10
The benefits of cheap energy
All of these companies have announced new or re-opened factories
and plants in the US
PricewaterhouseCoopers: One million new manufacturing jobs by
2025 due to cheap energy costs (compare with Australia)
Between 2010 and the end of March 2013, almost 100 chemical
industry projects valued at around $72bn were announced

11. Slide 11
Not everyone will benefit
There will be losers from the US energy boom:
• Other oil & gas producers, primarily in the Middle East
• Australian East Coast LNG operators?
• Those countries which compete with US manufacturers
(Europe and some parts of Asia/South America)
Geo-political considerations also apply:
The US may have less interest in the Middle East, given a
reduced reliance on oil & gas from the Middle East

12. Slide 12
It’s not all good news however
The US Federal
Reserve’s
Balance Sheet
Various
programs to
stimulate the US
economy have
resulted in the
Fed owning over
$4 trillion in
debt securities

13. Slide 13
A different view of the problem
How does the Fed get
back to here?
And what are the
implications of this
process?
US Federal Reserve Balance Sheet
On the way up = falling interest rates rising stock, bond & property markets
On the way down = ?

14. Slide 14
Normalising interest rates is important
US interest rates cannot remain at close to 0% indefinitely – increasing rates
without damaging the US economy will be a delicate (impossible?) task

15. Slide 15
And now…The ‘Bad’…
Europe survived the
sovereign debt crisis
on 2010 (so far), but
faces weak
economic growth
and the threat of
deflation

16. Slide 16
Europe’s primary threat:
Annual Inflation Rates 2011 to 2014
Inflation in major Euro nations and the Eurozone as a whole are at worrying levels

17. Slide 17
What’s wrong with low inflation?
Low inflation itself is not the problem, the problem arises when prices stop rising
and begin falling (deflation)
Why is deflation bad?
1. When people expect prices to fall they become less willing to spend and less
willing to borrow
2. Deflation worsens the position of borrowers (debts have to be paid back with
dollars that are worth more than the dollars you borrowed)
3. Wages tend to fall along with prices and because most people are usually
reluctant to accept wage cuts, this is normally achieved through mass
unemployment

18. Slide 18
Slow economic growth is now a long term issue
Eurozone GDP growth rates 1961 to 2013
Slowing economic growth rates are a feature of the Eurozone economies,
although the past 5 years have been particularly weak

19. Slide 19
Fixing Europe
In the short term:
• Earlier this month the European Central Bank announced plans to buy asset-backed
securities from banks, hoping to increase bank lending
It is expected that the ECB will have to adopt its own Quantitative Easing, much
like the US Federal Reserve adopted in 2008
In the medium to long term:
• Europe will need to undertake long overdue structural reform
 Labour market deregulation
 Tighter fiscal integration
 A Eurozone-wide banking union
 Increased competition
 Reduced regulation and administration

20. Slide 20
And finally, …the ‘Ugly’.
Australia’s largest trading partner faces an uncertain short-term future

21. Slide 21
China: major challenges
In our view China must deal with three major issues in the short to
medium term:
1. Transition of the economy from a reliance on infrastructure spending
and government stimulus
2. Managing the fallout from a significant property and credit bubble
3. Balancing increased economic freedoms with restrictive political
freedoms (a topic for another day)

22. Slide 22
1. Economic transition
From this…
…To this

23. Slide 23
Progress has been made
China needs less
growth from
Investment and
more growth
from
Consumption

24. Slide 24
But more work is required
Very high
relative to
other Asian
nations

25. Slide 25
2. A property and credit bubble
In 2011 China had some of the most expensive housing in the world
Cheap Expensive

26. Slide 26
Now: house prices are falling

27. Slide 27
And credit growth is slowing
The rise and
fall of the
‘shadow
banking’
sector

28. Slide 28
Implications for Australia
Iron ore exports were worth $60 billion last year
The WA 2014-15 budget assumed an average price of $122 p/tonne
The May Federal government budget assumed a price of $110 p/tonne

29. Slide 29
Australia: State of the Nation

30. Slide 30
Undergoing our own transition
From this…
…To this

31. Slide 31
Why we have a problem
By 2016
annual mining
investment
expenditure
will fall to
nearly zero,
down from
over $100
billion at the
peak

32. Slide 32
The RBA’s response:
Real interest
rates are
once again
negative,
almost at
the same
level as
during the
GFC

33. Slide 33
The housing market is responding…

34. Slide 34
…though building approvals have slowed
11,000
10,000
9,000
8,000
7,000
6,000
5,000
4,000
Australian Home Building Approvals 2007 to July 2014

35. Slide 35
Mining remains important
Contribution to
GDP Growth:
Year-ended June
2014
Positive, but
still too low

36. Slide 36
Weak economy ~ Strong GDP
GDP = C + I + G + Net Exports
Weak Stable Weak Strong
2.00
1.50
1.00
0.50
0.00
-0.50
-1.00
Australia - Quarterly GDP Growth Rates (%)

37. Slide 37
Strong exports ≠ Strong jobs
No growth
We may be
exporting more
than ever, but
this does not
necessarily result
in more jobs

38. Slide 38
Our economy is getting some help
Australian Dollar/US Dollar Exchange Rate – May 2006 to Sep 2014
A weaker Australian dollar will provide assistance to sectors such as agriculture,
tourism, manufacturing and mining

39. Slide 39
Two important indicators:
An improvement in credit growth hints at signs of economic growth &
Low wage growth means that wage-drive inflation is not an issue

40. Slide 40
Overall a mixed outlook
Housing construction Unemployment
Interest rates Mining slowdown
Weakening AUD US economic growth

41. Slide 41
The stock market
5,700
5,600
5,500
5,400
5,300
5,200
5,100
5,000
ASX 200 Index – Past 12 Months
Annual Return: 2.83%
Emerging markets worries Ukraine crisis
Significant falls
during September
9/19/2013 10/19/2013 11/19/2013 12/19/2013 1/19/2014 2/19/2014 3/19/2014 4/19/2014 5/19/2014 6/19/2014 7/19/2014 8/19/2014

42. Slide 42
Recent market volatility
Company Capital loss in September
Westpac Bank -6.37%
ANZ Bank -5.98%
Commonwealth Bank -4.86%
National Australia Bank -4.86%
All Ordinaries Index -3.25%
• Overseas investors
• Capital adequacy requirements

43. Slide 43
748.00
1,496.00
2,992.00
5,984.00
8/3/1984
8/3/1985
8/3/1986
8/3/1987
8/3/1988
8/3/1989
8/3/1990
8/3/1991
8/3/1992
8/3/1993
8/3/1994
8/3/1995
8/3/1996
8/3/1997
8/3/1998
8/3/1999
8/3/2000
8/3/2001
8/3/2002
8/3/2003
8/3/2004
8/3/2005
8/3/2006
8/3/2007
8/3/2008
8/3/2009
8/3/2010
8/3/2011
8/3/2012
8/3/2013
8/3/2014
Long-term view – ASX Ords Index
1987 crash
“The recession
we had to have”
‘Dot com’
bubble
Pre-GFC
peak
Market low –
Mar 2009

44. Slide 44
A note on portfolio construction
Liquidity
Cash
The role of cash in a portfolio
Defensive
Diversification
Active
“Dry Powder”
Acknowledgement: Pimco Asset Management

45. Slide 45
Finally, our expectations
• We still expect that underlying Australian economic growth will be weak for the next 12
to 18 months (ignoring the impact of mining exports)
• Interest rates are likely to remain on hold until early or mid-2015, subject to an
improvement in housing construction & business investment
• The prospect of higher US interest rates will result in significant levels of market
volatility
• Key issues to focus on in the short to medium term:
− Mortgage delinquencies & loan arrears
− Increased levels of debt, particularly the commercial property sector
− Private equity transactions
− ‘Funny money’ and financial engineering

46. Slide 46
?
Any questions before I hand over to Ray?

47. Slide 47
Some comments on the industry
• Recent events in the financial planning/advice industry
“FOFA reforms sell
retirees short”
SMH May 12
• Looking forward
“Scandal shows its
time to clean up
financial planning
industry”
SMH June 26

48. Slide 48
?
Thank you
Please join us for morning tea