Farewell to a lousy year, but where will it end?

Shutdown

As we hit “send” this morning, the government of the United States is nine hours away from shutting down, which would be the 21st time it has happened, starting in 1976 and including two this year already.

The stock market is down again overnight for the fourth time this week and the tenth session out of 15 so far this month, but that has more to do with the lingering effects of the Fed meeting on Wednesday than the looming shutdown.

The average stock market move during past shutdowns, according to Marketwatch, has been 0.4%, and who knows what else was going on with markets at those times.

Mind you the general sense of worsening chaos in Washington wouldn’t be helping, that’s for sure. On top of the fight between the White House and Congress over the border wall, which is what the shutdown talk is about this time, there’s also the resignation of Jim Mattis as Defence Secretary and the withdrawal of troops from Syria, not to mention the continuing frenzy of wild tweeting from the President.

US government shutdowns have been getting worse over the years. In the 70s and 80s when Ford, Carter and Reagan were in power, government employees generally weren’t furloughed (put on leave without pay) but in recent years they have been more often. The record length was 27 days in 1995-6, when Bill Clinton was arguing with Newt Gingrich over spending on Medicare and a few other things.

This time it’s specifically about the border wall, and Trump’s demand for $5 billion to fund it.

Interestingly there was an item on the ABC’s PM programme this week quoting Dr Wayne Cornelius from the University of California saying that the wall “estimated to cost at least 25 billion at the low end and 70 billion at the high end, plus there would be at least half a billion per year in costs for maintaining the wall,” which I haven’t heard before.

Presumably the $5 billion is just to make a start, if he’s right. Anyway, Trump tweeted last night: “The Democrats, whose votes we need in the Senate, will probably vote against Border Security and the Wall even though they know it is DESPERATELY NEEDED. If the Dems vote no, there will be a shutdown that will last for a very long time. People don’t want Open Borders and Crime!”

It’s mostly political theatre, of course, and nothing new in the modern world of polarised politics and “total opposition”.

But underneath what’s going on is the effort by the Washington establishment to defend against the attack from Trump and his “drain the swamp” followers. It’s the same battle as the ones in Britain and France and the stock market is an innocent bystander, caught in the crossfire while ducking bullets from the Fed.

Not a great way to get ready for Christmas, but for a few days at least we can forget about the political dramas and focus on family ones...

Farewell to a lousy year

Well, what a rough way to end a rough year! You might have thought a Fed rate hike on Wednesday was well anticipated, but markets have reacted as if it was a total surprise.

Don’t be deceived by the talk that it was a “dovish hike” because the “dot plot” – that is, the Fed members’ forecasts of future rates – had come down from three hikes to two, and there was the addition of the word “some” in the statement.

The markets are telling you something else: 30% odds had been put on no hike at all. Markets always move at the margin, and the statement seemed to be way too bullish for what the recent data has been saying.

The Fed still talked about a strong labour market, even though aggregate earnings and hours worked declined in November and in his press conference chairman Jerome Powell said, “there’s a mood of concern, or a mood of angst about growth going forward,” without adding any moderation of the Fed’s tightening bias in response.

I wrote here in March that it looked like the “Powell Put” had a different strike price to those of his predecessors, Greenspan, Bernanke and Yellen.

The Fed Put is shorthand for the idea that the US central bank will rescue investors if the markets get messy, because the chosen medium for supporting the American economy is boosting asset prices. Therefore, the Fed won’t want them to go down too much. (A “put” is an option to sell and is often used by traders as a stop-loss insurance policy.)

My point was that the market will need to get into more trouble under Powell than any of the other three to prompt a pause in rate hikes, or a rate cut. That has now come home to roost. The realisation that the strike price of the “Fed Put” under Powell has changed is the reason the market is now tanking.

The Dow Jones is on track for its worst December since 1931, and it looks like being the worst month since the GFC, even though you might have thought all the conditions were in place for a nice Santa Claus rally: there was a successful meeting between Trump and Xi, with China backing down on its Made in China 2025 policy (or at least pretending to), Italy and the EU reached a deal, and the oil price is collapsing.

I’ve been writing all year that investing was going to be tough because of rising interest rates, short and long, and that is what occurred. “Don’t fight the Fed,” has never been truer.

This was the fourth Fed funds rate hike this year and the US 10-year bond rate went from 2.4% on January 1 to above 3% in October, before settling back to 2.8% now.

Sharemarkets always fall when interest rates are rising, except for 2017 – that was the great exception that proves (tests) the rule. Last year virtually every asset class went up and this year every asset class went down. In fact, 2018 saw the highest percentage in history of asset classes fall in price – higher even than in the Great Depression.

Gerard Minack says it was payback for 2017: US equity valuations are now below where they were when the tightening started in 2015, so normal transmission has been restored.

In short, we are in a liquidity squeeze and have been all year. A lot of assets are down more than 20% from their peaks, qualifying as a bear market – ASX energy stocks, ASX banks, the Shanghai Composite, Emerging markets, world financials, Hang Seng index, German Dax, the Irish and Greek markets, US Russell 2000, crude oil, silver, Nasdaq (just), and the FAANGs.

A bunch of other assets have fallen more than 10% and qualify as “corrections”, so far: Sydney real estate, the ASX 200 and All Ordinaries, S&P 500, Dow Jones, MSCI world index, the French CAC40, the Japanese Nikkei 225, sterling, platinum, iron ore, the Australian dollar, to name a few.

Assets that are up in 2018: the US dollar, natural gas, German bunds, Japanese bonds, world utilities, world healthcare stocks. And cash.

Where will it end?

The last two times markets went into this sort of nosedive, they were pulled out of it by a huge bout of Chinese stimulus (in 2008-09 and 2015-16). That’s unlikely to happen again this time. Even if Beijing does try to jump start its economy with monetary and/or fiscal stimulus, recent experience suggests it won’t work this time as well as it has before.

Another possible saviour is the oil price, now down 40% from its early October peak. That sort of drop in the oil price usually helps markets get back on their feet because of the impact on inflation and therefore interest rates, but these days it’s double-edged.

Falling oil price used to mean that less money flowed from Western consumers’ pockets to Russia, the Middle East, Venezuela and Nigeria. But now the world’s biggest producer is the US itself: Louisiana, Oklahoma and Texas are now on the other side of the transaction with OPEC etc, which means falling oil also has some negative consequences for the American economy.

Happily, for us the gas price has decoupled from oil and is rising, not falling, but if that were to change next year for some reason, the same would apply to Australia.

The most likely end to the liquidity squeeze and bear market is that the Fed actually does an about face next year and stops raising interest rates. That will happen if there is a big negative event or clear evidence that the US labour market has turned down.

What negative event? Some people think it will be the Chinese banking system or perhaps something in Europe, like Italy, France, or Deutsche Bank getting into serious trouble. Needless to say, none of those things would be good for markets, but they would at least produce renewed liquidity and a definite market bottom.

No, Benjamin, there is no Santa Claus

This question popped up on my screen in Thursday’s Facebook Q&A:

Benjamin: “I was hoping to raise cash just prior to the market falling. But unfortunately for one reason or another have been paralysed by indecision and now I find the market has fallen 13% and still done absolutely nothing. Market commentators like Percy Allan and a few others seem to think that this is just a correction and not a full on crash. I am just wondering if this is so whether I have missed the boat and I would be better off just riding out the correction and waiting for an opportunity to get out of the market at higher prices?”

I suspect Benjamin is in good company, hoping for the Santa Claus rally that never came.

But don’t beat yourself up Ben: picking the market top and cashing out at precisely the right time is no easy task and missing it certainly doesn’t necessarily mean something negative like you’ve been “paralysed by indecision.”

My answer to the question was a bit of a “general advice/personal advice” cop-out, or at least it started that way: it depends on your time frame and your style of investing. If you own individual stocks with a long time-horizon, then ride it out. These sorts of ups and downs are par for the course and need to be expected.

If you’re a market timer who invests in whole market ETFs with a short time frame, then you’re in whole different position and you might want to take out insurance against a further 10-20% drop and go to cash, at least to some extent.

Anyone who says they know what is going to happen next year is either fooling you or themselves, or both.

The most likely scenario is more of them same, but that could be wrong either way.

Glass half full, half empty

The glass half full scenario is as follows:

• Equity valuations have fallen. The market is now much cheaper: the average P/E ratio for the S&P 500 has fallen from 21 in September to 17 today. The ASX 200 P/E has come down from 16 to 13.7 times, below average.
• The Fed has become less hawkish. Yes, the Fed is still tightening policy and Wednesday effort was not “dovish”. But the Fed is paying attention to softer inflation expectations, housing market weakness, widening credit spreads etc. and is adjusting its stance accordingly. As a result, the dot plot of FOMC members has fallen from three in 2019 to two.
  That’s still above market expectations, but at least it’s down.
• Bond yields have fallen. The 10-year US bond yield peaked at 3.24% in September and has since fallen to 2.77%.
• Oil prices have fallen 40%. Like bond yields, oil prices were rising going into October, with WTI reaching US$76/bbl. Prices have since fallen -35% to about US$48. As discussed above, this is not as good for the US as it once was now that the US trade deficit in oil is much smaller, but for the economy at large, oil at less than US$50 is better than oil at US$75.
• The US-China trade war is on pause and the renminbi is no longer falling. There is a great deal of uncertainty on this front, particularly with this week's coordinated attack on Chinese hacking by the US and UK, but Trump seems to want a deal, and has postponed tariff increases.
• The Italian government has reached a budget agreement with Brussels. In many ways, it’s just another case of putting off the inevitable, but the risks of market disruption on this front next year have been reduced.

The glass half empty scenario goes like this:

• Relations between the China and the West break down completely. Yesterday’s charges against two Chinese nationals for hacking and espionage, along with the arrest of Huawei’s CFO look really bad, and could well escalate into full-scale trade and cyber warfare between the US (and the West generally) and China. The US, Britain and other western countries are effectively charging China with systematically stealing trade secrets from governments and companies. This week’s US indictment says Chinese hackers obtained access to 90 computers inside a range of companies and government agencies and stole hundreds of gigabytes of sensitive data. It alleges they accessed service providers and their clients in at least 12 countries, including Brazil, Canada, France, India, Sweden, Japan, and the UAE. How China responds to this, and how far the US takes it, will be critical for markets in the new year.

• The Fed really does have a tin ear. This is about the lower strike price for the Powell Put, discussed above. If the Fed presses on with normalising interest rates despite clear evidence that the economy is slowing and markets are in a mess, then all bets will be off next year. As Grant’s Almost Daily newsletter noted yesterday: “the Powell Fed, professedly “data-dependent,” yesterday chose to continue to tighten in the face of the real-time data of falling share prices, widening credit spreads, a plunging oil price and a flattening yield curve. In a CNBC panel discussion following the Powell press conference, a commentator insisted that there had been no “policy error,” adverse market reaction notwithstanding—it was obvious, he said. But if policy errors were obvious at the time they were perpetrated, our policy-makers would never err.” 
• Having taken aim at its foot, Britain shoots. The UK has three months to work out what it’s doing about Brexit. If they have another referendum and put the pin back in the grenade, to mix metaphors, everyone will breathe a sigh of relief and life will go on. If it’s “no deal Brexit” followed by Jeremy Corbyn PM, well then Britain will be in a lot of trouble. Perhaps this won’t matter too much to the rest of the world, since we’re not talking China or the US here, just a smallish once-great country, but a deep recession in Britain and total collapse of sterling would certainly not be good.
• China’s banking system goes belly up. I don’t think this is likely because the debts are mostly internal, and sort of government-to-government. But the reason the Shanghai stockmarket has fallen 30% this year is that investors are worried about financial strains in the private sector. Defaults are rising and the Chinese corporate bond market is in danger of shutting down completely. It remains a possibility, perhaps remote, that the government loses control of the situation and the banking system joins in the rout.

The Discount Rate is Higher

In some ways, the best way to describe what has happened in 2018 is that the discount rate of the future was increased – that is, the percentage by which future cash flows are discounted to estimate their present value is now higher than it was a year ago.

In other words, the multiple applied to future cash flows was reduced. The less certain is the future cash flow, the greater the reduction (see cryptocurrencies and cash-burning “growth stocks”).

Even reliable cash flows are going for knock-down prices: the rent on a nice place in Yarraville or Strathfield, for example, along with all Sydney and Melbourne real estate, dividends from the Commonwealth Bank, and all the banks, or interest payments on bonds guaranteed by the Government of the United States.

Australia’s property bear market, if such it is, is simple to explain: real estate is an investment asset that is always at least 80 per cent geared, which means the market is determined by availability and price of credit. In 2017-18 the price of credit didn’t change, but the availability did – drastically and deliberately (APRA did it). Or rather cheap availability dried up (credit is always available at a price).

There are two reasons for the correction/bear market in equities, both of which have already been dealt with in previous Overviews, so no need to do it again: first, the “tape” that equities are measured with – the global risk-free interest rate, aka the Fed funds rate -  went up so they went down, and second, and less tangible, the engines of capitalism – corporations – have come under increasingly strenuous attack, not just in the Australian royal commission, but around the world.

As Financial Times columnist Martin Wolf wrote in the piece I quoted here last week: profit is not in itself a business purpose – it’s a result of achieving the purpose, whatever it might be, such as making cars, disseminating information or transporting things.

The focus on profit and shareholder value means that companies are serving only those who are LEAST committed to them: the shareholders. Unlike employees, suppliers and the communities in which the companies operate, shareholders, says Wolf, “can divest themselves of their engagement in the company in an instant” – that is, sell.

For future corporate profits to be valued as they once were – that is, for share valuations and prices to recover – boards and executives can’t simply rely on more interest rate reductions. That’s not going to happen.

Companies will need to redefine their purpose: the narrow focus on profit alone simply won’t cut it any more.

Australia in 2019

The good news for investors in this country is that the bad news is in the price – of both the A$ and the sharemarket.

Here’s Gerard Minack’s typically pithy comment about Australia’s prospects next year: “My base case is that that the economy remains in the macro sludge.”

Yes, but by coincidence (or not?) both the sharemarket (ASX 200 total return) and the A$ trade weighted index have fallen 5.5% in 2018, so far. The only way that isn’t enough of a price reduction for the coming “sludge” is if there’s a recession next year instead.

So the key domestic question for investors, as opposed to the big global questions, is whether the economy slips into recession. That is almost certainly not going to happen (famous last words alert), if only because net exports, mainly LNG, and public infrastructure spending will keep real GDP growth above zero.

The domestic private economy – business and household – could go into its own recession, but that won’t show up in the official GDP number by which we measure recessions, and that largely hangs on the property market and more specifically the credit squeeze.

In that regard it was encouraging to see to APRA show some flexibility and remove the 30% cap on interest-only mortgage lending, having already lifted the overall lending cap.

I happen to think all investment loans should be interest only, since principal and interest is designed to repay a mortgage over 25 years, which really only applies to owner occupiers. Property investors have no intention of paying off the mortgage over 25 years and then owning the place debt-free – the idea is ridiculous. The intention is to own for a while, hopefully get a capital gain that is subsidised by tax deductions, and then sell and pay the CGT.

But I understand that is not a popular view and interest-only loans are perceived as terribly risky and aberrant, and should be temporary before reverting to P&I.

How silly. Can you imagine APRA and the banks deciding to send the economy into recession by forcing property investors to pointlessly convert en masse to P&I, thus raising their repayments and shrinking their other spending? That seems to be the hairy-chested intention of some people.

Anyway, barring that, the main issue with property concerns the wealth effect – that is, the impact of the decline in household wealth on household spending.

I suspect this is overstated and won’t be enough to send the economy into recession, even if ANZ’s Shane Oliver is right and prices in Sydney and Melbourne fall by a cumulative 20%.

Recessions are caused either by sharply higher interest rates or macro shocks, often, but not always, external, as in 2008 (when we didn’t have a recession in any case).

Interest rates are going nowhere except maybe down in 2019 so we can cross that off our list of worries. As for shocks, it comes down to what GaveKal calls a “whale”.

Charles and Louis Gave say liquidity squeezes are like dynamite fishing: When you have a big explosion under water, the shock wave kills all marine life within a certain radius. 

“Straight away, the small fish float to the surface, belly up. But the bigger fish take longer to show up, and only after a considerable delay does the dead whale finally break surface. In 2008, Bear Stearns was a porpoise. AIG was the whale.”

In the 1991 recession in Australia, I’d say Pyramid Building Society and Estate Mortgage were porpoises; the State Banks of Victoria and South Australia, plus Christopher Skase’s Qintex, were whales.

I wouldn’t want to name any names, but this time around it’s possible to see a few potential porpoises that could float lifeless to the surface, but I can’t see any whales.

But that’s the thing about whales, isn’t it? They’re under the water, until they’re not.

Speaking personally…

It’s been a big year, that’s for sure. In my speech at the big annual Kohler Family Christmas gathering (at our place) last week I went around the table and described what had happened to each one of us in 2018.

It was amazing: babies born, new jobs, big illnesses suffered and recovered from; everyone had had something big happen. And for me of course it was the merging of The Constant Investor with my first baby, Eureka Report.

So I end the year enfolded in the warm embrace of InvestSMART, a company led by my friends Paul Clitheroe and Ron Hodge, and 19% owned by another friend, Charles Leyland (or at least his fund). The move feels right for me, and I know it’s right for TCI members, who are already getting the best of InvestSMART’s content as well as everything I’ve been doing for TCI, and will soon get access to all of both.

It’s been a tough year for all of us as investors, but that’s life in the markets and no one should expect constant good times. On the other hand, it’s been a gripping year for commentators like yours truly because difficult times are far more interesting and challenging than good ones.

I’ll be taking a couple of weeks off now, along with everyone at InvestSMART, although we’ll be publishing twice a week from January 1 to 12, which is when my next Overview will appear in your inbox.

Have a great Christmas with your family and I look forward to helping you keep up with what happens in 2019, whatever the year may hold.

Research and Diversions

Research

Greenspan tells share investors: “run for cover”. Well, he says “at the end of (the) run, run for cover”, but of course he doesn’t know when that will be. He thinks the market “may have some upside left”, which will make the inevitable drop more painful. Mind you, last time he picked the top it was four years early. Just sayin’.

Is Trump withdrawing from Syria, or surrendering?

The fantastic tale of John De Lorean, who quit a hotshot career at General Motors in the 1970s, talked the British government into bankrolling a new sports-car factory, blew the money on living large, produced a few cars that scarcely worked, and tried to stave off financial collapse by pledging the remaining assets of the car company in a wholesale cocaine deal — which was, in fact, an FBI sting.

Pete Wargent: the gross debt ratio has now peaked out and ticked down in the September quarter, and it will likely be some way lower by the end of the calendar year. 

How far are house prices from fair value? Err, either a lot or not at all, according to this piece of analysis.

Baby Bunting is another Bunnings. Interesting!

Ross Gittins: America's vested interest in maintaining a rules-based trading system has diminished.

This is a fascinating piece: How Thatcherism produced Corbynism. It could also be headed “How Reaganism produced Trumpism”. “In Britain, as elsewhere, the Thatcherite project was self-undermining. While the country Thatcher brought into being was very different from the one she inherited, it was nothing like the country she intended to fashion. Insofar as it ever existed, her Britain was a country of dutiful middle-class families prudently saving for the future. But rather than consolidating and expanding this middle class, she consigned it to the memory hole. More individualist, post-Thatcher Britain is also less bourgeois.”

An excellent piece on the problems of blockchain. For example: “The costs of maintaining a blockchain are orders of magnitude higher and the cost needs to be justified by utility. A traditional centralized database only needs to be written to once. A blockchain needs to be written to thousands of times.” And needs to be checked thousands of times, and so on. 

To find a majority in Parliament, Prime Minister Theresa May would have to reach out beyond the Conservative Party to those Labour MPs who support a softer Brexit. This would alienate large sections of the hard Brexiteers in her own party. By doing so, she would most likely find a resolution to the national crisis but provoke a crisis in the Tory Party that could lead to a historic split. Similar challenges exist within the Labour Party.”

LBC’s James O’Brien lists all the things that are more important than whether Jeremy Corbyn called Theresa May a “stupid woman”. It’s powerful stuff.

The recklessness of the Brexiters has unsettled their own country, bringing discord and instability to a once stable democracy.

Failed by both its major parties, betrayed Britain lurches towards the abyss.

The only sensible option for Britain is a second vote.

The nine lessons of Brexit. “The risks are now both a democratic crisis and an economic one. We just cannot go on as we have been: evading and obfuscating choices – indeed frequently denying, against all evidence, that there are unavoidable choices. And the public will understandably not, for a very long time, forgive a political class which on all sides of the divide fails to level with it on the choices being made.”

Interesting debate on Brexit, between a radio announcer and an MP. Worth watching.

What defines England in the age of Brexit? Self-pity.

Google’s algorithm isn’t biased, it’s just not human.

Deutsche Bank, which has been fined hundreds of millions of dollars for laundering money for Russia, was reportedly the only bank willing to do business with Donald Trump in the 1990s.

France has the highest taxes of any wealthy country says OECD.

"Both-siderism" is a feeble, lazy attempt on the part of media to "balance" their coverage by resorting to the trope that "both sides" are equally culpable. Both-siderism is false equivalency, a verbal sleight-of-hand which posits that my peccadillo is as grievous as your armed robbery. 

Three big problems to fix in 2019: re-couple economic progress with gains in living standards; decouple it from environmental degradation; make sure no one gets left behind. Good luck with all that.

One word describes America’s relationship with China: rival.

Some global banks break ties with Huawei: first HSBC, now Standard Chartered.

Dr Elon and Mr Musk. “What it’s like to work for Elon Musk at Tesla. Very stressful. As one former executive put it: Everyone in Tesla is in an abusive relationship with Elon.”

Economics: the discipline that refuses to change.

A new approach to AI fakery can generate incredibly realistic faces, with whatever characteristics you’d like.

Yep, Bitcoin was a bubble. And it popped.

Read this if you don’t want to do your money on crypto. “It may be that there will be further ups and downs in the price of deflationary cryptos… until most people wake up to the fraud. There is evidence that this is already happening as more resources are poured into developing a stable crypto.

Last week saw the release of the University of Cambridge’s 2nd Global Cryptoasset Benchmarking Study. A few interesting things in it, if you’re still remotely interested in cryptocurrencies, including an increase in the coverage of multi-coin crypto service providers (exchange, wallet and payments), along with big growth in the number of id-verified crypto asset users.  

Who controls Bitcoin?

The corruption of the Republican Party: The GOP is best understood as an insurgency that carried the seeds of its own corruption from the start.

This is an interesting piece about AI: “the progress of the entire 20th century would have been achieved in only 20 years at the rate of advancement in the year 2000—in other words, by 2000, the rate of progress was five times faster than the average rate of progress during the 20th century.”

Contrary to what more alarmist voices have suggested, a bipolar U.S.-Chinese world will not be a world on the brink of apocalyptic war. This is in large part because China’s ambitions for the coming years are much narrower than many in the Western foreign policy establishment tend to assume. Rather than unseating the United States as the world’s premier superpower, Chinese foreign policy in the coming decade will largely focus on maintaining the conditions necessary for the country’s continued economic growth

Flying cars may become a $3 trillion market in 20 years. In many ways, an aircraft is “an easier software problem to solve than an autonomous car.” 

2018 in 5 charts.

How Facebook is fuelling the French populist rage.

When the bid goes to zero. “If the US central bank is going to use the manipulation of asset prices to conduct monetary policy, then they should expect to see periods of extreme market volatility as a result.  And no amount of book equity capital can save you when the bid goes to zero.”

How China views the arrest of Meng Wanzhou. This piece draws interesting parallels between the incarceration of the Huawei CFO and the events that led to the Opium War between Britain and China 200 years ago.

"This is one of a growing number of internment camps in the Xinjiang region, where by some estimates 1 million Muslims are detained, forced to give up their language and their religion and subject to political indoctrination.” And some of the fruits of this Chinese slavery is landing on our shores, appearing in the aisles of our stores, and ending up in your drawers.

Wall Street’s four letter word: “Sell”. They try not to say it.

Diversions

New Idea’s crack investigative team has brought down an Australian government minister. And here is the website Andrew Broad used, in case you were wondering: “Where beautiful, successful people fuel mutually beneficial relationships.”

The world is turning out awesome! There’s so much good stuff happening.

Something else along similar tones – from LaTrobe Financial: “It’s unfortunate to observe that (a) pessimistic bias pervades our news cycle and our thinking. Disasters and tragedies tend to happen quickly, in photogenic snapshots. Progress, by contrast, tends to be steady and incremental and pass almost without notice. When, for example, was the last time a reporter did a live cross to report on a country that had been peaceful and democratic for a generation?”

On the other hand: The West is falling and there’s only one group of people to blame: Ourselves.

On the limits of identity politics. “There is a liberal fantasy in which identities are merely chosen, so we are all free to be what we choose to be. But identities without demands would be useless to us. Identities work only because, once they get their grip on us, they command us.”

A tale about curling: Merv Curls Lead. It has everything: A blowhard manager building a team of champions; knife-edge games; cursing, split lips, and the banging of brooms; players from all walks of life and all parts of Canada; much curling jargon. “For Merv Bodnarchuk… the small-town traditions and ideals of curling held little appeal. He was going to make big bucks out of curling, upend the game, revolutionize the sport. Merv had a business plan.”

The borderless fluidity of open-office plans was supposed to break down creativity-stifling partitions. Instead, workers have never been more isolated.

Bearing a grudge is no cause for shame. Resentments remind us that our senses are attuned. If we eliminated grievances, we'd eliminate moral judgment.

Eric Clapton’s longevity and popularity — 129m records sold — puts him in a category all of its own.

And here he is doing I Shot The Sheriff. Of course.

The broiler chicken as a signal of a human reconfigured biosphere. Scientific paper full of startling facts about factory-farmed chickens. “Human-directed changes in breeding, diet and farming practices have resulted in “at least a doubling in body size” from the late medieval period to the present in domesticated chickens, and an up to fivefold increase in body mass since the mid-twentieth century.”

Where did we come from? The “out of Africa” hypothesis has been largely discredited. It now seems that modern humans arose at different times in different places, not as a new species, but as a continuation of indigenous populations.

The past is a ‘block of reality’. As new present moments come into existence, they are added to the block, and so the block grows. On this growing block theory of time, the past is real and the future is unreal – it doesn’t exist.

I found the best burger place in America, and then I killed it.

Some funny news bloopers.

The best photography from The New Yorker in 2018.

Bees evolved from wasp ancestors around 100 million years ago. Most wasps are sleek carnivores, but bees are flower-loving, long-haired, and often social vegetarians. Their shift to a vegetarian diet had a profound effect on the evolution of flowering plants. But it is not just gloriously coloured flowers that we owe to bees... Both our world and our brains, it seems, have been profoundly shaped by bees.

It’s four years today since Joe Cocker died. I’m still Cryin’ Me A River.

And it’s Giacomo Puccini’s birthday today (1858). Bet he never thought someone like Aretha Franklin would sing Nessum Dorma one day. It’s my favourite version of Puccini’s greatest hit, although Luciano is pretty fine, of course. Check out the look on his face after the final “Vincero”. And in case you’re not sick of Nessun Dorma yet, here is Pavarotti with Plácido Domingo and José Carreras (the Three Tenors), where they do the final Vincero together, but Pavarotti shows his clear superiority. Domingo and Carreras are thin a reedy by comparison, IMHO.

Oh, and the fabulous Grace Knight turns 63 tomorrow. Happy Birthday Grace! Here she fronting Eurogliders doing Heaven. Great song.

Facebook Live

If you missed #AskAlan on our Facebook group this week (or if you don’t have access to Facebook) you can catch up here. And we’ve just given the Facebook Livestream its own page where you can also opt to just listen to the questions and answers.

If you’re not on Facebook and would like to #AskAlan a question, please email it to hello@theconstantinvestor.com then keep an eye out for the Facebook Live video in next week’s Overview.

Last Week

By Shane Oliver, Head of Investment Strategy and Chief Economist, AMP Capital.

Investment markets and key developments over the past week

• The past week saw share markets fall further on the back of ongoing worries about growth not helped by a “not dovish enough” Fed, a lack of new measures to address China’s slowdown in a speech by President Xi Jinping, threats to US/Chinese negotiations, worries about a US government shutdown, a court ruling against America’s Affordable Care Act and problems at various US companies. This all saw credit spreads continue to widen and bond yields fall. Oil and metal prices also fell but the iron ore price continued to defy the gloom and rose. While the US dollar fell against a range of currencies on the back of a more dovish Fed, the $A also fell on global growth worries.
• From their highs a few months ago global shares and Australian shares have now fallen around 15%. While it would be nice to see a decent Santa rally (Australian shares have been trying!), even if we do see one the risks remain skewed to further weakness into the early part of next year as uncertainty remains regarding global growth and investor sentiment looks like it’s still not fully washed out. However, we remain of the view that this will be more likely part of a “gummy bear” market that leaves shares down 20% or so from their highs a few months back after which they start to rally again (like we saw most recently in 2015-16) rather than as part of a long and deep “grizzly bear” market like we saw in the GFC. The main reason for this is that we don’t see the US, global or Australian economies sliding into recession anytime soon.
• In this regard while there was much to worry markets over the last week there were some positives too (but as often the case in times like these the positives get overlooked as investor fear takes over from fundamentals) that provide a bit of confidence that we are not going into a long deep “grizzly bear” market:
• First, while the Fed’s commentary following its latest 0.25% rate hike was not as dovish as the market was hoping for and Fed Chair Powell needs to get some lessons from Yellen or Bernanke in how to talk to markets it does represent a dovish shift (with the Fed softening its expectations for future rate hikes) and indicates that it is aware of the risks around global growth and financial markets. We remain of the view that it’s going to have a pause in the first half of next year and that this will provide more confidence
• Second, although President Xi’s speech over the last week offered nothing new in terms of boosting Chinese growth, the People’s Bank of China announced more targeted easing.
• Third, while President Xi’s speech and news of a US Department of Justice case against Chinese officials allegedly involved in intellectual property theft do nothing to add to confidence that there will be a solution on the US/China dispute around trade and other issues, it has been confirmed that the US and China are planning meetings in January to resolve their differences.
• Fourth, the European Commission and Italy reached agreement over Italy’s budget deficit target for 2019 (lowering it from 2.4% of GDP to 2%) thereby avoiding placing Italy in an “Excessive Deficit Procedure. This has seen a sharp fall in Italian bond yields and makes it easier for the ECB to consider a new round of cheap funding for banks.
• Fifth, the oil price plunged again taking its fall from early October to 40%. This is bad for energy stocks but its great news for households (with Australian petrol prices falling to around $1.20 a litre) and industry.
• Sixth, the fall in share markets this month looks increasingly centred around the US. While US shares are down around 10.6% month to date other markets are down by less as they already had deeper falls. So, the US share market after years of outperformance appears to be catching down as it works off overvaluation in some areas (like FAANG stocks). Chinese shares and indices for emerging markets and Asian shares fell much earlier and harder and so far are holding above their October lows.
• Finally, a year ago investors were feeling upbeat about 2018 on the back of US tax cuts, stronger synchronised global growth and strong profits and yet 2018 didn’t turn out well. So it may be a good sign for 2019 from a contrarian perspective that there is now so much doom and gloom around.
• As I write the US remains at risk of a Federal government shutdown as President Trump is still insisting on more funding for his wall, the House of Reps has agreed to that but the Senate is unlikely too. This may be just some late argy bargy as Trump tries to appeal to his base and so a Christmas shutdown could still be averted. If a shutdown does happen though it would only threaten 10% or so of government because 75% is already funded, only non-essential services would shut and many public servants still work and get paid once it ends.
• Australia saw some good news over the last week with the mid-year budget review confirming that the budget is in much better shape than expected in May providing scope for tax cuts next financial year. In fact, the Government is even budgeting for tax cuts of around $3bn a year starting from next July and yet still projects rising surpluses. That said a $3bn a year tax cut is just 0.1% of GDP so it would be a pretty small stimulus (maybe $6 a week for an average earner which won’t buy a lot these days). The other issue is that the budget numbers may not get much better than this given threats to global growth (and hence commodity prices), wages growth continuing to run below the Government’s assumptions and signs from job ads that employment growth may start to slow.
• Meanwhile also in Australia, it’s hard to get too excited by APRA’s removal of the 30% cap on the proportion of mortgage lending that can go to interest only borrowers. This served its purpose well when it was introduced in March last year when interest only lending was north of 40%. But now it’s running around 16% and so the cap has become irrelevant, the focus has shifted away from arbitrary lending caps to a focus on  “responsible lending” (hence the focus on borrower income, expenses and total debt) and with property market psychology now very negative the desire for interest only loans has shrunk and banks are a lot more reluctant to make them. So, it’s doubtful that the removal of the cap will have any impact on property lending or property prices where we continue to see further weakness in year ahead. In fact, since the removal of the 10% growth limit on lending to investors in April lending growth to property investors has just slowed to record lows.
• Our view remains that the RBA will cut the official cash rate twice in 2019 taking it to 1%.

Major global economic events and implications

• US data releases were mixed with a rise in housing starts and home sales but another fall in home builder conditions and softer December readings for the New York and Philadelphia manufacturing conditions surveys.
• The Bank of Japan left monetary policy unchanged in ultra-easy mode and with core inflation in November at 0.3%yoy its set to remain that way for a long while yet.
• The Bank of England also left monetary policy on hold which is not surprising given the Brexit mayhem.

Australian economic events and implications

• Australian jobs data for November was mixed. Headline jobs growth remained strong but the quality was low with full time jobs falling and unemployment and underemployment actually rose. What’s more skilled job ads fell again as they have been since March pointing to softer jobs growth ahead.
• Meanwhile population growth remained strong at 1.6% or 391,000 people over the year to the June quarter with 60% coming from immigration. So it remains a source of support for headline economic growth and for underlying housing demand, assuming immigration levels are not radically cut.

What to watch over the next three weeks?

• In the US, the main focus will be on December labour market data (due Jan 4) which are expected to show a solid 180,000 rise in payrolls, unemployment flat at 3.7% and wages growth still around 3.1% year on year. In other data, expect consumer confidence (Dec 27) to remain strong, a pullback in the December manufacturing ISM index (Jan 3) and the non-manufacturing ISM (Jan 7) to readings around a still solid 57-58 and core CPI inflation (Jan 11) to remain around 2.2%yoy. Public comments by Fed Chair Powell on Jan 4 will likely support our expectation for a Fed pause.
• Eurozone data is expected to show core inflation (Jan 4) still low around 1%yoy and unemployment (Jan 9) flat at 8.1%.
• Chinese business conditions PMIs for December (Dec 31 and Jan 2) will be watched closely to see if the slowdown in the Chinese economy is stabilising. December data due for release around Jan 7 is likely to show inflation remaining low and growth in imports and exports remaining subdued and credit data to be released around the same time will be watched for the impact of recent policy easing.
• In Australia, expect credit growth (Dec 31) to remain modest, CoreLogic data for December to show another fall in dwelling prices (Jan 2)(Sydney and Melbourne prices are reportedly already down more than 1% for December so far), building approvals (Jan 9) to remain in a downtrend and only modest growth of 0.2% in November retail sales (Jan 11).

Outlook for investment markets in 2019

• With uncertainty likely to remain high around US interest rates, trade and growth, volatility is likely to remain high in 2019 but ultimately reasonable global growth and still easy global monetary policy should drive stronger overall returns than in 2018 as investors realise that recession is not imminent: 
• Global shares could still make new lows early in 2019 (much as occurred in 2016) and volatility is likely to remain high but valuations are now improved and reasonable growth and profits should see a recovery through 2019 helped by more policy stimulus in China and Europe and the Fed having a pause.
• Emerging markets are likely to outperform if the $US is more constrained as we expect.
• After a low early in the year, Australian shares are likely to do okay but with returns constrained to around 8% with moderate earnings growth.
• 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 some 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% led again by 10% or so price falls in Sydney and Melbourne on the back of tight credit, rising supply, reduced foreign demand and tax changes under a Labor Government impact.
• Cash and bank deposits are likely to provide poor returns.
• Beyond any near-term bounce as the Fed moves towards a pause on rate hikes next year, 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 still 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.