For your interest, attached is my monthly 'Over the Horizon' share market commentary for May2014

1. May 2014 — Over the Horizon Market Commentary by David Offer
Earlier in the month, Australia’s March quarter gross domestic product (GDP) figures were released for the March
quarter. These showed resilient quarterly growth of 1.1% that was ahead of expectations of growth of 0.8%. Annualised
growth for the 12 months to the end of March was 3.5%, a level of growth marginally ahead of Australia’s long term
average of 3.25%.
This favourable headline result was attributed to a surge in mining exports, which otherwise masked a benign domestic
economy. While there was an increase in investment in housing and household spending, capital investment was down
over the year. Consequently, annual unemployment has remained relatively unchanged at 5.8% and inflation has been
contained at 2.8%. Australia’s Reserve Bank of Australia (RBA) interest rate setting of 2.5%, which has remained constant
for the last 9 months, appears likely to continue to remain unchanged for some time to come.
At the current time, there are a number of global issues that point towards economic headwinds for Australia.
The first is that the European Central Bank (ECB) has addressed the issue of a stagnating European economy by cutting
the bank’s key interest rate to 0.15% from 0.25% and dropping its deposit rate (the rate paid to banks who leave cash at
the ECB) to minus 0.10% from zero. Effectively, the ECB is now charging banks to hold money with the ECB and this is
being done in an effort to force banks to lend more to customers. This and other ECB stimulatory measures have created
upwards pressure on the Australian dollar as investors exploit the difference in Central bank interest rate settings. It now
appears likely the Australian dollar is going to remain high for considerable time to come and this is not good news for
Australian exporters.
Next on the list is an increasingly oversupply of housing in China, which is contributing to a lower iron ore price. Recent
research suggests that there are approximately 50 million unoccupied homes across China. While many of these will
gradually fill on the back of government urbanisation polices, it is concerning that up to 25% of these subsidised vacant
houses are owned by high income earners. As these houses can be readily sold, this suggests that Chinese property
prices will remain depressed for some time to come. While affordable housing is one of the Chinese Government’s main
growth-boosting programs for the remainder of this year and next, it is likely housing will not feature as much in the Central
Governments next Five Year Plan that will come into effect in 2016.
With 30% of Australia’s iron ore exports to China utilised within China’s property sector, this helps explain the current
weakness in the iron ore price. However, with RIO Tinto and BHP Billiton arguably the lowest cost producers of iron ore
globally, with a breakeven price for iron ore production of US$43 a tonne and US$50 a tonne respectively, our majors are
well positioned for any downturn. Fortescue Metals is in a less desirable position, with a breakeven cost of US$72 a
tonne. Many of Australia’s smaller iron ore producers have breakeven costs closer to $100 a tonne, and these are the
companies that will be really vulnerable in the event of protracted weakness in the iron ore price.
Another major global headwind is the high oil price due to escalating and tragic civil unrest in Iraq. In addition, the Russian
Ukraine conflict has evolved with Russia no longer supplying gas to Ukraine unless payment is made up-front and at an
inflated price. Should this escalate with Russia ceasing the allowing of gas to transit to Europe via Ukraine, this would put
further upward pressure on energy prices.
Finally, US growth is proving to be weaker than expected with the International Monetary Fund (IMF) cutting its outlook for
U.S. growth in 2014 to 2%, nearly a full percentage point lower than its previous forecast. Reasons behind the cut include
the sluggish start to the year on account of harsh winter weather, tepid demand for exports and a cooling housing market
following an initial recovery post the GFC. More positively, recent economic news including improving homebuilder
confidence, a pick-up in consumer spending and strong job creation in April of 288,000 jobs (dropping the unemployment
rate to 6.3%), suggests that the economic slowdown over the brutal winter may be just a temporary blip.
Against this difficult global backdrop and a benign domestic Australian economy that remains exposed to a likely downturn
in the mining sector as capital expenditure retreats from record levels, it is concerning that Australian household debt has
reached record levels. At $1.8 trillion, it towers over our government debt at $300 billion. A redeeming factor is that 72%
of Australian household debt is owed by the top 40% of high income households, suggesting that Australia’s borrowers
should be reasonably able to manage their debt obligations. Nevertheless, such a high level of borrowing indicates that

2. Australian consumers, along with our Federal government, have used a lot of ‘spending ammunition’ to deal with any
unforeseen economic shocks or global slowdown.
The majority of Australian household debt has gone into real estate. When comparing Australia’s property prices relative
to income earned, Australia is now the third most expensive property market in the developed world, behind only Belgium
and Canada.
Notwithstanding the above issues and in the absence of investment alternatives, share markets globally have tended to
steadily march higher, led by the US market which is now sitting at a record high of 16,781. However, the higher markets
rise, the greater the risk of a fall or at least a modest pullback. We are comfortable with our increasingly defensive stance
within portfolios.
If you would like to discuss any of the above or would like to discuss any aspect of your portfolio, please do not hesitate to
contact our office.
Sincerely
David Offer
AUTHORISED REPRESENTATIVE 259188
Director
HORIZON INVESTMENT SOLUTIONS PTY LTD
SUITE 1, POST OFFICE PLAZA, 153 VICTORIA STREET, BUNBURY WA 6230
T. 08 9791 9188 F. 08 9791 9187
E.david.offer@horizonis.com.au www.horizoninvestmentsolutions.com.au
Horizon Investment Solutions Pty Ltd, ACN 083 142 438, ABN 79 668 035 212, AFSL 405897
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