My Five Point Late Cycle Checklist, House Prices, Brexit, China, and more

Last Night's Markets
My Five Point Late Cycle Checklist
Pollack: Why we went to 98% invested in October
House Prices: How Far?
Brexit: Be Careful What You Wish For
China: Getting Desperate
Respiri, Napoleon and the French Revolution
Research and Diversions
Facebook Live
Next Week
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Last Night's Markets

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My Five Point Late Cycle Checklist

It’s a bit early to start talking about next year, but every second question I get at the moment Is about how late in the cycle we are, and what this means for investors next year. “Should I sell, and go to cash?”

Investors are worried, for good reason. The Goldman Sachs bear market warning is flashing 73%, the highest since 1969, or something ridiculous. Percy Allan’s secret sauce signal has moved to “Sell” for the first time in two years, and there’s a constant barrage of apocalyptic talk to go with increased market volatility.

To conclude at the beginning, I’m not moving to cash myself and I’m not recommending that to others. But it is definitely a good time to be more defensive. Below is my five-point checklist for how to do that.

I swore off those sorts of big calls seven years ago after making a wrong “sell everything” call, but in any case, I don’t invest in “The Market”. I invest in companies that I like, and that I think will perform better than a bank deposit, much better.

But as for the market – well, that’s a different story.

This year, so far, has been a bust: the ASX 200 accumulation index has returned minus 1.6%, the MSCI global index minus 4.2%. There might be a Santa Claus rally, as the spruikers are now spruiking as they try to drum up some business, but it won’t be enough to turn 2018 into a good year.

Next year, I fear, will be more of the same – at best. Could the sharemarket underperform cash two years in a row? Yes of course.

The question is: what is a defensive asset? At times like this it’s often best to ask Warren Buffett. We can’t pick up the phone, but we can look at what he’s doing.

Berkshire Hathaway disclosed on Wednesday that it had bought 35.7 million shares in JP Morgan Chase, the world’s biggest bank, for about US$4 billion.

Warren Buffett’s company now has investments in 14 US financial institutions, worth US$94 billion. The portfolio ranges from regional banks like Bancorp and M&T Bank to Wall Street goliaths like Goldman Sachs and JP Morgan. That investment in financials represents 45% of Berkshire Hathaway’s total portfolio.

So … just follow Buffett and buy banks? The trouble with that is the Australian banks are in an entirely different situation to the American ones. They are riding a housing downturn that threatens to get messy as well as a regulatory crackdown that is far from over, including yesterday’s boost to ASIC’s funding (see below).

What to do?

I think the first thing is to recognise that it’s difficult or even impossible to pick the top of a cycle. The problem with the latter idea is that, as in October 1987, the first day can be a lot more than 10% - you can be down 20-30% before you know it, and even then you don’t know whether to buy the dip or sell the bear.

In many ways risk is a personal thing. It’s true that volatility can be measured, but that needs to be weighed against your own tolerance for volatility.

So if you would feel better in cash now, then do it. There may be an opportunity cost because the market has a bit left in it, but that needs to be weighed against the risk – as you see it.

My own approach is to perform a portfolio check to ensure that it is sufficiently defensive at the moment. Even though I’m 66, I’m a long term investor and I write for those of a similar disposition, so I don’t want to be going in and out of the market.

Here’s my late-cycle checklist:

1. Cash. Rather than go to cash myself, I want to make sure the companies I have invested in won’t need to ask for more of it at least for a couple of years. That’s because they are either making plenty of cash flow from selling their products or services, or because they have enough in the bank to cover their cash burn (that’s right – I’m not getting out of cash-burners, because they often have a great business, as long as they can survive through a bear market). The thing to look at is free cash flow, that is after capital expenditure.
2. Quality. This is a more nebulous idea, and comes down to how the earnings will fare in a recession. Obviously all businesses suffer during a recession or bear market, but some less than others. Specifically: how discretionary are its products, and therefore vulnerable to drop in consumer spending? Has the management been tested by a previous downturn, or will the next one be their first?
3. Valuation. Transurban is a defensive asset with a largely recession-proof revenue stream, but with a PE ratio above 50 it’s expensive. That makes it non-bear market proof. The same goes for Sydney Airport and APA Group. A bear market will take the biggest toll on expensive companies.
4. Liquidity. This is a standard point in any defensive checklist, but it’s more complicated in my view. That’s because the last thing I think you should be doing in a crash or a bear market is selling at the bottom, so whether the stock can be sold is not that relevant.
5. Last but not least, focus on yourself. Where are you at in life? Do you need the money you’ve got invested soon? Are you relying on the income? If so, you might need to take a more defensive stance and specifically make sure you are not relying on dividends that will be vulnerable in a recession and may be cut. If you still have, say, 20 years till you need the money you could be less defensive, and have that time-frame in mind as you go through the rest of the checklist.

None of this is to suggest that I think we are heading for a recession and a bear market, but the risks of those things are clearly rising.

The Australian economy should be OK because the construction boom and resource exports, but the tumbling housing market (see below) and high levels of debt leading to a slump in domestic consumption could offset those positives.

Also, the Chinese economy should also be OK, but it is not responding to stimulus (see below on this too).

The US economy looks OK, but investors are adjusting their thinking about tech stocks. I doubt that it’s 2000 all over again, but markets have a habit of overshooting when they adjust.

Finally, a quote from Gerard Minack to end this item with:

“My sense from recent client meetings is that most investors see the October declines as temporary, and expect equity markets to be stronger by year-end.  This is consistent with the November Bank of America/Merrill Lynch fund manager survey. It reports that cash balances fell in October – suggesting that investors were buying the dip – while the average respondent expected the ultimate peak for US equities to be around 10% above current levels. In short, the October set-back is seen as a dip to buy.  

Tactics are not my strong suite. But it seems to me that if the Fed continues to tighten through most of next year – which is my base case – then the pressure on risk assets will intensify, not moderate. Given the prospect of at least a difficult first half of 2019, it seems to me a tactical bounce would be a great chance to lighten up on risky assets.”

Pollack: Why we went to 98% invested in October

For an alternative view – always worth having - let’s turn to an extract from the latest note from our friend, Loftus Peak’s technology-focused Alex Pollack:

“October was bad. The financial doomsday preppers sold off high growth stocks, lifting their cash holdings as the market fell. At a point the S&P 500 was down 9.3% for the month of October before recovering and closing down 6.9%. The Wall St Journal reported that “stock funds fell an average of 7.9% — wiping out all year-to-date gains. 0.0%... is the average return, according to Thomson Reuters Lipper data, for all U.S.-stock mutual funds and exchange-traded funds this year through Oct. 31.

“Global investors threw out some of the best companies in the market, which hurt Loftus Peak investors – companies which are set to play a significant role in the way business runs for decades to come.

“Contrast this to the oil industry. Mohammed bin Sultan, (or MBS as he is known) is the Saudi prince embroiled in the nastiness about the murder of Jamal Khashoggi. He has a day job – CEO of Aramco, the largest oil company in the world, a company the reserves of which have never been quantified publicly, but which are at least 5 times the size of the next largest, Exxon.

“As reported in the New Yorker recently, at a gathering of prominent venture capitalists at the Fairmont Hotel, in San Francisco earlier this year, MBS spoke bluntly about Saudi Arabia’s prospects. According to one attendee, he said, “In twenty years, oil goes to zero, and then renewables take over. I have twenty years to reorient my country and launch it into the future.”

“The attendee is reported to have said, “My jaw was on the floor.”

“This is big stuff. There would be no better informed group in the world than the Saudis on what is happening in oil, and what renewables mean for it.

“And what are they doing about it? The Saudis are the largest investors (US$45b) in Softbank’s US$100b Vision Fund, the world’s largest disruptive investment vehicle, run by Masayoshi Son, an early investor in Alibaba.

“What is the Vision fund buying? It owns ARM, the processor chip architect for the Apple iPhone (every single version). Softbank believes that connected devices (not just people) are emerging as the global megatrend, so low power ARM mobile chips will have a major role to play. The Saudis plan to put another US$45b into a second vision fund, also US$100b, the details of which are still being finalised.

“This isn’t to say that investors can’t make a return betting on oil companies – there had been a significant rally in the price this year, and plenty did well.

“But it seems like a hard game to play - judging political cross-currents with supply/demand forces overlaid by what Donald Trump tweeted this morning – all of these are factors in the oil price.

“We lifted our investment weighting to 98% in the weak October

“Back to October. Whilst the market continued to sell, we stuck to our investment process, remembering that no-one is going back to using a Gregory’s street directory to find the address of their party, or strapping on a cd player for the morning run, meaning that these technological and disruptive developments are not going away.

“Pricing such massive secular themes, which challenge the status quo, won’t be a smooth process. Market dislocation is to be expected, of which we took full advantage this time around, entering October with 10% in our cash holdings and finishing with 2%. But we took some heat - October was the Portfolio's worst month ever in absolute terms (-8.28% down, against -5.36% performance of the benchmark MSCI All Countries World Index (net in AUD).” 

House Prices: How Far?

Shane Oliver says 20% (Melbourne and Sydney total decline); Tim Lawless says 15%. Spruikers Anonymous says: “she’ll be right”.

My view: predictions are fruitless, if not pointless. House prices are falling, and won’t stop falling for a while. Where they stop, nobody knows, especially with an election coming up that involves negative gearing and CGT changes proposed by the likely winner.

There are four factors that traditionally influence house prices: credit flows, employment, credit flows and credit flows. Employment is fine, but the other three are not.

In a piece this week that used the word “warning” eight times in the first three paragraphs, Bob Gottliebsen wrote: “we are now starting to see the vicious downward cycle stemming from the unprecedented credit squeeze being imposed on the nation by APRA, the royal commission and the other regulators.”

That’s Bob being conservative and understated, as usual (not!), but I’ve been paying attention to him for 40 years, and I’m not about to stop now. However, it should be noted that APRA Chairman Wayne Byres said in July, “the heavy lifting on lending standards has largely been done.” That suggests we are seeing, and will continued to see, the after-effects of past tightening rather than new tightening.

But then they announced plans to increased total capital standards by 4-5 percentage points, from 14.5% to 18.5-19.5%. Unless that is accompanied by a loosening of risk weightings for real estate mortgages – unlikely – that would clearly be a new tightening, so the “vicious” credit squeeze may not be over.

The bigger problem is that at some point – possibly now – reduced demand for credit takes over from reduced supply as the driver of downward momentum. And that is driven by price and economic expectations: people will borrow less if they think house prices will fall further (see chart below) or the economy will weaken so their incomes might decline.

In other words, the decline gets a life of its own, which is why it becomes impossible to predict.

Brexit: Be Careful What You Wish For

Britain’s delusions about Brexit were stripped bare this week: it turns out that the Poms can’t have their cake and eat it. The idea of frictionless trade with the EU without obligations, as PM Theresa May had promised, is impossible.

The hollow-eyed, wall-staring hopelessness of the UK’s position, having voted blithely to leave the EU in 2016, became clear as May cajoled and bullied her Cabinet across the line and then stepped out to front the microphones and explain that this deal was the best they could do.

By the time she stepped up to the despatch box in the House of Commons to explain it to MPs, the minister in charge of Brexit, Dominic Raab, had quit and her government was in crisis and the rest were talking about knocking her off.

It was an extreme example of the proposition that if you make both sides mad you must be doing something right. But the problem for those who want a harder Brexit than she negotiated, and those at the other extreme who want no Brexit at all, is that Theresa May is undoubtedly right that this is the best deal possible.

Britain simply can’t have access to the EU markets unless it obeys the same rules as the rest of the EU, but if it leaves the EU as directed to by the 2016 referendum, it will have no say in those rules.

That’s what transport minister Jo Johnson meant when he used the word “vassalage” as he resigned from the Government earlier in the week. May’s plan now is to exist in a half-way house called the customs union - a bit like Norway -  but that involves giving up control instead of regaining it, as the original Brexiteers had imagined they were fighting for.

May has repeatedly ruled out the “vassal state” option but this is exactly what she has had to agree to for a transition period lasting two years, which would almost certainly have to be extended, and extended, and extended.

In other words, they have gone for the “Hotel California” option: you can check out, but you can never leave.  

Former EU trade commissioner and UK trade secretary, Peter Mandelson, wrote in the FT this week: “For those who think this paradox is going to ease with time, I have disappointing news. If anything it will worsen. The longer Britain lingers inside either the single market or the customs union, or both, either through indecision, the operation of the Irish border backstop or a desire to put off the consequences of leaving, the more onerous the conditions will become.”

The key stumbling block has been the Irish problem, which has been bedevilling British politicians for a hundred years – specifically it’s about the position of Northern Ireland, which is part of the UK and therefore part of the Brexit, but with a completely open border with the Republic of Ireland, which of course is part of the EU.

When the Irish Free State seceded from Britain in 1922 and Ulster stayed, a hard border was established between them with customers posts and infrastructure for searches etc.

With the creation of the Single Market in 1992, the checks were phased out and the border was opened, although IRA violence after that led to military checkpoints. But after the 1998 Good Friday Agreement, the border checkpoints were eventually removed by 2005.

With both Ireland and the UK part of the EU, the Irish border is non-existent, and ever since the Brexit referendum it’s been the staunch position of the British Government that it would not result in a return of a “hard border” in Ireland.

Early on there was a push within Ireland for a re-unification of the north and south, and in April 2017 the European Council even agreed that in the event of reunification, Northern Ireland could join the EU.

All of which has been regarded with horror by Northern Ireland’s Democrat Unionist Party, which holds the balance of power in the British Parliament, although DUP also doesn’t want a return to a hard border.

Theresa May has declared that there would be no barriers in the Irish Sea – that is, that Northern Ireland would not be treated differently the rest of Great Britain, and that set up the paradox that Mandelson referred to: Britain couldn’t leave the EU while retaining an open border with Ireland, but couldn’t fully leave the EU unless there was a hard border with Ireland.

The result is the deal that May’s Cabinet agreed to this week – a half-way house.

May had no choice: the Ulster Unionists control her government and they will not accept any change in the status quo, which in turn means there is no Parliamentary majority for full English Brexit as voted for in June 2016.

So Hard Brexit is now off the table, and Soft Brexit is the only option. But Nigel Farage, one the leaders of the Brexit push, reflected a widespread view among Brexiteers this week when he said: “I am so angry I can barely put it into words.” 

That’s because it will involve the free movement of EU citizens and leave the UK subject to decisions of the European Court of Justice, both of which are unacceptable to the Farage mob.

So where to now for poor, benighted Britain? Well, Theresa offered two alternatives this week to her deal: a new referendum or no Brexit at all. Just call the whole thing off.

Neither of those things is very likely. A Hard Brexit is possible if May’s Government falls, which could well happen, but in reality, the baseline scenario for investors must be that the UK Parliament eventually passes some form of May’s deal – the Norwegian-style endless transition.

This will not be good for Sterling or British assets, not calamitous perhaps, but not good.

A more remote possibility is a new referendum and a vote against Brexit, which would lead to a big rally in sterling and the UK stockmarket, but that’s very risky - could equally result in a second vote in favour of Brexit, and a much ruinous Hard Brexit.

It all confirms the old saying “Be careful what you wish for”.

China: Getting Desperate

The October Chinese data dump showed an economy that is losing momentum fast. Fixed investment is being supported by government spending alone, infrastructure spending was down, but a bit less than before. Retail sales growth weakened further. Property sales volumes posted another month of decline, falling -3.1% YoY. And although construction starts remained strong, up 14.7% YoY, growth was slower than the rates in excess of 20% registered over the previous four months. 

The big downside surprise came from the credit data. Outstanding total credit grew 10.3% year on year, and private sector credit by 8.8%, the slowest rates in the past 15 years. Credit growth to the corporate sector (both private and state) slowed to 7.3%.

All this points to a further slowdown in economic growth, especially as the current strength of the export sector, with buyers front-running the threatened year-end introduction of new US tariffs, will not last.

And all this despite the authorities throwing the stimulus kitchen sink at the economy this year, with a huge blow out in the fiscal deficit and constant monetary easing.

In the past week we have seen growing policy desperation:

• Despite evidence of rising defaults, the Chinese banking regulator announced last week that banks must now increase lending to private firms, targeting a 50% share of new loans by 2021 from 25% currently. Assuming conservative loan growth to the consumer (read property market) and state owned enterprises, this would imply a 340% increase new bank loans in 3 years. It means defaults are only heading in one direction – up. Add in bond and wealth management product issuance and this is bad news for the banking system and the already huge debt to GDP ratio.
• The trade war with the US is only going to worsen in the months ahead. As I written here before, it’s not about trade but a more fundamental conflict led by the Trump White House designed to stop China becoming a technology superpower and to force US companies to switch away from Chinese suppliers.

The PBoC and the Government will have to introduce more stimulus and keep trying to get the exchange rate down, but they seem to be pushing on a string.

Respiri, Napoleon and the French Revolution

From Prof Cara MacNish (who says she doesn’t own any Respiri shares, but likes the tech and is considering “buying a few”):

Hi Alan

As you highlighted in last week’s Overview, Martin asked a great question about health tech company Respiri, following your CEO interview with Mario Gattino. 

“…Whilst you are concerned with their cash flow, I am concerned with their product – I simply don’t know anywhere near enough to recommend it. Then – its place in the market – there are many reliable, accurate flow meters available at a fraction of the cost… Maybe theirs is a bit more high tech, but I believe could be inaccurate at low flow rates when there may not be enough air flow to create a wheezing sound – and this is when asthma is most dangerous. What about a technical review by an independent body – after all if the product is not all that good, and it is a single product company, the future does not look bright – irrespective of their cash flow.”

Having had a family member rushed to Emergency more than once with difficulty breathing from Asthma, this topic is close to my heart. Any advance on early detection, and ultimately prediction, of asthma attacks would be a welcome addition, whether its in place of, or alongside, air flow monitoring.

I mention alongside air flow because Respiri’s Wheezo meter and related products focus on quite a different physical indicator (or modality) to flow rate, which means they may pick up on different information. They will also have different sensitivity.

So how does the product work?

An acoustic monitor, like our ears, receives a sound signal that is a mixture of many components, for example, the sounds of breathing, coughing, snoring, a distant television and other background noise. We call this a ‘time domain’ signal because it varies over time. The monitor needs to ascertain how much of that signal characterises what we commonly call wheezing.

To achieve this, we rely on the work of Jean-Baptiste Joseph Fourier, a French mathematician and physicist from the 18th century. Joseph had a fascinating and chequered career. Born in 1768, he was orphaned at age nine, and fortunate to be educated by a Benedictine Order. Not being of high enough birth for a commission in the scientific corps, he took up a military lectureship in mathematics. Soon after he was briefly imprisoned for a prominent local role in the French Revolution.

Fourier’s next lucky break was to accompany Napoleon Bonaparte on his Egyptian expedition as a scientific adviser. While the British put a premature to the expedition, Fourier had Napoleon’s trust and in 1801 was appointed Governor of a district of Grenoble. While in Grenoble he began working on the propagation of heat in solids, and in 1822 published his seminal paper on the analytical theory of heat. 

It is one of the results in this paper that Fourier is most famous for. Fourier claimed that any ‘function’ (like our monitor’s sound signal) could be broken down into a series ‘standard’ functions (or sine waves) at various frequencies - a little like a musical note containing different harmonics. The Fourier Transform, as it became known, transforms a signal from the time domain to the ‘frequency domain’, allowing us to investigate how much of the signal is made up from the components at different frequencies. A digital version, called the Discrete Fourier Transform, is used by computerised devices like the Respiri’s Wheezo to analyse an acoustic signal.

The frequency domain data allows us to isolate a component we’re looking for - in this case, ‘wheezing’ - from other components and background noise. Importantly in relation to Martin’s question about enough air to create a wheezing sound, it's worth noting that the wheezing does not necessarily need to be audible to the human ear (either in volume or over background noise) to be present and identifiable in the signal. In fact, it would not even need to be a noise in the human audible frequency range.

It's a great use of technology, but reaching a mass market has its challenges - between regulatory approvals and competitors with big pockets, there is no doubt that health technology is a tough gig. 

Respiri, like most health tech companies, has found the route to market difficult. Respiri changed its name from Isonea Ltd in July 2015, prior to a 2016 capital raising of $4.3m. Isonea, in turn, changed its name from KarmelSonix Ltd in August 2011,  prior to a 2012 capital raising of $4m.

KarmelSonix grew out of Salus Technologies Ltd, which had interests including gene therapy, in 2006. In 2004 Salus Technologies in turn appears to have risen from the ashes of Q-Vis Ltd, which went into administration in 2002. Q-Vis sought to market laser eye surgery technology from Perth’s prestigious Lions Eye Institute.

In 2008, an RM Research outlook on KarmelSonix stated that “we believe the WheezoMeter has the potential to move the Company into a cashflow positive position by CY2010 with commercial sales now likely to commence shortly on the back of recent TGA and FDA approvals”. The WheezoMeter, they reckoned, had the potential to generate net revenues of $7m in the Australian market alone within three years. The Wholter and PulmoTrack devices were also said to be near completion.

That the company has persevered with its acoustic asthma management technology since at least 2006 is perhaps a testament to the promise of the technology. I would love to see the company succeed - it's a great example of Aussie ingenuity, and the new Board comes with considerable experience in bringing health tech to market.

Joseph Fourier’s story is also a terrific reminder of the importance of fundamental research. It's hard to predict what benefits it will bring in the future.

Research and Diversions

Research

Says Bob Gottliebsen: “we are now starting to see the vicious downward cycle stemming from the unprecedented credit squeeze being imposed on the nation by APRA, the royal commission and the other regulators.

Says Guy Debelle, deputy governor of the Reserve Bank: No we’re not. “When you implement a change in lending standards the existing loans are no different to how they were the day before. …the available evidence suggests that the policies have meaningfully reduced vulnerabilities associated with riskier household lending and so increased the resilience of the economy to future shocks.”

Morgan Stanley: “don’t get too carried away by a year-end rally.”

In pushing for “dispatchable 24/7 power”, Energy Minister Angus Taylor is ignoring AEMO, which runs the grid. The power companies appear to be seeing it as a chance to milk him.

“It’s November, 1983; I’m sitting in the auditorium at Apple’s worldwide sales meeting in Honolulu. The house lights dim and ‘1984’ begins. Conceived by ad agency Chiat/Day, directed by Ridley Scott of Blade Runner fame, and destined to be aired nationally only once (during the 1984 Super Bowl), the minute-long movie leaves us with this message: “On January 24th, Apple Computer will introduce the Macintosh. And you’ll see why 1984 won’t be like ‘1984’.””

“Giant hanging bricks could store energy better than batteries”. Gotta say this looks convincing to me: not that it would replace lithium batteries in cars, but definitely in large installations it could replace pumped hydro or big batteries.

Interesting profile of Margrethe Verstager, the EU’s competition czar. “Four years after being appointed to one of the E.U.’s more controversial positions, Vestager has become both a global celebrity and a lightning rod….in her zeal for challenging vested interests, she has taken on some of the world’s biggest corporations, including Apple, Amazon, Facebook and Google.”

“Bean counting is too important to be left to today’s bean counters.” And: “Accountancy used to be boring – and safe. But today it’s neither. Have the ‘big four’ firms become too cosy with the system they’re supposed to be keeping in check?” The answer, as you would have guessed, is, er, probably not. This is a good piece about the big accounting firms and their role in financial vulnerability, but it’s a bit of a fence-sitter.

This guy says he can answer Paul Krugman’s question: “What is the problem that Bitcoin solves?” He says: “Modern financial history is littered with hyperinflation, defaults and currency devaluation. Bitcoin could put an end to that.” In other words, he says, the problem is it solves is the current monetary system itself.

When will the Fed hit the pause button? As Mike Tyson said: “Everyone has a plan until they get punched in the mouth."

The truth about negative gearing. Well, this guy’s truth anyway.

The futurist philosopher Yuval Noah Harari thinks Silicon Valley is an engine of dystopian ruin. So why do the digital elite adore him so?

Who owns emoji’s? Answer: The Unicode Consortium, the body that oversees the lexicon of symbols with which computers communicate. Yes, but who’s behind the curtain? Google, Apple, Microsoft, Facebook, IBM, SAP, Huawei, plus the governments of Oman, Bangladesh, India and Tamil Nadu, one of India’s constituent states.

The war inside 7-Eleven. The company (in the US) has been battling its store owners for years. It seems to have found a new tool: the immigration authorities.

Artificial intelligence and machine learning have reached the skincare industry—and the results are a little crazy.

Six steps to Australian industry 4.0. “Australia is a high performing creative culture – and we are currently embarked on a major industrial transformation occurring internationally known as the 4th industrial revolution or Industry 4.0. Our competitiveness, however, depends on paying close attention to a number of critical factors. Some we’re working on; others need a lot more encouragement.”

5 reasons why leadership is in crisis. “There is an alarmingly weak correspondence between power and competency. Those in power are not necessarily up to the job of discharging their responsibilities to the benefit of those they lead.”

8 fascinating and fearsome frontiers of science you should know about. “we called on a network of experts to tell us which corners of scientific research make them most excited and which most concerned. Six hundred and sixty replied.”

Whatever happened to the hole in the ozone layer? Most countries in the world came together in a treaty, and humanity cut emissions by over 75%.
As a result, the hole stopped growing in the 1990s and recently started to shrink again. Maybe it can happen again?

It doesn’t matter how many times we are forced to read the quote “history doesn’t repeat itself but it often rhymes”, the reality is that timing the end of a long-term equities bull market is very difficult to do and it may result in missing significant opportunities. Every equities market cycle is unique.

You want to understand identity politics? Here's your primer on identity politics, in tights, with bodyslams.

The coal industry’s preferred climate escape route of promoting carbon capture and storage (CCS) on coal power plants has disappeared as a financially viable option.

The Earth is in a death spiral. It will take radical action to save us. Why do civilisations collapse? Not because they lack technology or expertise, but because the power of oligarchs blocks the necessary solutions. Will this happen to us?

Diversions

Neuroscience says this one song reduces anxiety by 65 percent. It’s called “Weightless” by Marconi Union, and, yeah, it’s not bad, de-stress wise. A bit sort of washy, if not wishy as well. Made me feel a bit anxious about when will it end, though.

A piece in the US this week: Melbourne’s terrorist attack was far less deadly than it might have been. The difference: gun control.

Adventures in insomnia: sleep diets, weird dreams and the singularity.

The history of vanilla is far from plain vanilla.

In Defense of "Designer Babies" “Why we should not let fears about inequality stand in the way of technological progress that could potentially make the next generation healthier, happier, and smarter.” I know this isn’t a very popular, or correct view, but I think I agree with this.

A review of two books about war: Future War: Preparing for the New Global Battlefieldby Robert H. Latiff, and The Future of War: A History by Lawrence Freedman. “A dark mood overcame me as I read these two books… one can’t help but be struck by the cool, acquiescent prose in which the war studies experts portion out their arguments, as if war is and will always be a human necessity, a feature of our existence as natural as birth or the movement of clouds.” 

The Inspection Paradox: “Airlines complain that they are losing money because so many flights are nearly empty. Passengers complain that flying is miserable because planes are too full. They could both be right. When a flight is nearly empty, only a few passengers enjoy the extra space. When a flight is full, many passengers feel the crunch. Once you notice the inspection paradox, you see it everywhere. 

This one is better, I think: it’s a review of six books about World War 1. “Russia stepped in to protect its Serbian clients; the Germans supported their Austrian allies; the French marched to fulfill their treaty obligations to Russia; Great Britain honored its commitment to come to the aid of France. Within five weeks a great war had broken out.”

The Sins of Celibacy: The greatest responsibility for the problem of sexual abuse in the church clearly lies with Pope John Paul II, who turned a blind eye to it for more than twenty years. But while much of the press coverage of the scandal has been of the Watergate variety: what the pope knows, when he found out, and so forth. This ignores a much bigger issue that no one in the church wants to talk about: the sexuality of priests and the failure of priestly celibacy.

Life on the Lecture Circuit: Frederick Douglass’s moral crusade entailed exhausting rail journeys, hostile mobs, and time away from his dysfunctional family.

Camille Paglia: The silence of the academic establishment about the corruption of Western universities by postmodernism and post-structuralism has been an absolute disgrace."

Thanks to genetically-engineered pigs, the shortage of donor organs could be a thing of the past.

It’s 50 years this week since The Beatles’ White Album was released. I was 16, and SO excited! It was huge – not just for me, but it was a turning point, one of the greatest moments in musical history. No, I’m not kidding! Here it is (the whole thing, starting with Back In The U.S.S.R.). (And yes, I’m listening to it now).

https://www.youtube.com/watch?v=0ArlUSVDQIw&list=PLycVTiaj8OI80AsTGjYJAP...

And here’s a great piece in The New Yorker about it: The Accidental Perfection of The White Album. “The Beatles’ naïve and aggressively experimental musicianship propelled their most fractured and divisive project into a kind of accidental perfection. Fifty years later, the record is still good, still indelible, still as clean and pure as its sleeve, requiring no explanation or description beyond the band’s name.” 

And today would have been Jeff Buckley’s 52nd birthday, if he hadn’t gone swimming in May 1997 in the Mississippi River, and drowned. He’s best known for his version of Leonard Cohen’s Hallelujah, but I can’t play other versions of this song than Leonard’s, even Jeff Buckley’s, it’s just not right, so here’s Last Goodbye. He certainly has a beautiful voice. Had I mean.

https://www.youtube.com/watch?v=3MMXjunSx80

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.

https://www.youtube.com/watch?v=B3fPbHStrtk

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.

Next Week

By Ryan Felsman, Senior Economist, CommSec

Australia: Reserve Bank in the spotlight

·         The Reserve Bank Board’s November monetary policy meeting minutes and a speech by Governor Philip Lowe at the CEDA annual dinner are the highlights in the coming week. Data releases are mostly second tier. Tourism, skilled internet job vacancies and the CBA’s ‘flash’ manufacturing and services’ gauges feature.

·         The week kicks off on Monday in Australia when CommSec releases the Home Size Trends Report. Changes in the size of homes has implications for builders, developers and retailers of home appliances. If bigger homes are built, this may result in fewer homes that are needed to be constructed to absorb increases in population.

·         Also on Monday, the Bureau of Statistics (ABS) releases the September overseas arrivals and departures data. The weaker Aussie dollar is supportive of overseas tourism demand. Over the year to August a record 1,435,700 tourists came to Australia from China, up by 7.7 per cent.

·         On Tuesday, the regular weekly reading on consumer confidence is published by ANZ and Roy Morgan. And the Commonwealth Bank’s Business Sales Indicator for October is issued. Sales have lifted for 19 successive months.

·         Reserve Bank Governor Philip Lowe speaks about “Trust and Prosperity” at the CEDA Annual Dinner in Melbourne at 7.20pm AEDT on Tuesday.

·         Also on Tuesday the ABS releases the “National Accounts: Distribution of household income, consumption and wealth (2003/04-2017/18)” publication. Supplementary data on household income and wealth, access to goods and services, population, housing, government benefits and taxation will be of particular interest, given the impact on overall living standards.

·         On Wednesday, the Department of Jobs and Small Business issues its monthly skilled internet job vacancies data. The Internet Vacancy Index fell by 0.6 per cent in September, but is still 1.6 per cent higher than a year ago. Job vacancies are at 6½-year highs in Tasmania, up by 16 per cent from a year ago. 

·         On Thursday, the ABS releases its population projections for states, territories, capital cities and state regions. According to the ABS, “the projections are not predictions or forecasts, but are illustrations of the growth and change in population which would occur if certain assumptions about future levels of fertility, mortality, internal migration and overseas migration were to prevail over the projection period.”

·         On Friday the CBA releases the ‘flash’ manufacturing and services purchasing managers’ indexes for November. Business activity rose at the slowest pace in the survey’s short history in October.

US home building and durable goods orders data in focus

·         In a holiday-shortened week in the US, a raft of housing-related data are issued. Durable goods orders feature with the ‘flash’ purchasing managers’ manufacturing indexes from developed economies, such as the US, Japan, UK and Eurozone.

·         The week kicks off on Monday in the US, with the release of the National Association of Home Builders (NAHB) Housing Market Index. The index has held steady at around 70 points since June. NAHB Chief Economist Robert Dietz has said, "Favourable economic conditions and demographic tailwinds should continue to support demand, but housing affordability has become a challenge due to ongoing price and interest rate increases."

·         The usual weekly data on US chain store sales is released on Tuesday along with October monthly housing starts and building permits figures. Housing starts fell by a greater-than-expected 5.3 per cent in September as construction activity in the South fell by the most in nearly three years (down 13.7 per cent) due to Hurricane Florence disruptions. But starts are forecast by economists to rebound by 1.6 per cent in October.

·         US building permits fell by 0.6 per cent in September – the second straight monthly decline – as permits for the construction of multi-family homes declined by 7.6 per cent to 390,000 units. Permits are tipped to fall by 0.8 per cent to 1.26 million units in October. 

·         On Wednesday in the US, the October consumer durable goods data will be issued. In September, the data was volatile, distorted by a 120 per cent surge in orders of defence aircraft. Business equipment investment rebounded in the September quarter, but economists don’t expect this to be sustained with a 2.5 per cent decline in orders tipped in the preliminary read for October.

·         Also on Wednesday, weekly MBA mortgage applications and monthly existing home sales data are issued. Sales of previously-owned homes fell to the weakest level (5.29 million) in almost three years in September – the sixth straight monthly decline. US mortgage rates have lifted to the highest level in almost eight years.

·         And the Conference Board’s Leading Index for October is also scheduled for Wednesday. The index, which takes into account building permits, the ISM index of new orders and sharemarket prices, has lifted for 12 consecutive months.

·         US markets are closed for the Thanksgiving Day public holiday on Thursday.

·         On Friday Markit’s ‘flash’ manufacturing purchasing managers’ indexes are issued for November across developed economies.

Last Week

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

Investment markets and key developments over the past week

• “Risk off” returned with a vengeance to financial markets over the last week with most share market falling and bond yields declining as last month’s worries returned, tech stocks came under renewed and the continuing plunge in the oil price weighed on energy shares. Australian shares have almost fallen back to their October low with financial shares under renewed pressure. Chinese shares were an exception and managed a gain. Copper and gold prices rose but the oil price continued its plunge and the iron ore price fell slightly. While the $US rose slightly the $A rose helped by strong Australian jobs data.
• It’s still too early to say we have seen the bottom in share markets. Put very simply there are three types of significant share market falls – corrections with falls around 10%, “gummy” bear markets with falls around 20% but where the market is up a year later (like in 1998, 2011 and 2015-16) and “grizzly” bear markets where a year after the initial 20% fall the market is down another 20% or so (like in 1973-74, the tech wreck or the GFC). A grizzly bear market is unlikely because, short of some unforeseeable external shock, a US, global or Australian recession does not imminent as the excesses that normally proceed recession (overinvestment, inflation surging, tight monetary policy) are not present on a significant enough scale. However, we have already had a correction in mainstream global shares and Australian shares (with circa 10% falls into the October lows) and it could still turn into gummy bear market, where markets have another 10% or so leg down – a lot of technical damage was done by the October fall that has left investors nervous, the rebound from late October was not particularly convincing and many of the drivers of the October fall are yet to be resolved.
• However, there were three positive developments over the last week which help add to our conviction that we are not going into a grizzly bear market. First, while Fed Chair Powell remains upbeat on the US economy and a December hike looks assured (for now), he is clearly aware of the risks to US growth from slowing global growth, declining fiscal stimulus next year, the lagged impact of 8 interest rate hikes and stock market volatility and appears open to slowing the pace of interest rate hikes next year or pausing at some point. The stabilisation in core inflation around 2% seen lately may be supportive of this. Overall, he now seems a lot more balanced than in early October when referring to rates going to neutral and beyond.
• Second, there have been more positive signs on trade. Talks between the US and China on trade have reportedly resumed “at all levels”, US Treasury Secretary Mnuchin and Chinese Vice-Premier Liu have spoken by phone, the China Daily has reported that China and the US have agreed to promote a bilateral relationship, China has reportedly sent a trade document to the US and US Trade Rep Lighthizer has reportedly said the Jan 1 lift in the tariff rate on China to 25% was on hold. All of this is on top of the Trump/Xi phone call a few weeks ago. The US/China trade dispute is unlikely to be resolved quickly when Trump and Xi meet at the G20 summit at the end of the month but with Trump wanting to get re-elected I remain of the view that some sort of deal will be agreed before the tariffs cause too much damage to the US economy. And finally, for now at least the US has held off on tariffs on automobiles.
• Finally, while the 27% plunge in the oil price since its October high is a short-term negative for share markets via energy producers, ultimately it has the potential to extend the economic cycle as the 2014-16 plunge did (although its likely to be on a much smaller scale this time). Oil prices are short term historically oversold and due for a bounce but its increasingly looking like slower global demand than expected is a contributor to the price plunge – along with US waivers on Iranian sanctions allowing various countries to continue importing Iranian oil (which highlighted yet again that Trump doesn’t want to let anything damage US growth and weaken his re-election chances in 2020), rising US inventories, the rising $US, and the cutting of long oil positions. This means while oil prices are unlikely to fall for as long or as much as they did in 2014-16 when they fell 75% (see below) they may stay lower for longer. This is bad for energy companies but maybe not as bad for shale producers as in 2015 as they are now less geared and their break-even oil price has already been pushed down to $50/barrel or less. And it’s less of a threat to the US economy as energy investment is much smaller than it was in 2014. It will depress headline inflation (monthly US CPI inflation could be zero in November and December) and if it stays down long enough it could dampen core inflation. All of which may keep rates lower for longer. And its good news for motorists. For example, Australian petrol prices have plunged from over $1.60 a litre a few weeks ago to now falling back to around $1.30 in some cities and prices could still fall further as the oil price fall flows through to the bowser with a lag. That’s a saving in the average weekly household petrol bill of around $10.

[caption id="attachment_179168" align="alignnone" width="565"] Source: Bloomberg; AMP Capital[/caption]

• Out of interest US energy production is continuing to surge – so much for Peak Oil!...

[caption id="attachment_179166" align="alignnone" width="534"] Source: Bloomberg, AMP Capital[/caption]

• …but a re-run of the 2014-16 75% oil price plunge is unlikely as amongst other things OPEC spare capacity is much lower than it was then and they are already talking about cutting production whereas back in 2015 Saudi Arabia initially refused to cut production and OPEC was in disarray.

[caption id="attachment_179167" align="alignnone" width="531"] Source: Bloomberg, AMP Capital[/caption]

• At times like the present it is good to have some comic relief and the Brexit mess is certainly providing that (for everyone except the British that is!). Yes, the May Government and the EU have reached a draft agreement that would see the UK exit the EU but remain in the single market with all its rights and responsibilities until a formal relationship is agreed. But no sooner than May’s Cabinet agreed to support it, various ministers started to resign (including the Brexit minister who presumably played a key role in the deal) begging the questions of whether May will survive, whether the deal will pass parliament, whether there will be a new election and maybe even another Brexit referendum. Just as well I didn’t waste any time reading the 500-600 page draft agreement! The bottom line is that it’s still too early to get upbeat on the British pound. The Brexit debacle should also make various Eurosceptic parties across Europe realise that if it’s this hard to work out how to get out of the EU its going to be even harder to get out of the Eurozone.

Major global economic events and implications

• US economic data mostly remained favourable with solid growth in retail sales, strong small business optimism, mixed but okay regional manufacturing conditions, continuing labour market strength and slightly slower than expected core CPI inflation of 2.1% year on year in October. In fact, the October CPI reading is consistent with the Fed’s preferred core private consumption deflator measure of inflation falling back to around 1.9% year on year. This is all consistent with the Fed continuing to raise rates for now but at a “gradual” pace.
• Eurozone GDP growth for the September quarter was confirmed at a relatively weak 0.2% quarter on quarter or 1.7% year on year but with the German economy actually contracting by 0.2%. There is clearly an economic as well as a political incentive for the German grand coalition government to agree a fiscal stimulus.
• Japanese September GDP also contracted – by 0.3% quarter on quarter – but this looks to reflect payback after strong June quarter growth and the impact of natural disasters.
• Chinese data for October was a mixed bag with soft readings for retail sales, money supply and credit growth, flat unemployment at 4.9%, but somewhat stronger readings for industrial production and investment and continuing gains in home prices. The overall impression is that growth has slowed but remains somewhere around 6-6.5% year on year.

Australian economic events and implications

• Australian data over the last week provided another reminder that while the housing market is turning down it’s not all doom and gloom for the Australian economy. In fact, jobs growth remained very strong in October with full time jobs growth dominating and unemployment remaining down at 5%, wage growth perked up a bit further in the September quarter and consumer confidence rose. All of these things are positive but not enough to justify an imminent interest rate hike as underemployment remains very high at 8.3%, wages growth has only really picked up because of a faster increase in the minimum wage and abstracting from this is still stuck around 2% year on year, consumer confidence is likely to be dampened as house prices continue to fall and business confidence has actually been trending down lately and fell again in October.
• So allowing for these things our view remains that the RBA won’t start raising interest rates until 2020 at the earliest and given the housing related downturn there is a significant chance that the next move could turn out to be a rate cut – although this would be unlikely before second half next year as it will take a while to change the RBA’s relatively upbeat thinking on the economy and rates.

What to watch over the next week?

• In the US, the focus is likely to be on business conditions PMIs for November to be released Friday which are expected to remain solid at around 55. Meanwhile, expect the NAHB housing market conditions index for October (Monday) to remain strong, housing starts (Tuesday) to bounce back a bit after a fall in September and existing home sales (Wednesday) to do the same and underlying durable goods orders (also Wednesday) to show modest growth.
• Eurozone business conditions PMIs for November (Friday) will be watched for signs of improvement or at least stabilisation after a further fall last month.
• Japanese headline inflation for October (Tuesday) is likely to show a rise to 1.4% year on year thanks to higher oil prices last month, but core inflation is likely to remain low at around 0.4%yoy. The manufacturing conditions PMI for November will be released Friday.
• In Australia, a speech by RBA Governor Lowe on Tuesday will be watched for clues on the outlook for interest rates. Meanwhile, the minutes from the RBA’s last board meeting (also out Tuesday) are likely show that it remains relatively upbeat and still sees the next move in rates as most likely to be up but that it remains in no hurry to move at present. Skilled vacancy data will also be released Wednesday.

Outlook for markets

• Shares remain at risk of further short-term weakness, but we continue to see the trend in shares remaining up as global growth remains solid helping drive good earnings growth and monetary policy remains easy.
• Low yields are likely to drive low returns from bonds, with Australian bonds outperforming global bonds as the RBA holds and the Fed continues to hike.
• Unlisted commercial property and infrastructure are still likely to benefit from the search for yield, but it is waning.
• National capital city residential property prices are expected to slow further with Sydney and Melbourne property prices likely to fall another 15% or so, but Perth and Darwin property prices at or close to bottoming, and Hobart, Adelaide, Canberra and Brisbane seeing moderate gains.
• Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.
• Having fallen close to our target of $US0.70 the Australian dollar is at risk of a further short-term bounce as excessive short positions are unwound. However, beyond a near term bounce it likely still has more downside into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate pushes further into negative territory as the US economy booms relative to Australia. Being short the $A remains a good hedge against things going wrong in the global economy.