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Capricorn Investment Partners Limited Client Presentation 8 March 2012

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Capricorn Investment Partners Limited

Client Presentation

8 March 2012


General advice warning

This presentation and the associated discussion is general in nature and does not take your individual situation into account. You are advised not to act on anything contained herein, or discussed as a consequence of the contents of this document, without receiving financial advice from a suitably qualified person such as a financial planner, lawyer or accountant.


What will be covered

Australia and the Global Economic Environment


Stock Market Performance


A quick look back at 2011...

  • Characterised by crises, both natural and financial:
  • Natural
  • Floods in Queensland (January), Thailand (November), New South Wales (December)
  • Cyclone Yasi
  • Earthquakes in Japan and New Zealand
  • Financial
  • Ongoing Greek and Euro-zone sovereign debt issue
  • European austerity measures and public reaction
  • US government debt ceiling negotiations
  • USA loses AAA credit rating

The impact of these events on the ASX

Greek debt crises

Japanese earthquake & tsunami

US govt debt ceiling negotiations



The Australian economy remains relatively strong

Despite the wide-ranging crises of 2011, the Australian economy is still relatively well-positioned

GDP growth has remained positive and is expected to be around trend at 2.5 to 3.0%. Inflation is also under control and expected to be within RBA target


The retail sector continues to struggle

Australian retailers are being forced to cut costs and rationalise store numbers, as sales growth disappears

And this is why..... ”Paradox of Thrift”


Household debt levels may have peaked

Not only are we saving more, we’re also less inclined to take on more debt, be it credit cards, car loans or mortgages

The property market has also suffered, with average prices falling by over 5% in 2011


The ‘Two-speed’ economy remains an issue

Most growth and the majority of corporate profits are concentrated in the mining sector

No growth in profits


ASX – Net Profits by Sector



Mining industry dominates investment

The majority of business investment now takes place in the mining industry, with less emphasis on traditional sectors such as manufacturing

However the mining industry is still a relatively minor employer, with only 2.1% of Australians employed directly in the industry


But reliance on mining poses risks

If the current commodities boom should end, economic activity would slow, tax revenues would fall and the government would have few options to stimulate demand

What happens if this occurs?



Primary concern remains the AUD

The continued strength of the AUD presents problems for a range of sectors of the economy: retail, travel, manufacturing and others

110% appreciation of the AUD against the USD over past decade

Average since float in 1983: 83c


The Global Economic Environment

Continuing concerns over Europe, some signs of growth in the United States


Europe: yet more crises to come

17 summits were held in 2011 to resolve the Euro-zone sovereign debt crisis and still no definitive solution has been found


‘Austerity’ is the new economic paradigm

Faced with high sovereign debt levels, governments in Europe have adopted various austerity measures to lower their debt/GDP ratios

However austerity at the time of a recession can be self-defeating where tax revenues fall faster than spending is cut


It’s still possible that Greece will default

Even after the most recent $160 billion bailout, Greece will still have a debt/GDP ratio of 120%

90% debt/GDP ratio – commonly viewed as point of no return


Greek economic recovery assumptions are heroic

For Greece to avoid default, its economy must exhibit a stunning turn-around over the next few years

The reality is very different: 48% youth unemployment, -6.8% GDP growth, $6 billion of annual tax evasion, 13.6% govt deficit


Collapse in Greek Manufacturing

A rapid economic recovery in Greece looks unlikely when you consider what is happening to the manufacturing sector

Greek Manufacturing PMI


The Greek stock market reflects the gloom

The Greek stock market is down 86% from its pre-GFC peak


Why does Greece matter?

With an economy the same size as Victoria’s, Greece is a minor economic player, the real issue is the European banking system


Owes $400bn to banks in Europe

If Greece defaults...

The banks write-off their loans

Which leads to a credit crisis in

Europe as banks pull their funding

A number of banks in Europe collapse

or are nationalised

Italy & Spain

Resulting in a European recession

And on it goes...

Contagion then spreads to other Euro nations such as...


Problems of too much debt are widespread

Many countries are close to the 90% government debt/GDP ratio, which usually presages an economic crisis


Recent ECB action has helped avoid a crisis

Similar to action taken by the US Federal Reserve, the European Central Bank has taken steps to provide liquidity to the European banking system through a form of quantitative easing

LTRO = Long-Term Refinancing Option

The ECB agrees to supply unlimited amounts of Euros for 3 years at 1%

European banks have so far borrowed €1.018 trillion

Which is then invested in sovereign bonds yielding upwards of 6%


LTRO has had a significant impact

The costs of funding for highly-indebted European countries has fallen significantly as European banks invested funds from the LTRO in Euro-zone government debt

Italian 10-year bond yield




A similar outcome for Spain


Spanish 10-year bond yield


Primary purpose of LTRO is to buy time for indebted countries to act to reduce their debt/GDP ratios – it is not a permanent solution


United States – signs of recovery

Growing signs of a recovery by the US economy may help to offset any fallout from the ongoing European sovereign debt crisis

Weak but clear signs of recovery in US rail growth


Manufacturing in the US has also improved

The health of the manufacturing sector closely tracks overall GDP and recent readings are positive


Another positive sign – US car sales

US consumers are regaining some level of confidence following the GFC, evidenced through their willingness to buy new cars


US unemployment finally recovering...

Sustained reduction in the US unemployment rate as the private sector begins to re-hire workers


But...the US Housing market is still weak

Despite the pickup in employment and faster economic growth, the US housing market, the source of the GFC, still remains weak. A sustained recovery requires an improvement in the housing market

Stabilising but not yet growing


Fairly cheap by historical standards

Pre-GFC high

ASX All Ordinaries – 1992 to 2012

Based on the past 20 years, the Australian stock market appears undervalued

GFC market low

Dotcom bubble collapse

1994 bond market crisis


Similar story over 40 year timeframe

ASX All Ordinaries – 1970 to 2012

8.37% compound annual growth rate from 1974/75 to 2009


Yet the ASX has underperformed US market

Despite the Australian economy not having a recession during the GFC, and the lack of a housing crash, our stock market has significantly underperformed the US market over the past 2 years

All Ords down 7.73%

Dow Jones up 24.74%

Most likely explanation for the underperformance – the persistently strong AUD


Investment approach

  • Given the local and global economic situation, our investment approach remains focused on:
  • generating a high level of portfolio income through fixed-interest investments and fully-franked dividend paying industrials; and
  • investing in selected cyclical and growth-oriented companies where appropriate
  • Current opportunities we favour:
  • selected fixed interest securities (e.g. Origin, recent and existing bank issues)
  • specific companies where we consider them oversold or underappreciated: NIB, Cromwell (income), Origin, Telstra, Leighton Holdings

Thoughts for the year ahead

  • 2012 is likely to be dominated by a number of key issues:
  • ongoing sovereign debt crisis in Europe, and
  • the resilience or otherwise of the US economic recovery
  • In regards to Australia:
  • we expect slowing economic conditions to force the RBA’s hand, with a number of interest rate cuts by the end of the year, and
  • stock market performance, while volatile, should improve over the -13% experienced over 2011



Thank you