Practical matters

Q: There's a lot of political debate about the surplus. Why is balancing the books so important?

The ideal situation is to have a modest level of public debt, usually less than 60 per cent of Gross Domestic Product (GDP), and to run a balanced budget over the course of an economic cycle. Beyond a certain level though, investors will regard public debt as unsustainable and demand that the government pay higher interest rates. This can also affect private borrowers as government borrowing rates often form the base from which all private sector interest rates are determined.

The political debate tends to exaggerate some of these arguments. Australia's level of public debt is quite low by global standards—around 25 per cent of GDP compared to the US, which is about 100 per cent of GDP and parts of Europe, which is even higher than that. The debate in Australia has focused on how long we are taking to get back to surplus, as we are currently looking at eight years of budget deficits, which is a long period. It’s about balance—a small level of public debt is fine, but at excessive levels, it’s a problem. Fortunately, we are a long way from that.

Q: There seems to be fears of a potential housing bubble in Australia – should we be worried?

The best outcome for Australia would be a period of moderate house price growth, averaging around 2.5 per cent per annum and no more than five per cent, because rising house prices are good for household wealth, but if they are too strong it becomes unsustainable and housing becomes increasingly unaffordable. With house prices growing at around five per cent, we are nowhere near the bubble-like proportions we had a few years ago, when house price gains were typically around 15-20 per cent per annum.

The only way house prices will surge and have a bubble is if home buyers become prepared to take on a lot more debt again. Fortunately though Australians are more cautious about debt these days, having seen the impact of too much debt in the US and Europe and what excessive growth in house prices can do. This suggests there's probably not going to be another house price bubble. The more likely scenario is prices will continue to go up over the next 12 months and then it will settle down at a fairly modest annual pace.

Q: With interest rates at historic lows, shouldn't we direct all our spare money into property?

It's a question of balance. Beyond the family home, putting more money into property means acquiring investment property, and currently the rental yields on property are very low. History tells us the best returning assets in Australia over long periods of time tend to be property and shares, followed by bonds and cash. In the interests of having a well-diversified portfolio, it’s probably best to have a mix of these assets.

The further you are away from retirement, the greater the bias towards growth assets like property and shares. But typically Australians already have a high exposure to property via the family home and when rental yields are quite low compared to the yield on shares (typically around 5.5 per cent once you add in franking credits), it makes more sense to look at shares as an investment rather than property. The bottom line is to have a balanced portfolio and to seek advice on the appropriate mix depending on one's circumstances.

Q: Developed market shares are outperforming emerging market shares. What’s the effect on our currency?

Over the last year or two we have seen emerging market shares struggle. In fact, year-to-date, they are down about 12 per cent, whereas shares of developed countries such as the US, Europe, Japan are up around 10 per cent or more. After a decade or so where the global cycle favoured emerging shares over developed markets, it seems the cycle is starting to swing back the other way, as growth in emerging countries slows a bit and growth in developed countries improves. This has implications for Australia, because we benefited from surging commodity prices that flowed from strong growth in the emerging world, which in turn boosted the value of the Australian dollar.

As the emerging world slows down a bit, at a time when the supply of resources is increasing on the back of significant investment in new mines and energy sources, the trend in commodity prices has turned down. This, combined with falling interest rates in Australia, is putting downwards pressure on the Australian dollar. For investors, this makes unhedged international investments more attractive relative to hedged international investments. Hedging refers to an overseas investment, where the underlying manager uses foreign exchange contracts to translate that investment back to Australian dollars, so when the Australian dollar rises in value the investor won't suffer a loss. With the Australian dollar in a down trend, it’s desirable to have more exposure to foreign currency, through unhedged international investments.

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What you need to know

This document was prepared by AMP Capital Investors Limited (ABN 59 001 777 591, AFSL No 232497). This document, unless otherwise specified, is current at Monday, 9 September 2013 and will not be updated or otherwise revised to reflect information that subsequently becomes available, or circumstances existing or changes occurring after that date. While every care has been taken in the preparation of this document, AMP Capital Investors Limited makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance.

This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.