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Weekly Market Update – 15th February 2019

Weekly Market Update

Investment markets and key developments over the past week

  • Global share markets rose over the last week helped by optimism on US/China trade talks, progress towards averting a renewed partial government shutdown in the US along with okay earnings results. Australian shares were little changed having outperformed sharply in the previous. Bond yields were little changed. The oil price rose but metal and iron ore prices fell. The $A was little changed as the $US rose.
  • Progress in US/China trade talks and the (likely) avoidance of a return to the partial government shutdown in the US are both positive to the extent that they help dial down the political risk that weighed on investors last year. If the March 1 tariff deadline is delayed it’s likely that the US auto tariff threat will also be delayed as Trump has been inclined to avoid multiple battles at once. Avoiding a return to the shutdown even if Trump goes down the contentious path of declaring a National Emergency to get Wall funding – is good news as it removes a threat to the economy and adds a bit to confidence that a debilitating battle over the need to raise the debt ceiling from March will be avoided.
  • Some lessening in political threats (for now) along with a swing to more dovish/stimulatory economic policy globally are consistent with views that this year will be a decent year for share markets. However, with share markets having run hard from their December lows and technically overbought and economic data still weak the risk of a short term pull back is high. The Australian share market particularly looks to have run ahead of itself. Earnings results have been better than feared but economic growth looks to be slowing, the earnings outlook is constrained, and RBA rate cuts are still a way off.

Major global economic events and implications

  • US data was messy over the last week. Retail sales fell sharply in December possibly reflecting the impact of the shutdown and share market falls at the time, small business confidence continued to fall and jobless claims rose continuing a rising trend. Against this, job openings and hiring were all strong. Meanwhile, headline inflation was weak thanks to falling energy prices, but core inflation was flat at 2.2% year on year and with momentum accelerating again. The weakness in retail sales is consistent with the Fed pausing, but the acceleration in core CPI inflation in recent month means that it’s premature to conclude that the Fed has finished tightening for this cycle. Expect the Fed to be on hold for the next six months with maybe one hike later this year.
  • The US December quarter earnings reporting season continued to surprise on the upside over the past week, but its still showing a slowdown from previous quarters as the tax boost and underlying earnings growth has slowed. 80% of S&P 500 companies have now reported with 72% beating on earnings with an average beat of 3.3% and 60% beating on sales. Earnings growth is running at 18.5% year on year for the quarter. As can be seen in the next chart the level of surprises and earnings growth is slowing down. US earnings growth is likely to be around 5% this year.

US earnings growth slowing

Source: Bloomberg, AMP Capital

  • Eurozone December quarter GDP growth was confirmed at 0.2% quarter on quarter or 1.2% year on year. Germany just missed out on falling into a technical recession with growth of just 0.02% qoq. Pressure on the ECB and the German government for more stimulus is intensifying.
  • Japan’s economy grew again in the December quarter after a natural disaster affected September quarter. But GDP is flat on a year ago. That said inventory, trade and public investment were the drags on growth and consumption & investment were solid. The BoJ will still have to keep the pedal to the metal.
  • Chinese exports and imports bounced back in January suggesting that things aren’t as bad as feared. That said it would be wrong to get too excited either way as the Lunar New Year holiday is known to distort Chinese data around this time of year. Meanwhile inflation continued to fall in January.

Australian economic events and implications

  • After weeks of poor data, Australian data was mixed over the last week. On the positive side the NAB survey measure of business conditions and consumer confidence bounced back in January and February respectively although both remain at uninspiring levels. Pressure remains on the housing market though with housing finance sliding sharply in January, reports that China has moved to make it even tougher for its citizens to move money out of China destined for property markets in Australia and elsewhere and ASIC moving to toughen up its regulatory guidance to lenders to the effect that Household Expenditure Measure benchmarks are too low an estimate of borrowers’ living expenses and that actual verification of income is required. In terms of the latter while many lenders have already moved in this direction its likely that there is still further to go in terms of tightening up lending standards.
  • The Australian December half earnings reporting season has been better than feared but shows a slowdown in growth and caution regarding the outlook. So far about a third of results have been released. 60% of companies have seen their share price outperform on the day of reporting (which is above a longer term norm of 54%) and 45% have surprised analyst expectations on the upside which is around the long term average, but a more than normal 33% have surprised on the downside, the proportion of companies seeing profits up from a year ago has fallen and only 55% have raised their dividends which is a sign of reduced confidence in the outlook – six months ago it was running at 77%. Concern remains most intense around the housing downturn and consumer spending.

Australian company profit results relative to market expectations

Source: AMP Capital

Australian company profit results relative to a year ago

Source: AMP Capital

Australian company dividends relative to a year ago

Source: AMP Capital

What to watch over the next week?

  • In the US, expect the minutes from the Fed’s last meeting (Thursday) to confirm that the Fed remains upbeat but that it is waiting patiently to decide what to do next in terms of interest rates and that it might end its quantitative tightening process earlier than previously expected. On the data front expect a slight rise in the National Association of Homebuilders’ conditions index (Tuesday), a modest rebound in underlying durable goods orders, business conditions PMIs for February to remain around 54-55 and existing home sales (all due Thursday) to rise slightly.
  • In the Eurozone the focus will be on whether the business conditions PMIs (Thursday) show signs of trying to stabilise after falling through most of last year or continue to fall.
  • Japanese inflation data for January is expected to show core inflation rising slightly but only to 0.4% year on year.
  • In Australia the minutes from the last RBA board meeting (Tuesday) will confirm the shift to a neutral bias in terms of the immediate outlook for interest rates and Governor Lowe’s parliamentary testimony on Friday will be watched for further clues in terms of how the RBA is seeing the outlook for the economy. On the data front expect December quarter wages growth (Wednesday) to hold around 0.6% quarter on quarter or 2.3% year on year as the lift in the minimum wage increase to 3.5% continues to feed through. January jobs data is expected to show a 5000 gain in employment and a rise in unemployment to 5.1%. Data for skilled vacancies and the February CBA business conditions PMIs will also be released.
  • The Australian December half earnings results season will see its busiest week with 70 major companies reporting including Ansell, Brambles and Coles (Monday), BHP, Bluescope and Cochlear (Tuesday), Fortescue, Stockland, Seven Group and Woolworths (Wednesday), and Coca-Cola Amatil, Nine and Wesfarmers (Thursday). 2018-19 consensus earnings growth expectations are around 4% for the market as a whole. Resources, building materials, insurance and healthcare look to be the strongest with telcos, discretionary retail, media and transport the weakest and banks constrained.

Outlook for investment markets

  • Shares are likely to see volatility remain high with the high risk of a short term pull back, but valuations are okay, and reasonable growth and profits should support decent gains through 2019 as a whole helped by more policy stimulus in China and Europe and the Fed pausing.
  • Low yields are likely to see low returns from bonds, but they continue to provide an excellent portfolio diversifier.
  • Unlisted commercial property and infrastructure are likely to see a slowing in returns over the year ahead. This is likely to be particularly the case for Australian retail property.
  • National capital city house prices are expected to fall another 5-10% this year led again by 15% or so price falls in Sydney and Melbourne on the back of tight credit, rising supply, reduced foreign demand, price falls feeding on themselves and uncertainty around the impact of tax changes under a Labor Government.
  • Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 1% by end 2019.
  • The $A is likely to fall into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will likely push further into negative territory as the RBA moves to cut rates. Being short the $A remains a good hedge against things going wrong globally.

Haynes Royal Commission: The trouble started decades ago…

The profitability of Australia’s Finance industry – dominated by our big banks – has trended down over recent decades.  The return on shareholder funds peaked in the early 1990s after the recession of 1991 and the crash of several banks.

The big players could see non-bank finance sectors growing much faster than banking revenues, and the exhibit below shows their concern eventuated.  These days, banking accounts for less than a quarter of the industry’s total revenue of over $700 billion.


So, the big players diversified into the growth and other finance sectors which they did not understand.  They became theme conglomerates and hoped that concentric marketing to existing customers would create greater profits.

They didn’t and, like all conglomerates, were difficult to manage.  The diversified sectors require different IP, different cultures, semi-autonomy and face different competitors.

The gains began going to the employees, especially C-suite execs, salespeople/BDMs and brokers more than the shareholders.  As competition grew, greed and cheating began and followed the apocryphal “boiling frog” syndrome over the past decade in particular.

Our regulators have been shown to have abrogated their responsibilities, making us wonder what the last $5 billion tax payers’ money has achieved over a decade or so.  Many if not most boards at the big end of town are red-faced.

The Haynes Royal Commission has been thorough, fearless and reformative.  The big financial institutions may now go back to more being more focused than conglomerates, more ethical, easier to manage, and more transparent to Boards.  Just in time to face the new challenge – which isn’t faster growth on the other side of the fence appearing to be greener – but digital disruption. These include online financial services, block chain and other daunting challenges.

Author: Phil Ruthven, Founder & Director IBISWorld

Volatile Markets: A FinSec Comment

Global shares had a bumpy couple of weeks, as strong economic data and corporate earnings were offset by geopolitical concerns. Most major markets had a positive start to the week as investors regained their composure after last week’s sharp sell-off, with many indices posting their largest one-day rallies since March.

What caused the sharp sell-off?

The main reason underpinning the pullback was a response to concerns that rising interest rates (increasing bond yields) in the U.S. would cause a national or global slowdown.

This compounded with rising US – China trade tensions and other macro-economic news from around the world caused the market to ‘connipt’.

The obvious question is, what now?

Should inflation and wages in the U.S. surprise on the upside then the Fed may be forced to move rates more aggressively, this would definitely not play out well for equity markets. We continue to monitor risk and retain our view that whilst a cautious stance is warranted, we do not expect “the sky to fall” anytime soon. What we do expect is a choppy period of consolidation as markets come to terms with the normalisation of rates in the US.

If you have any questions regarding the recent market developments or your portfolio positioning, please contact your adviser.

For more regular updates please click here to ‘opt-in’ to receive our weekly market update.

Good People Doing Bad Things – How Did We End Up Here?

It is a story that has made news headlines the world over. A story about culture and greed impairing the judgement of people who should have known better. While both sides of politics have been very vocal in the wake of Hayne’s interim report, no one has touched the vexed question of how did we end up here?  

The impact on the victims has been devastating. The behaviour of the financial services community despicable and unforgivable. The viewing has been a mesmerising blend of ‘can’t watch but can’t look away’.

But to understand how we got here we need to look back nearly 30 years to the remarkable and visionary reforms of the Hawke/Keating government. That is, not at any level to lay blame at their feet but to point to a moment in time where the first piece of a complex puzzle was laid. A puzzle that through the next 25 years would gather a trifecta of seemingly unrelated circumstances to form what has become the tsunami that is now known as the Hayne Royal Commission into Misconduct in Banking and Financial Services.

 The Rise and Rise of the Big 4

Through the late 1980s and early 1990s, including the “recession we had to have” Hawke and Keating, followed later by Howard and Costello introduced reforms that led to Australian Banks becoming the most robust in the world. Reforms that would combine with the rise of China to open up the economy to what has now become 28 years of consecutive economic growth.

Throughout this period the market capitalisation of these banks has increased ten-fold which given that they occupy 4 of the top 10 holdings in almost every Australian superannuation fund has meant that every working Australian has benefited profoundly from their unmitigated success.

Forward to 2008 and the GFC. The worlds banks imploded under the weight of the subprime crisis and the freezing up of the credit markets. Bear Stearns and Lehman Bros were the high-profile casualties but there were hundreds of others. Australia was not immune. St George lurched into Westpac, Bankwest was rescued by CBA and Suncorp was saved by the timing of the government guarantee. But our big 4 banks prevailed, in-fact before long they were stronger.

We were applauded the world over for the way that our economy survived the worst economic crisis since the 1930s depression with barely a flesh wound. There are those that claim dumb luck, but the strength and management of our big banks were in no small way responsible for Australia dodging a bullet.

To this end, over 25 years Australia’s big 4 banks had developed ‘hero’ status. “Best in the world”, ”pillars of strength and resilience”. Their leaders were held on pedestals and retirees dined out on their ever-increasing flows of franked dividends.

The Mutation

Another of Keating’s great reforms was the introduction of the compulsory superannuation system to deal with Australia’s soon to retire, Baby Boomer generation. In the banks effort to broaden their revenue base and continue with the exponential expansion of their balance sheets, the lure of a multi-trillion dollar pool of retirement saving made a lot of sense. Through the early 2000s each of the major banks made acquisitions to gain a foothold in the market. CBA bought Colonial, NAB purchased MLC, ANZ purchased Mercantile Mutual in a JV with ING and Westpac purchased BT and Rothschild.

In these deals were the beginnings of the mutation that would see these banks lose their way.

The acquisitions were ostensibly, old life companies. Sales based organisations where ‘agents’ were paid a commission for selling a product to a consumer. There was often advice involved but often not. The principle approach was ‘caveat emptor’ and the assumption that if the consumer saved something rather than nothing, then some good had been done. If advice was provided it was paid for by commission from the product manufacturer and effectively the public was trained to place no value on it. Advice became something that came with the product.

But the need for considered, tailored advice was growing. The industry needed to become a profession and move to a fee based model where the public valued the advice and was prepared to pay for it. This was met with an innate resistance, ingrained over many years. The banks did not rail against this but rather acquiesced to their more learned wealth management sales executives who told them “it ain’t broke! Advice is paid for by the product manufacturer because consumers don’t value it”.

The tyranny of the vertically integrated business model prevailed.

The money flowed in. Billions of it. Further acquisitions were made to gain both product advantage and the favour of an increasingly spoilt force of advisors who had come to realise just how valuable their favour was. Consciously and in some cases subconsciously, advisors were adopting business models that made them more valuable to their product manufacturing friends by leveraging the risk of a change in loyalty in return for a large cheque ensuring tenure.

Product manufacturers referred to the advisors in their sphere of influence as ‘distributors’ and acquisitions of distribution networks were made, making many owners of these networks unimaginably wealthy.

The very word ‘distribution’ (not advice) said it all.

 The Regulators Weigh In

This then brings us to the issue of the regulators.

Let us not fool ourselves about the intent of the legislation that has been brought into play over several regimes. Quite rightly, it has been installed to change the behaviours of the industry and to ensure outcomes are focussed on ‘people before profit’. However, through a lack of understanding of the history of the business models and the products that were already in place, the impact these new laws have had is a disappointment.

As each new wave of law failed to gain traction, the complexity of the laws increased and became so prescriptive that tick a box compliance was the only way to comply. Thoughtless, tick a box compliance. This was exacerbated by the constant cries of foul play by the Industry Fund movement who refused to accept that the retail offerings may in fact have offered a reasonable alternative to the moral high ground claimed by the Union backed Industry Fund regime.

For every change the industry adapted, ‘the spirit’ of that change was compromised on both sides of the Retail/Industry fund divide. Thinking was dedicated to how to comply with the law without giving up the behaviour that the law was designed to change. As a result, consumer outcomes only ever improved marginally.

In defence of the self-licensed advice movement, there has always been a constant pressure on the product manufacturing community to improve features and reduce the price of the end superannuation products to the consumer. But this cause was lost in the politics of the broader campaign because advisors need product solutions to execute their advice and the institutions controlled the product and the margin.

War Rooms

When the major institutions were caught out they arrived with armies of lawyers from the top end of town to defend their position and ultimately negotiate on outcomes that were private, less costly and less damaging for the provider. The regulators could not afford to throw the same legal talent at the issue as they did not have the same budget or the internal talent to brief the legal team. It was a case of ‘bows and arrows against the lightening’. The regulator could not afford to lose for fear of loss of reputation or costs being awarded against them and so the ‘enforceable undertaking’ regime began.

This, in a world where the Banks were still harbouring hero status and had an air of invincibility about them. Who were the regulators to question their integrity?

Inside these institutions there was the ongoing pressure to improve dividends to the plethora of shareholders including the superannuation funds that most Australians were members of. There was a sense of untouchability that came with the fact that folklore had seen these institutions save our Nation from the full force of the GFC and that the senior management of these organisation was seen as the epitome of success in the corporate world. Geniuses who were to be revered at all costs and were never questioned or challenged.

Is it any wonder that a mutation in the moral code was let loose at some stage in this journey and went undetected and unmanaged until the blow torch of the Hayne Royal Commission? It was a culture where the unjustifiable became more justified each time the behaviours, the decisions, the mutation went unchallenged.

This Royal Commission has highlighted some heinous behaviours and the recommendations need to seek to ensure that we never find ourselves in this situation again, however it is worth reflecting on the 28 years of history that came together to all but justify the collapse in values that led to the outcomes that have been exposed.

A combination of hero status, invulnerability, shareholder pressure, cultural misalignment and in the end dumb luck led the management of our most revered organisations to turn a blind eye to the social responsibility that is at the core of their existence. Much like the leadership of Australian cricket after a similar period of invulnerability.

“Things are so bad that new laws might not help” Justice Kenneth Hayne

Let us hope that in the fall out we are not burdened with another wave of crippling regulation but laws that need to be thought about. Laws that challenge participants to ask ‘what is the spirit of this law and how do I need to interpret it?’. Tick-a-box compliance leads people to think about what they can get away with. We need new laws that acknowledge the role that these organisations can play in shaping a positive society and a positive economy and a code of conduct installed that all participants embrace as a way forward in the enhancement of a better financial community.

In the words of Commissioner Hayne:

“The law already requires entities to do all things necessary to ensure that the services they are licensed to provide be provided efficiently, honestly and fairly. Much more often than not, the conduct now condemned was contrary to law… Passing some new law to say, again, ‘do not do that’ would add an extra layer of legal complexity to an already complex regulatory regime. What would that gain?

What is needed is better enforcement in order to ensure that banks and other financial institutions apply basic standards of fairness and honesty by obeying the law, not misleading or deceiving, acting fairly, providing services that are fit for purpose, delivering services with reasonable care and skill, and, when acting for another, acting in the best interests of that other?”

Bitcoin and The Basics Of Cryptocurrencies

Three years ago Bitcoin was $250AUD. With a 10,000% increase in price since then, it is starting to generate significant buzz with the everyday investor, as is the underlying technology driving it, “blockchain”. But what are digital currencies and should you be investing in them? We asked renowned technologist and futurist, Mark Pesce to take us on the bitcoin / blockchain journey.

“Never invest in a business you don’t understand.” A simple bit of advice from the Sage of Omaha, Warren Buffet, largely responsible for turning him into the most successful investor in history.

Very few people understand cryptocurrencies, but many see the meteoric rise in the valuation of Bitcoin – over AUD $20K as this is written – and feel as though they should be investing. But why? What is it – other than the pile-on of investor interest – that makes Bitcoin or any other cryptocurrency worth investing in?

The qualities of cryptocurrencies mirror the qualities of ‘normal’ currencies in two key features: they’re difficult to counterfeit and you can’t spend the same currency twice. In subsequent articles we’ll look at the mechanism making all of this possible – the blockchain – but for now it’s enough to know that every cryptocurrency fulfills these conditions.

The original cryptocurrency, Bitcoin (symbol: BTC), for many years looked like a solution in search of a problem, but as it found uses and gained users, its exchange value increased. Investors began to think of it as a store of value. The first Bitcoin price spike accompanied the ‘haircut’ Cyprus imposed on bank deposits, as depositors used Bitcoin to spirit funds out of the country. The acceleration in the value of Bitcoin began there, as more investors came to appreciate Bitcoin as both a store of value, and as a mechanism to avoid currency exchange fees.

If Bitcoin retains its status as the ‘store of value’ cryptocurrency, it could evolve into a role similar to that of gold, which possesses an intrinsic less than its exchange value. (As to whether Bitcoin can maintain this role indefinitely, that’s a question to ask a psychic – not a futurist!)

Together with Bitcoin, there are three more cryptocurrencies that are interesting because they follow Warren Buffet’s rule – you can understand them.

Ethereum (symbol: ETH) is the next most valuable cryptocurrency after Bitcoin, but it’s unlikely anyone will use Ethereum simply as a store of value. Ethereum is ‘smart money’ – a cryptocurrency that’s also a computer program. This means you can use Ethereum to create ‘smart contracts’ – for example, a simple escrow contract that automatically transfers funds from one party to another when a particular condition is fulfilled. That contract can be written into Ethereum, rather than on paper – and it allows parties to enter into contract relationships with great ease. Ethereum may find its greatest value enabling international trade finance, and for that reason it’s viewed as a cryptocurrency with a bright future.

Ripple (symbol: XRP) was originally created to provide a settlement mechanism between banks. That’s happening – but very slowly, as that is both a very conservative and very carefully regulated area of banking. More recently, the Gates Foundation selected Ripple to be used in a project that enables billions of unbanked and underbanked people to have access to an advanced set of mobile banking, payments, credit and investing services. That should give Ripple billions of users, and create a fair bit of demand for the cryptocurrency.

Finally, the Basic Attention Token (symbol: BAT) allows Web users (that’s all of us) to pay publishers directly for their content, rather than forcing those publishers to rely on advertisers. It’s a new model for funding content on the Web, and it also means advertisers can pay Web users directly for putting ads into our Web browsers. We’ll get paid for surfing the Web – and can pass those payments along to our favourite websites.

Bitcoin, Ethereum, Ripple and the Basic Attention Token all do things that are easy to explain – and understand. The same can not be said for many of the 900-plus other cryptocurrencies flogged by speculators. Be like Buffet: if you can’t understand it, why would you invest in it?

Mark Pesce is a futurist, inventor, writer, entrepreneur, educator and broadcaster with 35 years experience working in technology, He holds honorary appointments at the University of Sydney and UTS.

Original article courtesy of Adviser ratings, December 2017

Yes, Virginia, There is a Banking Royal Commission – Unfortunately

In a matter of days, Santa will be putting the finishing touches on his “Naughty” and “Nice” lists and it remains unclear on which side of the ledger the banks will sit.

It’s an understatement, of course, to suggest the big four (CBA, Westpac, ANZ and NAB) won’t be expecting an outpouring of festive cheer and goodwill from their 17+ million customers this year.

Despite holding around 2.5 trillion of our money, collectively – (and 80% of the nation’s loans) – it’s become almost a national sport to criticise the banks. And, it’s got to be said, with some good reason.

Concerns involving the banking sector date back at least three years, when a Senate committee recommended a royal commission into the Commonwealth Bank’s financial planning scandal. Last year, more wrongdoing was uncovered at CBA’s insurance arm (CommInsure) as well as allegations made against the other majors – ANZ, NAB and Westpac.

But – without trivialising the impact of those scandals on the industry and, more importantly, the individuals and families affected – an expensive and lengthy royal commission is NOT the answer.

The sector is already one of the most highly regulated in the world. Since the financial crisis banks have cooperated with 37 separate reviews, investigations and inquiries, leading to a raft of reforms from FoFA to Professional Standards to name a few.

The current commission – which will run for 12 months, delivering a final report in February 2019, at an estimated cost of $75 million – is unlikely to unearth anything new.

Let’s not be fooled.

This is nothing more than a quick political fix, hastily thrown together by an under-pressure Government at the eleventh hour, to appease disgruntled Nationals senator Barry O’Sullivan and other backbenchers who were prepared to cross the floor and side with Labor and the Greens to pass legislation for an inquiry.

It was inevitable. They knew it. The PM knew it.

Despite spending a year and a half categorically, unequivocally ruling out a royal commission – an inquiry former PM John Howard warned would be “rank socialism’’ – the only option left was to make the best out of a bad situation and set its terms of reference and try to control the mandate.

Malcolm Turnbull, already deeply bruised from the Dual Citizenship fiasco (at the time of writing the Opposition is now in damage control itself over the issue with several of its members potentially being referred to the High Court) appeared weak and out of touch with both his party and the electorate.

Perception is everything in politics and the Prime Minister still appears to be in the pockets of the banks, because the backflip came precisely the day after the banks themselves signed the “permission slip” gifting the PM political cover.

Politics has trumped economics yet again.

On the positive side, the commission has promised a deep dive into more than just the banks and it looks like industry funds could be subjected to some unwelcome scrutiny. In its infamously titled “Rivers of Gold” report released last month, the Institute of Public Affairs found monetary links between a number of industry super funds and the Labor movement, with more than $18 million flowing to trade union organisations over a three-year period. Needless to say it has people talking.

The problem is, there’s always a bigger picture. The risks of staging this inquiry in the full glare of the public spotlight is that you diminish the standing and strength of the banks, and undermine our economy with it.

Granted, the big four are corporate powerhouses, earning billions in profits, but let’s not forget the old State Banks of Victoria and South Australia which collapsed, robbing thousands of customers of their life savings. A strong financial and banking sector provides a significant and crucial buffer to protect us all if the economy experiences a downturn, or worse. It was one of the key reasons Australia was able to withstand the GFC crisis, which forced the closure of 465 banks in the United States alone.

Secondly, some will argue the Tall Poppy Syndrome is alive and well in Australia. We do seem to have a propensity to go after anything that is successful. Look what the mining tax did to the resources industry – our mining companies stopped investing in Australian projects and retreated overseas.  The carbon tax hamstrung the automotive industry, with utilities costs an enormous burden.

Thirdly, banks are the highest taxpayers in Australia – injecting around 14 billion into the government’s coffers each year.

Finally, we simply can’t afford for world markets to lose faith in the big four. The flow-on effects would be disastrous, fuelling potential interest rate rises, asset contraction and a slowing economy.

Even David Murray who led the last extensive review into the financial sector agrees. He has hit out at politicians and regulators fearing that “if the commission forces banks to grant widespread forgiveness of soured loans, it could undermine the entire system”. The Australian Financial Review, 6 December – Bank probe ‘threat to the system’.

It’s a sobering thought.

This may not be a royal commission we had to have, but we’ve got it. And only time will tell what lasting impact it will have, both financially and politically.

As we hang our stockings and trim the tree this time next year, Chief Commissioner Kenneth Hayne will be close to wrapping up the inquiry, putting the finishing touches on the final report for public consumption.

The proof, as always, will be in the pudding.

Bitcoin: the very definition of a bubble

Legend has it that Joe Kennedy, father of former President John F Kennedy, avoided the stock market crash of 1929 by selling his entire portfolio just days before prices collapsed. He did this, the story goes, after receiving a share tip from a shoeshine boy. When taxi drivers, lift attendants and young lads on the sidewalk are speculating in stocks, he concluded, “the market is too popular for its own good”.

The stock market is riding high today but I’d be amazed if your next cab ride results in a share recommendation. This unloved bull market has failed to generate much excitement. It’s quite unlike the explosion of interest in shares in the late 1990s when everyone knew someone who had made a killing in some obscure internet stock and fear of missing out was intense.

So, if Joe Kennedy were having his shoes polished today he would not be talking equities. What he might well be steered towards, however, is an investment in bitcoin, the crypto- currency which is tracing the classic parabola of every bubble in history, from tulips to internet incubators.

Two years ago, you could have bought a bitcoin for $300; today, it would set you back $7,000. Its price has doubled in six weeks. It’s not just the price of bitcoin that is increasing but the speed of the gains is accelerating. The chart is turning left and heading straight up the page as asset prices always do in the final stages of an irrational mania.

Perhaps unsurprisingly, the exponential rise in the price of bitcoin is setting alarm bells ringing. Tidjane Thiam, the chief executive of Credit Suisse, said this week that the speculation around the alternative currency is ‘the very definition of a bubble’. As he observes, the only reason to buy or sell bitcoin is to make money, ‘which is the very definition of speculation and has rarely led to a happy end’.

His comments echo those of JP Morgan boss Jamie Dimon who recently described bitcoin as a ‘fraud’. He said that anyone ‘stupid enough to buy it’ will pay the price for it in future.

I don’t know whether Thiam and Dimon are right. In fact I don’t really know much for sure about bitcoin and it’s this lack of clarity that makes me think they are both right. I’ve been trying to get my head around bitcoin for a while and I’m frankly none the wiser.

I’m not even terribly sure what bitcoin is: a currency or a commodity? It sounds like the former but it fails to exhibit the essential characteristics of money.

It can hardly be viewed as a store of value. That requires at least a modicum of stability. Unlike the pound in my pocket, however, I can have no idea what a bitcoin will be worth tomorrow or in a year’s time. That, in turn, reduces its value as a unit of account. Why would another individual be prepared to accept my bitcoin for a good or service when its future value is so uncertain; for the same reason, why would I want to spend my volatile bitcoin rather than hoard it in the hope of further appreciation.

So bitcoin is a poor currency. But neither is it really like gold or any other physical commodity. Gold may not generate an income – it’s value is only what someone else is prepared to pay me – but it does at least have some decorative and industrial uses.

When it comes to bitcoin, people really are buying it solely because they expect other people to take it off them later for an even higher price. There is no better definition of the ‘greater fool theory’ than this.

As with every asset price bubble, of course, it is not wholly groundless. Ever since President Nixon broke the link between paper currencies and gold in 1971, dollars, pounds and euros have been little more than an act of faith. The value of a bitcoin is no more illusory really than a currency that depends on our collective trust in political leaders and central banks. Like gold, crypto-currencies are free from political interference, regulation, confiscation, inflation or debasement.

It may be that, as electronic commerce becomes the norm, cryptocurrencies will become viable mediums of exchange. The blockchain technology that underpins them may well be the future.

But I’m prepared to wait and see. I will not be risking my savings on what looks remarkably like the tulip mania of the 1630s. By the peak of the madness in 1637, the price of a single bulb was worth ten times a craftsman’s annual income. In three years, bulbs had soared in value sixty-fold.

Like all bubbles, Dutch tulips ended badly. A default on a bulb by a buyer in Haarlem was the bubble-popping catalyst and the implosion was savage. Within a matter of days, prices had fallen to a hundredth of their previous levels.

Peter Lynch said he would only invest in companies if he could ‘draw their business models with a crayon.’. Warren Buffett also famously warned against investing in businesses you cannot understand. If ever there were an investment that fits this description, bitcoin is surely it.

While bitcoin is soaring, the greater fools look like those of us refusing to follow the siren calls of the latter-day shoe-shine boys. Like Joe Kennedy, however, I’m pretty relaxed about who will have the last laugh. What goes up like a rocket comes down like a stick.


Article Source: Fidelity Australia – Tom Stevenson, Investment Director

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Weekly Market Update – 26th May 2017

Weekly Market Update

Investment markets and key developments over the past week

Share markets rose over the last week, reversing the Trump FBI/Russia Bump from the previous week as investors bought the dip supported by mostly good economic and profit news. US shares rose 1.4%, Eurozone shares rose 0.04%, Japanese shares gained 0.5%, Chinese shares rose 2.3% and Australian shares gained 0.4%. The gains in Australian shares were constrained by ongoing worries about the banks, retail shares and weakness in the iron ore price. Bond yields were flat to down, commodity prices were weak with iron ore down 7.6% but the Australian dollar was little changed.

The past week saw terrorism rear its ugly head again this time in Manchester in the UK – Our thoughts are with all those affected. Despite some fears to the contrary, the financial market impact proved yet again to be minor with UK shares only falling 0.1% the next day before rebounding and there was no sign of any impact on other share markets. This is consistent with the experience since early last decade that has highlighted that terrorist attacks on targets like crowds, buildings and entertainment venues etc., don’t really have much economic impact. While the 9/11 attacks had a big short term share market impact with US shares falling 12% they had recovered in just over a month, the Bali and Madrid bombings had little impact, the negative 1.4% impact on the UK share market from the London bombings of July 2005 was reversed the day after, the French share market only fell 0.1% the next trading day after the November 2015 Paris attacks and 0.3% the day after the July 2016 Nice attack.

Moody’s downgrading of China’s sovereign credit rating from Aa3 to A1 is unlikely to have much impact. China’s debt problems are well known with China’s policy makers seeking to restrain debt, most investment in Chinese bonds is internally sourced and China is not dependent on foreign capital being the world’s largest credit nation.

As widely expected, OPEC agreed to extend its production cuts to March next year but for the oil price it was a classic case of “buy on the rumour, sell on the fact.” OPEC is basically in a bind: if it cuts supply further it will lose more market share to shale oil but if it hikes production oil prices will plunge again. So it chose the middle path.

President Trump’s fuller budget request released in the last week is best ignored. As always Congress will put the budget together – Trump doesn’t even need to sign it off.

The latest Australian bank rating downgrades tell us nothing new but the drip feed of negative news around the property market in Sydney and Melbourne is continuing to mount: surging unit supply, bank rate hikes, tightening lending standards, reduced property investor tax deductions, ever tighter restrictions around foreign buyers, etc. Our view remains that home price growth has peaked in Sydney and Melbourne and that price declines lie ahead, particularly for units. The extent of the unit construction boom in Sydney is highlighted by the residential crane count which has increased from just 62 in September 2014 to 292 in March.

Source: Rider Levett Bucknall Crane Index, AMP Capital

Major global economic events and implications

US data was mostly good with the highlight being a rise in the overall business conditions Purchasing Managers’ Index for May pointing to reasonable growth. Meanwhile home sales fell, but home prices continued to rise and March quarter gross domestic product growth was revised to 1.2% annualised from 0.7%. The main dampeners were weaker than expected trade, inventory and durable goods data. The minutes from the last Federal Reserve meeting confirmed that it is likely to hike rates again in June and looks to be on track to start running down its balance sheet (i.e. reversing quantitative easing) from later this year by letting a gradual amount of maturing bonds roll off each month. Rate hikes and balance sheet reduction all remain conditional on the economy continuing to behave though.

Eurozone business conditions Purchasing Managers’ Index data remained very strong in April and business confidence rose in Germany and France which is all consistent with strengthening growth in Europe.

Japanese headline inflation rose slightly in April, but with core inflation still zero, the Bank of Japan is set to continue quantitative easing and maintain its zero per cent 10-year bond yield policy for a long time.

Australian economic events and implications

Australian March quarter construction data fell, adding to the downside risks to March quarter gross domestic product growth. However, it’s not all bad as the 4.7% slump in residential construction looks temporary and likely to reverse in the current quarter as the impact of Cyclone Debbie drops out and the huge pipeline of work yet to be completed kicks in, public construction is up strongly reflecting state infrastructure activity and December quarter construction activity was revised up significantly.

Weak March quarter construction activity along with very weak retail sales and a likely growth detraction from net exports highlights that absent an upside surprise in public spending, equipment investment or inventories, March quarter gross domestic product growth looks likely to be near zero with the risk of another contraction. Reflecting this along with ongoing softness in underlying inflationary pressures, there is far more risk of another Reserve Bank of Australia rate cut by year-end than of a rate hike.

What to watch over the next week?

In the US, the focus is likely to be on the May Institute for Supply Management manufacturing conditions index (Thursday) and jobs data (Friday). The Institute for Supply Management data is likely to have remained solid at around 55 and jobs data is likely to have remained strong with a 175,000 rise in payroll employment and unemployment remaining unchanged at 4.4%, but wages growth modest at around 2.7% year-on-year. In other releases, expect solid growth in April consumer spending but a fall back in inflation as measured by the core personal consumption deflator to 1.5% year-on-year and consumer confidence in May to have remained strong (all due Tuesday), pending home sales (Wednesday) to reverse a fall seen in March and the April trade deficit (Friday) to deteriorate.

Eurozone business and consumer confidence readings for May (Tuesday) are expected to remain solid and unemployment (Wednesday) is likely to have fallen to 9.4% from 9.5%, but core inflation is likely to fall back to 1% year-on-year from 1.2% reversing a distortion in April due to Easter.

Japanese jobs data for April is expected to remain solid – helped of course by a falling workforce, but household spending data is likely to remain weak (all due Tuesday) and industrial production data (Wednesday) is likely to show a bounce.

Chinese business conditions Purchasing Managers’ Index data (Tuesday and Wednesday) is expected to soften marginally.

In Australia, expect building approvals (Tuesday) to show a 3% gain after a sharp fall in March, credit growth (Wednesday) to remain moderate, CoreLogic data to show a further moderation in home price growth, retail sales to show a 0.2% bounce after several soft months and March quarter business investment data to show a 0.5% decline as mining investment continues to fall (all due Thursday). Of most interest in the investment data will be investment intentions which are expected to show some improvement in non-mining investment.

Outlook for markets

Shares remain vulnerable to a further short term setback as we are now in a weaker seasonal period for shares with risks around President Trump, North Korea, Chinese growth and the US Federal Reserve’s next rate hike providing potential triggers. However, with valuations remaining reasonable – particularly outside of the US, global monetary conditions remaining easy and profits improving on the back of stronger global growth, we continue to see any pullback in shares as an opportunity to “buy the dips”. Shares are likely to trend higher on a 6-12 month horizon.

Low yields and capital losses from a gradual rise in bond yields are likely to see low returns from sovereign bonds.

Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this demand will wane as bond yields trend higher.

National residential property price gains are expected to slow, as the heat comes out of the Sydney and Melbourne markets.

Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.

For the past year the Australian dollar has been range bound between $US0.72 and $US0.78, but our view remains that the downtrend in the Australian dollar from 2011 will resume this year. The rebound in the Australian dollar from the low early last year of near $0.68 has lacked upside momentum, the interest rate differential in favour of Australia is continuing to narrow and will likely reach zero early next year (as the US Federal Reserve hikes rates and the Reserve Bank of Australia holds or cuts) and commodity prices will also act as a drag (particularly the plunge in the iron ore price). Expect a fall below $US0.70 by year end.

Source: AMP CAPITAL ‘Weekly Market Update’

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Weekly Market Update – 19th May 2017

Weekly Market Update

Investment markets and key developments over the past week

  • Most global share markets fell over the last week on the back of the political crisis around President Trump. US shares fell 0.4% after recovering some of their losses later in the week, Eurozone shares fell 1.1%, Japanese shares fell 1.5% and Australian shares fell 1.9%. Australian shares are now down around 4% from their high earlier this month and have been hit by the weak global lead combined with pressure on the banks as a result of the Budget’s bank levy along with expectations for slowing credit growth and weakness in retailers on the back of weak retail sales and fears around the competitive threat from Amazon. Chinese shares managed to buck the global trend and see a 0.6% gain. Reflecting the risk off environment bond yields generally fell, but commodity prices mostly rose helped by a falling US dollar. The weaker US$ and good jobs data also helped support a small bounce in the A$.
  • The standard narrative right now seems to be that the ‘Trump trade’ drove the surge in global share markets since the US election and that this will now reverse because of the political crises surrounding President Trump. In our view this may be a little too simplistic. First, the main reason for the rally in shares since last November has been the improvement in economic conditions and surging profits that has occurred globally and not just in the US and which had little to do with Mr Trump. Second, the political crisis around the President won’t necessarily stop the pro-business reform agenda of the Republicans. In fact, unless things become terminal for Mr Trump quickly it’s more likely to speed it up. There is no doubt the political risks around President Trump worsened over the last week with increasing talk of impeachment and concern that it will impact the Republican’s tax reform agenda. However, it’s a lot more complicated than that:

    First, impeachment is initiated by the House of Representatives and can be for whatever reason the majority of the House decides and conviction, removal from office, is determined by the Senate and requires a two thirds majority.

    At present Republicans control the House with a 21 seat majority and won’t vote for impeachment unless it’s clear that Mr Trump committed a crime (and so far it isn’t obvious that he has) and/or support for him amongst Republican voters (currently over 80%) collapses.

    However, Mr Trump’s overall poll support is so low that if it does not improve the Democrats will gain control of the House at the November 2018 mid-term elections and they will likely vote to impeach him. Then it’s a question of whether Mr Trump can get enough support amongst Republican Senators to head off a two thirds Senate vote to remove him from office.

    This is all a 2019 and beyond story, but the point is that Republicans only have a window out to November next year to get through the tax cuts/reforms they agree with Mr Trump should happen. So if anything, all of this just speeds up the urgency to get tax reform done because after the mid-terms they probably won’t be able to.

    Now there is another way for the Vice President and Cabinet to remove a President from office under the 25th Amendment of the Constitution which is aimed at dealing with a President who has become mentally incapable. While some may claim this one is a no brainer, Vice President Pence is a long long way from doing this.

    The bottom line is that while the noise around President Trump and particularly the FBI/Russia scandal will go on for a while it does not mean that tax reform is dead in the water.  On this front work on tax reform is continuing including in the Senate and Mr Trump’s infrastructure plan (which is likely to be around leveraging up Federal spending and encouraging states to privatise their assets and recycle the proceeds) looks likely to be announced soon.

  • Share markets have had a great run and are due a decent 5% or so correction as a degree of investor complacency (as indicated by an ultra-low VIX reading two weeks ago) has set in and the latest scandal around President Trump may just be the trigger. North Korean risks are another potential trigger and after all it is May (“sell in May and go away”). Australian shares are down 4% from their high early this month, but global shares are only down 2% or so. However, providing the current Trump scandal largely blows over for now allowing tax reform to continue it’s unlikely to derail share markets beyond any short term correction. Valuations are reasonable particularly for share markets outside the US, global growth is looking healthier, profits are rising (by around 14-15% yoy in the US and Japan and by 24% yoy in Europe) and global monetary conditions remain supportive of shares.

  • It seems to have been a week for political scandals. Aside from those around President Trump, a corruption scandal has engulfed Brazilian President Temer highlighting that big risks remain around Brazil and allegations have emerged regarding Japanese PM Abe (although he is likely to survive them).

Major global economic events and implications

  • US economic data was mostly good. Housing starts fell in April but driven by volatile multi units and a further increase in the already strong NAHB homebuilders index points to strong housing conditions going forward. While the New York regional manufacturing conditions index fell in May it rose in the Philadelphia region and industrial production rose sharply in April. Meanwhile, jobless claims remain at their lowest since the early 1970s. All of this is consistent with the Fed hiking rates again next month. The political noise around President Trump will only impact the Fed if shares and economic conditions deteriorate significantly and that looks unlikely.
  • The Japanese economy accelerated to 0.5% quarter-on-quarter in March driven by consumption and trade taking annual growth to 1.6% year-on-year. This was the fifth consecutive quarter of growth, the first such run in 11 years.
  • Chinese data for industrial production, retail sales and fixed asset investment slowed in April consistent with other data indicating that recent policy tightening is impacting. Our view remains that GDP growth will track back from March quarter growth of 6.9% year on year to around 6.5%. The Chinese authorities have little tolerance for a sharp slowing in growth and policy makers are already showing signs of easing up on the policy brake. Meanwhile property price growth seems to have stabilised around 0.5% a month over the last few months, but is still slowing in Tier 1 cities.

Australian economic events and implications

  • Australian data was mixed. Jobs growth was strong again in April and forward looking jobs indicators point to continuing strength ahead, but consumer confidence fell and wages growth remained at a record low of just 1.9% year-on-year.
  • While the good jobs numbers will help keep the RBA on hold for now regarding interest rates the continuing weakness in wages growth is a concern and highlights ongoing downwards risks to growth, inflation and the revenue assumptions underpinning the Government’s projection of a return to a budget surplus by 2020-21. With unemployment and underemployment remaining in excess of 14% it’s hard to see what will turn wages growth up any time soon. So while our base case is that interest rates have bottomed, if the RBA is going to do anything on interest rates this year it will more likely be another cut than a hike. Particularly if property price growth slows.

What to watch over the next week?

  • OPEC meets Thursday and is likely to extend its oil supply cuts in the face of rising US shale oil production. OPEC is in a bind: if it cuts supply further it will lose more market share to shale oil but if it hikes production oil prices will plunge again.
  • In the US, in the week ahead expect the minutes from the last Fed meeting (Wednesday) to remain consistent with another rate hike at the Fed’s June meeting and the Markit manufacturing conditions PMI for May (Wednesday) to show a slight improvement from April’s reading of 52.8. New home sales (Tuesday) and existing home sales (Wednesday) are expected to fall back slightly after strong gains in March, home prices (Wednesday) are expected to show a further gain and April durable goods orders (Friday) are expected to remain consistent with continued reasonable growth in business investment. March quarter GDP growth (Friday) is likely to be revised up to 0.9% annualised from an initially reported 0.7%.
  • In Europe, expect May business conditions PMIs (Wednesday) to remain strong consistent with stronger economic growth.
  • Japanese core inflation for April (Friday) is expected to remain around zero consistent with the Bank of Japan maintaining a zero 10-year bond yield and quantitative easing for a long time.
  • In Australia, March quarter construction data is expected to show continued softness in mining related engineering construction but gains in residential and non-residential construction. Speeches by RBA officials Debelle, Bullock & Richards will be watched for any clues on interest rates.

Outlook for markets

  • Shares remain vulnerable to a further short term setback as we are now in a weaker seasonal period for shares with risks around President Trump, North Korea, Chinese growth and the Fed’s next rate hike next month providing potential triggers. However, with valuations remaining okay particularly outside of the US, global monetary conditions remaining easy and profits improving on the back of stronger global growth, we continue to see any pullback in shares as an opportunity to “buy the dips”. Shares are likely to trend higher on a 6-12 month horizon.
  • Low yields and capital losses from a gradual rise in bond yields are likely to see low returns from sovereign bonds.
  • Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this demand will wane as bond yields trend higher.
  • National residential property price gains are expected to slow, as the heat comes out of Sydney and Melbourne.
  • Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.
  • For the past year the A$ has been range bound between $US0.72 and $US0.78, but views remain that the downtrend in the A$ from 2011 will resume this year. The rebound in the A$ from the low early last year of near US$0.68 has lacked upside momentum, the interest rate differential in favour of Australia is continuing to narrow and will likely reach zero early next year (as the Fed hikes rates and the RBA holds) and constrained commodity prices will also act as a drag. Expect a fall below US$0.70 by year end.

Source: AMP CAPITAL ‘Weekly Market Update’

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FinSec Partners Disclaimer

Into the Unknown

Into the Unknown: Key Takeaways

PIMCO recently published its Cyclical Outlook for global growth, inflation, trends and transitions likely to affect the investment landscape in 2017. Below are some key takeaways:

With Trump, Brexit, Italy’s “No” vote and China’s currency woes, the world economy and markets have embarked on a journey into the unknown. As coauthor Andrew Balls and I noted, the only certainty in our view is that the “tails” in the distribution of potential macro outcomes have become fatter – i.e., more extreme scenarios, which usually have a low probability of taking place, have become more likely.

The downside, or left-tail, risks are defined by rising debt, monetary policy exhaustion and the populism-powered transition from globalization to de-globalization. By contrast, upside, or right-tail, opportunities may emerge from potential deregulation, awakening animal spirits and the accelerating transition from exhausted monetary policy to growth-supportive fiscal policies.

Three key macro transitions in 2017

The path for the economy and markets will likely be determined by how three difficult transitions play out on the cyclical (six- to 12-month) horizon:

  • The transition from monetary to fiscal policy, which has gained speed with the European Central Bank tapering the monthly run-rate of its asset purchases to €60 billion, the Bank of Japan abandoning its money supply target in favor of a yield target, and the next U.S. administration likely to embark on a more expansionary fiscal policy.
  • The transition from globalization to de-globalization, which has been underway for some time but looks set to accelerate as governments in the U.S. and elsewhere will likely become more inward-looking.
  • China’s currency regime transition from what was a U.S. dollar peg until August 2015 to the current quasi-basket peg to what may become a managed or even free float of the yuan.

Investment implications

Investors should consider a patient approach and aim for capital preservation until the veil of uncertainty over future policies starts to lift. With markets prone to overshooting and undershooting and likely to swing back and forth between our secular New Neutral and a potential “New Paradigm,” better opportunities to deploy liquidity should emerge in the course of 2017.

Joachim Fels is PIMCO’s global economic advisor and a regular contributor to the PIMCO Blog.