Global equity indexes are pushing out to new record highs, with talking heads attributing this new leg up to “dovish” comments by the nominee to succeed Ben Bernanke as the Chairman of the US Federal Reserve, Janet Yellen, during Congressional testimony this week.

The S&P/Australian Securities Exchange 200 Index (ASX) is right up there with the S&P 500 Index and the Dow Jones Industrial Average at or approaching their best-ever readings.

And the Australian dollar has rallied off a 12-month low of USD0.8901 on Aug. 30, 2013, to USD0.9367 as of this writing, despite a less-than-stellar update by the Reserve Bank of Australia (RBA) of its economic growth forecast.

The RBA, in its most recent quarterly Statement on Monetary Policy, which was finalized on Nov. 7, 2013, noted that record-low interest rates are having a positive effect on the economy but forecast the full benefits may not be seen until well into 2015.

Variable borrowing rates are now below their 2009 Great Financial Crisis lows in the aftermath of the central bank’s most recent cut in its overnight cash rate to 2.5 percent in August.

Still, the RBA expects Australian gross domestic product (GDP) to expand by 2 percent to 3 percent in 2014, down from an August 2013 forecast of 2.25 percent to 3.25 percent.

The less rosy outlook is due to faster-than-forecast decline in mining investment, with the most significant pullback happening in the coal sector.

The RBA did note improving business and consumer confidence, which should flow through to stronger non-mining business investment and a pick-up in household demand. But the effects likely won’t show up in GDP growth until 2015.

Further strengthening in the Australian housing market could provide a jolt to sentient and consumption, though at the risk of rising indebtedness.

In light of the below-trend GDP growth forecast, unemployment is expected to increase gradually for the next year or so. Later in 2015, improvement in non-resource investment will drive jobs growth.

Still, the Australian Bureau of Statistics reported an unemployment rate of 5.7 percent in October, well below the US jobless rate of 7.3 percent, the UK’s 7.6 percent and the Canadian and German rates of 6.9 percent, for example.

And long-term Australian joblessness has remained relatively steady, which means that as the economy improves the unemployment rate should follow.

The RBA noted that most of the recent rise in the unemployment rate has been attributable to individuals unemployed between four and 51 weeks, who are more likely to be unemployed for cyclical reasons.

Crucially, economic growth for Australia’s trading partners is forecast to rise from a recent average of 4 percent to 4.25 percent, right above the long-term average, in 2014.

The RBA is optimistic about the US economy gathering momentum over 2014, though it expressed caution over the lingering debt ceiling and budget disputes as well as the timing and pace of the Fed’s withdrawal of its “quantitative easing” program.

Europe is also forecast to get back on a positive trajectory in 2014, though growth will remain weak. The European Central Bank’s decision to cut its benchmark interest rate to 0.25 percent should provide some help.

China, now Australia’s biggest trading partner, has recently posted a strong set of economic data.

The Middle Kingdom’s GDP grew by 7.8 percent on a year-over-year basis during the third quarter of 2013, in line with expectations and ahead of the country’s 7.5 percent annual growth target. It also ended a two-quarter slowdown.

Chinese industrial production rose 10.2 percent in September 2013, also in line with economists’ estimates. Retail sales growth of 13.3 percent for the same month was slightly below expectations of 13.5 percent, but the double-digit growth is still a positive.

China’s consumer price index accelerated slightly to 3.2 percent in October, up from 3.1 percent in September largely due to higher food prices. Chinese exports grew 5.6 percent year over year in October to USD185.4 billion, reversing a 0.3 percent decline in September.

Fixed-asset investment, a measure of government spending on infrastructure, rose 20.1 percent during the first 10 months of 2013, a slight slowdown from the 20.2 percent pace through September.

October’s data suggest that China’s recovery is perhaps stronger and more sustainable than observers expected and that inflation is still not a serious threat. Full-year inflation is tracking to about 2.7 percent, well below the control target of 3.5 percent.

These are welcome developments as the world digests reforms hammered at during the Communist Party’s Third Plenum this week.

This gathering has traditionally set the economic tone for a new government and comes a year after China embarked on a once-a-decade leadership transition that was completed in March.

According to reports from the official Xinhua News Agency citing the ambitious plenum document, the Communist Party’s leadership has decided to further loosen its one-child policy, to allow more private investment into banking and to start requiring state enterprises to return a larger share of dividends to the government.

China’s household registration policy is to end in smaller cities, and farmers will be given more rights to their land. Legal reforms, too, were announced. The successful implementation of the reforms isn’t guaranteed, and the changes are likely to face significant opposition.

China will begin to allow couples to have two children if just one of the parents is an only child. Beijing had previously required both parents to be only children. “The birth policy will be adjusted and improved step by step to promote ‘long-term balanced development of the population in China,” Xinhua reported. This is a positive step that should help improve China’s demographic profile. As a good friend and former colleague used to often remind, demographics is a powerful force.

China also pledged to move more quickly on banking reform with a much-anticipated move: allowing more private money into the state-owned banking system. “China will open up the banking sector wider, on condition of strengthened regulation, by allowing qualified private capital to set up small-and medium-sized banks,” according to Xinhua.

China’s state-owned enterprises (SOE) will also be asked to contribute more to state coffers. SOEs had been returning dividends ranging from zero to 15 percent. Should this reform survive they’ll be required to pay 30 percent by 2020.

According to Xinhua’s report of the official Party statement from the Third Plenum, “The money will be used to improve people’s livelihood.”

This is a key development. China’s new leadership is focused on transitioning from an investment-led to a consumption-led growth story, moving from reliance on big-ticket government-led investments and to making private spending, including by consumers, the main driver for what they hope will be more moderate yet sustainable expansion.

But that doesn’t mean its hunger for natural resources is satiated. Demand growth for commodities will remain robust due to Chinese wealth creation, demographics, and urbanization. Those factors will also drive demand for services, domestically and internationally, as we detail in this month’s In Focus feature.

Australia’s GDP growth rate has outpaced the collective average for advanced economies in 18 of the last 21 years, demonstrating the country’s economic resilience and flexibility. The Land Down Under hasn’t experienced a recession in more than two decades.

Australia was able to outperform all advanced economies in the wake of the Great Financial Crisis due to a timely fiscal and monetary response, a flexible exchange rate, a resilient financial system, high population growth and strong trade links.

The latter factor is critical to Australia’s economic performance over the coming decades. And the key relationship is with China.

Portfolio Update

GrainCorp Ltd (ASX: GNC, OTC: GRCLF) and other interested parties have been assured that a final regulatory decision by Australia’s Foreign Investment Review Board (FIRB) on Archer Daniels Midland Co’s (NYSE: ADM) proposed acquisition of the AE Portfolio Aggressive Holding “will be made by 17 December 2013.”

ADM has offered AUD12.20 per share plus AUD1 per share in dividends, a total of AUD3.2 billion. GrainCorp’s board has recommended acceptance of the offer by shareholders.

But he shares took a steep dive on Nov. 15 trading on the Australian Securities Exchange (ASX) due to a report in The West Australian that the Australian government may block the deal.

At these levels it’s yielding more than 5 percent.

We included GrainCorp among our original “Eight Income Wonders from Down Under” because it’s a high-quality company with easily identifiable cash flows. Management continues to make moves that complement the core business.

It remains to be seen what the Australian government will do, first, with the Foreign Investment Review Board decision on the ADM proposal and then, second, how it will help GrainCorp and the nation’s farmers compete in Greater Asia.

But we are happy to have a new opportunity to recommend a solid business with bright prospects and the proven ability to support and grow a dividend.

Portfolio Update has more on GrainCorp, fiscal 2013 earnings for Australia & New Zealand Banking Group Ltd (ASX: ANZ, OTC: ANEWF, ADR: ANZBY) and updates on several Conservative and Aggressive Holdings.

In Focus

China’s urban middle-class population alone, if considered as a country, is larger than the entire US total population today.

An estimate by researchers at the School of International Service at the American University puts the number of China’s middle class at 630 million by 2022–that’s three-quarters of urban Chinese households and 45 percent of the entire population.

By 2022 China’s middle class will be consuming goods and services valued at USD3.4 trillion, approximately 24 percent of gross domestic product (GDP).

Research by McKinsey & Company suggests that more than 75 percent of China’s urban consumers will earn RMB60,000 to RMB229,000 (USD9,000 to USD34,000) per year by 2022.

In purchasing-power-parity terms that range is between the average income of Brazil and Italy.

The service sector is expected to account for half of China’s GDP in 2022, up from 44 percent today. This partly reflects the increasing willingness of China’s upper middle classes to spend on things such as travel; food; entertainment and leisure; education; and health care.

Consumption in these sectors–domestically and abroad– is growing rapidly.

In Focus identifies five high-quality dividend-paying Australia-based companies well placed to benefit from this rising Chinese middle class.

Sector Spotlight

Crown Resorts Ltd (ASX: CWN, OTC: CWLDF, ADR: CWLDY), until a name change approved by shareholders at this month’s annual general meeting known simply as Crown Ltd, is well placed to benefit from not only a revival of consumer sentiment in Australia but the emergence of a middle class on China as well.

Crown operates and manages gaming and entertainment facilities, bars, restaurants, nightclubs cinemas and retail outlets. It also develops hotels and conference facilities. Crown’s assets in Melbourne and Perth continue to deliver solid and relatively defensive earnings. These assets are the company’s main cash flow generators, and there is some concentration risk.

Crown’s 33.7 percent stake in Macau-based Melco Crown Entertainment Ltd (Hong Kong: 6883, NSDQ: MPEL) represents a growth opportunity, and future dividend flows from Melco Crown will bring some diversification.

We’re adding Crown Resorts to the AE Portfolio Aggressive Holdings based on its solid cash flow from Australia and the long-term potential of its opportunity to serve Asia’s rapidly emerging middle class.

We have more on Crown Resorts in this month’s first Sector Spotlight.

This has been the warmest winter on record in many markets in Australia, with heating degree days tracking below the 20-year average in all four states included in Australia’s National Electricity Market (NEM) since July 1, 2013.

The inevitable impact on energy demand has resulted in AE Portfolio Conservative Holding AGL Energy Ltd (ASX: AGK, OTC: AGLNF, ADR: AGLNY) offering a rather subdued outlook for financial and operating results for fiscal 2014. And that’s weighed on the stock price.

But AGL has developed a balanced portfolio of generation assets to provide competitive sources of energy, not only to its substantial commercial and industrial customer base but also to its retail customers that now total some 3.85 million accounts.

In addition to the largest portfolio of renewable electricity generators in Australia AGL also has one of the largest and most competitive thermal power plants. AGL is also positioned to profit from a strong portfolio of gas contracts and gas storage facilities.

This month’s second Sector Spotlight focuses on AGL Energy.

News & Notes

Still Patiently Awaiting the Australian Economy’s Rebound: Although the Reserve Bank of Australia doesn’t expect the economy to revert to its long-term growth trend until 2015, there are a couple of bright spots among the country’s sectors, including the resource space, notes AE Associate Editor Ari Charney.

The Dividend Watch List: The Dividend Watch List includes updates on How They Rate companies that announced lower dividends during fiscal 2013 earnings reporting season Down Under, which recently concluded. It also includes those that reduced earnings guidance in recent weeks.

The ADR List: Many Australia-based companies that list on the home Australian Securities Exchange (ASX) are also listed on the New York Stock Exchange (NYSE) or over-the-counter markets as “sponsored” or “unsponsored” American Depositary Receipts (ADR).

Here’s a list of those companies, along with an explanation of what these ADRs represent.

How They Rate

How They Rate includes 112 individual companies and four funds organized according to the following sectors/industries:

• Basic Materials
• Consumer Goods
• Consumer Services
• Financials, including A-REITs
• Health Care
• Industrials
• Oil & Gas
• Technology
• Telecommunications
• Utilities
• Funds

We provide updated commentary with every issue, financial data upon release by the company, and dividend dates of interest on a regular basis. The AE Safety Rating is based on financial criteria that impact the ability to sustain and grow dividends, including the amount of cash payable to shareholders relative to funds set aside to grow the business. We also consider the impact of companies’ debt burdens on their ability to fund dividends. And certain sectors and/or industries are more suited to paying dividends over the long term than others; we acknowledge this in the AE Safety Rating System as well. We update buy-under targets as warranted by operational developments and dividend growth.

In Closing

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David Dittman
Editor, Australian Edge

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