Dixon Advisory

Shock super slug to us all

Nicole Pedersen-McKinnon — Sun, 13 May 2012 03:51:00 GMT

13 May 2012, The Age

Last Tuesday night three lucky Australians won $25 million; at virtually the same moment, tens of thousands of unlucky ones lost an annual $25,000. It's far worse than it sounds, too.

Superannuation was always going to be in the cross-hairs of a budget billed as the toughest in 25 years. One of the cuts was a two-year delay in the plan to let people 50 and over with less than $500,000 in super keep paying in up to $50,000 a year - halving almost overnight their allowable contributions.

Some numbers from super specialist Dixon Advisory, exclusive to Smart Investor Money, reveal the full extent of the government's super slugs to 50 and overs.

Under the original $100,000 cap, you could potentially grow a $200,000 fund to $2 million by age 65. Under the next $50,000 cap, you could have grown it to $1.2 million. And under the new $25,000 cap, you could at best hope for $700,000. (Calculations are in today's dollars and assume a balance of $200,000 at age 50 and a moderate real return of 4.8 per cent for 15 years.)

Read the full article: Shock super slug to us all

$18,200 tax threshold opens up new investment opportunities

Daryl Dixon — Sun, 13 May 2012 03:27:00 GMT

13 May 2012, The Canberra Times

The major changes to last week's budget include the substantially higher income tax threshold of $18,200 and the steep reduction in the super concessional contributions caps to $25,000 annually. For people aged over 50, this tax year is the last opportunity to claim a tax deduction of up to $50,000 for self-employed or employer super contributions. Next year, the maximum limit falls to $25,000 for all taxpayers, forcing those wanting to build up their savings quickly to look at the suitability of other tax concessions.

Surprisingly in a year when the government desperately sought additional revenue, the budget did not alter any of the tax benefits available for negative gearing. This means that over the next six weeks, individual geared investors can reduce this year's tax bill substantially by prepaying up to 12 months of their interest and other tax deductible expenses. Doing this will result in a substantially larger negative gearing tax loss this tax year and entitle the investor to a prompt refund of the resulting gearing tax benefits as soon as they submit their 2011-12 tax return.

Self-employed people and other taxpayers eligible to claim a personal super tax deduction similarly have until June 30 to deposit up to $25,000 or $50,000 (for those aged over 50) in their super fund to claim a tax deduction.

Particularly for taxpayers aged 55 or more, there are further tax advantages flowing from this strategy because of their ability to use the money deposited in their fund to start a tax advantaged income stream.

In claiming superannuation tax deductions, care needs to be taken to ensure that total annual deductible super contributions do not exceed the designated caps because all excess contributions will trigger penalty tax.

For superannuation fund investors also, the budget decision not to reduce the company tax rate for large companies is good news because any reduction in company tax will reduce the value of the imputation credits on fully franked dividends received by their super fund.

For retirees and other investors, the new $18,200 tax-free area to apply from July 1 opens up new investment opportunities, including holding sufficient investments in personal names outside a super or pension fund to receive this amount of taxable income. In the future, one attractive strategy will be to retain sufficient investments in personal names to earn up to $18,200 annually tax-free and invest the balance in a low or no tax superannuation or pension

Read more about the author Daryl Dixon, Executive Chairman of Dixon Advisory.

Get ready for aged care changes

John Wasiliev — Sat, 12 May 2012 02:06:00 GMT

12 May 2012, Australian Financial Review

Entering a nursing home can be expensive, so how do the proposed assets and income tests affect the aged-care means test?

Under the proposed reforms, there is an asset and an income test for the care contribution. To calculate the income test, you work out how much of the super pension is assessable income, by dividing the account balance ($400,000) by the relevant number (20) – this comes from your life expectancy at the age you started the pension. Official government Life Tables tell you what this will be. This determines how much of the $25,000 pension is income-test assessable. The $20,000 result means $5000 is assessable.

Linda Wilson, Director of Technical Services at Dixon Advisory adds, "From the age of 65, you must satisfy a work test before contributing to super. It requires you to be gainfully employed for at least 40 hours in a consecutive 30-day period in a financial year. Gainful employment means employment or self-employment for gain or reward in a business, trade, profession, vocation, calling, occupation or employment. It excludes voluntary work."

Read the full article: Get ready for aged care changes

MPs' super tax dodge slammed

David Crowe — Sat, 12 May 2012 01:59:00 GMT

12 May 2012, The Australian (subscription required)

Labor's budget strike on wealthy Australians has opened a hornet's nest of inequity, as politicians, senior public servants and judges are spared the full force of changes that will raise $2.5 billion from superannuation.

The Gillard government scrambled to clarify its tax plans late yesterday as experts slammed the measures for hurting workers trying to save for their retirement without imposing the same penalties on others.

Daryl Dixon, Executive Chairman at Dixon Advisory comments, "What I can't believe is that they were silly enough to introduce it. It's been an inequity since 2007 but it's been made worse by the reduction in the cap from $100,000 to $25,000 and made worse again by reintroducing the surcharge. If you're going to do it, you have to treat all super fund members the same way, including defined benefit fund members."

Read the full article: MPs' super tax dodge slammed (The Australian subscription required)

Short sighted move to damage confidence

Daryl Dixon — Wed, 09 May 2012 07:30:00 GMT

9 May 2012, The Canberra Times, Budget 2012 Canberra Reaction

By reducing the superannuation savings of higher income and older middle-income taxpayers by $2.4 billion over the next four years, last night’s tax changes could well end up seriously damaging confidence in our super system. Responding to political concerns about the greater value of the tax concessions to higher-income taxpayers, $1 billion of the tax increases will come from taxpayers earning more than $300,000 annually.

The remaining $1.4 billion will come from the pockets of older taxpayers with relatively small superannuation account balances needing to boost their savings to ensure a comfortable retirement. From 1 July onwards, the government has set the annual maximum tax deductible super contribution at $25,000, a 50 per cent reduction on the cap available this tax year.

The additional revenue comes from breaking the promise to retain the cap at $50,000 for taxpayers aged over 50 with an account balance of less than $500,000. The Treasurer has stated that this will still happen in 2014-5, two years later than earlier promised. In the meantime, many Australians wanting to boost their super savings when their mortgage and education expenses are reduced later in life will not be able to do so.

The lower $25,000 annual cap will also result in more taxpayers incurring penalty tax bills for exceeding the annual contribution cap. Even with the larger caps applying currently, employees – particularly in jobs where employers including the Commonwealth provide superannuation benefits as a set percentage of salary – are receiving penalty tax bills.

While the one $25,000 annual cap for all will make life simpler for the Australian Taxation Office, levying the additional tax on contributions by taxpayers with annual incomes above $300,000 will present difficulties. The major problems will be the same as those involved with administering the Coalition’s superannuation surcharge: valuing and taxing the funded and unfunded defined benefit entitlements of government and university super schemes.

Low-income taxpayers have fared much better with the government delivering on its commitment to refund the 15 per cent contributions tax payable to taxpayers in the 15 per cent tax bracket, which will apply up to an income of $37,000 next tax year. This change will ensure that all taxpayers receive a taxation benefit from contributing to superannuation.

These changes to the contribution tax arrangements will overall reduce the attractions of boosting superannuation savings, especially for as long as negative gearing still continues to receive unlimited tax assistance. The negative gearing tax benefits are like the super fund ones were before the latest changes – of much greater value to higher marginal rate taxpayers than to lower income earners.

By severely reducing the available superannuation tax deductions over the past four years, the government has made negative gearing the most tax effective investment strategy. Instead of encouraging direct saving in superannuation for retirement, our tax system now heavily subsidises investments funded by borrowing other people’s savings.

Compared with the complexity of levying additional tax on the super contributions of taxpayers earning more than $300,000 a year, the ATO could easily collect additional tax revenue from negatively geared investors by limiting the amount of the available annual tax concession.

The government obviously found it much easier to target superannuation to boost its revenue from higher-income taxpayers.

Read more about the author Daryl Dixon, Executive Chairman of Dixon Advisory.

Will bank funding costs rise due to the short-term interest rate reduction?

Daryl Dixon — Sun, 06 May 2012 03:56:00 GMT

6 May 2012, The Canberra Times

Last week's 0.5 per cent reduction in the official short- term interest rate to 3.75 per cent will turn attention again onto whether bank funding costs have risen or not. This will be a key factor in the decisions taken by the big four banks on whether to pass on fully to customers the benefits of the latest rate reduction.

The politicians' comments are emphasising the need for a full flow-on of rate reductions to assist mortgage and small business borrowers. But with our ageing population and superannuation fund and other investors holding increasing amounts of cash and fixed interest investments, there's another large vested interest group losing out when interest rates fall.

Competition is forcing banks to pay more to attract and retain deposits, benefiting Australian savers and investors. For the government to expect self-funded retirees who pay full income tax on their interest income to subsidise cheaper loans for borrowers ignores the fact that Australia still relies heavily on overseas borrowings.

While the mining boom lasts, Australia will continue to attract short and longer term overseas funds including from carriage trade investors, especially from countries keeping their interest rates artificially low. If, however, commodity prices fall dramatically and our exchange rate falls, this inflow of funds could disappear quickly.

Given the uncertainties in the world financial system, the banks have been reducing their reliance on overseas funding to avoid a recurrence of the problems experienced during the GFC. They have been doing this by offering interest rates well above the cash rate to attract domestic term and cash deposits.

Overseas funding is now also more costly because of the Greek default and continuing concerns about the weaker European economies. Till now, competition has led to astute investors receiving between 1 per cent and 1.5 per cent a year more than the cash rate risk free up to the government guaranteed amount of $250,000 per deposit.

While this week's official rate reduction will reduce the rates on offer, borrowing costs for all our financial institutions are certain to remain well above the official cash rate. The cost of overseas funds has risen substantially, leaving them with only two options, continue to borrow overseas at higher rates or pay more to increase their domestic deposits. This is why the need to further reduce their reliance on overseas funding sources could result in mortgage rate reductions less than the official rate cut.

Read more about the author Daryl Dixon, Executive Chairman of Dixon Advisory.

Abbott may well be just what the doctor ordered

Max Walsh — Sat, 05 May 2012 04:03:00 GMT

5 May 2012, The Australian

With 17 months to go until the next election, it may appear premature to be writing about an Abbott government. For investors, 17 months should be well within their attention span. Any shorter duration would almost qualify as day trading.

The advent of an Abbott government will not be a business-as-usual changeover. It will represent significant political discontinuity for Australia.

Abbott and his team espouse a more robust contemporary form of conservatism, notably in economic management, than has been the case of the non-Labor coalition in the past.

Abbott's central theme as opposition leader has been his vocal rejection of new and increased taxation. He has rejected both carbon and mining taxes, promising to repeal them if elected. He has also promised income tax reform that would be lower for individuals, being both flatter and wider.

The economic shadow ministers, Joe Hockey and Andrew Robb, have positioned themselves as debt vigilantes. If delivered, this means an Abbott prime ministership will lead to smaller government both in terms of the bureaucratic body count and what are now called ``entitlements''.

Abbott has set himself what would, under any circumstances, be an heroic agenda. However, the limits of government are determined by external and domestic factors over which the government of the day has little control. It's not contentious to say that rarely has this been more apparent than now.

Externally, we have serious economic recessions across the peripheral economies of Europe. The genesis of this situation can be found in excessive debt across governments and banking systems.

Largely at the urging of Germany, the successful anchor economy of the eurozone, the credit collapse caused by excessive debt is being addressed by austerity measures that are creating political instability.

The US is also faced with the prospect of a further bout of recession. Although it is certainly in better shape than Europe, it has its own debt problems.

Whoever wins the November presidential election will face an economic management crisis before Inauguration Day. It's being called Taxmageddon.

Tax cuts introduced by the Bush administration are scheduled to expire unless rolled over by Congress. As well, a raft of spending cuts, enacted last year as a trade-off to lifting the debt ceiling, will be imposed. In their present form, these actions would cause a serious contraction to the US economy.

China will have a new politburo by the end of the year. It is expected that the changeover will reflect continuity rather than any change in direction. Continuity, however, means a slower growing economy as China seeks to achieve structural change by becoming a much more consumer-oriented society.

That will take time. Meanwhile, it will retain a heavy dependence on exports. Its two major markets are Europe and the US.

Australia, meanwhile, remains in a far better economic condition than just about any other developed economy. I would put Canada marginally ahead.

However, the bursting of the credit bubble, which has humbled Europe and the US, has had its impact here. This has been most obvious in the household sector that was leveraged to a greater degree than other developed economies.

The most obvious manifestation of household deleveraging has been the sluggishness of retail sales and the decline in housing prices.

It's worth noting that Australia has 5.4 million baby boomers who have begun to enter retirement. Their median age is 55 going on 56.

Under any circumstances, people lift their savings as they approach retirement. However, their capacity to do so has been inhibited by the poor performance of the favoured savings vehicle equity. Flat and declining housing prices haven't helped. Nor have changing superannuation rules.

Another driver of domestic economic activity that is set to bite is the reversal of what were, until late last year, our further rising terms of trade.

Another consideration that has begun to emerge in recent weeks is the strength of our mining investment boom. BHP has closed one coalmine with rumours of another to follow. Rio Tinto has pulled the plug on its proposed $9 billion spend on six new coal terminals.

All of these factors add up to a more challenging era for Australian economic management.

These issues could well be compounded by the Gillard government's fiscal legacy. Labor is moving to make its policy decisions as Abbott-proof as possible.

Furthermore, it's highly likely, given the probable extended duration of being in opposition, that the present Labor front bench will leave the incoming government with some very expensive political booby traps. I can't see Wayne Swan practising self-restraint next year.

An Abbott government will face a difficult economic environment. But it will have a fundamentally sound base to work with. Furthermore, Abbott's brand of muscular conservatism, providing it is applied with bottom-line integrity, may well be just what the doctor ordered.

Read more about the author Max Walsh, Deputy Chairman of Dixon Advisory.

The silver lining on redundancies can be super

Daryl Dixon — Tue, 01 May 2012 00:54:32 GMT

1 May 2012, The Canberra Times, Public Sector Informant

Given the announcements we've already heard, next week's federal budget could be the start of widespread public sector job shedding similar to that begun by the Hawke government in 1988.

At that time, the enhanced redundancy benefits provided by the Commonwealth Superannuation Scheme encouraged many long- serving employees to compete for a package. The present disappointing investment returns have reduced the superannuation incentives for CSS members to volunteer for a package. However, members of the Public Sector Superannuation Scheme may be keener to apply, given their far superior redundancy options, particularly when alternative employment is available.

The PSS forces resigning members to preserve all or the largest part of their benefit, which becomes untouchable and earns low interest for many years. The redundancy options are, by comparison, extremely attractive. This is because, in designing the PSS, the government was focused on closing off access to the CSS's generous preservation benefits. As a result, the PSS does not pay any interest on the compulsorily preserved employer benefit after the member resigns.

Instead, this part of the benefit is indexed only for future inflation until the benefit is claimed either at age 65 or earlier retirement after the minimum preservation age (60 for most members). Furthermore, by not funding this component of the employer benefit, the government reduces this part of the PSS benefits by an extra 15 per cent tax when the member finally accesses it as a lump sum.

By comparison, the preserved CSS employer benefits are generously treated. They attract interest at the fund earnings rate until age 55 or a later date chosen by the member. Moreover, when taken, they must be converted to an indexed pension benefit provided on a commercially attractive basis.

Recent poor fund earnings rates have taken some of the gloss off this arrangement. Nevertheless, by opting for the cash investment portfolio, deferred CSS members have received a return higher than inflation in recent years.

In the meantime, increasing life expectations have added to the attractions of taking a PSS redundancy. This is the result of actuarial miscalculations in 1990, when the purchase price of the immediate pensions available before age 55 was set for redundant members prepared to take 50 per cent or more of the entitlement as a pension. Compared with resigning and being forced to preserve their super, leaving it untouchable and earning very little until at least age 60, a PSS redundancy provides immediate access to a generous, fortnightly, lifetime, indexed pension.

Just how generous the pensions on offer are can be seen by examining private sector offerings. There are few commercial offerings of lifetime, inflation-indexed pensions with attached surviving spouse benefits, and those that are available are expensive. At age 60, for example, a lifetime annuity comparable with the PSS cannot be bought for a price less than 20 times the annual pension. The PSS offers its age 60 pension at a cost of 11 times the annual pension.

In redundancy situations, a PSS pension's cost increases gradually as the commencement age falls. But even at as young an age as 30, the PSS offers a pension at a cost of only 17 times the annual pension. At that age, the running yield is a lifetime, inflation-indexed yield of 5.9 per cent a year, payable with a 67 per cent residual entitlement to a surviving spouse. By any comparison, this is an attractive, safe return. Inflation-indexed Commonwealth bonds, for example, presently yield about 2 per cent a year plus inflation.

While the above analysis is only general in nature, it highlights how important it is for federal public servants who are considering a redundancy package to examine closely their super options to evaluate the pros and cons of giving up their job. For CSS and PSS members, the extra options available in a redundancy situation are crucial. In some situations, where the member intends to rejoin the Australian Public Service at a later date, the option of preserving all of their benefit in the PSS and CSS could also be attractive. This is because, when they rejoin the APS, they will have the option of regaining access to the CSS and PSS's superior super benefits compared with those in the PSS accumulation plan (known as the PSSap).

In redundancy situations, PSSap members are once again the poor cousins. Unlike all other federal employees, they don't receive any special superannuation benefits.

Read more about the author Daryl Dixon, Executive Chairman of Dixon Advisory.

Industry insight: Dixon Advisory - an introduction to buying property in super

Dixon Advisory — Sun, 29 Apr 2012 23:11:00 GMT

30 April 2012, DHA Investor Insights

Recently there has been a lot of debate around the returns (or lack thereof) generated by large retail and industry super funds. With equity markets bouncing sideways and affecting retirement savings, many investors are now looking to take control of their superannuation portfolios.

Many are turning to property as a safe haven. Investing in residential property inside a super fund can offer significant benefits to investors of all ages. The diversification of the investment portfolio away from traditional investment classes such as equities, the considerable tax advantages and the concept of investing in a tangible asset have encouraged a flood of new enquiries on the topic.

Residential property can produce stable, long-term returns across all economic cycles. While recent media attention has concentrated on the softness currently being experienced, the fundamentals are compelling for a long-term investor. Demand continues to outstrip supply, a positive scenario for any investment class, with ANZ putting the current undersupply at 240,000 dwellings nationally. The expectation of reduced interest rates and increasing rental incomes makes the current market attractive to potential purchasers.

On the tax side, investors can use concessionally taxed money, such as an employer’s compulsory 9% super contributions or salary sacrifice, to cover the loan repayments for a property within super. Rental income is taxed at a maximum of 15% (0% once an investor starts a pension) and capital gains tax can be avoided entirely if the property is sold in the pension phase (that is, following retirement).

While these points are important, one of the major attractions of the strategy is it can allow investors to get exposure to the property market with little impact on their personal disposable income. Because the government mandates that a certain amount of your salary is paid into superannuation, you can use those contributions to fund the property investment. That means no additional personal saving is required, with all costs borne by the super fund.

Tim Coates from Dixon Advisory speaks about the benefits of this kind of investment in the video Investing in property in SMSFs.

What’s involved?

The only way to achieve direct property ownership using your super is via a self managed super fund (SMSF). Investors can borrow up to 80% of the purchase price. Your existing super must be large enough to fund the remaining 20% of the property value as well as all the usual transaction costs.

Be aware that a loan within a SMSF is costly to obtain. The associated costs can be up to $8,000 (paid from your super). However, those costs can quickly be recouped from the attractive tax treatment of the investment. You will typically need a super balance of at least $120,000, which will allow you to purchase a property valued at around $400,000. (This super balance can be the combined total super of up to four members in a self managed super fund.)

Case study 1

Rachel is 40 years old and has a balance of $120,000 in her self managed super fund. She has 20 years left to her planned retirement at the age of 60. With an income of $80,000, Rachel intends to make contributions of $15,000 to super each year until she retires.

Under these circumstances, Rachel’s SMSF can purchase a residential property valued at $400,000. Rachel’s SMSF pays the $80,000 deposit (plus costs) and the bank loans the remaining $320,000.

Based on historical growth rates and the current super environment, Rachel could expect the property to be worth almost $1.5 million when she considers retirement at age 60 by which time the debt will be fully repaid. If Rachel sells the property after she has started a pension, she will have $1.5 million available to fund her retirement, all tax free.

Case study 2

Husband and wife John and Karen are both 55 years old and intend to retire at 65. Their current combined balance in their SMSF is $120,000 and they intend to contribute $25,000 p.a. each to super – a total of $50,000 each year. As in the case of Rachel, the bank loans their SMSF $320,000 towards a $400,000 residential property purchase. Their fund contributes the deposit ($80,000) and costs.

Using the same assumptions from Rachel’s case study, the property will be worth $772,000 when John and Karen reach 65, with the debt completely repaid in the 8th year of ownership. The fund in total will be worth close to $900,000 and they can sell the property after they start pensions, with the proceeds completely tax free.

Is it right for you?

Investing into an asset with gearing is not suitable for everyone. You should consider your appetite for risk, time to retirement and your level of annual contributions into super before going ahead.

Like all financial strategies, talk to your advisor about how the investment might work best for you.

Interested in knowing more? Dixon Advisory is running property investment seminars.

Read more about the Tim Coates, Associate Director, Property Investment Advisor at Dixon Advisory.

Read the original article on the DHA website.

Reduce outstanding debts for financial freedom

Daryl Dixon — Sat, 28 Apr 2012 23:57:00 GMT

29 April 2012, The Canberra Times

While the recent increase in household savings rates is adding to the woes of the retail sector, for many financially over-stretched families, the resulting scope to reduce their outstanding debts is providing greater financial freedom. With credit card interest rates as high as 20 per cent per annum, reducing outstanding balances as quickly as possible provides very tangible benefits.

A big bonus comes from paying off all outstanding card debt. From then on, paying off future monthly account balances before the due date avoids any further interest charges. By far the worst trap of credit cards is that interest free credit is only available on cards with no overdue account balance.

Not paying off even a small amount of the previous month's balance results in interest charges on all new transactions at the card interest rate from the date of purchase. This is why credit card statements highlight paying off only the minimum required monthly payment rather than the full outstanding balance before the due date.

Clearly, the highest returns from saving can be obtained from paying off all credit debt as soon as possible. The returns from doing this are far higher than those available by repaying an owner-occupied home mortgage faster than required. Where the opportunity is available to redraw or increase the size of a home mortgage, doing so to pay off all credit card debt can also substantially reduce total borrowing costs.

This strategy will, however, only pay off if credit card debt is not allowed to blow out again and every effort is made to reduce the outstanding mortgage. Where there is no outstanding interest- bearing credit card debt, paying off a mortgage as quickly as possible provides a very high tax- free return.

Our federal government penalises investors who opt to hold cash reserves and other investments instead of paying off their mortgage debt. This is an especially harsh part of our tax system, especially compared with the unlimited tax deductions available for the negative gearing of investments. Once all home and consumer debt has been paid off, there is no scope to avoid income tax on further savings other than undertaking negatively geared investments. While there is strong speculation that the superannuation tax concessions will be further reduced in next month's budget, it appears that the negative gearing concessions will again escape unscathed this year.

Read more about the author Daryl Dixon, Executive Chairman of Dixon Advisory.

Daryl on ABC Radio Nightlife, 29 May 2012

Daryl Dixon — Fri, 27 Apr 2012 03:49:34 GMT

27 April 2012, ABC Radio Nightlife

Daryl Dixon's next appearance on ABC’s Nightlife with Tony Delroy will be 29 May 2012.

This date has changed from the original scheduled date of 15 May 2012.

How European & US markets gained a positive week

Daryl Dixon — Sun, 22 Apr 2012 08:04:00 GMT

22 April 2012, The Canberra Times

Last week, Asset Check warned that European debt concerns could lead to weaker world share markets and that the Australian market would follow them down. That assessment was spot on.

But this week has been a positive one for both European and United States markets, for three reasons. First, the International Monetary Fund issued a positive view on likely world growth and in the process confirmed that Australian GDP was expected to grow by around 3 per cent next year.

Coming at a time when vested interest groups are talking the economy down in the hope of convincing the Reserve Bank Board to reduce interest rates, the 3 per cent growth estimate provides some comfort about our future prospects. The Reserve Bank may still opt to reduce the official rate before the budget, but the odds are increasing that any action will be left till after the budget.

The second boost to market and European confidence was that Spain was able to issue a larger than expected amount of bonds to investors, allaying concerns of another Greek situation. Unfortunately, as has been the case before, this could change unexpectedly.

Readers should be aware that the IMF's projection of stronger world growth is based on the assumption that any further European sovereign debt problems will be resolved using the bailout fund.

The third sentiment booster came from the US reporting season, which has just started. What is now becoming increasingly evident is that the major US companies, including those in the manufacturing sector, have emerged from the recession in a strong financial state. They have benefited from highly competitive US labour costs and productivity increases required to adjust to lower staffing levels.

Far from being destroyed by competition from Chinese and other competitors, the major US companies are now stronger and more competitive than they have been for many years. What is still unclear is how much further room there is for US share prices to rise.

As in the forthcoming Australian budget but even more so, the US government needs to increase taxes and reduce spending in order to reduce its outstanding debts. Such action will inevitably impact on corporate profits either via increased taxes or reduced earnings growth. All things considered, whilst there have been positive developments, share investors may need to remain cautious for some time yet.

Read more about the author Daryl Dixon, Executive Chairman of Dixon Advisory.

US is a good bet for investors

Max Walsh — Sat, 21 Apr 2012 08:14:00 GMT

21 April 2012, The Australian

First a quick quiz. How many of the following companies do you recognise? Alcoa, American Express, AT&T, Bank of America, Boeing, Caterpillar, Chevron, Cisco, Coca-Cola, DuPont, Exxon, General Electric, Hewlett-Packard, Home Depot, Intel, IBM, Johnson & Johnson, JPMorgan Chase, 3M, Kraft, McDonald's, Merck, Microsoft, Pfizer, Procter & Gamble, Travellers, United Technologies, Verizon, Walmart and Walt Disney.

I suspect that most readers not only recognised all 30 names but also had a good idea of their area of activity.

By my reckoning, about two-thirds of those companies are involved in manufacturing.

Now, I wonder how many readers could name just five large Chinese manufacturing operations. Or for that matter five British, German, French or South Korean manufacturers.

Japan is the only economy that could boast five or more readily recognisable corporations of global significance.

Certainly it doesn't have 30. In fact, I could probably throw in another 20-odd American companies. I chose the 30 above simply because they constitute the Dow Jones Industrial Average index.

The Dow Jones rollcall serves to remind us that American manufacturing is not dead.

On the contrary, there are persuasive arguments that it is enjoying the opening years of what may well turn out to be an extended renaissance.

One joke I encountered more than once when researching this column is that these days an American textile factory employs only a man and a dog. The man is there to feed the dog, which in turn is there to keep the man away from the computer-driven machinery.

The widespread use of high technology across US factories has reduced the importance of labour costs as an element in the total cost equation.

There has been a shift to in-sourcing, which means jobs that once were moved offshore are now returning to the US.

Another important cost variable that is changing is that of energy, as the exploitation of huge coal and shale gas reserves proves to be a game changer.

US natural gas prices have collapsed over the past six to seven years from a peak of $15.40 per million British thermal units to about $2 today.

Petroleum imports now account for 40 per cent of the country's current account deficit. There is a strong prospect that the US will become a net exporter of energy in the next five to 10 years.

The drop in gas prices will not only affect electricity prices but will also affect chemical and fertiliser prices.

US manufacturing is positioned to be a net winner from China's economic progress.

Australia, Canada and other commodity exporters have been in the Chinese sweet spot in recent years as demand for bulk materials such as iron ore and coal has soared.

China now concedes that this development model has reached its use-by date.

Structural change towards a consumer-based society has been adopted in principle.

America's leading exports today are civilian aircraft, semiconductors, cars, pharmaceuticals, machinery and equipment, motor vehicle accessories and entertainment.

All of these will be at the top of China's shopping list (and that of other developing economies) as it makes the transition to a consumer-oriented society.

The impact of that is already under way.

President Barack Obama promised in 2010 that the US would double its exports in the next five years. That was widely dismissed as empty political rhetoric, but in the past two years, export growth has averaged 16 per cent, more than enough, if continued, to hit the target.

In his January State of the Union address, Obama mentioned manufacturing eight times. In his three previous State of the Union addresses, he had mentioned it only once.

It's possible or probable that he was reacting to focus group polling. A survey for the Alliance of American Manufacturing found 79 per cent of likely voters this year said the US had lost too many manufacturing jobs.

However, the US is unlikely to return to the golden days of manufacturing, in which unskilled labour earned a decent middle-class wage.

Since that time, the gap between the skilled and unskilled has widened, as the required skills have become not only more technical but also under constant pressure for upgrading.

The US has become a two-speed economy, a trend that is destined to continue as its manufactured products displace bulk commodities in the Chinese market.

As is the case in Australia, the share of national income going to profits to the high-speed sector -- in our case the export-oriented mining sector of the economy -- has been increasing at the expense of wages.

Exchange rate appreciation in Australia has meant the buying power of wage earners has continued to rise in absolute terms -- at least so far.

In the US, the pressures of unemployment are such that many workers have little, if any, bargaining power.
Some exporters have introduced two-tier wage systems, which mean new employees are paid less than older ones.
General Electric is now paying new hires $US12-$US19 an hour compared with the incumbents' pay of $US21-$US32 an hour.

Similar arrangements are now showing up in the motor vehicle sector, steel and tyre companies and among makers of farm machinery.

That hardly adds up to a workers' paradise, but it does reinforce the reality that America's export recovery will be skewed in favour of investors.

Read more about the author Max Walsh, Deputy Chariman of Dixon Advisory.

Europe driving our share market downwards

Daryl Dixon — Sun, 15 Apr 2012 00:10:00 GMT

15 April 2012, The Canberra Times

Just when share investors were regaining confidence that better times are ahead, problems in European financial markets have yet again emerged to drive markets lower. Whether or not this will cause the Australian market to give up its recent gains remains to be seen but the timing of the latest market weakness is unfortunate, coming just before what is expected to be a contractionary federal budget.

Despite the recent increase in the size of the Euro bailout fund, it is now only all too evident that, contrary to the growing confidence that the situation was improving, European financial markets could face funding difficulties for several years.

The biggest concern is whether the large-scale austerity programs in the main problem countries will succeed in reducing their borrowing requirements. Furthermore, Germany's continuing reluctance to shoulder a larger part of the rescue costs of bailing out the weaker countries will limit the European Central Bank's scope to keep interest rates down.

While financial markets are reporting that Australian borrowing costs are coming off recent highs, raising overseas funds will continue to be a problem for our financial institutions as previous European bank sources of funds dry up.

On the positive side for share investors, the inflow of foreign funds into government bond investments suggests that official interest rates could be as much as 1 per cent lower in 12 months' time. There is now even increasing speculation that the Reserve Bank will reduce the official short-term rate in May.

Rarely do federal budgets have a major impact on the share market but if speculation about changes to depreciation and research and development allowances prove to be correct, this year could be an exception.

With the IMF now warning that commodity markets have peaked and could fall in 2012-13, budget attacks on the generosity of the tax arrangements for our major mining companies could add to the concern about the impact of the new rent resources tax.

The falling share prices of the largest listed companies, BHP and Rio, have already slowed the advance of the overall market indices. Mining sector budget tax increases could drag the market down even if interest rates are falling.

Overall, until the budget details are revealed, our share market is likely to gyrate and be led by overseas markets. If the European situation remains gloomy, the market could well drift downwards.

Read more about the author Daryl Dixon, Executive Chairman of Dixon Advisory.

Fiscal policy's impact upon the monetary mix

Daryl Dixon — Sun, 08 Apr 2012 04:32:00 GMT

8 April 2012, The Canberra Times

Despite widespread disappointment, particularly in the retail and housing sectors of the economy, the Reserve Bank has been prudent in not reducing the official short-term interest rate.

The bank's board is not yet convinced that the threat of inflation has disappeared and is sensibly waiting to see how contractionary the May federal budget will be.

Every indication is that Treasurer Wayne Swan will achieve a small surplus but how this is to be achieved is yet to be revealed.

A real possibility is that the budgetary shortfall will be largely removed by reductions in forward projections of capital outlays and grants. The states appear to be in the firing line.

Even one of the remaining Labor premiers is expressing concern that the federal government could be planning to balance its budget by reducing assistance to the states.

Any such action, combined with lower-than-expected GST revenue, will inevitably result in increased state fees and charges and higher borrowing requirements.

Thus, while it may look attractive to provide a stimulus to the retail and housing sectors by a reduction in the official interest rates now rather than later, the bank's cautious approach leaves all options open for a larger reduction if there is a sudden deterioration in Australian activity.

Both the Chinese and US economies are relatively strong and there is increasing confidence that the worst may be over in Europe, at least for the time being.

Money markets are pricing in a greater-than-even chance that short-term interest rates will be lower within a three-month time frame. Realistically, this suggests that the next official interest rate cut, if it comes, will be in June.

In the meantime, households are continuing to save at historically high rates and to concentrate on paying off debts. Financial institutions are reporting that a high percentage of borrowers are in advance of their required repayments. There is no certainty that borrowers would use the benefits of any interest rate reduction to increase their expenditure, so a rate cut could have relatively small tangible benefits for the economy.

The ray of hope for borrowers is that if annualised inflation remains below the bank's 2 per cent target level, the board will find it difficult to resist the political and retail and housing sectors' pressure to reduce interest rates. In a world where rates are being kept at artificially low levels to avoid recessions, it will become increasingly difficult for the Reserve Bank to keep our interest rates at or about current levels without good reason.

Read more about the author Daryl Dixon, Executive Chairman of Dixon Advisory.