Kohler's Week: China awakes from the dream, Greece oh Greece, American economy, Eureka Interactive

Last Night

Dow Jones, up 1.2%
S&P 500, up 1.25%
Nasdaq, up 1.54%
Aust dollar, US74.5c

China awakes from the dream

Two reliable but unknown barometers of the popular media’s appetite for a particular financial matter are what time I get the first call from the ABC’s hard-working network news desk and what time in the 7pm bulletin they run my little spot. Usually I get the first call from Rob or “Shove” at 3.30pm and I usually appear on the screens at 7.20pm. But on a few days this week the call has arrived in the morning and I’ve been bumped up in the bulletin; the same thing happened last week.

This means something happened in the financial world that impinges on the popular psyche, usually because it’s scary (markets going up is not as interesting, so I stay at 7.20pm). This week the scary thing was China, last week it was Greece. 

The media love a good crisis and generally try not to spoil it with sober analysis. A 30 per cent stock market crash is a joyful event, especially one that’s far away and especially if it’s in a supposedly socialist country, so lots of fun can be had by all – hell, I happily joined in the other day with this piece in Business Spectator entitled “Socialism, let me introduce capitalism”  (it’s a subscription article – if you’re not a subscriber, sorry about that, but you get the gist of it).

Eureka Report, however, is nothing but sober analysis.

You’re probably not a dabbler in the Chinese stock market, so the question of whether it now represents a buying opportunity is not directly relevant. But it’s certainly indirectly relevant to you as an investor and resident in Australia.

It may be a buying opportunity rather than the start of a bear market, such as the one that began in Japan in 1990, but that’s a pure guess and I’m certainly not going to back that view with actual hard-earned money. It just looks more like an October 1987-style very nasty correction to me, rather than the end of a bull market.

One thing on my inexpert (about China) mind is that the Chinese share market is usually described as a casino, which appears to be true: it is the plaything of a small number of relatively wealthy Chinese gamblers who want to do something other than travel to Macau for a punt at the tables. There are about 90 million brokerage accounts, but most people have two (one for Shanghai and one for Shenzhen) and many have multiple accounts so they get bigger allocations in IPOs, so there are probably fewer than 30 million actual “investors” -- less than 2 per cent of the population. The Chinese love gambling and these people are the ones who have enough of a stake to enter that particular casino.

I don’t know much about gambling, don’t do it myself, but I imagine that gamblers are used to losing, and having lost, tend to go back for more, otherwise there would be no gamblers left. They don’t suddenly take the pledge and swear off the sauce. Of course the 30 per cent crash would have wiped out many of the margin traders, so they won’t be back for a while, but on the whole I’d say it’s: "I bet on red but black came up – oh well, I’ll be lucky next time."

On more substantive reasons than the psychology of gamblers to be relatively optimistic, here's a graph from Ken Courtis of Starfort Investments in Hong Kong, who I’ve met a few times at the Davos Connection conferences at Hayman Island.

Not sure if you can read the small print there, but essentially he’s saying that it’s not yet a crash – the market has given up about a third of what it gained in the past 12 months and this follows a seven-year bear market which started with the "popping of the Bush Bubble". It’s not in any way comparable, says Ken, "with the Japanese crash of 1989, when the stock market lost 85 per cent of its value, and 25 years later still hasn’t got back half of what it lost (see 30-year Nikkei chart below):”

But look, the future is unknowable. That initial three-month fall in the Nikkei from December 29th 1989 to early April was 25 per cent. I’m sure the Japanese were feeling alert but not alarmed, shaken but not stirred, at that point. “Ouch”, they would have been saying. “That hurts, but it’s a buying opportunity!” The Nikkei duly rallied 10 per cent before falling another 40 per cent by September.

One of the reasons for the general panic this week was that the Government appeared to panic, which is never good. The measures announced to stop the market falling and get prices back up were extraordinary, unprecedented – “whatever it takes”. It turned a stock market crash into a major political event.

Why did it do that, apart from the laughable notion that market crashes shouldn't occur in a socialist country and Something Must Be Done?

There have been a lot of theories put forward about the Government’s actions, including that it’s worried about a financial crisis, that it wants to privatise state-owned enterprises and therefore needs a strong equity market, or even that President Xi Jinping is using the market to keep the members of the Communist Party happy while he cracks down on corruption.

I think it’s just pure politics: the Government was cheer-leading the rally, saying that it represented tangible evidence that its policies were working to deliver the “Chinese Dream” (a socialist, non-democratic version of the American Dream). By intervening so frantically in the market this week it was just trying to preserve its credibility and popular support through the tried and trusted Chinese Government method of: “when in doubt, cover it up.”

Problem is, it won’t work and the Government will simply look powerless, and lose credibility. Long-standing western governments have long-since learned not to stand in front of a financial tidal wave with your arms outstretched in front of you, and instead focus on the clean-up operation.

So the Chinese Communist Party leadership will learn some valuable lessons out of this, and one of them might be that it is difficult, maybe impossible, to reform and transition an economy without a period of low growth and a rise in unemployment.

The stock market bubble happened because the authorities were trying to pump the economy up with liquidity and credit while transitioning away from heavy export industries towards a more service-related domestic economy, as well as cracking down on corruption and introducing market reforms. Debt-funded infrastructure and the margin-loan funded stock market boom were part of what they hoped would be a Chinese miracle: painless reform and transition.

Unlikely. The stock market crash probably means that growth will have to be allowed to fall to much less than the 7 per cent Government target, possibly as low as 5 per cent or less.

This is not good for Australia and probably means we are in for a technical recession, as export volumes decline on top of the price decline that’s already happened.

Greece, oh Greece

The moment of truth for both Greece and the eurozone has finally arrived. Tomorrow is the last, final deadline. Past behaviour suggests that a deal will be cobbled together and disaster will be avoided, which is what I have always believed and still do. But there are many more problems now than there have ever been before: it’s more difficult  than ever to hide the fact that Greece’s numbers don’t add up, the referendum has made it politically difficult for the Government to actually implement austerity and unlike at any previous deadlines, this time the banks are closed and obviously bust.

Yesterday the Greek Government sent its latest reform plan to the Eurogroup for consideration, asking for €53.5 billion. This morning it has been comprehensively leaked. There are three letters – one from Alexis Tsipras, one from the new finance minister, Euclid Tsakalotos, and one detailing the proposed reforms.

The FT has posted them herehere and here.

In summary they completely ignore the result of the referendum last Sunday and plead to be allowed to stay in the Eurozone. There is no mention of debt relief, which is probably why Yanis Varoufakis resigned, they agreed to the creditors’ demand to find new VAT revenues of 1 per cent of GDP and, as part of that, to tax processed foods at the normal VAT rate of 23 per cent. The proposal maintains a primary surplus of 3.5 per cent of GDP by 2018 and retains the progression of 1 per cent this year, 2 per cent next year and 3 per cent the year after.

There remains a gap on taxing the islands: the creditors want one rate for the whole country, while the Government has hung onto the idea of taxing the islands at a lower rate of VAT because many are remote and expensive to service, and there is also a gap on pension reform – the creditors want the proposed reforms done immediately, while Government wants to wait until October this year, which is not a big difference. And apart from that the Government has acceded to all of the creditors' demands.

There are two problems with this: it’s an answer to a question that no longer exists, since the creditors proposal was withdrawn, and Angela Merkel made it clear that any new plan requesting a lot more money than the €7.2 billion that the last one was about (such as €53.5 billion) would have to be very different. More would have to be done. The proposal submitted yesterday does less.

And second, the referendum result strips away what’s left of the Greek Government’s credibility. There wouldn’t be much confidence anyway in Brussels and Berlin that it could actually implement the reforms proposed, but since 61 per cent of the people voted against them last week, the confidence would be zero.

Nevertheless there are three scenarios now:

1. The creditors basically accept the latest reform plan and accept that it can be implemented – kicking the can down the road, except this time there would have to be capital controls, because the people would be unhappy and also disbelieving, and more inclined than ever to get their money out. With Cyprus, capital controls lasted two years. Since the Greek economy is already in recession and the proposal requires more fiscal austerity and debt relief, the Syriza party will probably split and dump Alexis Tsipras. He might still command a majority in Parliament by getting the support of the Opposition, but an election would have to be likely, and given the result of the referendum, instability is guaranteed. Also, the banks would still have to be recapitalised, either by giving depositors a haircut or the ECB putting more eurozone taxpayers’ money in as equity.

2. Immediate exit from the eurozone. This would come about if the ECB decided the banks were no longer solvent, since Emergency Liquidity Assistance, which has been keeping them alive till now, is provided on the basis that they are solvent and have a temporary liquidity problem. If the ECB decided that they weren’t solvent, ELA access would be cut overnight and the Government would have to nationalise the banks and issue a new currency. The losses to the Greek population would be colossal and Greece would require humanitarian aid.

3. Slow exit. This would probably involve some kind of parallel currency, and since members of the eurozone can’t issue a separate currency, this would have to be IOUs issued to pensioners and others inside Greece whom the Government owes money to, which can then be used as legal tender in payments to the government and transferred between people. I know, it’s semantics to not call this a currency. After all, that’s what bank notes are – IOUs. But that fiction would at least allow the ECB to keep providing ELA so the banks remain open, although they would still need to be recapitalised, presumably by depositors taking a haircut. 

Either way Grexit would be very negative for the Greek economy and lead to an even deeper and longer recession than they have already suffered. That really should have been explained better before the referendum.

I’m still clinging to the view that the first is most likely, but with much less conviction than before. Grexit is now a real chance. 

It would not mean a full break-up of the euro, and with the ECB’s open-ended QE program the immediate contagion risks would be very limited. There may be long-term political implications though. If Greece exited, it would prove that it can be done, which would theoretically encourage the anti-EU forces in Europe. Then again, if Greece became totally penniless and required humanitarian aid as a result of Grexit, then maybe it would be a force for cohesion in the EU rather than further exits.

So far there is not much sign of contagion in the bond markets and the ECB is printing plenty of money (see these charts from Societe Generale):

And here is what the market thinks of the Greek banks: their bonds are currently trading at 25c in the dollar, down from 100c just a year ago.

Below is a note that Clay Carter sent me this week about how best to invest in Greece’s future:

"National Bank of Greece (largest bank in Greece) has an ADR that trades in the US. Its symbol is NBG US. It is off 60 per cent YTD.

It is liquid – 29 million shares traded last night.

It is the best way to play Greece. 

It closed at $US0.99 and is now a "penny" stock

If you think Greece will stay in the EU and the banks "survive" this is the way to make a bit of money

I bought some early this AM but with money I can afford to lose. If Greece goes to the drachma this goes to zero.

It might be hard to get set at a reasonable price. I would suggest a limit order, say $US1.10 or better.

Short interest is 20 per cent of the float so any positive news will send this thing to the moon.

Regards

Clay".

American economy

In all the excitement about China and Greece this week, the US is being ignored, including the minutes from the last Federal Open Market Committee (FOMC) meeting (not surprisingly).

The general reaction was that the FOMC is more cautious because of what’s happening abroad, which is great news since the US economy is now doing fine and if the first rate hike is delayed because external events stay the Fed’s hand, well that’s a plus for growth and the markets.

"While participants generally saw the risks to their projections of economic activity and the labor market as balanced, they gave a number of reasons to be cautious in assessing the outlook.” They then went on to list the reasons, which aren’t worth going through here, but there were a few.

On Greece, the minutes said: "many participants expressed concern that a failure of Greece and its official creditors to resolve their differences could result in disruptions in financial markets in the euro area, with possible spillover effects on the United States.”

Yet despite all the turmoil and uncertainty in Europe and Asia, the US is showing a lot of resilience.

The economy is on track to bounce back from the first contraction, with growth of at least 2.2 per cent, possibly more. Retail sales rose 1.2 per cent from April to May, and consumer sentiment surveys show confidence at post-GFC highs. There were 223,000 new jobs in June, continuing the solid pace of new hiring that’s been going on for a while.

The housing market is also rebounding, after a bad patch last year. Existing home sales were up 5.2 per cent in May, and prices were up 7.9 per cent from the year before. New home sales rose 2.2 per cent in May, and were up 19.5 per cent from the year before. New housing starts fell 11.1 per cent from an extraordinary 22.1 per cent rise in April, but were still up 5.1 per cent from a year ago. Construction spending rose a 0.8 per cent in May, up 8.2 per cent from the year before.

The only real weak spot is manufacturing, with declines in industrial production in both April and May. 

If it weren’t for the potential for contagion out of Greece and/or China, a September rate hike would be a lock.

So whichever way you look at it, the rest of 2015 will be rocky: either China and Europe get worse, which will be bad for markets, and if they don’t the US will hike rates, which will be bad for markets.

Eureka Interactive

I did two live interviews this week – one on the phone and one on video. With each of them the number and quality of the questions from subscribers watching and listening was great! And don’t forget if you can’t make the actual event, you can lodge a question ahead of time if you want and I’ll ask it.

The phoner was Russell Baskerville, the managing director of Empired, which is the Perth-based IT services business that our analyst Simon Dumaresq currently has as a buy, with a target price of $1.05 (currently it’s 77c). Here’s Simon’s most recent note on the company, and here’s a link to the interview.

The video was Nigel Finch, chairman of 3D Medical, in which my super fund holds a few shares. I put it to him that what’s going on in the world of 3D printing is a land grab – companies attempting to establish a first-mover position that will produce solid revenue and profits later. He agreed. You can watch or read the interview here.

10th Birthday

We had a party the other night for our 10th anniversary, and there were speeches, drinking, nibblies, some satisfaction at having lasted 10 years and plenty of laughter (which got louder as the night went on). And a palpable presence in the room was you, dear member, the person for whom we are all working.

Speaking personally, it's been a wonderful decade of serving, and trying to delight, a group of the most discerning individuals. There can be nothing more satisfying than meeting the high standards of shrewd and demanding customers, and that’s what you represent for us. It’s a privilege to work for you.

Readings & Viewings

This is four years old, but I’ve just seen it for the first time. “The Ship Song Project” – it took a year to film at Sydney Opera House, with a whole lot of great singers doing a part of the song each. It’s fantastic.

Great, inflammatory (as usual) speech by Nigel Farage on Greece, talking directly to Alexis Tsipras: “the European project is starting to die” and “Mitterand and Kohl were monsters” and “you should lead the Greek people out of the Eurozone with your head held high". Watch it!

Ambrose Evans-Pritchard: Germany is at last bowing to pressure from a chorus of voices to give Greece some debt relief.

This is a fantastic, if difficult, article on Greece, by Professor of International Economics at the London School of Economics, Paul de Grauwe.

And here is a piece from Bloomberg that simplifies it: Greece will live or die by this formula.

 

Greece: a nation of tax cheats, welfare frauds and early-retirement pensioners living off of other people's money.

Michael Keating (former Treasury Secretary): What has so far escaped attention is how Greece, while locked into the euro, has become completely uncompetitive.

Good summary from Reuters of the latest situation with Greece.

Missed Greek and Iranian deadlines meet geopolitical reality (not sure if this is subscription or not – if it is, sorry!)

Greece’s No is no victory for democracy.

And an excellent analogy for the referendum (very short video).

And a relevant clip from Chopper (the movie) - “Nev, if you don’t give me the cash in 20 seconds, I’m going to shoot you”.

This is a column by John Pandazopoulos, President of the World panHellenic Inter Parliamentary Association, whatever that is, and a former Victorian Government minister. He’s been visiting Greece lately, and writes about their tax avoidance habits, e.g.: "The amazing thing is that most businesses actually bill you for the VAT and, rather than pass it on to government to pay for public services, they pocket it.”

Some stuff you should know about Greece before you lose your shit.

They’ve been negotiating in bad faith.

(Sorry about all the Greek stuff, but there has been so much fantastic material published in the past week, I couldn’t resist passing some of it on.)

A good video rant by Waleed Aly on The Project about the Trans Pacific Partnership trade deal.

Five reasons why Beijing’s market stabilisation has failed.

Another five: Five peculiar things about China’s market meltdown.

The 30 per cent fall in the Chinese sharemarket over the past month should be viewed as a "significant price correction" rather than an "ominous sign" about economic growth, says AMP Capital.

Fantastic piece on what the Chinese crash looked like from the inside.

Optimistic forecasts by the Reserve Bank have left us ill-prepared for the fallout from China’s stockmarket collapse.

Good piece by Gay Alcorn on the Bill Shorten Royal Commission hoo-haa this week.

Australian house prices are 30 per cent undervalued, says Reserve Bank official (in personal capacity).

I interviewed Michael Hewitt-Gleeson for my Qantas radio show this week. He started the lateral thinking movement with Edward de Bono in the 1970s and now runs what he calls the “School of Thinking”. He’s an interesting guy -- it’s worth a look.

Paris’s first skyscraper in 40 years is, as you would expect, amazing.

The “hyper-loop”, Elon Musk’s astonishing idea for rapid transport, is closer than you think.

Ha! “Craft coffee” is becoming the province of chin-stroking joy thieves.

Autonomous cars could spell the end of the taxi industry. Is that a good thing?

Where is Google taking us?

Why we’ll never have an iconic record cover like Dark Side of the Moon again.

It’s the 14th anniversary of The Office, the Ricky Gervais TV show. Here is someone’s idea of the 14 best moments.

And on the subject of Ricky Gervais, here’s a wonderful video of him with Larry David, creator of “Seinfeld”. (Warning, there is lots of swearing in this)

At the Coney Island hot dog eating contest on July 4th, some idiot ate 61 in 10 minutes.

Happy Birthday Gough Whitlam, born on this day in 1916, and died last October. Here he is speaking at the National Press Club in 1985.

And here is Noel Pearson’s marvellous eulogy at his funeral. Loved the way he referred to him as “this old man”.

And happy birthday Suzanne Vega, 55 today. Here she is doing Luka.

Next Week

By Craig James, Commsec

Business and consumer confidence focus

The domestic economic data dries up over the coming week with more of the ‘second tier’ indicators in focus. Of particular note is the business confidence survey on Tuesday. However it is a different story on the global front with a plethora of ‘top tier’ indicators slated for release. In China, economic growth, trade and retail sales figures are in focus. And in the US, retail sales, inflation and the Fed Beige Book are due. Investors will also spend time dissecting US earnings results.

In Australia, the week kicks off on Monday when the Reserve Bank releases May data on credit and debit card lending. Consumers are using credit cards more often but paying off outstanding balances by the due date. Also on Monday broader lending finance data – covering personal, business, housing and lease loans – is released.

On Tuesday, the NAB business survey for June is released. Investors will be hoping that confidence and conditions build on the upbeat May result. Business confidence is holding at a nine-month high supported by the Federal Budget policies to drive business activity. Of interest will be the demand for new borrowings. In May, the proportion of firms reporting that they did not require credit fell from 72 per cent in April to 50 per cent. More borrowing should essentially lead to more investment and a lift in broader economy activity in coming months.

On Wednesday, the Westpac/Melbourne Institute monthly measure of consumer sentiment is released – a survey that provides a useful check on the similar and timelier Roy Morgan weekly survey (released on Tuesday). The ongoing global concerns surrounding a potential Greek exit from the Euro zone, and the rout in Chinese sharemarkets is likely to dampen sentiment. Also the ABS will release figures on dwelling commencements for the March quarter.

Also on Wednesday the Bureau of Statistics (ABS) recasts the industry data on new car sales, converting the original data into seasonally adjusted and trend estimates. The Federal Chamber of Automotive Industries has already reported that a record 125,850 new cars were sold in June, up 6.4 per cent on a year ago. Interestingly we may be seeing a mixed picture on consumer spending but the same cannot be said for sales of sports utility vehicles (or four-wheel drive vehicles). It is clear that demand for SUVs is the main driver of vehicle sales, scaling new heights in June to be up almost 15 per cent on a year ago. In fact just over one in three new vehicles sold in Australia is a SUV.

Overseas: Chinese economic data takes centre stage

The US and China vie for economic dominance over the coming week. Investors are likely to focus more on the Chinese economic data given the recent rout in share markets and also due to the release of economic growth figures for the June quarter. In the US, inflation and retail sales figures will be closely watched, while the rest are largely ‘second-tier’ readings.

The week begins on Monday when June data on Chinese trade is released. A trade surplus of US$55 billion is expected, largely due to the anticipated pullback in imports (-16.0 per cent in June).

On Tuesday, the ‘top shelf’ US indicators make an appearance. May figures on retail sales are issued together with the data on business inventories. Economists expect that sales lifted by 0.3 per cent in June after a 1.2 per cent lift in May. Excluding autos, sales may have lifted by 0.6 per cent.

On Wednesday, the Federal Reserve Beige Book is released alongside the Empire State manufacturing survey, industrial production figures and the producer price index (PPI). Probably the most influential is the Beige Book – a summary of conditions across 12 Federal Reserve districts. The report will be a key input to the decisions made by Federal Reserve policymakers at their next meeting. Business inflation should remain contained with a lift of 0.3 per cent expected for June. Better results for manufacturing and industrial production are expected.

 In China, on Wednesday economic growth (GDP) figures for the June quarter will be released. The economy is probably growing at a 6.8 per cent annual pace. On the same dayChina’s National Bureau of Statistics issues the usual monthly activity readings, covering retail sales, production and investment.

On Thursday, the National Association of Home Builders (NAHB) index is released alongside the Philadelphia Fed Business outlook. The usual weekly data on claims for unemployment insurance is also released

And on Friday four indicators are expected. The indicators include consumer prices, housing starts, building permits and the preliminary reading on consumer confidence for July. US housing starts are tipped to lift from 1.04 million to 1.1 million in June. New building permits are expected to have fallen by around 12 per cent in the month.

The core reading of consumer prices (excludes food and energy) is tipped to have lifted just 0.2 per cent in June to be up 1.7 per cent over the year - giving the Federal Reserve ample time before needing to commit to the first rate hike.

Sharemarket, interest rates, currencies & commodities

The US earnings season cranks up a notch in the coming week. According to FactSet, across the S&P 500 index earnings are expected to fall 4.5 per cent in the second quarter – marking the first drop since the third quarter 2012. Interestingly when the energy sector is excluded, earnings are forecast to have lifted by 2.2 per cent.

And while hopes aren’t high for a good season of profit results, the contrarian view may prove more rewarding. Analysts issued similar downbeat predictions ahead of first-quarter earnings, as well, forecasting a 4.9 per cent decline in S&P 500 earnings. In the end, profits grew by 0.8 per cent and by an even better 8.6 per cent excluding the energy sector.

 On Tuesday, six companies are expected to report including Johnson & Johnson, JP Morgan Chase, Wells Fargo, and Yum! Brands. On Wednesday there are another eight companies listed including Bank of America, Intel, Netflix, and Delta Airlines. On Thursday, earnings results are expected from 13 companies including Citigroup, eBay, and Goldman Sachs. And on Friday there are six companies listed including General Electric and Honeywell International.

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