Dow Jones, up 0.63%
S&P 500, up 0.45%
Nasdaq, up 0.54%
Aust dollar, US70.9c
Where are we?
I’m going on two weeks’ leave (we’re visiting our daughter Alice in London, and thence to her boyfriend’s parents’ house in the south of France, so life will be tough…) so I thought the best thing today would be to give a broad overview of where we’re at as investors at the moment, and then look at the dangers and opportunities, as I see them.
We’ve been through quite a vicious correction lasting almost five months so far, but it was overdue and should have been pretty much expected. The continuing volatility suggests it may not be over yet, but I don’t know whether it is or not (no one does).
As I pointed out on the ABC news last night there’s been a correction every year since the big one in 2008 (that bugger was 53 per cent, of course, and changed the world). The corrections in 2010 and 2011 were 14 and 21 per cent respectively, but since then they have all been less than 10 per cent (8.5, 9,8) and, really, no more than a clearing of the sinuses. This year’s is 13.5 per cent so far, so roughly in line with 2010.
I don’t think we have entered a global bear market – they require a recession or a drastic monetary tightening. But markets can be elusive things, hard to pin down. For example, most people would think the last six and a half years was a bull market and are wondering anxiously when the next bear market will start, and if you look at the global MSCI, that’s a perfectly reasonable point of view.
The global index is dominated by the US, so here that is:
The S&P 500 bottomed, satanically, at 666 on March 9, 2009, and is now at 1961 so even including this year’s correction the compound capital return from the US share market has been 18 per cent per annum, an amazing bull run.
The Australian market is an entirely different matter. Here’s the 10-year chart of the ASX 300:
I actually look at that and think we’ve had an eight-year bear market rather than a six-and-a-half-year bull market. The compound annual return since September 2007 has been -1 per cent pa. That’s a bear market. The only thing that has saved us has been dividends: include them and the return has been positive, but not much. Taking the timeframe from the March 2009 bottom, the compound annual return on the ASX 300 accumulation index (including dividends) has been 12 per cent.
And what’s more if you exclude the banks, we haven’t even had a bull market since March 2009. The ASX 300 resources index (XKR) is now BELOW that March 2009 bottom, so the Australian resources sector has been in a very serious bear market for more than a decade. Looked at in that light, the run-up between 2009 and 2011 can be seen as a bear trap – a rally based on unsustainable Chinese stimulus.
ASX 300 Resources
Before I go on, a couple of side notes:
1. As I am sure is clear from the above, the "Australian share market" doesn’t actually exist, as a single thing anyway. The domination of banks and resources means that it is at least two things and can’t sensibly be seen as one. There are times when they move together – they ran up together in 2005-2006 and crashed together in 2008 – but most of the time they don’t. And during the “hunt for yield” era that has applied since late 2011, the bank index has gone up 60 per cent and the resources index has fallen 40 per cent – an outperformance of an incredible 100 per cent… within one market!
2. Charts. I love charts, as you know, but I take absolutely no notice of “chartism”, by which I mean trying to predict the future using them. I know lots of people make a lot out of watching moving averages crossing over and the various shapes of the charts, such as heads and shoulders, and good luck to them, but I think that is hocus pocus. The reason I get a lot from charts is because they help provide perspective – they keep you grounded in history. I fell into using them on the ABC News by accident – the Head of News wanted me to illustrate my spot with video, as Peter Wilkins was doing with sport, but there simply wasn’t enough of it each day, and none of it was interesting anyway (men in suits) so I had to think of something else. The result is that I spend a lot of every day looking at all sorts of different charts, trying to find two or three for the News that will tell a relevant story, and the continuous historical perspective this gives me is invaluable.
So much for the past, which, as I’m sure you know, is no guide to the future. Just because the resources sector has been in a 10-year bear market doesn’t mean it’s about to enter a bull market (although there are some smart people around who are starting to think it will) and just because the banks have had a four-year, 60 per cent, rally doesn’t mean they’re done with rising.
I can’t predict what will happen from here and won’t try; I think the most useful thing to do is stare the dangers in the face and come to a view about how, um, dangerous they are.
Whereas the catalyst for each of the annual corrections since 2009 was Europe, and more specifically Greece, this one has been all about China. That’s especially true of the sell-off in August, which was prompted by the People’s Bank of China’s decision to devalue the renminbi slightly and widen the peg, but the scene was set by the crash of the Shanghai and Shenzhen share markets in June.
China is said to be trying to pull off the “impossible trinity”, which is floating the exchange rate, freeing capital controls and running an independent monetary policy. I’m not sure that’s right. Since the August devaluation, the PBoC has been pouring foreign exchange reserves into propping up the currency and it’s not entirely freeing up capital flows either. Therefore I don’t think there will be a big, or sudden, market-driven devaluation of the renminbi.
The Chinese economy has sailed through the June share market crash unscathed, so far, and will probably remain unscathed – by the crash at least. There have been, and will be, plenty of headlines and hand-wringing, but the fact is that neither the banks nor Chinese consumers generally have much exposure to the market. Equities represent less than 5 per cent of household wealth and while a lot of the speculation has been on margin loans, as a percentage of the banks’ loan books these are insignificant. Even if the market crash has another leg down, that won’t cause a systemic crisis.
Real estate speculation isn’t a big danger either, in my view, since prices have boomed as a result of internal migration driving up urban housing demand. The danger with property is that housing construction is peaking at the same time as infrastructure investment has reached its limit, so the investment growth that has sustained the Chinese economy for 15 years, and by extension the Australian economy, is coming to an end.
Real growth in investment, net of inflation and depreciation, is probably now zero in China. Most industries seem to have some degree of overcapacity and there is enough infrastructure since almost the entire population now lives near enough to a motorway or train station. Also, the flood of people moving from the bush to the city is now tapering off and with it the need for more city housing, beyond normal population growth (which is itself slowing because of rising education standards).
In other words China is going through the transition that almost everybody has been predicting: from an economy based on heavy industry and infrastructure investment to one based more on services and consumption. It’s not smooth, but nothing involving human beings is ever smooth.
The big danger with China, it seems to me, is that the Communist Party tries to too hard to maintain control, and doesn’t have the confidence or benevolence to allow freedoms to develop as they will have to.
In Tiananmen Square in 1989, China laid out its future course: economic capitalism within a strict, even brutally enforced, one-party socialist political system. The Party’s deal with the people was that it could retain power, and the members could line their pockets (or rather, their Swiss bank accounts) as long as everybody’s prosperity improved as a result of allowing greater economic freedoms. That’s been working pretty well for 25 years.
That deal has just about run its course. Xi Jinping has come to power at a crucial time and in every speech he has made he has focused on the need to eliminate corruption and make China great again. He’s a real Donald Trump this bloke. Making China Great means, in part, turning the renminbi into at least a regional and preferably global, trading and reserve currency. It’s part of the definition of greatness, and great countries don’t have weak currencies.
But here’s the rub: capital now wants to leave China, because the political system makes it more risky than the great democracies of the world, and there are better risk-adjusted returns available elsewhere. The potential capital outflow is being exacerbated by Xi’s tough anti-corruption drive, which is lassoing a lot of wealthy comrades. Obviously those who haven’t been caught are highly motivated to get their money out. There is not a huge refugee or migrant outflow from China, as there is from the really brutal dictatorships, although it’s moderate and growing, but “social unrest” is constantly hanging over the place, and driving the Government to preserve economic growth and employment.
I suspect the tension between what you might call the old and new China – that is, the tightly controlled socialist model and the free market one – is made flesh through Xi Jinping and the PBoC governor Zhou Xiaochuan. Xi is not very interested in economic policy and is prioritising anti-corruption and preserving Party control; Zhou has a clear agenda of financial liberalisation and full renminbi convertibility with the aim of one day usurping the US dollar’s supremacy in Asian finance.
The nature of the markets, and the world for that matter, has changed a lot since the GFC. Specifically I’m referring to three big changes:
A. ETFs. A large number of investors have decided that they don’t want to pay high fees to so-called active managers who mostly just hug the index, and can instead get cheap, transparent and liquid market access through exchange traded funds (ETFs). What’s more, the perfectly sound way that they manage this is with “stop loss” plans that sell at a certain point in any decline. The reason this is sensible is that the investors are not making decisions about the nature of the firms they are investing in, it’s all about market timing.
B. HFT. High frequency trading (HFT), sometimes called programmatic trading, is often greater than 50 per cent of market volume, and sometimes much more. As I’ve written in the past, there are several powerful computers in the ASX basement, and those of every other global stock exchange, connected by fibre to the ASX mainframe. They demand that their cables are all the same length, no matter where in the room their hardware is, so none has the advantage of electrons going to and from the ASX more quickly than anyone else. There are many HFT strategies but they usually involve some form of minute arbitrage, and they almost always must end each day square.
C. Regulation. Merchant banks, or investment banks as the American ones became known, have a long and rich history. They began in Venice facilitating the grain trade (the word “bank” comes from the Italian for “bench”, banca, which is what they used to sit behind). Throughout history, and right up until 2009, their job was to make markets more efficient, by acting as agents for producers and investors and by buying and selling the products and securities themselves when natural liquidity was short. The 2008 crash changed all that by sparking a regulatory response through the Dodd-Frank Act, the Volcker Rule and various clamps on banks’ proprietary trading around the world. It’s made the banks safer, but they can no longer act as liquidity providers of last resort.
All of this means that when a fire breaks out in the nightclub known as global financial markets, the exits will be smaller, there will be more patrons and they will be more panicky.
We are already seeing the results of that this year with big moves up and down, such as the 7.7 per cent uptick by the Nikkei the other day or August 24, when the Dow moved 4500 points intraday, both up and down. Risk has not been removed by post-2008 regulation, or programmatic trading or the use of ETFs, it has simply been either disguised or moved from bank balance sheets to you and me.
3. Australian recession
Goldman Sachs’ economist Tim Toohey said this week that there is now a 30 per cent probability of a recession in Australia before the next election (there is, of course, a 100 per cent probability of a recession some time in the future). Thirty per cent sounds about right to me.
A couple of things about this: first, a technical recession is no big deal when the latest reading is 0.2 per cent and there have been a couple of one-quarter contractions in the 24 “non-recession” years since the last one, and second, GDP is only one measure of economic health. Most of the others are already contracting.
The big deal is the headline. RECESSION! It would scream. And if the underlying cause of the technical recession were to be non-technical - i.e. low business and consumer confidence – a spiral could develop. Against the gloomy prognosis was the surprisingly strong employment report on Thursday, with a fall in the unemployment rate from 6.3 to 6.2 per cent.
Most likely GDP growth next year will be stuck at around 2 per cent, with possibly one quarter of contraction and the risks firmly to the downside. The cash rate is likely to be cut at least once more, possibly twice.
As I explained last week, the main investment losers in a recession would be those in banks in a big way. If you missed it, there was a table of Jonathan Mott’s suggested impact of a moderate recession on the banks, and specifically on their dividends (they would “likely” be cut). A subscriber wrote to ask: what about the miners’ dividends? The answer is that a recession in Australia should have minimal impact on the miners, since their product is sold overseas. Obviously most industrials would be affected, although to some extent their fate would hang on how far the currency falls.
How low will the Aussie go? Depends a bit on what the Fed does. If, as I expect, the first rate hike is put off, the US dollar could continue to range trade as it’s done for six months. If that’s combined with a bottoming out of commodity prices then the Australian dollar could stay in the high 60s.
That would be a good result, in my view. The currency can be a cruel saviour: yes it would boost tourism and exports, and help local manufacturers, but the price is lower living standards, inflation and higher interest rates. But this is just the whine of someone who’s going to Europe tomorrow and only getting less than two-thirds of a euro to the dollar.
This list of three dangers is not meant to be comprehensive – I’m sure there are many more. I’m just saying that these are the three worst, and most likely.
I haven’t included the US rate hike because I think it will be delayed and even if it does happen this month, it will be “one and done” – that is, a small hike of, say, 10 basis points and then nothing for quite a while.
I think the refugee crisis is very challenging for western governments, but as I have written in this piece in Business Spectator (subscription) it is mostly a function of the weak global economy and the collapse in world trade.
The only other thing worth mentioning is oil, and with it other commodities. Goldman Sachs published a report last night that said oil could go as low as $US20 a barrel, because "the oil market is even more oversupplied than we had expected and we now forecast this surplus to persist in 2016 on further OPEC production growth, resilient non-OPEC supply and slowing demand growth".
The energy sector on the ASX has already been the worst performing this year (down 27 per cent versus the market down 5 per cent). Another halving of the oil price could mean the global losses for energy producers start moving from equity holders only to lenders, in other words, large-scale bankruptcies. The same goes for further significant falls by other major commodities, such metals, bulks and foods.
That is a possibility, but a remote one (I hope). Clearly another big fall by commodity prices is the greatest danger of all for Australia and Australian investors, which is not a happy note on which to fly out on holidays.
The good news is that one way to deal with all market-related dangers, apart from moving into under-rewarding cash, is to invest in businesses, not stocks. Yes, you usually have to buy them on the market, but the companies that I and our analysts at Eureka Report are trying to find for you have qualities that are independent of what the market is doing. Their share prices can't escape market volatility, but their underlying business have either growth prospects that don’t rely on the economy, outstanding management or cash flow and dividend protections that mean they will be insulated from any downturn. We strongly believe in Warren Buffett’s first rule, which is: don’t lose money. (The second rule is: don’t forget the first rule.)
Slater & Gordon
I’m one of the shell-shocked Slater and Gordon shareholders who have watched its share price tumble from $7.50 to less than $3 in six months. Horrendous. I’ve been trying to get managing director Andrew Grech into the studio for months, and while I still haven’t managed that, I did get him on the phone on Monday and recorded an interview for you (and me!).
It’s still a decent business, I think, and I’m still a holder, but for the time being it’s all about the (public) ASIC investigation into its accounting processes. These investigations are not usually public, but apparently one or two hedge funds found out about it somehow, shorted the stock and leaked it. Big profits ensued. SGH is currently the most shorted stock on the ASX, even at $2.77. That means that if the ASIC investigation comes up clean there will be a mad scramble by the shorts to cover. The stock will definitely spike. But there is no way of knowing what will happen. And then, of course, there are the controversies about the company’s UK acquisition – a good business bought from questionable characters, it would seem.
But make your own mind up. Listen to the interview here.
I interviewed iSentia CEO John Croll on Thursday, the same day The Australian had a story that Veda Group was “stalking” the company. Veda promptly denied it and John did too in my interview – convincingly. So no dice there. Anyway, iSentia has just made its own significant takeover – paying $48 million for King Content, a content marketing business (it’s an earn out over three years, not cash up front).
John explains that deal, how his business works, and how King Content fits in, in a solid half hour interview, which you could catch up with, and read, here.
My third interview this week is with Dr Shanny Dyer, the managing director of Nemex, which is about to be renamed Wavefront Technology following a backdoor listing.
Wavefront, which is the business Shanny has been running for some years, owns biometric identification technology, which is very interesting indeed. She explains why it’s better than fingerprints and iris ID and why they’re going to make a lot of money from it. You can watch, and read, the interview here.
Readings & Viewings
Since I’m going to England tomorrow, here’s The National doing “England". Wonderful song, and by the way this band’s drummer is the best around, I reckon.
Only a US-Russia agreement can produce a settlement in Syria.
Where Australia ranks on refugees.
A nice Cathy Wilcox cartoon on the refugee crisis.
Surprised that Syrian refugees have smartphones? Sorry to break this to you, but you're an idiot. (That’s the headline – you’re not really an idiot.)
Paul Krugman: Donald Trump is right on economics.
Two qualities, more than any others, have driven conservatism in our time. The first is cultural and racial resentment. The second is what we might call spectacle. Trump is conservative resentment and spectacle made flesh.
I hate gambling. This is a remarkable piece by a gambling retention officer: “I make people gamble again.”
Who’s responsible for the refugees? (Hint: it’s America.)
Stephen Roach: China’s complexity problem.
China confronts the market.
Apple is hiring people to predict what you’re thinking.
Yanis Varoufakis: how Europe crushed Greece.
This is an amazingly skilful mash-up of a lot of different actors from various films.
Professor Rod Tucker, one of Australia’s leading broadband experts, wrote a scathing piece this week about the NBN.
This was a wonderful Foreign Correspondent item on the ABC this week, about a Tibetan orphanage.
Australian property is the most expensive of all rugby playing countries
Someone hacked a self-driving car’s computer and told it there was a car there when there wasn’t.
The great unwind has arrived.
Luke McKenna used to work for us as a young journalist at Eureka Report and Business Spectator. Here’s a great video about his new business in New York – selling coconuts!
By Shane Oliver, AMP
Investment markets and key developments over the past week
Share markets have had another volatile week as worries about China and the Fed linger, but most markets saw gains. While expectations regarding the long talked about Fed interest rate hike continue to wax and wane, more stimulus measures and soothing words from China have helped. Against this background bond yields rose, oil prices were flat and metal prices rose and the Australian dollar had a decent bounce back above $US0.70.
For the next month or so, the going is likely to remain rough for shares with the risk of further falls as worries about the Fed and China linger. From a technical perspective the bounce from the lows a few weeks ago in most major share markets has lacked the conviction needed to firmly indicate that the lows have been seen. Concerns about the Fed could be resolved fairly quickly if in the week ahead it indicates that it is aware of the downside risks to global growth and inflation from China and the emerging world and is not going to do anything to exacerbate the threat. However, the problems in the emerging world could take longer to be resolved. These have been highlighted by the downgrading of Brazil’s credit rating to junk status by Standard and Poor’s. What a fall from grace that has been! With Russia also in the dog box we have clearly gone beyond the time when the term BRIC conjured up favourable economic thoughts.
However, beyond the uncertain near term environment I expect to see the usual seasonal strength into year-end helped along by much improved valuations, increasing confidence that China has got its growth under control and investors getting more comfortable that the Fed is not going to do anything to upset US/global economic growth.
Policy stimulus measures in China continue to flow with talk of more fiscal stimulus, including no personal tax on dividends for investors who hold shares for more than a year, and Premier Li indicating no intention to depreciate the Renminbi. Consistent with this China’s foreign exchange reserves fell by $US90bn in August indicating the PBOC has sold foreign exchange to defend the Renminbi. The decline was less than many had feared though and still leaves FX reserves at a huge $US3.56trn, indicating plenty of scope to defend the currency around current exchange rates.
Major global economic events and implications
US data confirmed that its labour market remains very strong with record job openings, the ratio of job openings to the labour force at its highest since 2001, the ratio of unemployed to job openings at the lowest since 2001 and another fall in jobless claims. Taken on its own the strength in the US labour market clearly provides a strong case for a Fed rate hike. Against this, the pressures on US inflation remain down with import prices over the year to August down 11 per cent, or 3 per cent if fuel is excluded. The combination of falling commodity prices and the strengthening $US points to the risks remaining on the downside for US inflation, which is contrary to what the Fed has been looking for and argues against a rate hike.
Eurozone June quarter GDP growth was revised up to 0.4 per cent quarter on quarter from 0.3 per cent. Business conditions PMIs and confidence levels point to a further acceleration going forward. The combination of very attractive valuations, improving growth indicators and ECB monetary stimulus argue strongly in favour of being overweight Eurozone shares.
Japanese June quarter GDP was surprisingly also revised up but only from -0.4 per cent quarter on quarter to -0.3 per cent, but this was mainly due to inventories. Weak machine orders and economic sentiment indexes suggest growth remains weak.
Chinese trade data was mixed with exports being a bit stronger than expected but imports a lot weaker, although the latter may be due to lower commodity prices. Inflation rose to 2 per cent year on year in August but this reflected higher pork prices with non-food inflation remaining just 1.1 per cent and producer prices deflating by 5.9 per cent so there is nothing to stop further needed monetary easing here.
Australian economic events and implications
Australian economic data was messy. Jobs data for August was yet again surprisingly solid with employment up 2 per cent on a year ago and unemployment falling back to 6.2 per cent leaving in place a flat trend. July housing finance was solid but with continued indications that finance is at last rebalancing back towards owner occupiers. Further softness is likely in investor finance ahead as the real tightening in bank lending conditions to investors only kicked in late in July. Confidence readings were decidedly on the soft side though with business confidence falling in August even though conditions were solid and consumer confidence falling back to the low end of the range it’s been in for the last 18 months. With continued sub-par economic growth and confidence it’s likely that jobs growth will slow a bit in the months ahead resulting in the unemployment rate resuming a gentle rising trend.
By Craig James, Commsec
Another busy week
With a lack of top-shelf indicators in Australia over the coming week, investors are likely to pay more attention to overseas events in the coming week. In Australia the Reserve Bank will dominate proceedings, with a speech or data release scheduled by the central bank on every day of the week.
Drawing most focus will be the Reserve Bank Board minutes on Tuesday, the Reserve Bank Bulletin on Thursday and testimony by Reserve Bank Governor Glenn Stevens to the House of Representatives Economics Committee on Friday.
In the US the highlight is the Federal Reserve meeting over Wednesday and Thursday, but there are numerous top-shelf economic indicators to monitor as well. And in China, key economic data covering trade, inflation, production, investment and retail sales will be released on Sunday.
In Australia, the week kicks off on Monday when the Reserve Bank releases July data on credit and debit card lending. Consumers are using credit cards more often but paying off outstanding balances by the due date.
On Tuesday the Bureau of Statistics releases the data on new motor vehicle sales for August. The industry group, the Federal Chamber of Automotive Industries, released the original data a week ago and it showed that new car sales totalled 90,705 in August, up 2.9 per cent on a year ago. The ABS data will recast the industry estimates in seasonally adjusted and trend terms.
Also on Tuesday the Reserve Bank issues minutes of the board meeting held a fortnight earlier alongside the ANZ/Roy Morgan weekly consumer sentiment survey. There were few changes in the wording of the statement so the hope is that the Board minutes will prove to be more insightful than in the past.
On Wednesday the Reserve Bank assistant governor Guy Debelle delivers a speech titled 'Some Current Issues in Financial Markets' at the Actuaries Institute Banking on Change Seminar in Sydney.
On Thursday the ABS releases detailed employment data for August. Not only will the figures include estimates on participation rates and work hours but it will also include the latest quarterly estimates of employment across industry groups. Jobs growth over the past year has been relatively healthy and the data should provide some interesting comparisons on which industries were doing the hiring.
Also on Thursday, the Reserve Bank issues the latest quarterly Bulletin publication including a range of topical articles.
And on Friday, the Reserve Bank governor faces a grilling by politicians. And providing that they can abstain from playing politics and ask questions of real interest, then real value can come from the session, such as the governor’s view of the ideal level of the Australian dollar, the outlook for the labour market and in particular the 'new normal' for growth.
Overseas: Chinese data and US Fed dominate attention
On Sunday the monthly batch of Chinese economic indicators are released: retail sales, production and investment. There are signs that Chinese economic activity is gaining pace and investors would want to see further confirmation of that trend.
Expect annual retail sales growth near 10.6 per cent with production near 6.3 per cent and investment near 11.2 per cent. The risk is that the results print on the weaker side of expectations,especially given that China closed down heavy manufacturers and restricted transport in Beijing due to the World Athletic Championships. We would expect activity levels to lift in coming months.
In the US, the week kicks off on Tuesday with retail sales figures, industrial production and the influential Empire state survey scheduled for release. Retail sales may have expanded by a good, but not great, 0.4 per cent in August (headline measure), while the underlying (non-auto) measure may have lifted by 0.3 per cent. The pull back in the 'flash' manufacturing index has economists expecting that industrial production may have eased by 0.2 per cent in August after the 0.6 per cent lift in July.
On Wednesday the key consumer inflation figures (the consumer price index) is released alongside the NAHB housing market index. The CPI for August should once again show that headline inflation is rather tame. In July the consumer price index rose 0.1 per cent to be up just 0.2 per cent over the year. Even stripping out food & energy prices, the core CPI rose by a tame 0.1 per cent in July. Economists tip the core CPI measure to fall by 0.1 per cent in August to be up 1.8 per cent over the year.
The US central bank policymaking group, the Federal Open Market Committee, meets over Wednesday and Thursday with the decision announced at 4am Sydney time on Friday morning. The guessing game as to when the Fed will lift rates may not be resolved -- the probability of the meeting deciding the first interest rate rise in a decade -- is around 28 per cent. However, the text of the decision will be important in determining whether the Fed is on course to lift rates in December.
On Thursday the weekly data on claims for unemployment insurance is issued together with housing starts, building permits, current account balance and the influential Philadelphia Federal Business outlook. Economists expect that housing starts may have fallen by around 4.6 per cent in August following a modest 0.2 per cent lift in July, with building permits unchanged.
On Friday the US leading indicators index is released and the index may have risen by 0.2 per cent in August.