Kohler's Week: Jobs, Banks, Bonds, RBA shanks it, Talga Resources, Bulletproof

Last Night

Dow Jones, up 1.49%
S&P 500, up 1.34%
Nasdaq, up 1.18%
Aust dollar, US79.3c

US Employment

Job numbers rebounded in April according to figures out this morning and the US unemployment rate fell to its lowest level in seven years – 5.4 per cent. Payrolls rose 223,000 in April, but the March figure was revised down to 85,000. 

Most importantly the quick consensus from Wall Street analysts was that while the report was good, it wasn't good enough to force the US Federal Reserve to hike rates before September, which is when most of them think rates will start rising this year. The senior global strategist at Wells Fargo Investment Institute, Scott Wren, summed it up for Marketwatch: “It was a healthy jobs number, indicating the economy is doing OK, but it's unlikely to sway the Federal Reserve too much.” As a result, the stockmarket had a big session, with the S&P 500 up 1.3 per cent and the Dow up 1.5 per cent.

Here's a chart of the quarterly jobs growth (monthly numbers jump around too much, so no one really takes much notice of them, especially the Fed). You'll see that the most recent two quarters are lower than the previous two and a half years:

And the other thing that will keep the Fed's finger off the trigger, is wages growth and hours worked, both of which remain fairly weak:

Of course the other reason markets went for a run last night is the result of the UK election. Apparently all the Tory voters were shy and didn't tell the pollsters what they were doing, so Cameron's victory was a big surprise.

The FTSE in London jumped 2.3 per cent as a result and that mood more than spread to Europe, where the Euro Stoxx 50 was up a remarkable 2.8 per cent.

And you may be pleased to know that there was a surge in bond prices as well – yields fell across the board, but especially in Germany. All of which augers pretty well for decent gains on the Australian market on Monday.

Banks

This chart is telling:

It shows the Australian bank share price index (red) and the five-year bond yield inverted (blue), which is effectively the bond price.

The chart is telling you that the key reason for the sudden fall in bank share prices this week is what's happening in the bond market – it isn't to do with their profits.

I talked about the bond market at length last week and warned that bank share prices would come under pressure, and so they did.

So to the extent that reporting of this week's bank sell-off focused on their first half earnings reports, it missed the point. The big four reported cash profits totalling $15.4 billion, up 10.7 per cent – nothing wrong with that. Most increased the dividend to no avail. Even CBA's flat quarterly earnings didn't warrant the 5.9 per cent crunch that followed.

To drive the point home, the average rise in the banks' yields this week, as a result of the share price falls, was LESS than the increase in the bond yield, which implies that their earnings results actually mitigated the effect of the bond market sell-off on their share prices.

On Monday morning the total market cap of the big four banks was $431.67 billion. The total dividend for the previous 12 months was $9.59 – so a yield of 4.99 per cent (the yield was dragged down by CBA's yield of 4.59 per cent; the others were all above 5).

Now their total market cap is $417.57 billion; total dividend $9.80; average yield 5.29 per cent – an increase of 5.95 per cent over the week.

On Monday morning the five-year bond yield was 2.106 per cent; now it's 2.3469 – an increase of 11.44 per cent.

Bonds

This graph from Dave Rosenberg of Gluskin Sheff, via Business Insider, provides the context for what's happening:

It's the global 10-year bond yield back to 1522 (not sure where he got the figures for the 16th and 17th centuries, but let's assume he's got a really old version of Bloomberg).

The message is that yields have only been this low twice before, in the history of the world. The low in 1932 is pretty obvious, but I'm not sure what happened around 1580, apart from the Spanish Armada.

This time there's no war with Spain and no Great Depression – just a bubble, a game of pass the parcel based on incorrect forecasts of Armageddon.

As I wrote last week, the action lately has been led by German bunds, which began to spontaneously combust a bit less than two weeks ago, probably in response to Bill Gross' call that they were the “short of lifetime”.

Here's what the German 10-year bund yield has done in the week since my last email to you:

The yield was 0.37 last week; now it's 0.59, having touched 0.8, getting a bit disorderly.

And here's a 12-month perspective on bunds:

According to the Merrill Lynch bond index, the global bond market has lost about $US350 billion in value over the past two or three weeks.

To put that into context, the bond sell-off in June 2013 that became known as the “taper tantrum”, because it was sparked by a Ben Bernanke comment that QE would soon be tapered, wiped $US1.5 trillion off the value of global bonds – so this one is not yet in the same league.

However – and it's a big however – during the 2013 “taper tantrum” the Aussie banks corrected 12 per cent; so far this time they have fallen 11 per cent already, so the impact on the banks of this bond correction is proportionally much greater than the one in 2013 (because bank valuations are more stretched).

Back to the bond market … the questions now being asked are what caused the bond fire, and is this the end of the great bond bull market?

I think it's pretty clear that the cause is rising inflation and GDP growth in Europe, primarily because of the ECB's QE.

First, inflation:

Source: Societe Generale

In addition to that, euro area growth has now been positive for two years and is beginning to accelerate, and the good news is that the growth is solidly based on private consumption, net exports and investment, as this chart from RBC Capital Markets shows:

Bond markets were priced for deflation and catastrophe in Europe and not only has the worst not happened, it's pretty clear that it won't, thanks to the ECB printing money.

Markets are also beginning to come around to my view that Greece will not default or exit the eurozone: apart from anything else, the Greek ‘crisis' has been dragging on for so long now that it loses all meaning.

It's important not to get distracted by idiots and brush fires, and to remain focused on the big picture.

And the big picture is this: global bond yields are rising because the final thing to be worried about, after years of ticking off the worries one by one – European deflation and depression – is no longer worrying.

There's also probably an element of the market anticipating the ‘lift off' in the US Fed funds rate – whether that happens in June, September or December.

In 1994, when Greenspan started raising rates, the bond market collapsed, but in 2003-04, when rates again rose, the bond market took it in its stride. So who knows?

Maybe something else will come up to worry about and send bond yields back down, but for the moment all the pressure is for higher long-term rates – not necessarily for another “tantrum” but steadily rising bond yields.

That means the price paid for Australian bank dividends will steadily fall, with a few jerks along the way (bond volatility has risen sharply).

Meanwhile, with unemployment rising and the housing market approaching a peak, the banks are not going to be in a position to offset that by increasing their cash dividends.

The conclusion is self-explanatory: if you're trading bank shares, it's time to sell. If you bought a while ago for income, hang in there but expect a paper loss – but only from what you thought you had, not what you actually paid.

Investing in Greece

By the way, a few people have written to me following my bullish call on Greece, to ask how to invest in it.

I think the only ETF is listed in New York (code - GREK.ARC) which is clearly the best way to do it, if you're interested; there isn't an ETF in Australian dollars. Apart from that you'd have to invest in individual stocks listed in Athens, which is more complicated and risky.

Yellen about valuations

One of the things markets think they might have to worry about is equity valuations, especially in the US. That was highlighted this week by a remark by Federal Reserve chair Janet Yellen that valuations “are generally quite high”.

The US market promptly sold off 0.3 per cent and ended the day 0.5 per cent lower.

But Yellen's record in sharemarket diagnostics is not great: in July she last year she called biotech stocks “substantially stretched”. Since then they have rallied 22 per cent.

US equity valuations are not particularly stretched, as this chart of average price earnings ratios during economic expansions over the past 50 years demonstrates:

RBA shanks it

The Reserve Bank surprisingly mucked up this week's rate cut by explicitly removing its easing bias at the same time. The result was that the Aussie dollar went up instead of down.

I know the boffins of Martin Place will say they are not necessarily targeting the exchange rate, but … yes they are.

Glenn Stevens seems to have been saying forever that the currency should be US75c, and he almost got it there a month ago when it hit a low of US75.33. Since then the iron ore storm has passed and the price has rallied from its low of $US47 to $US61, and weakening US data has seen the US dollar index decline 5 per cent.

Result: AUD at US79-80c. Yesterday the RBA tried to reintroduce an easing bias, but the markets had moved on.

If the exchange rate indeed bottomed at US75.33c and is stuck around US80c for a while, this is very bad news for the Australian economy.

Monetary policy itself has lost its ability to stimulate the economy, and the fiscal policy certainly won't. The Government will be pulling back the deficit for years.

The exchange rate is more important than it has ever been in supporting economic growth, specifically by encouraging business investment.

At US80c it simply won't do it. Glenn Stevens is right: it needs to be US75c or less, and more importantly businesses need to see that rate as permanent and reliable.

As things stand, the rate is too high and too unreliable to prompt any increase in investment. For that reason, the economy will continue to weaken.

Talga Resources

I do these CEO interviews simply to introduce you to interesting ideas, and this week's is a ripper.

Talga started out as an explorer with some gold near Marble Bar. It floated in 2010, but two years later its CEO and 10 per cent shareholder Mark Thompson didn't like what he was seeing in the gold market, and commodities generally, and he was dead right.

So he went looking for something else and came up with five deposits of graphite in north Sweden – about as far from Marble Bar as it's possible to get (especially in temperature).

Now Talga is building a pilot plant in Germany to make graphene, the wonder substance that everyone's talking about and which sells for thousands of dollars per kilogram, if you can get it.

Thompson says Talga's graphite is such that it can produce graphene in bulk quantities and at much cheaper pries – in other words that he can transform the graphene market.

A scoping study on the resource last year conservatively estimated the pre-tax net present value at $490 million. The current market cap of Talga is $60 million (share price is 43c).

As always I haven't done enough work on the stock to know whether it's a buy or not, but I certainly think it's interesting. And by the way, thanks to subscriber Andy Bellingen for the suggestion.

You can watch the interview and/or read the transcript here.

Bulletproof

I interviewed the CEO of Bulletproof, Anthony Woodward, last November, but cloud computing is such a fast-moving space I thought I should talk to him again.

Since November Bulletproof has bought a consulting business and increased half yearly revenue by 46 per cent and profit by 20 per cent. Meanwhile the share price has fallen 30 per cent.

You can watch the interview and/or read the transcript here.

Readings & Viewings

Video of the week. This is Tesla's Elon Musk presenting the Tesla Powerpack – the wall-mounted battery that the electric car company launched a week ago to solar power from the roof. It's not just a sales pitch but a really interesting glimpse into the future of energy, I think, and well worth watching to the end (18 minutes).

Here's my son Chris, doing a video for The Australian, where he works. A chip off the old block, but far more handsome than his old man!

If Greece had not existed, Europe's leaders would have had to invent it.

I don't know if you've heard of the Jarvis Cocker song, “Common People”, well apparently everyone thinks it's about Yanis Varoufakis's wife, Danae Stratou. I'm not sure if that's interesting or not, but it's quite a good song.

The British election: the conduct of the press was perhaps the biggest issue.

Forget neck and neck – the UK election was a terrible trouncing.

Why we vote the way we vote.

What should you learn from Machiavelli? 

Michael Lewis: everywhere you turn in Greece, you now see that ordinary feelings of self-preservation have been suspended.

Nouriel Roubini: the dollar joins the currency wars.

An international comparison of goods and services taxes.

Five horrific realities of daily life in the past that have been edited out of history.

Bill Gross gets maudlin: "Having turned the corner on my 70th year, like prize winning author Julian Barnes, I have a sense of an ending. Death frightens me…"

The world we see in our mind is not the world our eyes and brain perceives.

The reforms to pensions announced by Scott Morrison this week are welcome, but they're a paint job.

The many failures of the CPI

This an oldie but a goodie. The ultimate dog tease. I always laugh at this.

It's hard not to notice that women are increasingly wearing tights about, as if they're pants. But they are not pants! Hello!

In the US, the NSA is listening to everybody and converting spoken words into searchable text. 

Carly Fiorina, former Hewlett Packard CEO and now Presidential candidate: 85-95 per cent of what we do online is superficial and useless.

This year for the first time people will spend more time online than watching TV.

The truth about low glycemic diets.

Property investors are crazy for Collingwood.

Five things analysts are saying about Australia's rate cut – from the Wall Street Journal.

The drone industry is about to be revolutionised. It's an industry? And it's going to be revolutionised already? Sheesh.

Public debate is now undermoralised and overpoliticised.

Is having a loving family an unfair advantage?

This was a really interesting story on the Religion and Ethics Report on RTN this week. A gay couple in Israel got a baby from an Indian surrogate in Nepal, using a donor egg from South Africa. The embryo was made in Thailand.

A warning ahead of the Federal Budget: don't bow to nihilism!

Alan Greenspan – the worst ex-chairman ever

You might remember I interviewed John Sharman of Medical Developments International in January. They make a painkiller called Penthrox. Well, you might be interested in this piece about it on the CSIRO blog.

Errol Brown, the lead singer of Hot Chocolate, died this week. I never thought much of him, and especially his signature tune “You Sexy Thing”, until I learned this week that he wrote that song for his wife of 41 years! What a nice man!

Happy Birthday Bill Joel, 66 today.  You gotta love "Scenes From An Italian Restaurant".

Mysteries abound concerning the state of Joni Mitchell's health. Her lawyers says she'll be out of hospital soon but she's still unconscious apparently, and having a “conservator” appointed to look after her affairs. Her official website hasn't been updated since April 28. What the hell's going on?

I could drink a case of her, and still be on my feet.

Last Week

By Shane Oliver, AMP

 Shares had a rough week on the back of a continuation of the global bond sell-off, some soft US data, comments by Fed Chair Yellen regarding equity valuations and concerns regarding Greece. The correction in the US dollar continued and this helped metal prices see further gains and the Australian dollar rise helped by the removal of an explicit RBA easing bias.

What's driving the market wobble? It seems the global and Australian investment scene has hit another rough patch. From recent highs US shares are down 1 per cent, Japanese shares are down 4 per cent, Eurozone shares are down 7 per cent, Chinese shares are down 8 per cent and Australian shares are down 5 per cent.

Several factors are driving this. First deflation fears have abated, which is good but its pushed up bond yields. This partly reflects the fall back in the US dollar (on Fed rate hike delays) which has allowed commodity prices and notably oil to rebound and so the acute oil price collapse driven fear of deflation from earlier this year has receded allowing bond yields to move higher.

This has been given a push in Europe by stronger growth and higher German bond yields have also removed a lid on US and Australian bond yields. The back-up in bond yields has impacted high yield shares dragging down share markets generally. Second, some share markets were due a correction – notably Europe, Japan and China – after very strong gains and were thus vulnerable. Third, we have entered a seasonally tougher part of the calendar year (“sell in May and go away…”). Finally, Australian shares have also been hit by perceptions that the RBA may have finished easing, fears about a stronger Australian dollar and talk (and reality in NAB's case) of bank capital raisings.

Is it a correction or something worse? In the absence of unambiguous and broad based share market overvaluation, bull market extreme investor euphoria and excessively tight global or Australian monetary conditions that will drive bond yields rapidly higher or slow growth significantly the broad trend in shares is likely to remain up. However, periodic corrections are healthy and normal. For example, Australian shares are so far down 5 per cent from their recent peak but they had a 9 per cent pullback last September-October and an 11 per cent pull back in mid 2011 all against a rising trend - so what's new? It's too early to say that this correction is finished. But in anticipation of a correction in bonds and shares we have been running a higher than normal cash allocation and see recent moves as healthy and as setting up investment opportunities for when the bull market resumes.

Too early to say for sure that the RBA has finished cutting rates. While it was no surprise to see the RBA cut rates again taking the official cash rate to an historic low of 2 per cent, it was disappointing to see the RBA drop its explicit easing bias, which has led many to conclude that the next move in rates is up.

My base case is that 2 per cent is the low, but it's way too early to be confident of this. With the mining investment boom still unwinding, non-mining investment remaining weak and the Australian dollar remaining too high and at risk of going higher the longer the Fed delays the risks are still skewed towards another rate cut. While the RBA has once again dropped its explicit easing bias the combination of its now lowered growth and inflation forecasts, its expectation that unemployment will be around 6.5 per cent mid next year and its assessment that a further fall in the Australian dollar is necessary all suggest that it retains a soft easing bias.

If the Australian dollar does not oblige and head lower and the investment outlook start to improve then it will be back threatening, and if necessary, cutting rates again. At the very least rates are set to remain low for a long while. With the RBA not seeing growth above trend until 2017 a rate hike looks to be a long way off.

Major global economic events and implications

US economic data was messy again. The services conditions PMIs were solid and unemployment claims remained low, but the trade deficit blew out, the ADP employment survey was weaker than expected and productivity was weak in the March quarter thanks to the weak Q1 GDP outcome.

The March quarter US profit reporting season continues to come in better than expected. We are now 90 per cent done and 72 per cent of companies have exceeded earnings expectations and more importantly earnings growth expectations for the quarter have moved up from -5.6 per cent year on year six weeks ago to now 2 per cent, a record turnaround.

While eurozone retail sales disappointed in March, final business conditions PMIs were revised up for April to show only a trivial fall from March and remain at a solid level indicating that the pick-up in economic growth continues. Stronger German factory orders added to the case.

Weaker than expected Chinese exports and imports for April reinforce the case for more Chinese monetary easing, with the pause in the Chinese share market making it easier to do so.

In the UK, exit polls and early results suggest the return of the Cameron Government, avoiding a long period of political uncertainty although a referendum on the UK's membership of the EU will create a bit of noise. Don't forget though that the EU is not the eurozone.

Australian economic events and implications

Australian economic data was reasonably positive. While the labour market was soft in April this followed two strong months and the ANZ job ads survey continues to point to more jobs growth ahead. Meanwhile the housing construction cycle is continuing to point up with a new record high in dwelling approvals and a new cyclical high in new home sales. Retail sales slowed a bit in March but the March quarter was solid and annual growth is good. Of course all of this just reinforces what we have known for a while, ie that household demand is strong. But what's still lacking is a pick-up in non-mining investment. Meanwhile, the AIG's services and construction business conditions surveys were on the weak side and the TD Securities Inflation Gauge for April was benign providing the RBA with plenty of flexibility.

Next Week

By Craig James, Commsec

The Federal Budget and lending in focus

Some would claim that the release of the Federal Budget is the highlight in the coming week. But in truth, data on wages, home loans and other lending data are probably more important – especially as the Government has set its sights on a tame Budget.

The Federal Budget is released on Tuesday night at 7.30pm AEST. There is little reason for the evening release, more habit, rather than necessity. The bottom-line numbers swing on the economic assumptions, but it is generally included that the path to surplus has become flatter and more protracted.

The deficit for the year to March was $48.9 billion or around 3 per cent of GDP. The Department of Finance has indicated that the budget numbers are around $4 billion better than expected at present. But much could change in the last three months of the year. The full-year deficit was projected at $40.4 billion or 2.5 per cent of GDP.

The budget is likely to be centred on measures to boost small business activity and measures to reduce the cost of child care and increase child care places

The aim of any budget is PPP – lift productivity, lift population, and/or lift workforce participation.

But looking away from the budget, in Australia the week kicks off on Monday with the release of the NAB business survey. This survey is generally released on a Tuesday but has been brought forward ahead of the budget. At present both business conditions and confidence are relatively subdued.

On Tuesday data on housing finance is issued. Based on data from the Bankers Association, we expect that loans for owner occupation (loans for people wanting to live in homes) rose by 1.3 per cent in March. And the total value of loans (owner-occupier and investment) probably rose by 2 per cent.

The weekly consumer confidence reading is also issued on Tuesday together with credit and debit card lending figures from the Reserve Bank.

On Wednesday, the main measure of wages – the wage cost index – will be issued. Wages are up by just 2.5 per cent on a year ago, the slowest growth rate since the series began in 1997. Nevertheless, wages are still growing faster than either headline or underlying inflation rates.

Also on Wednesday, delayed tourist arrivals data for November is released together with annual government finance and taxation revenue figures.

On Thursday the Bureau of Statistics (ABS) issues detailed employment figures.

And on Friday the broader gauge of lending in the economy is released, including commercial, personal and lease loans in addition to housing finance.

‘Top shelf' indicators on both the US and China

So-called ‘top shelf' economic indicators are released in both the US and China in the coming week.

China may actually kick off proceedings over the week – it depends when the scheduled lending and money supply data is issued. Release is scheduled between Sunday and Friday.

In the US the employment trends index is slated for release on Monday. On Tuesday, the National Federation of Independent Business releases its Business Optimism index alongside the JOLTS survey of job openings, monthly federal budget data and weekly chain store sales figures.

On Wednesday, the first of the ‘top shelf' indicators is issued in the US, namely retail sales. Economists tip a solid 0.6 per cent increase in April after the 0.9 per cent lift in March. But fluctuating petrol prices influence the results. Data on business inventories is released the same day with the weekly figures on mortgage lending.

In China, key ‘top shelf' indicators are also issued on Wednesday, namely retail sales, production and investment. Annual growth rates are slowing, but that is ‘normal' for a maturing economy.

On Thursday, the producer price data (business inflation) is released in the US. There are no signs of inflationary pressure and thus no rush to lift rates. A 0.2 per cent rise in the “core” rate (excludes food and energy) is expected. The usual weekly figures on claims for unemployment insurance are also issued.

And on Friday in the US, industrial production figures are issued together with capital flows, consumer sentiment and the New York Federal Reserve manufacturing index. A modest 0.2 per cent lift in production is tipped.

Sharemarket, interest rates, currencies & commodities

The Australian sharemarket has been making heavy weather of a push back to historic highs – and with good reason – valuations have become less enticing.

The ratio of share prices to earnings (PE ratio) stood at 16.4 in March – a 15-month high and well above the decade average of 14.3 and 15-year average of 15.2.

Some would say that higher valuations can be supported given that returns on alternative assets remain low. But property remains solidly in favour over other assets while investors remain much more risk-averse than the 1990s or early noughties.