Also significant is the recent volatility in
world sharemarkets. Will there be a flight to 'value' and the
safety of the LPTs? The vital question is: 'when will the current
bout of interest rate rises come to an end?' because this may
well signal the start of the next long term uptrend in LPT prices.
This assessment focuses on how LPT prices will
be affected over the next twelve months by:
- Interest rate outlook
- Current sharemarket volatility
- LPT prices relative to their NTAs
Interest Rate Outlook
Traditionally, higher interest rates hurt the
LPT market. They increase the cost of debt and, by increasing
yields on safe, fixed interest investments, make them relatively
more appealing than LPTs. Interest rate movements are thus the
most critical component in any assessment of the outlook for
the LPT market.
March quarter CPI data indicated an annualised
inflation rate of about 2.25% compared with a low of around
1.25% in late 1998. Then, on 3rd May, the Reserve Bank of Australia
('RBA') raised interest rates by 0.25% to 6.00%. The RBA has
justified its rate rise decisions on the basis of the effects
of a higher CPI and increasing levels of credit on inflation,
the threat of a GST-fuelled wage breakout, and external factors
(particularly the $AUD weakness and the need to maintain an
interest rate differential between Australian and US bond rates).
Countering this argument, many analysts believe
that the RBA have been unnecessarily aggressive in increasing
rates by 1.25% in four instalments since November 1999. These
analysts say that these rate hikes have already started to bite
and further rate rises would unnecessarily slow the economy
later in the year. They point to the fact that retail sales
have already slowed, and highlight downturns in consumer and
business confidence levels and a strong likelihood of a post-GST
slump in activity particularly in building. In fact, the RBA
Governor, Mr MacFarlane, acknowledged evidence of such a slowdown
in his most recent statement.
But, more recently, Australia's ailing currency
and concern over interest rate differentials relative to those
in the USA have grabbed the limelight. Because investment monies
flow to countries with the higher interest rates, the currency
of the lower interest rate economy will suffer.
The statements accompanying rate rises in April
and May focused on the significant inflationary risks from a
lower $AUD which would raise the cost of imports. We believe
the downside potential for the $AUD is limited as long as the
RBA is prepared to raise interest rates to protect the currency.
The $AUD will also be supported by growth in world industrial
production which drives commodity prices. The possibility that
the U.S. Federal Reserve ('Fed') will increase rates by 0.50%
in their May meeting threatens our interest rate outlook. Should
this eventuate, the RBA may be forced to follow suit, nudging
the upper bound of PIR's interest rate forecast for the end
of the calendar year out to 6.75%.
Notwithstanding this, PIR anticipate at least
one further 0.25% rate rise before the end of the calendar year.
Indeed, the RBA, in line with their pre-emptive approach, may
increase rates by a further 0.50% (likely to be spread over
two separate increases) taking the cash rate to 6.50%. The case
for a further increase is strengthened considering the potential
flow-on impact of the GST on inflation. PIR expects the post-GST
slow down coupled with the lagged impact of the RBA's 'gentle'
manipulation of monetary policy to slow the economy towards
the end of the calendar year.
Sharemarket Volatility
'Volatility' has become a polite word for precipitous
drops followed by technical corrections. Recent volatility in
world sharemarkets will produce winners and losers and also
much uncertainty. The market reaction to the crash of 17th April
illustrates how, under these conditions, investors and fund
managers flee to the safety of solid blue chip 'old economy'
stocks and LPTs. And, since 1 January this year the LPT index
has risen by 2.39% while the All Ords has fallen by 2.07%.
Continued volatility in the Australian sharemarket
should see the LPT Index supported within a 40 point range (1220
- 1260) for the next few months as some investors bet on the
unabated growth of the 'new economy' whilst others seek the
solace of value-based securities. PIR anticipates an overall
slowing in the economy towards the end of the year, bringing
to a close the current round of interest rate increases sparking
greater interest in the LPTs. This may push the Index moving
toward its previous September 1999 high of 1325.
LPT Index Discount/Premium to NTA
A simple way to assess the relative value of
LPTs is to compare unit prices with the net market value of
its property assets (ie. price to NTA). Historically, LPTs have
represented good value for investors when the Index has traded
at a discount to NTA. The LPT Index is currently trading at
just a 1.7% discount to NTA. This would suggest that further
falls are needed before LPTs become good buying and upside potential
in this sector is somewhat limited. (On the other hand quality
independent research can identify buying opportunities at most
stages of a cycle.)
The current round of monetary tightening may
drive the LPT Index towards a higher discount to NTA by the
end of the calendar year. Alternatively, continued volatility
in the domestic sharemarket may see funds flow to the safety
of LPTs, causing prices to increase to unattractive levels for
the value investor.
Conclusion
We expect the LPT Index to trade within a range
of 1220 to 1260 points during the next few months. Following
an economic slowdown towards the end of the calendar year we
expect to see substantially higher LPT prices triggered by the
RBA's monetary policy strategy, the anticipated inflationary
impact of the GST, and a likely decline in sharemarket activity.
