My temptation this month was to headline this piece “The Calm before the Storm,” as the most widely watched gauge of investor fear, the Chicago Board Options Exchange Volatility Index, known as the VIX, has hit a five-year low and trading volumes on global exchanges have bottomed out ahead of what promises to be, at least, a compelling September.

The VIX broke below 14 for the first time since June 2007 early this week and closed Friday at 13.45. It hit a weekly closing high of 79.13 on Oct. 24, 2008, the peak of the post-Lehman fear. It’s closed below 15 only two other times since that period, in April 2011 and March 2012.

We’ve seen similar complacency before, when the VIX indicated low levels of fear. It’s important to keep in mind that the VIX is simply a measure of the prices of puts and calls, options that profit from falling and rising prices, respectively. But lower prices suggest that traders are paying less for protection.

But complacency is no place to be. In mid-April 2010 the VIX hit 15.6 as the S&P 500 rallied. Less than four weeks later the S&P was 8 percent lower. In late April 2011 the VIX touched 14.6. By mid-June 2011 the S&P 500 had lost 7 percent. As recently as March 2012 the VIX was as low as 14.3. The S&P fell 4 percent over the next two weeks of trading.

But this is all technical stuff.

Fundamentals appear to be firming. And so here we have again the duality that seems to have provided the thematic structure for In Brief since we debuted in September 2011: bad news and good news, all within the context of an ultimately unsatisfactory global economic recovery from the 80-year event that was the Great Financial Crisis.

About those fundamentals, Germany and France both beat expectations for gross domestic product (GDP) growth in the second quarter, though the eurozone and wider group of 27 European countries saw an anticipated quarter-on-quarter contraction of 0.2 percent.

The German economy has demonstrated some resilience, with 0.3 percent growth. Economists had expected the quarter-on-quarter figure to come in at 0.1 percent.

The Mannheim-based ZEW economic think tank’s monthly poll of economic sentiment slid to negative 25.5 from negative 19.6 in July. Negative 25.5 is a 2012 low. Economists had expected an “unchanged” reading.

“The indicator’s decline in August signals that financial market experts still expect the German economy to cool down throughout the next six months. Especially export-oriented sectors may be affected,” noted the ZEW.

France, meanwhile, also beat with flat growth rather than an anticipated 0.1 percent contraction. Although Spanish GDP contracted by 0.4 percent, the IBEX closed the week at a four-month high. Italy’s GDP fell at an annualized rate of 2.9 percent in the second quarter, but the FTSE MIB Index closed at its highest level since early April.

Returning state-side, quite a few US economic indicators have outperformed expectations in the last couple of weeks.

Payrolls, the trade deficit, the US Federal Reserve’s Senior Loan Officer Survey, retail sales, homebuilder confidence and industrial production all came out better for July than had been anticipated.

The Conference Board said on Friday its Leading Economic Index climbed 0.4 percent to 95.8, reversing a 0.4 percent decline in June. The biggest driver in the increase for LEI was the fact that fewer claims for unemployment benefits were filed in July. Building permits jumped, which could point to more construction down the road.

Multifamily housing starts rose also rose in July, but single-family home starts were down 35,000 in July. And applications for home purchases declined for a fifth straight week to their lowest level since February.

It appears that the US housing market is finally bottoming, but that’s as far as I’m willing to go on that front. This long process of absorbing one of the great misallocations of resources continues.

US retail sales did grow in July after three months of contraction, but AAA reported that gasoline prices moved up another USD0.04 to gallon to USD3.72, the highest level in three months.

Despite the positive up-tick the LEI points to slow growth through the end of 2012, at least according to one economist at The Conference Board. The unemployment rate remains stuck at 8.3 percent, although the recent trend has been enough for some analysts and economists to begin suggesting that QE3 may not happen in September.

The preliminary University of Michigan Confidence Survey for August registered a 73.6, topping consensus expectations for a 72.2 and up from 72.3 in July, 73.2 in June and 79.3 in May. The current conditions component rose almost five points to its highest level since January 2008. But the outlook component fell 1.1 points to its lowest level of the year.

Some historical context for the 73.6 confidence reading: The 10-year average is 79.2, the 20-year average is 87.5 and the 30-year average is 87.8. One-year inflation expectations also ticked up to 3.6 percent from 3.0 percent a month ago, to the highest level since March.

Even as signs of a strengthening consumer abound, both the New York and Philadelphia regional manufacturing indices look to be heading for contraction in August, the City of Brotherly Love’s reading for a fourth straight month.

The US Dept of Commerce’s inventory-to-sales ratio pushed out to its highest level since February 2010 due to a drop in sales. And both the headline and core Producer Price Index rose higher than forecast.

Inflation in India was lower than expected, and the Sensex is approaching a five-month high. But elsewhere in Asia the news was not so rosy. Japanese GDP growth was lower than expected in the second quarter, an annualized 1.4 percent, well below the 2.7 percent the consensus hoped to see.

And foreign direct investment in China declined for an eighth month out of the past nine in July, suggesting global confidence in the world’s second-largest economy is shaken. As has been noted here often, China looms literally and figuratively over everything Australian.

A month from now we’ll have a much clearer idea about what will happen with Greece, Spain and Syria. So too will the US Federal Reserve have provided more information about its next policy moves. And the quadrennial pissing contest also known as the US presidential election will be that much closer to being over.

But we simply can’t know what’s going to happen next.

Portfolio Update

The AE Portfolio Conservative Holdings were chosen for high yields with the potential to grow as strong underlying companies build their businesses. But they also lack commodity price exposure, which in large part accounts for their outperformance in a year when many fear a global slowdown.

The only challenge with these stocks right now is price. Many trade above our buy targets, some well above. Our advice for new investors is to just be patient.

Natural resources are the cornerstone of the Australian economy. Resource-focused stocks are volatile, as they’ve once again proven this year. And so long as investors are worried about the health of the global economy, our Aggressive Holdings will continue to be choppy.

The silver lining is the dips we’ve seen for many of these stocks this year have set up them up at good buying prices. And because all of these are solid companies, we can expect a strong rebound when the market mood shifts more bullish on growth, particularly for Asia.

There’s more in this month’s Portfolio Update, including an in-depth discussion of a closed-end fund that focuses on Australian and Asian fixed-income securities.

In Focus

If you’re new to AE and investing in Australia, you need to focus on the five Conservative Holdings that were part of the Portfolio on Sept. 26, 2011, specifically AGL Energy Ltd (ASX: AGK, OTC: AGLNF, ADR: AGLNY), APA Group (ASX: APA, OTC: APAJF), Australia and New Zealand Banking Group Ltd (ASX: ANZ, OTC: ANEWF, ADR: ANZBY) Envestra Ltd (ASX: ENV, OTC: EVSRF) and Telstra Corp Ltd (ASX: TLS, OTC: TTRAF, ADR: TLSYY).

As of this writing, only APA group is trading below our buy-under target. But that’s fantastic place to start, as the stock has come down from a recent high due to concern about what it will take for it to win a bidding war for the assets of Hastings Diversified Utilities Fund (ASX: HDF). APA is yielding 7.5 percent as of the close of trading in Sydney on Aug. 17.

BHP Billiton Ltd (ASX: BHP, NYSE: BHP), GrainCorp Ltd (ASX: GNC, OTC: GRCLF) and New Hope Corp Ltd (ASX: NHC, OTC: NHPEF) are the original Aggressive Holdings, though GrainCorp is currently trading well above our buy-under target.

Beyond this plan of action, look to this month’s Sector Spotlights, Aggressive Holding Oil Search Ltd (ASX: OSH, OTC: OISHF, ADR: OISHY) and new Conservative Holding SMS Management & Technology Ltd (ASX: SMX, OTC: SMSUF).

SMS Management & Technology, meanwhile, is what you might call the first graduate from the group of stocks profiled in this month’s In Focus feature.

Prior to earning its final AE Safety Rating System point, making it a “6,” SMS was another company we liked a lot but that was just outside looking up at the top 20 that comprised the Portfolio. It was among the “other receiving votes,” to borrow from the terminology used to describe college football and basketball teams that get a lot but not enough voting support from members of the media or coaches to make it into weekly top 25 rankings.

We’ve now expanded the Portfolio to 21, with an ideal up-side of 25. It’s highly likely that those remaining spots–should we opt to fill them–will be filled by one or more of the companies profiled in the August In Focus.

Sector Spotlight

Melbourne, Australia-based SMS Management & Technology Ltd (ASX: SMX, OTC: SMSUF) specializes in improving operational performance and IT delivery, everything from business integration to compliance, process improvement to change management and technology strategy to systems integration and application development.

SMS, which has never cut its dividend and now earns a “6” according to the AE Safety Rating System due to its recently announced dividend increase, is a new member of the Australian Edge Portfolio as a Conservative Holding.

The stock has generated a total return of 27.25 percent in US dollar terms since the Sept. 26, 2011, debut of AE, and is up 41.93 percent in calendar 2012. Its long-term performance is equally impressive, including an 88.43 percent five-year total return.

SMS helps businesses innovate to solve their particular problems. More important, it helps them sustain and improve operations so they can remain going concerns.

During the 12 months ended Jun. 30 SMS posted a net profit of AUD30.6 million, up 3 percent on the previous 12 months, while revenue was 10 percent higher at AUD335.8 million. The growth is more modest than last year when the company’s sales surged 23.6 percent.

Earnings before interest, tax, depreciation and amortization (EBITDA) grew 5 percent to AUD44.3 million; last year EBITDA rose 10.8 percent to AUD42.2 million. SMS Consulting EBITDA grew by 7 percent, while M&T Resources EBITDA shrank by 14 percent.

SMS will pay a final dividend of AUD0.17 per share on Oct. 26 to shareholders of record on Oct. 5. The shares will trade ex-dividend as of Sept. 28. The final dividend is up 3 percent over the prior corresponding period. Its full-year payout of AUD0.305 per share is 2 percent higher than in fiscal 2011.

This final dividend figure represents 68.1 percent of earnings per share, at the midpoint of company policy to pay 65 percent to 70 percent to shareholders.

We shine a Sector Spotlight on this new Conservative Holding.

This month’s second Sector Spotlight falls on Oil Search Ltd (ASX: OSH, OTC: OISHF, ADR: OISHY).

Oil Search has been paying a dividend since May 2003, but it would be stretching things to describe it as an “income play.” Make no mistake: This is an aggressive growth story with a modest income component.

Since October 2008 the stock has been on a strong uptrend, broken for a short time by a fall 2011 slide, characterized by a bullish technical indicator, “higher lows.” In other words, buyers are coming in sooner on dips as time passes.

In light of its recent operating results, including successes in its drilling and exploration programs that suggest PNG LNG could be even more prolific than forecast, we anticipate it will soon make “higher highs” as well.

News & Notes

Newcomers: We’re adding a new category to the How They Rate table this month, Funds, and four names to populate it. One is a closed-end fund that invests in Australian and Asian debt securities, one is an exchange-traded fund (ETF) the objective of which is to reflect the US dollar price of the Australian dollar and two are ETFs that track the broader Australian market and small-capitalization stocks Down Under, respectively.

The Dividend Watch List: The Dividend Watch List includes updates on How They Rate companies that announced dividend cuts during the recently opened earnings reporting season Down Under, lowered earnings guidance in recent weeks as well as those that cut payouts during their most recent reporting period.

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 109 individual Australian companies organized according to the following sector/industries:

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

We’ve added a new section this month, Funds, with details on four new additions to How They Rate coverage in News & Notes.

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
Co-Editor, Australian Edge