Testing times for the big banks
The Reserve Bank holding the cash rate steady at 1.5 per cent was the most notable non-event this week, disappointing Citibank economists that have long been hoping for a further reduction.
Commodity prices are up – boy, are they up – inflation is steady, running at an underlying rate of 1.5 per cent, unemployment is low and household consumption is growing, offsetting the decline in mining investment. “Why shoot your few remaining bullets at a non-existent target” is the RBA’s thinking.
The only area of concern in the statement, which must be parsed for meaning like a post-modernist PhD, was a lunge at the housing market. Last month the bank’s statement claimed "some markets have strengthened recently." This month it was "some markets have been rising briskly." To translate: If you’re thinking of investing in new apartment complexes in Sydney and Melbourne, please, don’t.
Readers would be aware of our repeated warnings in this regard, which were echoed this week by the latest Housing Boom and Bust report from SQM Research. Managing director Louis Christopher believes that “the housing market is currently at its second most overvalued point on record and now, given a combination of factors including loose monetary policy, strong population growth and booming local economies, prices in Sydney and Melbourne will be rising from this very lofty valuation point.”
Yes, we get the boom Louis, but what about the bust? “The end of 2017 will see both Sydney and Melbourne markets dangerously overvalued and paving the way for a possible correction in 2018 ... The authorities need to take action sooner rather than later. Failure to do so will result in double digit national housing price growth in 2017 driven by out-of-control Sydney and Melbourne housing markets.”
APRA has been on to this for a while. In late 2014 it informed banks that property investment loan books could not grow at more than 10 per cent a year, a rule which was subsequently ignored by all but Westpac. True, loan-to-valuation ratios were increased, lending to foreign purchasers was restricted and rates were increased but, as Christopher suggests, none of this has had much effect.
Back in July 2007, just before the proverbial hit the fan, Citibank chief Chuck Prince told the Financial Times that “as long as the music is playing, you’ve got to get up and dance”. In Australia, the music is turned up to 11 and the dance floor is shaking with exuberant loans officers. Back in May, The Australian reported that at Teachers Mutual and UniBank – hardly go-to lenders for property speculators – lending growth was 60 per cent above APRA limits. "Banks don't want to miss the market," said the chief executive of Mortgage Choice, John Flavell.
APRA’s 10 per cent growth cap sounds tough, but with wages growth at a record low of 2.2 per cent per annum how can it be? While the media is fixated on ANZ’s divestment of its Asian operations and wealth management arm, this is the big issue for bank shareholders, one we’re keeping an eye on in our coverage of ANZ and Westpac’s recent results. Growing bad loans and the provisioning to deal with them is the thing to watch.
And another thing
Before moving on, let’s just pay tribute to ANZ’s ‘back-to-the-future-and back-again’ strategy. In 1984, ANZ acquired Grindlays, an Asian bank with a focus on India. Sixteen years later it was sold to Standard Chartered, seven years before ANZ chief executive Mike Smith announced its Asian expansion strategy, which has just been knifed by new CEO Shayne Elliott.
These guys change strategy more than I change my socks, and they’re better paid for it. Smith earned more money over his tenure than any CEO in Australian history ($88 million) while presiding over the worst total shareholder returns of all the big banks. You wouldn’t catch genuine owner-managers like the Brown brothers at ARB Corporation or Graham Turner at Flight Centre carrying on like that. Turner’s base pay is a mere $400,000 and his incentives package another $350,000. His real bonus is the dividend, which last year came in at $23m. That’s a proper alignment of interest to my mind.
More misalignment was on display at Fairfax this week, which announced a profit warning. Back in 2013, CEO Greg Hywood was issued a truckload of options, exercisable at 58c a share, as part of his long-term incentive scheme. Fair enough. But having reached all his targets the board mysteriously paid him $2.8m in cash in return for cancelling half his options, at a price of 35c. The market price at the time was 93 cents.
This kind of deal smacks of insiders doing favours for each other. If Hywood really believed in Fairfax he would exercise a few of the 9.33m options he owns, most of which are in the money despite the profit warning. Instead, he trousered the cash. Hywood appears to be of the same mind as our Fairfax analyst James Greenhalgh, who loves the Domain online classifieds business but doesn’t like all the trouble and strife that comes with it.
Credit Suisse’s report on market darlings – high-quality businesses trading at really high PERs – got a good run in the business press this week, which I imagine was the point of it. For readers, the interest was only passing. At least according to CS’s definition, Australia has the most expensive market darlings in the world.
The stocks included Cochlear, Treasury Wine, Transurban and Sydney Airport, all of which have been on our Buy List at some point, although with average forward PERs of over 40, they left long ago. A further list – stocks meeting the ‘hello daaarling’ definition that CS identified as future market darlings – featured a swag of stocks that have been big winners for us in recent years, including South 32, Caltex, ResMed and the aforementioned ARB.
What can we take from this, other than the possibility that Japan, the UK and Korea might be good places to look for reasonably priced high-quality companies?
Cheap stocks tend not to make it into the mainstream media, and by the time they do, they’re no longer cheap. If and when Credit Suisse publishes this report in a few years’ time, I’d be surprised if a few unknown companies like Reckon, GBST and Amaysin, now on our Buy List, weren’t in it. If you want to pay a cheap price, don’t expect everyone to know about it.
Incidentally, next week small company analyst Alex Hughes has a fascinating review of 3PL coming out. You may not have heard of it, but your children and grandchildren possibly have. It’s an interesting opportunity, so watch out for it.
With the US election due on Tuesday, we’ll soon know who will be the next POTUS. Clinton looked a shoe-in up until the last few days but, if the polls can be trusted, the gap appears to be narrowing. Stats guru Nate Silver at FiveThirtyEight believes that yes, Donald Trump has a path to victory.
The link between presidential choices and stockmarket performance is tenuous in my view, and certainly not causal. But in this case, it’s hard to imagine how a Trump presidency would enhance global stability and build on the gains we’ve made over the past few years. So, at risk of causing you to expel coffee over the dining room table, I offer this parting image. If you do have a vote, please use it wisely. If not, well, there’s a great Test match on.
Readings and Viewings
During another busy week, here are a few snippets we spotted for your reading and watching pleasure.
In the wake of the Hanjin collapse, South Korea has thrown its shipbuilding industry a $US9.6 billion lifeline.
Business lobby the Australian Industry Group is respected on both sides of the political divide. Here AIG chief Innes Willox presents on the future of Australia's electricity market.
Donald Trump has lit a fire underneath the gold price, Bloomberg says.
But HSBC says buy gold, no matter who wins the American election.
The American election campaign has been a gusher for CNN.
A Yerdeni Investments blog on the tyranny of too many economists. “The text of Yellen’s prepared remarks had 19 question marks related to her topic.”
With 20-20 hindsight, many analysts must be thinking how they go their GoPro profit forecasts so wrong this week.
Amid another rate hold this week, hedge fund manager Minyoung Sohn on the failure of the Fed: “Once a people that liked to save and spend almost equally, now (Americans) are a population that prefers to save.”
Bank of England governor Mark Carney has to face up to the fact, he got things wrong on the UK economy.
It's no going back for Egypt now as, on Thursday, it floated its pound. It has been devalued by nearly a third.
And why we need another Eisenhower to end the mess in the Middle East.
Unfortunately for Vladimir Putin, Russian energy politics are coming to the end of their heyday.
Speaking of leaders under pressure, things seem a little rotten in the state of France.
Trans-Tasman liveability wars; swapping Sydney for Wellington: “I can't wait to be part of a Kiwi renaissance, propelled by economic and technological change.”
Modern Age magazine on the 70th birthday of Animal Farm. "He thought Napoleon was supposed to represent Lenin, failing to recognise Stalin’s character in the successful pig who betrayed the Bolshevik Revolution."
Mitchell Sneddon's recipe(s!) of the week: "Whip these up at market close and sip in the sun. When I used to live in Darwin, a friend and I invented The Mitchell Street Throat Punch similar to number four ... but with a little less fruit."
Investment markets and key developments over the past week
US election uncertainty really hit markets over the past week as news of the FBI’s intervention saw average opinion poll support for Clinton over Trump decline to one to two points. This along with falling oil prices saw share markets fall, except in China, bond yields in major countries decline and gold rise on safe haven demand. Commodity prices were mixed with metals and iron ore up but oil down on a strong US oil inventory build and fears OPEC won’t implement its deal to cut production. The US dollar fell on the back of election uncertainty and this along with higher metal prices saw the $A rise.
If the US election result is to be reasonably decisive – a big if! – we should have an idea who won by around 1-2pm (Sydney time) on Wednesday. What can we expect from investment markets? I tend to think the median American voter will reject misogynism, racism and narcissism and this combined with the Democrats natural advantage in the Electoral College favours a Clinton win, but following the narrowing in the polls over the past week it is now a very close call. Even if Clinton wins there is close to zero chance of the Democrats retaking control of Congress in a clean sweep. The last few weeks have seen shares sell off when developments favoured Trump and rally when developments favoured Clinton and get the jitters when there is talk of a Democrat clean sweep – suggesting investors favour a Clinton victory as long as it’s not a clean sweep. At the moment it seems investors have factored in maybe a 50-50 bet. Given all this:
A Trump victory would likely trigger a further initial bout of 'risk off' with shares down by 5 per cent or so (both in the US and globally) and safe havens like bonds and gold rallying as investors fret particularly about his protectionist trade policies triggering a global trade war. Australian shares would be particularly vulnerable to this given our high trade exposure (exports are 21 per cent of GDP in Australia against 13 per cent in the US). While the Fed would be less likely to hike in December if Trump wins the Australian dollar would likely still suffer from the threat to trade and the initial 'risk-off' environment. A Trump victory to the extent that it leads to falls in investment markets and worries about a global trade war may also increase the chance of another RBA rate cut in Australia. Beyond the initial reaction, sharemarkets could then settle down and get a boost to the extent that his stimulatory economic policies look like being supported by Congress, but much would ultimately depend on whether we get Trump the pragmatist (who backs down on his more extreme policies, e.g. around protectionism) or Trump the populist. Congress along with economic and political reality can probably be relied on to take some of the edge of Trump’s policies to some degree, but this would take time.
A Clinton-Democrat clean sweep of the Presidency and Congress would likely also trigger a bout of nervousness in US shares as it would be easier for Clinton to implement less business friendly tax and regulatory policies that would weigh particularly on US health, energy and financial stocks. This would likely be more focused on US shares though with less of an impact on global/Australian shares. However, this scenario is now very unlikely.
The best outcome for shares would be a Clinton victory but with Republicans retaining control of at least the House as this would be seen as “more of the same”. This would likely see a decent relief rally in US, global and Australian sharemarkets. While there may be concerns about her policies on income and capital gains tax and regulation, these would have little chance of getting through a Republican Congress. The downside is that if her win is narrow a Clinton presidency is likely to be weak with a poor mandate, ongoing controversy around the FBI investigation of her emails, issues around the Clinton Foundation and very low popularity. Historically, since 1927 US total share returns have been strongest at an average 16.7 per cent p.a. when there has been a Democrat president and Republican control of the House, the Senate or both.
Source: Bloomberg, AMP Capital
Of course there is the question of what will happen if the result is unclear – either with no candidate winning the necessary 270 Electoral College votes or the result being so close that it’s contested as occurred in 2000 between Bush and Gore. Either result will likely see shares under pressure short term. In the first scenario, the House of Representatives will decide with one vote to each group of state representatives and since it will almost certainly have a Republican majority Trump will win. But get this: the Senate then chooses the vice-president from top two candidates so we could have Vice-President Clinton to President Trump! In the second scenario, the 2000 experience saw US shares fall about 8 per cent and safehavens rally until a result was declared – but prior to the 2000 election shares had rallied (whereas now they have fallen) and the falls were likely affected by the tech wreck recession around that time.
Finally, while all this sounds a bit messy – just recall the fears around Brexit which after a few days saw global markets move on to focus on other things. And at least this time around there is less complacency. Global sharemarkets rallied into the Brexit vote, whereas this time around they have already fallen 3-4 per cent over the last two weeks to price in maybe a 50 per cent chance of a Trump victory.
Looking beyond the boulder in the investment road that is the US election ... the news over the last week or so has actually been reasonably good. This is most evident in business conditions PMIs which rose in most countries in October both for services and manufacturing and are trending up after a soft patch earlier this year. This is good for profits and hence share markets. While it keeps the Fed on track to raise interest rates in December it’s a far more positive back drop (US election uncertainty aside) than was the case a year ago.
Source: Bloomberg, AMP Capital
Major global economic events and implication
US data was good. Personal spending saw solid growth in September, the ISM manufacturing conditions index rose adding to evidence that the manufacturing sector is healthier and the non-manufacturing conditions ISM remained strong and employment indicators remain solid. Meanwhile there were no surprises from the Fed which left interest rates on hold as expected but expressed more confidence on the economy and inflation and indicated that the case for a hike has continued to strengthen. Bottom line: barring a shock (e.g. a Trump win or bad data) the Fed remains on track to hike in December.
Revenue growth and better margins have driven an end to the profit recession in the US. The US profit reporting season is now over 80 per cent done with 76 per cent of companies beating on earnings and 57 per cent beating on sales. Profits are on track to be up in the quarter, up on a year ago and up relative to the last high in 2014.
Eurozone growth continued in the September quarter at a moderate pace of 1.6 per cent year-on-year with a rising trend in business conditions PMIs and confidence readings pointing to a possible pick up ahead. However, with core inflation remaining low at 0.8 per cent, headline inflation just 0.5 per cent and unemployment remaining high at 10 per cent pressure on the ECB to extend it quantitative easing program beyond March next year remains.
The UK High Court’s requirement that the British parliament approve the triggering of Brexit is unlikely to stop it but reduces the chance of a hard Brexit. Meanwhile the Bank of England is now on hold. Both are short term positive for sterling.
There was no surprise from the Bank of Japan which left monetary policy unchanged. It’s already doing open ended quantitative easing anyway until inflation exceeds its 2 per cent target.
Chinese manufacturing and services PMIs rose in October and are actually trending up adding to confidence that Chinese growth has stabilised.
Australian economic events and implications
In Australia, as expected the RBA left interest rates on hold with inflation in line with expectations and its inflation and growth expectations little changed from three months ago as confirmed in its Statement on Monetary Policy. Short of a shock – e.g. financial turmoil in response to a Trump victory or a run of very soft economic data – it’s hard to see the RBA cutting interest rates at its December meeting. However, with housing construction likely to slow next year, an expected slowing in house price momentum leading to fading wealth effects, falling full time jobs a concern for consumer spending, credit growth slowing, inflation risks skewed to the downside and the likely need to offset regulatory driven pressure on banks to raise mortgage rates, we are allowing for another interest rate cut in the first half of next year.
Australian economic data was a mixed bag. On the strong side the trade deficit fell sharply driven by the surge in coal prices, non-residential building approvals are rising solidly, business conditions PMIs rose in October and September retail sales saw a decent gain. But against this, retail sales volumes were soft in the September quarter, home building approvals fell sharply and credit growth is slowing. Momentum in Sydney and Melbourne home prices remains strong according to CoreLogic but its weak to moderate elsewhere and the Melbourne Institutes’ Inflation Gauge showed weak inflation continuing into the current quarter. Bottom line: the risks remain skewed to rate cuts.
US election to dominate; Home loans data in Australia
The US presidential election will dominate proceedings over the week. In Australia there are few highlights but the monthly business survey and the data on home loans will attract most interest.
The week kicks off in Australia on Monday with ANZ releasing the October report on job advertisements. In the past this was a trusted gauge of labour demand but nowadays more people are going straight to company websites and using social media to scour for available positions. Job advertisements fell from four-year highs in September, down by 0.3 per cent in the month. But it was only the second fall in job ads in the past five months. Job ads are up 3.7 per cent on a year ago.
There is a bevy of events scheduled on Tuesday. Roy Morgan and ANZ release their weekly gauge of consumer sentiment. In addition the Head of the International department at Reserve Bank, Chris Ryan, delivers a speech in Hong Kong.
But the main interest on Tuesday is likely to be in the latest monthly business survey from National Australia Bank. In September the NAB business conditions index rose from 6.8 points to 7.7 points (long-term average 4.8 points). The business confidence index rose from 5.6 points to 5.9 points (long-term average 5.8 points).
On Wednesday the Melbourne Institute and Westpac release the monthly variant of consumer confidence – for November. The questions asked in the survey are the same as the weekly measure. The number of respondents is around the same also. But once a quarter (the next release being in December) respondents are asked their views on the wisest places to put new savings.
On Thursday the Australian Bureau of Statistics releases September figures for housing finance – new lending commitments. Based on a survey by the Australian Bankers Association, the number of new lending commitments provided to budding home owners may have fallen by 2.44 per cent in the month. And the total value of all owner-occupier and investment loans may have fallen by 2 per cent.
Also on Thursday, the ABS will release data on tourist arrivals and departures as well as inflows and outflows of immigrants. In August tourist arrivals fell by 0.2 per cent. And departures fell by 0.8 per cent. Arrivals are up 10.8 per cent on the year with departures up 4.5 per cent.
On Friday Reserve Bank Deputy Governor Guy Debelle participates in panel discussion at FINSIA’s Regulatory Panel.
Overseas: US election to dominate investor attention
It is a rare week when there are no ‘top shelf’ US economic indicators to report on. But that is the case in the week ahead, allowing even more attention to be devoted to the US election. In China, trade and inflation data will be released. There are five talks from US Federal Reserve presidents over the week.
The week kicks off on Monday in the US with the release of consumer credit figures and the employment trends report. Economists expect that credit grew by $US19 billion in September after a $US25.87bn lift in August.
On Tuesday in the US the presidential and congressional elections are held with results filtering through over Asian trade on Wednesday. At present the presidential election is too close to call while control of the Senate and House of Representatives also could shift.
At present Republicans control the Senate 54-46. And Republicans have 246 seats of the 435 seat House of Representatives. Polls suggest that Democrats have a 65 percent chance of taking control of the Senate. But the task of winning the House of Representatives is far more difficult. The Washington Post currently projects Republicans maintaining control. Democrats would need to win all “safe” seats, “predicted Democrats”, all “toss up” seats and even a few of the “predicted Republicans” seats to control the House.
In terms of US data on Tuesday, the National Federation of Independent Businesses release the business optimism index for small businesses. The JOLTS survey of job openings is also issued on Tuesday with the weekly report on chain store sales.
In China on Tuesday, the October trade data (exports and imports) is released. Other data has shown a lift in the pace of the Chinese economy so investors will want to see confirmation in the trade data (especially imports).
On Wednesday in China the October data on producer and consumer prices is released. Business deflation ended in September with producer prices now up 0.1 per cent on a year ago.
In the US on Wednesday, the September data on wholesale sales and inventories is released together with the usual weekly report on mortgage transactions – purchases and refinancing.
On Thursday in the US, October data on the federal budget is released, alongside the weekly data on claims for unemployment insurance.
And on Friday the November consumer sentiment estimates are released.
Craig James is chief economist at CommSec.