A year in review (Talking Finance)

Hello and welcome to the final Talking Finance for 2018, I’m Alan Kohler and what a year it’s been!  To reflect on how the markets are finishing the year, I speak to Shane Oliver, Head of Investment Strategy and Chief Economist at AMP Capital.  ‘The Kook’, Stephen Koukoulas, of Market Economics, gives us his thoughts on the economy and more specifically, the housing market.  Bevan Shields, Canberra Bureau Chief for The Sydney Morning Herald and The Age, shares his thoughts on this train wreck of a government and politics generally.  And Steve Sammartino, author and futurist, reviews the year in big tech.

Listen to the podcast or read the full transcript below:

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And now to tell us what’s going on in the markets, here’s Shane Oliver, Head of Investment Strategy and Chief Economist at AMP Capital.  Shane, the Fed raised rates last night.  I guess, when Donald Trump tweeted a day or so ago that they shouldn’t do it, that was it, it was going to be locked in from that moment.

SO:  It did make it a little bit harder for the Fed not to raise rates, I think, because otherwise they would have been accused of political interference.  But the other aspect is that, if they didn’t raise rates, even though with a market probability of 70%, the market might then say, ‘Well, what does the Fed know that we don’t know?’  I think the Fed sort of felt that it had to go ahead with that hike. The statement that we got from the Fed was a lot more dovish than we’d seen in the past. 

They did modify their expectations for further gradual hikes by inserting the word, ‘some’ further gradual hikes.  They even lowered the so-called [dot-floss] of market participants expectations for interest rate hikes next year from three hikes to two, and they’ve also lowered their long-term expectation for interest rates from 3% to 2.75%.  And on top of all of that, they acknowledge the issues in financial markets and global developments in saying that they’re monitoring them.  But I think the market was still expecting more, the market expected more dovish comments from the Feds and I think the market was also a bit disappointed that Jerome Powell’s press conference wasn’t a bit more dovish.  For example, he dismissed recent market turmoil as just a bit of volatility.

I guess, as an economist – he’s not an economist, but as an economist he might say that, but it doesn’t go down well with market types.  He also implied that the Fed’s program to reduce their balance sheet, this is the unwinding of quantitative easing, would continue on autopilot.  I think that sort of indicated a lack of sensitivity for the risks around the economy and markets and that’s why we saw the sell-off in the US overnight.  There was some good news out of the US overnight that looks like a shutdown was potentially going to happen this weekend, isn’t going to happen, a government shutdown. 

Out of Europe, there’s a deal between Italy and the European Commission over resolving their budget differences.  But all of those things were totally ignored.  The focus was fully on the Fed and the Fed wasn’t dovish enough. 

In fact, the Dow and the US market in general is heading for its worst December apparently since 1931.  

SO:  That’s right, it’s pretty bleak.  December is historically a strong month of the year.  This period that we’re in now, from mid-December up to the end of December, is usually particularly strong, it’s often referred to as the Santa Claus rally, but Santa Claus really hasn’t come this year, or at least he hasn’t come yet, so it looks like a pretty bleak December.  I guess a lot of this is in the timing though, the fall in the US share market is now pushing around 13-14% which is similar to the fall we had top to bottom back in 2015-16 when the market peaked in the first half of 2015 and then ultimately fell into February of 2016 by 14%.

It’s sort of approaching those sort of declines.  My own feeling is whether Santa Claus comes or not in the next week or so, I hope he does, to feel a little bit happier over Christmas.  But my own feeling is we’ve probably got more downside in markets from here, pushing us down towards that 20% level that some people call a bear market.  I don’t think it’ll be a deep bear market, I don’t think this is a re-run of the GFC.  I’d characterise this as what I’ve been calling them lately, ‘gummy-bear’ markets.  If you think about major share market falls, you’ve got corrections where you come down 10% or so.  A few months later it’s all forgotten about, then you’ve got occasions where the market comes down around 20%.  We saw that in 2011, we saw that in 2015-16 in Australia, we also saw that in 1998. 

But a year later it’s all forgotten about and the market’s a lot higher.  I call that a gummy-bear market because it gets the title bear market.  But it’s on the way back up again pretty soon after that 20% decline.  Then there’s a ‘grizzly-bear’ market, which obviously is a lot worse and that’s like the GFC or the tech-wreck where you come down 20%, a year later you’re down another 20 or 30%.  I don’t think it’s a ‘grizzly-bear’ market because I don’t see the US economy going into recession and I do think through the first half of next year at least, the Fed won’t be raising interest rates.  I think we’ve seen the hikes from the Fed for a while now.

I think other central banks, the Chinese, possibly the Europeans, will provide more stimulus in the first part of next year, which ultimately will help growth pick up again globally, so we avoid a recession and therefore avoid a ‘grizzly-bear’ market.  I think there’s still more downside it looks, in markets from here.  We haven’t yet seen a wash-out in terms of sentiment and obviously those worries about global growth, what the Fed will do, will linger into the first part of next year.  Unfortunately, I’d rather it wasn’t the case, but I think that’s where the risks point to, a bit more downside from here.  

So, the 2015-16 correction you referred to was actually a magnificent buying opportunity, you don’t think this time it is?

SO:  I think it will be ultimately, but we’re not there yet.  If you look at, the Australian share market is up to its low.  The low was actually Monday a week ago, although it could easily slip below that and probably it quite possibly will today.  Roughly speaking, Australian shares are down about 13%, global shares are down about 13% as well on average.  Obviously, emerging markets, Chinese shares are down a lot more.  I think if you’re a value investor you’d sort of start to say there isn’t the value creeping into markets and you’d start looking around now.  It’s just that I think we’ve got a little bit more downside and when the dust settles we’ll probably – the amount will be circa 20%, so it’s probably another 5-10% to go in terms of downside, and then like 2015-16 it will turn into a great buying opportunity.

The problem is trying to time it.  I could be wrong, we could bottom out in the next couple of days or we could go down another couple per cent and then bottom out early next year.  We don’t know precisely.  I kind of think that given my view that we’re not going into a ‘grizzly-bear’ market, we’re not going into a recession globally, therefore you’d start to average in from around here.  We have seen fairly hefty falls.  If you were happy to buy back in August when the Aussie share market was at a 10-year high, you should actually be happier now because the market is 13% cheaper than it was back then.  But you can’t time the bottom perfectly, so you’d probably say, well I’ll put a little bit in the next few days, and then maybe put a little bit more in in January some time and then a little bit more in in February, so you’d average into the market rather than trying to time it.  

Good to talk, as always, Shane.  Thanks.

SO:  Thanks, Alan.

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And now to talk about the economy, here’s Stephen Koukoulas, he’s got his own little business called Market Economics, he also is Chief Economist for Dun & Bradstreet, writes for Yahoo, and is a general ‘man about town’!  Stephen, you’ve got a bet with Tony Locantro of Alto Capital in Perth to the effect that if property prices, that is to say the aggregate national property price is down 35% or more, you’ve got to give him $15,000 cash by – this is December quarter 2021 – and he only has to give you $2,500 if it’s less than 35%, so that’s big odds!  How are you feeling about your bet now?  That was a few months ago.  

SK:  That was a few months ago, I’m pretty happy still, that’s six to one odds and it followed, if you recall, a 60 Minutes report about three or four months ago which had claims of 40 to 45% falls in house prices, and I thought I better call this out so I made the offer and Tony stepped up.  It’s a fair offer, it’s based on the Bureau of Statistics House Price Series, so the impartial, unbiased numbers.  Prices are falling, we know that.  We know that from the CoreLogic which actually do feed into the ABS numbers, so there’s a strong overlap there.  The prices in Sydney are now down around about 10% from the peak, Melbourne’s down about 7% from the peak and that’s over the course of a year or a year and a half.

Now, I’m not terribly concerned about my bet yet, because I think a couple of things are happening.  One, as we saw yesterday, there’s a slight relaxation in the credit lending, particularly to investors and interest only loans.  Also, we’ve had a repricing from financial markets about interest rates and they’re now pricing in the risk of a rate cut, and as we discussed just recently, Alan, I still think the next move in rates is down here in Australia.  That will put something of a floor under the market. 

The other thing which is apparent in the housing finance numbers is that there seems to be a considerable amount of pent up demand when we fall, and by that I mean, when we have first home buyers having been frozen out of the market in recent years as prices were going up, many of them have got their deposit, many of them have got their credit organised, many of them have saved a little bit more, so when they see prices dropping from, for argument’s sake, $750,000 down to $700,000 down to $650,000, my hunch and my expectation is that they’ll step up and we’ll see first home buyers sort of replacing investors as the source of demand.  But look, prices fall a bit more in the next six to 12 months but I think that will be about it.

What effect do you think what we’ve seen so far – and perhaps as you say another six months, what effect do you think that will have on the economy more generally through the wealth effect and consumption?

SK:  I’ve spent a lot of time on this because it concerned me and it was something that I knew a little bit about and in the last few months I’ve laboured over a bunch of academic research on the correlation between changes in wealth and growth in household spending.  Every piece of literature I’ve found – and this is from the various Federal Reserves in the US, from our own Reserve Bank, from other academic sources – that there is undoubtedly a correlation between change in wealth and change in consumer spending.  When wealth is increasing, there tends to be a positive link to consumer spending and obviously the downside of that is when prices fall and wealth is being diminished, that consumers tend to hunker down and don’t spend as much.  The only caveats on that is that there is a lag and different research finds different lags, sometimes it’s only one quarter between the fall in wealth and the impact on spending.  Sometimes it’s three to four quarters, so it’s almost a year before consumers realise they’ve lost their money and then they hunker down.

The other thing is the magnitude of the effect which was interesting.  At the very least it seems to be that for each $1 change in wealth there’s about a 2-3 cent change in consumer spending.  If your wealth drops by $1,000 you’re going to cut your spending by somewhere between $20 and $50 a year.  It doesn’t sound a lot, but nonetheless we know the direction of the change.  So, if house prices continue to fall, the risk for the consumer side of the economy remains pretty subdued.  

Yes, and what about other sides of the economy?  I suppose, we’ve got net exports which are strong, infrastructure spending which is also strong, where do you think the balance lies?

SK:  They’re excellent points and I’m not forecasting a recession, far from it.  I don’t think there’s much probability of that or anything like that, because as you point out, the infrastructure spend from the state governments in particular is very robust and you would expect to see a bit more from the federal government as the election looms in the new year.  I think public sector spending will be a decent size positive for the economy, and our export sector – commodity prices are reasonably buoyant, the Dollar’s at a very competitive level here, approaching 71 cents, thereabouts.  We’re getting a big kick from our export sector and those two factors alone will probably contribute at least a percentage point to the bottom line GDP, so you need the rest of the economy to be dreadfully weak, which I don’t think is going to happen.

So, rather than a hard landing or anything wicked like that, I think it’s more the growth momentum in the economy which did peak at 3% earlier in 2018, sort of drops back to 2-2.5%, so not catastrophic, but just the sort of growth rate that sort of stalls the labour market, that sees inflation remain extremely low.  And again, it’s one of these ones where 2019 could be a year where it feels a bit uncomfortable for most of us, but still a long way away from a recession.   

Okay, thanks, Stephen.

SK:  Thanks, Alan.

[Music]

[Parliament audio clip]

Now to catch up with the latest gossip – I mean, politics – here’s Bevan Shields, the Canberra Bureau Chief for They Sydney Morning Herald and The Age.  Bevan, I had a meeting yesterday with a Vice-Chancellor of one of the universities and he said that he was hearing that increasingly there’s a likelihood that the election will be in March, not May.  But I wondered whether since you reported Malcolm Turnbull actually calling for a March election, I just wonder whether that kyboshed that idea, that the last thing Morrison will do now is actually have a March election because Malcolm Turnbull suggested it.

BS:  There’s that, Alan, but there’s also the problem that the government has very strongly made the case for the need for a budget in April and there are a lot of people inside the government including the Treasurer, Josh Frydenberg, who think they need to be able to deliver a budget, they need to be able to stand up in parliament, deliver a budget, outline a new suite of promises and programs that they can take to the election.  A lot of people aren’t convinced that you can just roll that out of the election campaign.  And I think the one thing the government needs at the moment is an agenda.  This is one of their big problems beyond all the scandals and own goals and all that sort of stuff. 

I think the biggest problem for them right now is that the public is looking at them and going, “What do you stand for, what are you promising me?”  I think at this point it’s probably 50/50 whether they go in March or May.  It’s something that, I think the Prime Minister is going to be spending a lot of time over summer contemplating.

Apart from anything else, I suppose, Josh Frydenberg doesn’t want to go down as one of those rare bread of Treasurers who never delivered a budget?

BS:  Exactly, he wants to stand up.  But I think he genuinely does believe that that is the best way to recapture the public’s attention.  The other element here is that the Liberal Party needs all the time that they can get because they need to raise money, they need as much time as they can to raise money for the campaign because they’re in a world of woe at the moment in terms of their fund-raising abilities, so even a couple of extra months could really make a difference for them.

Yes, but possibly not much of a difference, I guess.

BS:  What’s a few hundred thousand here or there, right?

Talk to us about Andrew Broad, Bevan.  You report that he tweeted in February, “When wealth is lost, nothing is lost.  When health is lost, something is lost.  When character is lost, all is lost.”  And that seemed to be a whack at Barnaby Joyce.

BS:  It certainly was, it was one of the catalysts, or the beginning of the end for Barnaby once the party room started to move away from him and now we know several months after he made that declaration he had met a woman via an online dating site and he had been talking to her for months with some pretty cringeworthy messages and he was boasting about his recent promotion to the front bench after Malcolm Turnbull was removed and New Idea landed newsagents with a thud on Monday with this story that he had met this woman in Hong Kong, she wasn’t particularly thrilled with his behaviour, she went to the press and reported everything he said, and he then referred her to the AFP. 

This totally derailed the MYEFO budget update on Monday and it was a funny book-end to the year, really, because the year started with sex and sleaze with Barnaby, that Broad played a role in, and the year has ended with sex and sleaze with Andrew Broad’s own indiscretions.

And Barnaby’s now saying that he knew that Andrew Broad was behaving like this back then.

BS:  He did, and this is the problem with this place, there are always rumours about people and I would suspect 95% of them are not true and that’s politics and people playing games, but you know, politicians are human, they’re not perfect, they make mistakes, they do things that they shouldn’t do.  Part of the problem for, I imagine, people like Barnaby as leader at the time but also the press is how you prove some of the rumours and some of the allegations.  If you think that that’s in the public interest and worth reporting, but I support New Idea for running this because he partly used taxpayer funds to get to Hong Kong.  He was boasting about his role as an assistant minister and it really did leave him exposed.   

But it is striking, Bevan, that this stuff is on one side of politics.  I mean, nothing like this is coming out of Labor and I refer also to the report you had the other day about the government staffer who sent this amazing ridiculous text to Annika Smethurst from News Corp.

BS:  That’s right.

I mean, this sort of stuff seems to just keep happening to the Coalition, but not to Labor.

BS:  And I don’t think Labor is perfect, I’m sure there are people in Labor who have done things that they shouldn’t.  I think the problem though is there’s enormous focus on the government and a narrative that’s really stuck now with incidents like this that the wheels are just falling off and the whole show is imploding and they’re limping to the election line.  But what happened with Broad this week has really turbo-charged a lot of those rumours inside Parliament House, there’s a lot of inuendo flying around and I’ve got to tell you, there’s a lot of focus at the moment on one particular Labor MP, and I think Labor is preparing for the possibility that there may be a story to come out over the coming months about a Labor MP.

Yes, the government’s having an absolute shocker at the moment, but all sides of politics, including the greens, are dealing with some of these issues and the public really has just had an absolute gutful, I think.

That’s true, we all can’t wait for the election so we can just draw a line on it and move forward. 

BS:  And the election will really tell us, I think, whether or not this instability we’ve seen in Australian politics over the last 10 years, whether we can draw a line under the sand on that or whether that’s here to stay and that really is up to Labor if Labor wins.  They’re very united at the moment.  They know that the prize is very close.  They know they’re about to get over the finishing line.  What happens after the election though is really critical, whether they can keep that together and whether they have really learnt the lessons that they experienced in government and that the Coalition has experienced in government. 

I think six months after the election, if things are calm, we may actually have a chance to get on and do some stuff in this country rather than talking about what people like Andrew Broad are up to in Hong Kong.

Good on you, Bevan, thanks.

BS:  Good to talk, thanks, Alan.

[Music]

And now to review the year in big tech, here’s Steve Sammartino, author and futurist.  Steve, it feels a bit like 2018 was a bit of a turning point for the big tech companies, led by Facebook, partly because of tax.  The governments of the world are starting to get sick of them not paying tax and are wanting to do something about it, but also about the way they behave.  Do you think that’s right?

SS:  I do think it is right, and in fact, the terminology people are saying is it’s the year of tech-lash, where people are back-lashing against big technology.  For the longest time, they seemed like the fun university graduates with colourful primary coloured logos, and we’ve just realised that they’re just big corporations and they’ve had this get out of jail free card for the longest time where their behaviour, move fast and break things has been seen as quirky and fun, but now we’re realising that they have implications that I think are big financially with the taxation, but also the scale of influence that they have now is probably not like we’ve seen with any corporation maybe in the history of the capitalist economy.  I don’t think we’ve ever seen that.  I think it’s justified and I think the tax is one of many things that we’ll see push back onto big tech next year.

Run us through quickly what’s going on with tax, which countries are doing what?

SS:  A lot of the countries are pushing back.  France and the EU were trying to get some tax onto the big tech companies and it was pretty hard to get that support through the EU because as you know we’ve got some low-tax jurisdictions in there, notably Holland and Ireland are tax havens.  But France just announced this week that from January 1^st they’ll be putting a new tax on – they’re calling it the GAFA Tax – Google, Amazon, Facebook and Apple – which they expect to raise 500 million euro.  Germany as well are putting a 3% tax on advertising sales which is interesting, and that’s to capture the growth of Google and Facebook who currently have 70% of the digital market and they’re actually getting all of the growth, so all of the companies in digital advertising are pretty much declining compared to those two. 

The UK are talking about launching a digital sales tax which they want to raise Great British Pound 400 million per annum.  It’s interesting when we look at the numbers, because the Fortune 500, they average 3% tax on revenue if we look at all these corporations.  But just in the UK, Google, Facebook and Amazon on 20 billion pounds of revenue, paid just a little over 70 million in tax, which is 0.4% on revenue.  I think what we’re probably going to see – and there’s been a lot of talk I think in many markets about taxation, the model of taxation change and go to more like a land tax business valuation or revenue model of tax, simply because in the digital economy it’s so easy to shift things around now. 

It’s even easier than it was with manufacturing firms who rented their brand names off companies that they owned and are influencing in other markets.  But it’s just getting so easy now that I think that there needs to the entire and there will be the entire reset of how taxation gets assessed and paid to governments around the world and Europe’s leading the cause.

You’ve also been talking about some sort of transparency on their algorithms, Facebook and Google in particular, similar to what food companies are required to now do with the ingredients on the pack.  The trouble with that is, we can all understand sugar and fat and buy the product anyway, because we don’t care…

SS:  [Laughs]

But nobody’s going to understand what the hell the algorithm ingredients mean, surely?

SS:  No, but I think they will, Alan.  Because no one knew what protein a couple of hundred years ago, that wasn’t part of our narrative, protein and sugar and what are trans fats versus normal fats… And what happens is, it really becomes an education process.  I think you’re right, in the short-term I don’t think people will necessarily understand.  With food, consumer goods, manufacturing, they used to get away with putting whatever they liked.  Coca-Cola had cocaine in it and we had heroin that was inside medicines for children and all manner of things.  At those times we didn’t understand but I think the narrative will change, I think that algorithms will become something that’s like an ingredients list on a cereal packet – and in the short-term, we won’t understand, but what it will do is it will create a new level of accountability.  Some of the language that might need to be used on this algorithmic transparency might include things like, they follow – the simple things of tracking, how they track you and where you go and that it’s geographically tracked.  There will need to be a taxonomy or a language, no pun intended there, to be invented around what these algorithms mean and we’ll be able to find out, I think, and the education process will probably start.  But yes, in the short-term, probably won’t change a lot of behaviour but it will create a level of transparency hopefully and we’ll be able to understand what’s going in over digital products.

Well, it’ll be interesting to see.  Thanks very much, Steve.

SS:  Pleasure.  Thanks, Alan.

[Music]

Well, it’s nearly Christmas, so let’s turn to someone who was actually born on Christmas Day.  No, not Jesus, Dido, born Florian Cloud de Bounevialle Armstrong – goodness me, no wonder she changed her name to Dido!  Anyway, here’s her song, Thank You, because I also want to thank you for your support this year, you’ve been wonderful, thanks.

[Music]

And that’s all from me, have a wonderful Christmas and a safe and prosperous new year.  I’ll talk to you in a couple of weeks and I look forward to continuing our conversation in 2019.