Kohler's Week: China, Greece, House prices, Alexium, Argo Infrastructure, New Eureka

Last Night

Wall Street was closed for the July 4 holiday
Aust dollar, US75.2c


All the talk was about Greece this week, but more important things – for Australia – were the goings on to our north.

On Friday morning the iron ore price slumped 6 per cent and it’s back to where it was before the April Fool’s Day crunch, when it fell below $US50 and was clearly oversold. Now it seems to be heading back there.

The renewed fall in iron ore coincided with the Shanghai Composite share Index falling 5.8 per cent on Friday, making it a fall of 21 per cent since last Thursday and 30 per cent from the intra-day peak on June 12. That is clearly a full bear market and normally we would conclude that the Chinese bubble has burst.

Last night the Chinese Government took some remarkably stupid action: it launched an investigation into short selling and market manipulation, “based on reports of unusual movements in markets”.

There have been unusual movements alright, but the reason for the bust is not shorters and manipulators – it's the preceding bubble. There are no doubt short sellers involved, but it’s the long sellers doing the damage. Of course, being a one-party dictatorship, China is used to dealing with inconvenient problems by cracking down on them: if you’re a carpenter with a hammer then everything looks like a nail. But financial markets are not susceptible to bullying and generally bite the hand that beats them. Next week could be very interesting indeed.

I’ve been watching the intra-day prices as I prepare the script for my ABC news spot each day, and the volatility has been incredible. Between when I sit down to write the script and go into the studio to record it, there have been swings of 5 per cent or more, requiring hasty re-writes. Also the increase in trading volumes has been staggering.

Note that the correction has occurred, and is continuing, despite support from the central bank: the People’s Bank of China has been cutting interest rates and the reserve requirement since last November and did it again last weekend, so the market is not a reaction to monetary tightening.

If the casino aspect of China’s share market is coming to an end that’s probably a good thing, although it will have an unpredictable effect on confidence. There are actually two distinct markets in Shanghai: Joyce Poon of GaveKal reports that the median performance of the top 25th percentile has been flat since June 12th, while the median stock in the bottom 25th percentile is down 43 per cent.

As with many things, you can’t assume China is normal. This is not a mature economy in which the middle classes and bankers have become carried away in an asset bubble and are now coming to their senses. China’s process of enriching its citizens has only just begun, with GDP per capita having just crossed $US7000.

As the Chinese people get richer, two things happen: they buy more stuff and GDP growth slows. They are big gamblers, but most outlets are banned and not all of them can get to Macau to play roulette and blackjack, so they turn to the stock market. It’s possible that their infatuation with punting shares has only just begun, and that this correction is merely a pause before the market takes off again.

There are 89 million brokerage accounts at the moment, rising rapidly. Only 55 per cent of them, or 50 million accounts, hold any stocks, which is 3.7 per cent of the population. In Hong Kong, a third of population traded stocks in the past year. I’d say share trading, like most things in China, has a long way to go.

The second effect of growing wealth and GDP – slowing growth – is also inevitable.

Gerard Minack put out a note on the subject this week containing this chart:

Gerard comments: "It’s important to stress that this change need not be bearish: it’s the natural transition from fast-growing economic adolescence to slower-growing economic adulthood. Moreover, it’s consistent with the stated strategic aim of Chinese policy makers: to achieve slower, better balanced, more sustainable, growth. It also explains why 7 per cent GDP growth now is seen as only modestly below trend, when last cycle it would have been seen as near a recession.”

The problem is that growth is now below 7 per cent and still falling and the central bank and the government seem powerless to do anything about it. It’s largely caused by the same problem afflicting most western economies – that monetary policy is not working any more. There are two things working against it: even though lending rates have come down quite a lot, the real interest rate for Chinese companies is still above 10 per cent because of wholesale price deflation, and secondly commercial banks are not lending anyway because they’re worried about credit risk.

Maybe that happened in Japan and Korea as well, but in any case, looking at Gerard’s chart it seems that China’s growth is heading inexorably towards 6 per cent and below as China approaches “economic adulthood”, as he puts it.

That can’t be good for the iron ore price.


It was quite amazing this week that people were actually saying Greece would go into default and exit the euro. As if!

I suppose we shouldn’t be surprised: newspapers and financial intermediaries profit from fear and volatility, so naturally they attempt to foster it. As I have repeatedly argued, Greece will not be defaulted, even though it will not repay its debts, and it will not be kicked out of the eurozone. Germany’s exporters will not allow it and Greece does not want it.

The only task is to persuade the people of Germany not to punish the “feckless” Greeks too harshly, and to keep the Greek people from voting for any more loony, left-wing political parties which try to reverse the excellent reforms that have been going on there since 2010, in the midst of the austerity-induced depression. To that end the European Central Bank closed the banks a week ago to focus the peoples' minds, so tomorrow’s referendum will see people certainly vote “Yes” to more austerity – anything to open the ATMs again so the poor people can get some cash.

As for the IMF and default, Ian Rogers' Banking Daily newsletter had a useful summary of the situation yesterday:

"The IMF has not declared an event of default: it is merely treating the missed payment as just that. Officially, Greece is now in arrears with the IMF.

The IMF does not declare events of default. It has a documented set of procedures that must be followed when a country falls into arrears. These procedures can be found on pages 912-3 of the Selected Decisions And Selected Documents Of The International Monetary Fund, December 2013.

These procedures must be followed and can take up to two years to work through.

And what happens at the end of the two years if the recalcitrant borrower has not made good? Their membership of the IMF is cancelled.

Sudan has a debt to the IMF that has been outstanding since 1984. Somalia has been in arrears since 1987 and Zimbabwe, the most recent to enter into arrears, has been this way since 2001.

By missing its payment to the IMF, Greece has defaulted on the €131 billion owed under the European Financial Stability Facility that was extended in December 2012. As a result, the arrangement expired on June 30 and has not been renewed, but the European Commission is not seeking repayment of the money owed and has signalled that it will not do so.

So everything continues as it was.”

Everything does, indeed, continue as it was, except that the IMF is suddenly agreeing with the Greek Government that some kind of debt write-off is required, having caused all the problems in the first place by refusing to countenance any write-offs in 2010 and demanding austerity instead, which led to Greece’s crushing depression and a blow-out in the debt rather than its reduction.

But that’s water under the bridge. To the extent that markets have corrected due to the Greek crisis, this represents a buying opportunity, since the crisis will be over soon.

One thing worth noting is that the atmosphere of crisis has temporarily halted the rising trend of bond yields, since the “risk-off” mood has led to some buying of bonds. This has had the effect of propping up bank share prices, but it will also be over soon and therefore it’s likely that yields will resume their climb. That means for banks the current situation is a selling opportunity.

House prices

Australia desperately needs a housing correction at some point, especially in Melbourne and Sydney. The high cost of housing is causing Australia to be uncompetitive, even though, unlike southern European countries and China, we have undertaken a lot of painful microeconomic reform to improve productivity. All of that good work is being drained away in the rising cost of living, led by shelter, which feeds through to everything else.

From the most recent trough in May 2012, the Sydney median price has compounded at 13 per cent a year, for a total rise of 43 per cent, and now sits at $772,200. Melbourne prices have compounded at 8.5 per cent per annum. Obviously, in each case the median disguises a wide variation, with a lot of relatively cheap apartments coming onto the market and very big rises in some suburbs.

As to whether it constitutes a “bubble” – I don’t know. That’s a different thing to saying prices are too high. To be honest, as investors in companies we can only hope it is a bubble that bursts fairly soon and brings down costs. On the other hand, I own an investment property in Melbourne and obviously I don’t want house prices to fall 30 per cent, but the usual post-boom correction of 5-10 per cent would be bearable and helpful for the country, economically and socially (to get the kids to move out).

And just to show (again) that you can prove anything with graphs…

Here’s the national median price:

And household leverage in Australia:

… Both of which prove it’s a bubble.

But even in Sydney prices are not rising as fast as they were 10 years ago and in most cities the rate of growth has been less than 5 per cent for a few years.

Also, rental yields are still quite reasonable, especially compared to term deposit interest rates.

So – perhaps not a bubble after all.

Forget the pointless argument about whether it’s a bubble or not – I think the point is that if you buy residential property investment now, your returns over the next five years are likely to be meagre. Whether they will be even less meagre than the current five-year term deposit rate of 3.1 per cent is hard to say, but the difference is that real estate is almost always leveraged, and rather a lot at that, while term deposits are not. My understanding is that banks have been happy to lend the entire amount and then a bit more for the lawyer and stamp duty; whether that is still the case, I’m not sure, but negative gearing ensures that leverage is the order of the day in real estate investing.

Thus a 5 per cent decline in value will probably equal a 50 per cent decline in equity (and vice versa of course). The requirements of negative gearing (lots of debt) render residential real estate the most volatile and risky of investments, especially at the moment – and let us not pretend otherwise.


I interviewed Gavin Rezos on Thursday, the executive chairman and largest shareholder in Alexium International – a $170 million market cap ASX-listed American company that sells fire retardant chemicals for military and household (furniture) use.

This is a really interesting story, mainly because the chemical that’s currently used as a fire-retardant – bromine – has turned out to be toxic and will probably be banned. It’s a $7 billion-$10 billion global market and Alexium has solid patents for an “environmentally friendly” replacement technology that is starting to get some traction. The company is still burning cash but expects to break even towards the end of this year.

By the way, this was the first of our new format CEO interviews, broadcast live to subscribers, with the capacity for you to ask questions as well. There were about 100 people watching the interview live on Thursday and I got a steady flow of terrific questions from the viewers, which I was able to put to Gavin. You can watch the video and read the transcript here.

I’ll be doing one or two of these a week from now on, so please tune in in future if you can and help me out with the questions!

Argo Infrastructure

I did a phone interview with Jason Beddow of Argo Investments about their new listed infrastructure fund, Argo Global Listed Infrastructure, which has raised $286 million. It listed on Thursday at $2 and went to $1.97 yesterday. The portfolio manager will be the big New York based real estate and infrastructure investor, Cohen & Steers, and they’ll get half of the fee of 1.2 per cent.

I think I’d prefer they got a performance fee, but the benchmark to be used has been doing 15 per cent for the past few years, so Jason will have the whip out on them. I suspect 15 per cent p.a. will be hard to sustain, but 10 per cent compound should be achievable over the long term.

The money won’t be going into an existing Cohen & Steers fund, but obviously the assets won’t be a million miles from what they like already, which is mobile phone towers, toll roads like Transurban in Australia, electricity and gas distribution and a couple of pipelines. If you’re interested in global infrastructure, it’s worth listening to the interview, or reading the transcript, which you can do here.

New Eureka

Well, we launched Eureka Interactive this week and so far so good. Also, our new listed investment company (LIC) analyst, Mitchell Sneddon, joined us this week and immediately got stuck into a live interview with Geoff Wilson, of Wilson Asset Management, and he did pretty well. Geoff is one of the best, most articulate, fund managers in the country, and well worth listening to. You can listen to their discussion here.

Our new income analyst joins us in two weeks to complete the team: growth, income, international and LICs, with model portfolios from each detailing their recommended weightings as well as their stock picks. And each of them will be regularly appearing on Eureka Interactive to answer your questions and to interview, with you, CEOs and fund managers.

Readings & Viewings

Hilarious, especially now: Monty Python’s sketch of the Greece Vs Germany soccer match, including Hegel, Kant and Nietzsche for Germany and Socrates, Aristotle and Pericles for Greece.

I have been a happy subscriber to Grant’s Interest Rate Observer for a long time. Here is a wonderful video about Jim Grant, its founder and editor.

Why small booms cause big busts.

For Democrats, Donald Trump amounts to a kind of divine intervention.

Here’s a story about, and picture of, Airbnb’s “data science” team. Amazing. There’s 30 of them!

Another excellent paper from the Grattan Institute on Australia’s fiscal challenge, and how to fix it.

A diagram of the Greek crisis (any one of them):

One of my favourite writers – Theodore Dalrymple – on the Greek difficulties.

Greece’s Prime Minister may be about to do exactly what he said he wouldn’t.

Joseph Stiglitz: how I would vote in the Greek referendum.

Some stuff you should know about Greece (it invented finance and has been broke rather a lot).

And here’s a picture of the ATM line inside the Greek Parliament, plus a whole lot of rather pithy comments about it.

Barrie Cassidy: why Tony Abbott hates the same sex marriage issue.

Michelle Grattan on the same subject.

And this is a pretty sharp comment from Politico on marriage equality (they’re lawyers):

This is pretty miserable: Graham Richardson says Bill Shorten won’t suffer much from admitting he lied. Truth counts for little in politics any more. Dear oh dear.

Some frank interviews with ordinary Beijingers about the stock market.

David Leyonhjelm on the Victorian prison riots this week: prisoners have the right to smoke.

The 10 best new financial year resolutions ever.

Another list of 10 – Jeremy Grantham’s 10 obsessions.

China’s Communist Party – still big and getting bigger.

A good essay on Keynesian economics.

The horrifying rule of Boko Haram

Solar is now as cheap as fossil fuel-electricity, but the old monopolies just won't get out of the way.

Joni Mitchell is speaking again after her aneurysm, and will make a full recovery, according to a friend.

I’ve been listening to Joni Mitchell a lot this week, as I think about her so ill, hoping she recovers. Feast your ears on Hejira for a few minutes, from 1986 when she was at the peak of her great powers – the greatest of the singer songwriters.

Last Week

Shane Oliver, AMP Capital

Investment markets and key developments over the past week

Shares had another volatile week with optimism about a Greek deal early in the week giving way to renewed concern as the saga continued. Chinese shares continued to correct and even the terrorist threat reared its ugly head again. Eurozone shares ( 4.4 per cent) held on to their gains from earlier in the week and Japanese shares ( 2.6 per cent) rose to their highest since 1996 but US shares slipped 0.4 per cent and Australian shares fell 0.9 per cent after two weeks of gains. Chinese shares also saw continued volatility with another 6.4 per cent decline. Bond yields generally rose, except in peripheral Eurozone countries where yields fell on hopes of a Greek breakthrough. Commodity prices were mixed but the $A fell as the $US rose.

The Greek saga continues. After getting a lot closer on a deal but then failing to quite get there, Greek PM Tsipras has now called a referendum for July 5 on the latest offer from Greece's creditors. This will probably pass with polls indicating two thirds of Greeks want to stay in the Euro, and around 56 per cent saying that this should be the case even if it involves a bad deal with Greece’s creditors. The current situation with runs on Greek banks will provide a reminder of the chaos that will follow if Greece does not remain. However, it is not certain as the Greek Government will be campaigning against it.

The week ahead will involve significant uncertainty. A missed payment to the IMF on June 30 could be handled by the IMF allowing Greece to be in "arrears" until the outcome of the referendum is known. The situation for Greek banks is rapidly worsening though and without ECB support will require a bank holiday or limits on withdrawals. So ideally the referendum needs to be held with the support of Greece's creditors – but so far this is unclear with Eurozone finance ministers telling Greece that its bailout program will expire on June 30. It’s also not quite clear what the Greeks will be voting on as the creditor offer will lapse. The continuing uncertainly will likely weigh heavily on Eurozone shares (which may give up their 4 per cent gain of the last week and then some), the Euro and global shares generally.

Putting aside the risks around the week ahead, having a referendum is probably a good way forward for Greece as it will indicate whether the Greeks want to stay in the Euro or not. If the referendum is passed it will send a clear signal to the Greek Government to engage constructively with the rest of Europe to provide funding and then work with the creditors to put Greece's debt burden on a more sustainable footing. The latter was getting close last year but the election of Syriza threw a spanner in the works. However, a Yes vote would not provide immediate resolution though as it may mean that a new Government would have to be formed. A No vote would put Greece on the messy path to an exit from the Euro (or Grexit).

Finally, while uncertainties around Greece remain intense leaving financial markets vulnerable, it’s worth reiterating the rest of Europe is in far better shape now to withstand a Grexit than was the case through the 2010-12 Eurozone crisis so the fall out in financial markets should be limited. If Grexit is the way it goes, at some point it will provide a big relief rally for Eurozone shares as it will mean that the whole silly, nearly six-year long debacle with Greece is finally over. A note produced earlier in the week looking at the main issues around Greece, including what would happen if there is no deal and a Grexit is also attached.

China cuts interest rates again, expect more easing ahead. The People’s Bank of China has cut its benchmark 12 month interest rate by another 0.25 per cent taking it to 4.85 per cent and has cut the required reserve ratio for some banks by another 0.5%. The 19 per cent fall in the Chinese share market from its high two weeks ago no doubt provided the cover for such a move as Chinese authorities want a calmer share market with a rising trend, but certainly not a crash. More fundamentally monetary easing is justified. Producer price deflation of around 5 per cent year on year has meant that real borrowing rates for many businesses are way too high. We expect the 12 month lending rate to be cut to 4 per cent or below by year end.

Major global economic events and implications

US data was mostly good, but the growth rebound after the March quarter soft patch is still looking slower than that seen last year. Housing indicators remain solid, unemployment claims and weekly mortgage applications are continuing to improve, consumer spending was strong in May and consumer confidence rose in June. But against this, the Markit business conditions PMIs for June fell to still ok levels but are well down from a year ago and underlying capital goods orders are rising but only modestly. While March quarter GDP growth was revised up to -0.2 per cent annualised from -0.7 per cent this is largely irrelevant because a seasonal reanalysis next month to remove chronic seasonal softness seen in March quarters will likely see it revised up to around 1%. The basic message is that the Fed is on track to hike later this year, probably in September, but the trajectory of rate hikes is likely to be very gradual.

Eurozone business conditions PMI's for June were impressive. Despite all the noise around Greece the composite PMI rose to 54.1 it’s highest in three years, driven by gains in both manufacturing and services. This is consistent with a further step up in the pace of Eurozone GDP growth this quarter to 0.5 per cent quarter on quarter, compared to 0.4 per cent last quarter.

Japan's manufacturing PMI for June was disappointing, but other Japanese data was more positive with the unemployment rate remaining at its lowest since 1997, the jobs to applicants ratio rising to its highest since 1992 and household spending up strongly from its tax hike driven low a year ago. Core inflation remains too low though at 0.4 per cent year on year indicating pressure remains on the BoJ for more easing.

China saw some good economic news with the flash Markit manufacturing PMI up a bit more than expected to 49.6 in June and consumer confidence up 1 per cent in June. That said it’s hard to get too excited as the PMI is still wallowing around in the same 48-52 range it’s been in for four years now.

The overall picture from the global manufacturing PMIs released so far for June is that global growth remains uneven (with falls in the US and Japan, but gains in Europe and China) and still modest, but is okay. In some ways this is good, too weak and we worry about recession but too strong and the risks swing to inflation and aggressive central bank tightening.

Official home price data for the March quarter confirmed that growth is mainly being driven by Sydney. While home prices in Sydney rose 13 per cent over the year to the March quarter, the average pace across the other capital cities is just 2.2 per cent. All Australian cities suffer from poor affordability, but after a couple of years of double digit gains the Sydney market is looking a bit bubbly with buyers seemingly getting attracted by the pace of gains. It clearly needs to slow. Moves by the NSW Government to speed up land release and channel some of its stamp duty windfall into infrastructure for public housing projects are positive moves. The pressure also remains on APRA and hence the banks to slow lending for property investors particularly into the Sydney property market. Assuming this is successful, the benign home price growth being seen outside of Sydney is certainly no barrier to another RBA rate cut.

Job vacancy reports provided contradictory messages, but we are still looking for more constrained jobs growth ahead than seen over the last year. Population growth also appears to be slowing providing another pointer to constrained economic growth. My view remains that another rate cut is a 50/50 proposition. July is out but watch the August RBA meeting.

Next Week

Craig James, Commsec

Jobs and housing in focus

In most months, a Reserve Bank Board meeting would attract significant interest. But not this month – data on jobs and housing will prove more important.

The week kicks off on Monday with ANZ publishing its series on job advertisements while TD Securities and Melbourne Institute issue its monthly inflation gauge.

Job ads have been trending higher for more than 18 months and are now up almost 10 per cent over the year.

Turning to the inflation gauge, the headline index was up 0.3 per cent in May after a similar increase in April. The annual rate of inflation held steady at 1.4 per cent. And annual growth of the underlying rate (trimmed mean) eased from 1.4 per cent to 1.3 per cent. The bottom line being that inflation remains well contained.

And this is a nice segue to the Reserve Bank Board meeting on Tuesday. Inflation is contained, home building is soaring, consumers are spending freely and businesses appear to be embracing the federal budget stimulus.

As a result no change in interest rate settings is expected. The key question is what will be the next move in interest rates, and when will the rate change be delivered? And on both these questions, economists appear divided. Some still think that interest rates could fall. But a growing number believe the Reserve Bank is now on the sidelines, perhaps to 2016.

Also on Tuesday the Bureau of Statistics (ABS) releases the May data on tourist arrivals and departures as well as migration figures. The ABS has being playing ‘catch up’ for the past few months after software problems caused delays in the production of these key indicators. From here on, the data will be one of the timeliest, providing key insights into the outlook for consumer spending and housing.

On Thursday the ABS releases the June jobs data. And if one indicator has surprised in recent months it has been this one. Most assumed that unemployment would trend higher if the economy was growing at only a 2.3 per cent annual pace. Not so. Job growth over the past six months has been the best in over four years. And the jobless rate has fallen, not increased. CommSec expects jobs rose by 10,000 in June and the jobless rate probably held at 6 per cent.

And on Friday the ABS releases the May data on housing finance. Data from the Bankers Association suggested that new lending commitments slumped by around 5 per cent in the month. If the forecast is confirmed then it may suggest that lenders are indeed tightening lending criteria. Either that or high prices could be choking off some of the effervescent demand for homes.

International: Mix of US and Chinese economic data

There is a healthy mix of economic indicators in the US and China in the coming week but with few standouts.

The week kicks off on Monday in the US with the ISM services index and the rival Markit series covering activity in the same sector. The ISM index is tipped to have lifted from 55.7 to 56.0 in June. Any reading over 50 suggests expansion of the services sector so activity appears healthy at present. The employment trends index is released the same day.

On Tuesday, the JOLTS survey on job openings is issued together with trade figures (exports and imports) and consumer credit data. The usual weekly data on chain store sales is also released.

On Thursday the usual weekly data on jobless claims – new claims for unemployment insurance are released. This timely indicator provides a regular check on the health of the job market.

And on Friday the Federal Reserve chair, Janet Yellen, delivers a speech while data on wholesale sales and inventories in the US is also scheduled.

In China, the official statistician (National Bureau of Statistics) releases data on producer and consumer prices. Business deflation still exists with producer prices down 4.6 per cent over the year. And consumer inflation is well contained with prices up just 1.2 per cent over the year. Low inflation readings will give the authorities further scope to cut rates if it is decided that more stimulus is required.

Sharemarket, interest rates, currencies & commodities

In the US, the earnings season – profit reporting season – has come around again. Mining company, Alcoa, traditionally kicks off the season, and it is has that lead position again, with the company scheduled to report earnings on Wednesday. PepsiCo and Walgreens Boots follow with earnings results on Thursday.

And despite key US share indexes not far from record highs, earnings expectations aren’t encouraging as shown in the analysis from Briefing.com: “The latest data from S&P Capital IQ indicates second quarter earnings per share is projected to decline 4.4 per cent to $28.42. On April 1, it was thought second quarter EPS would decline 2.1 per cent.”

In Australia, one of the more interesting results over the 2014/15 year was the relative absence of broader volatility. Certainly daily volatility picked up late in the financial year with investors jittery over rising bond yields and the Greek debt crisis.

But at the same time investors showed some comfort with the sharemarket in the 5,200-6,000 range. In 2014/15, the gap between the year’s highs and lows for the ASX 200 index was just 17.1 per cent – the smallest range for the index in 14 years. That result should provide investors with comfort that the market has fundamental support.

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