The Wrath of Hayne, the Budget and Election to come, China, ABC, Kavanaugh, and much much more

Last Night's Markets
The Wrath of Hayne
Budget Outcome = Election Cash
China
My ABC
Kavanaugh and the Court
Fed Rate Hike
Oil’s Upside Risk
Abernethy’s Three Risks
Bogle Model
Dividend Franking Petition
Correction: FGX
Research and Diversions
Facebook Live
Next Week
Last Week

Last Night's Markets

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The Wrath of Hayne

This is a difficult time to be an investor in a bank, or AMP, and yesterday’s interim report from Commissioner Kenneth Hayne ensured that it will only get worse before it gets better.

It is an extraordinary document: 115,638 scorching words in the main report, a total of 1000 pages of excoriation. (The executive summary is quite short – you can read it here).

Hayne barbecues everybody engaged in the industry: banks, insurance companies, advisers, regulators. No one escapes his wrath. The headlines this morning are devastating: “An industry rotten to the core” (The Australian), “Hayne strikes down greedy banks” (The Financial Review), “Inexcusable greed and dishonesty in financial advice” (The Age).

They brought it on themselves of course. Australia’s financial services industry is the classic case study for the old saying that if you don’t regulate yourself properly, you’ll get regulated by someone far less sympathetic.

Before the Royal Commission interim report came out yesterday afternoon, I happened to spend an hour watching this video of the world’s richest man, Jeff Bezos, being interviewed in front of audience in Washington two weeks ago.

Bezos explained that Amazon’s success is based on an “obsessive, compulsive focus on customers”, often at the expense of short-term profit. Others in business talk about focusing on customers, he said, but they are actually focusing on competitors.

Australia’s banks don’t even have to worry about competitors. As Hayne points out: “Competition within the banking industry is weak. Barriers to entering the industry are high. To participate in the economy, to participate in everyday life, Australians need a bank account. But they are reluctant to change banks.”

So what have the banks been focusing on, in the absence of customers and competitors? Profit, that’s what. Amazon goes after customers at the expense of profit; Australia’s banks have been going after profit at the expense of customers.

Hayne: “…there being little threat of failure of the enterprise, and there being little competitive pressure, pursuit of profit has trumped consideration of how the profit is made. The banks have gone to the edge of what is permitted, and too often beyond that limit, in pursuit of profit.”

Two things will happen now: first APRA and ASIC, having had strips torn off them by Kenneth Hayne, will be galvanised into action as ferocious, better-funded regulators, and second, the final report will be even bigger than the interim one, and it will be full of recommendations, not for less regulation, but more – much more. Kenneth Hayne is a black-letter lawyer; he will bury the banks in black letters.

It is way too late for the banks to get ahead of this, to convincingly change themselves into ethical customer obsessives to head off the extra regulation and compliance.

This royal commission is going to result in both a mountain of compliance and activist regulators. The banks and their shareholders have a few years of hell ahead of them, and the challenge or the board and management is going to be to effectively manage the businesses while at the same time ticking all the boxes and reforming their cultures.

There is one central challenge for the directors and executives involved in this industry no matter what happens with the final report of the royal commission: to somehow get rid of the sales culture in both banking and wealth management while still selling. It won’t be an easy trick, but it’s essential.

There is a section in the report that explains why it’s going to be hard for them to change:

“Banks’ dealings with customers seek to minimise risk to the bank. The bank fixes its risk appetite. It decides to whom it will lend and on what terms. It decides whether security should be provided and what form and value it should take.

"Hence, banks have only as much ‘skin in the game’ in their dealings with customers as the bank chooses. And there is always a striking asymmetry of power and information between bank and customer that favours the bank.

"Important deterrents to misconduct are, therefore, missing from the banking industry. Competitive pressures are slight. Fears of the enterprise failing are eliminated as far as possible. Fears of failure of particular transactions are mitigated by banks writing the terms on which the deal is done and then taking security against the customer’s default.

"Like any commercial enterprise, banks seek to maximise profit. Having survived the Global Financial Crisis, and being prudentially regulated against failure, annual profit has become the defining measure of success of Australian banks. That measure has been justified as being in the interests of shareholders and, because superannuation funds hold bank shares, as being in the interests of all Australians. But there being little threat of failure of the enterprise, and there being little competitive pressure, pursuit of profit has trumped consideration of how the profit is made. The banks have gone to the edge of what is permitted, and too often beyond that limit, in pursuit of profit. And they have gone beyond the limit:

• because they can; and
• because they profit from the misconduct that is described in this report.

"Risk to reputation was ignored. Discovery of misconduct was ‘managed’ by words of apology and promises to do better. But little more was done than utter the apology and make the promise. More often than not, remediation programs were eventually set up but usually after protracted negotiation. Profit remained the informing value.”

This is truly a turning point for banking and financial services, and those who invest in them.

It is another reason bank returns will be meagre, if not negative, for years to come.

Budget Outcome = Election Cash

The 2017-18 final budget outcome this week was a remarkable document – what Paul Keating would call a beautiful set of numbers.

The deficit was $19.3 billion less than forecast in the 2017-18 budget - $10.1 billion versus $29.4 billion. Receipts were $13.4 billion higher, payments were $6.9 billion less, and Future Fund earnings were $1.1 billion higher.

Half the difference in receipts came from company tax and the rest from a combination of individuals, super, customs, and GST. All categories of tax produced more money than predicted.

Of the lower payments, more than a third of it, surprisingly, came about because fewer people than expected registered for the NDIS, and a lot of the rest was due to delays in infrastructure payments to the states, so those amounts will eventually have to be paid.

Treasurer Josh Frydenberg said they remained on track to balance the budget in 2019-20, as forecast earlier, which means, I think, that they will look to spend at least half the 2017-18 windfall in election promises. So will Labor.

It means there’ll be spending and tax cut promises in the coming election campaign like we haven’t seen for more than a decade.

That means lots of fiscal stimulus next year, on top of the cash rate staying at 1.5%, probably for the whole of 2019.

And that means a stronger Australian GDP than anyone is forecasting.

Of course it could all come unstuck if China has a conniption as a result of the trade war, but as things stand we are going to have fiscal and monetary stimulus aplenty next year, which should go a long way towards offsetting the banking credit squeeze that is already resulting from the royal commission.

China

In light of that, this chart is encouraging, and like all good charts, is worth a thousand words:

As a reminder, the Li KeQiang index was created by The Economist in 2007 to measure three things that the then Party Secretary, and now Premier, Li Keqiang, said were better indicators of the economy than GDP.

The three things are freight traffic, electricity production and loan growth, shown separately in the chart and then as the index.

Note the deeply suspicious stability of GDP against the more credible freight and electricity lines. Loan growth is also stable, but that’s less suspicious since it’s controlled by the central bank.

My ABC

Just a brief comment on the week’s drama at my other employer.

It’s been a brutal, unsettling week for everyone at the ABC, but I think it might, in the end, go down as a great week for the organisation – one of the best since I started there 23 years ago.

First, an inadequate CEO has gone, second an unsuitable chairman (as it turned out) has also gone, and third not only has the ABC’s independence been reinforced, but its critics have been silenced, at least for the moment.

Sure, it’s all been quite unpleasant and disruptive, and everybody’s been getting terribly upset and having protests and meetings and such, but the end result, in my view, couldn’t be better.

Michelle Guthrie was the wrong choice and was rightly fired. Why? For a fundamental reason that goes to the heart of what the ABC is all about.

She was hired for her experience and expertise in digital distribution at Google, but what matters for the ABC is the content that is being distributed, not how it’s distributed. Obviously the technology has to work, but the leadership needs to be focused above all on the quality of the stuff being distributed and on representing and defending the ABC in the community. That simply isn’t Michelle Guthrie’s thing.

I thought Justin Milne was an OK chairman, but his clumsy attempts to get journalists sacked showed that he didn’t understand the job and also had to go.

I think Stephen Mayne is right - Milne is on too many boards. It’s partly about just being too busy, but the main thing is that being chairman of the ABC is not a business task. When you’re so busy being a businessman in the rest of your life it’s hard to change tack and become a public broadcaster on the days that you’re in ABC mode.

When Milne was telling Leigh Sales on 7.30 on Thursday that you don’t want to upset the person supply you with money, he was talking as a businessman worried about financial stakeholders, as you do, not someone involved in public broadcasting, which is not a business.

Apart from anything else, the idea that sacking journos to keep Coalition politicians happy would result in more money for the ABC is worse than naïve: they’re engaged in ideological combat, not a transaction. Nothing short of destruction or privatisation would satisfy the ABC’s enemies.

The best result of this week is that the ABC’s independence has not only been confirmed, but it is now sacrosanct. Woe betide anyone in Government now who tries to get a journo sacked, or tries to interfere with news judgement. The bar has now been set, and it’s high.

The only thing left to resolve is whether the rest of the board should go since they knew about Milne’s stupid emails trying to get Michelle Guthrie to sack Emma Alberici and Andrew Probyn but continued to support him for a week. They only abandoned him once the emails became public and his position became untenable.

Not good. I think they need to explain themselves and/or quit – the lot of them.

Kavanaugh and the Court

Another brief comment on a political matter. Actually, this is one of the biggest, most important stories in the world at the moment.

The American religious right that controls the Republican Party has shown that the most important institution in the US to them is the Supreme Court – more important than Congress or even the White House. And they’re right: the judges are there for life and the court is ultimately more powerful.

They voted for a known adulterer and sexual miscreant as President for the sole purpose of stacking the Supreme Court. They were prepared to hold their noses and install Trump in order to get abortion and other social reforms like same-sex marriage overturned.

They will now apply the same thinking to Congress and Kavanaugh.

They are now very close to shoving Brett Kavanaugh onto the Supreme Court, although this morning’s news is that one of the Republican majority on the nominating committee, Jeff Flake of Arizona, has said he wants an FBI investigation before he agrees, which is a large blowfly in the ointment.

But after the testimony against Kavanaugh from Christine Blasey Ford, the Republicans will lose Congress in the mid-term elections if he ends up on the Court because women won’t vote for them.

They don’t care. Congressional majorities come and go, but the court goes on - almost forever. What’s more, Kavanaugh will now have the power to profoundly change American society for a generation.

This was possibly the Republicans last chance in a long time to stack the Supreme Court: they were never going to let it pass.

Fed Rate Hike

There was a lot of focus after the Fed meeting this week on the removal of the word “accommodative” from the statement. It was actually a sentence that was removed: “the stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustainable move to 2 percent inflation”. Apart from that the June and September statements were identical.

But as the market quickly realised, what matters more is the “dot plot” – that is, the chart of dots that sets out each voting member’s interest rate forecast.

Here it is for September:

And here’s what it looked like in June:

The key point is that it’s slightly top-heavier in 2018 and 2019 - in June, seven expected four rate hikes this year, now it’s 11.

So it wasn’t really a “dovish” Fed statement, as first thought. There’ll be another rate hike in December and at least three next year. The Fed funds rate will be more than 3%, and probably double the Australian cash rate – the biggest gap ever.

That must lead to the conclusion that, all else being equal, the Australian dollar is heading lower.

As for the sharemarket, it depends on earnings (EPS) mostly.

[caption id="attachment_172658" align="alignnone" width="442"] Source: Minack Advisors[/caption]

If earnings hold up then a steady tightening cycle shouldn’t cause too much trouble, but valuations are stretched in the US and the chart suggests that the earnings cycle may have tipped over. Not much needs to go wrong for a significant adjustment to happen – and I’m thinking not just about higher US interest rates, but trade as well, not to mention the rising oil price….

Oil’s Upside Risk

Donald Trump was in normal gobsmacking form on Tuesday when he addressed the UN General Assembly and ticked off OPEC.

“OPEC and OPEC nations,” he said, “are, as usual, ripping off the rest of the world, and I don’t like it. Nobody should like it. We defend many of these nations for nothing, and then they take advantage of us by giving us high oil prices. Not good.

“We want them to stop raising prices, we want them to start lowering prices, and they must contribute substantially to military protection from now on. We are not going to put up with it — these horrible prices — much longer.”

Yes, the oil price is above the average, a bit, but half what it was in 2008.

But the main thing is that the oil price has largely been going up because earlier this year President Trump announced that sanctions would be re-imposed on Iran in November, something that had been well flagged and anticipated.

Before that announcement in May, Iran was exporting as much as 2.5 million barrels per day of crude and gas condensates, mostly to Asian buyers including China and India. By the first half of September, as buyers looked for alternatives ahead of the sanctions, shipments had fallen to 1.7mbpd. South Korea has stopped buying Iranian oil entirely, while India’s purchases have fallen from around 450,000 bpd of crude before the sanctions announcement to less than 400,000 bdp now.

Chinese buyers have said they will ignore the sanctions. With all the trade tensions going on, and the Chinese government trying not to inflame them, that might not prove so easy.

There’s a fair chance that about 1.5mbpd of Iranian supply will be lost next year, along with 500,000 from Venezuela, and with steadily growing demand it looks like there will be a global shortage of oil next year, which means the risk is for a higher oil price, not lower.

It could even get worse after last weekend’s terrorist attack in Iran.

Twenty-five people were killed, and more than 60 wounded, when gunmen opened fire during a military parade marking the anniversary of the beginning of the Iran-Iraq war. The attack happened in the southwestern city of Ahvaz, which is home to the country’s Arab minority.

ISIS formally claimed responsibility fairly quickly and there were some media reports suggesting that it was actually the work of Arab separatist groups with alleged ties to the powerful Sunni Gulf states.

Anyway, Supreme Leader Ayatollah Ali Khamenei didn’t muck about about: he blamed the United States’ “allies in the region” (ie Saudi Arabia), and wrote on his official website: “Their crime is a continuation of the conspiracies by the US-backed regimes in the region which have aimed at creating insecurity in our dear country.”

With the Islamic Revolutionary Guards Corps warning that it will take a “deadly and unforgettable revenge” against the perpetrators, the risk that the cold war between Iran and Saudi Arabia will become a hot one is rising. That will only get more likely as Iran feels the effects of the economic sanctions that are scheduled to start in November.

Meanwhile, oil demand is about to cross 100 million barrels per day, having reached 98.71mbpd in the June quarter. This is fully seven years ahead of the International Energy Agency’s prediction, made in 2017, predicted that it would reach 100mbpd in 2025.

Demand for both gasoline and diesel (“middle distillate”) are proving both remarkably stable – and rising steadily:

I’m not suggesting that the oil price is heading back to US$100 in a hurry, and therefore Woodside’s share price back to $45, but the risks are definitely towards the upside at the moment.

Abernethy’s Three Risks

My friend John Abernethy posted a good “View”, as he calls it, to his clients this week which is worth passing on. It has headed “The housing correction we have to have”, but started with a discussion of two other risks.

“The first is the tariff battle between the US and China. As this is likely to unfold through the US midterm elections (held on 6 November), it now has the appearance of being primarily driven by the political imperatives of the US President. A concurrent driver (more openly promoted by the President) is the economic imperative to bring China into line (IP protection) and to slow its growth to the benefit of US manufacturing.

However, the second driver struggles to pass economic scrutiny, because the transfer of manufacturing back to the US, by utilising trade walls, would take many years to transpire (if ever).

In the meantime, there is the heightened risk that a surge in inflation driven by tariffs could derail the monetary policy settings of the US Federal Reserve (the Fed).

The other event that is now moving the price of US bonds is the burgeoning US fiscal deficit and growing US government debt pile. The projected US 2019 fiscal deficit (October balance) is now over US$1 trillion or 5% of US GDP. With this projected blow-out comes the forecast that US government debt will lift above US$22 trillion over the next 12 months. The US ten-year bond yield has now pushed above 3% again (3.09% today) and there is a heightened risk that the US bond market could suffer a severe correction – sooner rather than later!

Looking at the US budget forecasts, we estimate that the weighted average interest rate paid on US government debt (bonds) is about 1.5%. This estimate is based on the $316 million of projected interest (on circa US$20 trillion of debt) that is to be expensed through the US government budget of 2018. This interest bill will represent a significant 40% of this year’s massive US deficit of US$750 billion.”

On the subject of housing, John bemoans the lack of a decent housing policy in Australia, or any policy at all.

“We reiterate that (the) heightened risk (housing mortgage debt) has developed because Australia does not have a policy that can be measured against a desired social outcome. A good aspiration for housing would be a policy framework that is focused upon “delivering housing that is affordable to both today’s and future generations”.

“Without that focus on a desirable outcome, there has been no requirement for the government or its regulators to act to check the growth in housing prices; the creation of a highly unaffordable property market is the result.”

APRA is now cracking down on risky lending and the market is having “the correction we have to have”. The outcome will be unpredictable.

On the subject of housing, Credit Suisse produced a report this week headed “Sydney housing is no longer a safe haven”, arguing six key points:

“1. Housing investors feed off other marginal buyers and are highly price sensitive.

2. Many first home buyers are priced out of the market.
3. Chinese buying interest is weak. Available capital flows data reveal that outflows have dwindled at low levels in recent quarters. More timely foreign exchange data suggests that the demand for AUDs has fallen with the demand for CNHs. Australia has not proven to be much of a safe haven against whatever has occurred in China.
4. The absence of growth in Chinese demand and the insufficiency of any recovery in first home buyer demand makes it hard for investors to be positive, let alone carry negative gearing positions. Overall, housing demand is likely to be weak for some time.
5. New housing supply remains elevated, despite clear weakness in prices. The overbuild could continue for a while longer, if building approvals are anything to go by. And the supply of existing homes from foreclosures could also increase.
6. House prices are likely to fall by 5-10% in 2019, after falling by roughly 10% in 2018. A large policy easing response, or supply correction is needed to steady the market. But until we see evidence of either, house prices fall by 15-20% from their 2017 peak. And if a supply correction occurs, real GDP growth will no longer be running at 3.3% annualized. Indeed, over the past year, residential investment has been contributing modestly to economic growth. A pull back in the sector will likely exert a material drag on activity.

Overall, the housing market outlook is poor, even before we consider the full impact of credit tightening, out-of-cycle rate hikes, and the risk of investor de-leveraging.

Bogle Model

Interesting note this week on the so-called Bogle Model from Marcus Tuck, head of equities at Mason Stevens.

It’s named after John Bogle, the founder of Vanguard Investments, and attempts to estimate average equity returns over the next decade. The main inputs are the starting dividend yield for the market, the estimated long-term rate of EPS growth, and an adjustment to normalize the market PE ratio (i.e. bring it back into line with the long-term average). When the market PE ratio is above average, it is expected to de-rate over the next decade thereby reducing the expected equity return, and vice versa. 

What follows are Marcus Tuck’s calculations of the current Bogle Model.

The 12-month forward dividend yield for the S&P 500 Index is 2.0%, the long-run EPS growth expectation is probably still about 5% (3% real 2% inflation), and the 12-month forward PE ratio for the S&P 500 is currently 16.8x, which is 2.1 PE points above the 10-year average of 14.7x.

Therefore, the Bogle Model predicts average US equity returns over the next decade of: 2.0 5.0 (14.7 - 16.8) = 4.9% p.a.

Turning to the ASX 200 Index, the picture is as follows.

The 12-month forward dividend yield for the ASX 200 Index is 4.5%, the long-run EPS growth expectation is around 5% (3% real 2% inflation), and the 12-month forward PE ratio for the ASX 200 is currently 15.5x, which is 1.5 PE points above the 10-year average of 14.0x. 

Therefore, the Bogle Model predicts average Australian equity returns over the next decade of: 4.5 5.0 (14.0 - 15.5) = 8.0% p.a. 

That is not greatly different to the actual market return of the past decade, which, with dividends reinvested, was 8.4% p.a. That analysis (and historical market return) does not take into account the additional benefit of dividend imputation, which is often overlooked. 

If we attempt to include franking in the expected return (recognizing that not all listed companies pay fully franked dividends), the Bogel Model calculation would become: (4.5 x 100/70 x 0.65 4.5 x 0.35) 5.0 (14.0 - 15.5) = 9.3% p.a. 

The Australian stock market has actually been one of the highest returning stock markets in the world over the past century, partly because our dividend yield is usually always quite high to begin with. There will always be year-to-year volatility but, where things stand at the moment, the average return for Australian equities over the next decade may not be that different to what it was over the past decade, although there will be moments when it won't feel like it.

Dividend Franking Petition

Geoff Wilson of Wilson Asset Management is running a petition to try to get the Labor Party to change its mind on dividend franking and not remove franking credit cash refunds from low-tax payers.

I’ve signed it (even though I’ll probably now get spammed by Wilson). If you’d like to sign it too, you can do it by clicking here.

FGX correction

In my interview with Louise Walsh of Future Generation Investment Co (FGX) I remarked that the stock was trading at a premium to NTA of 32%. That was wrong. The premium is currently 8% (NTA is $1.24 and the price is $1.34).

Research and Diversions

Research

Ben Griffiths and David Allingham of Eley Griffiths Group: Why we’re bullish in 5 charts.

Short but very interesting piece: It’s very possible that the dominant cryptocurrency hasn’t been created yet (Google was years late to the search engine party, and Facebook came long after most people assumed the social network wars were won). “Although I don’t think the US government can stop cryptocurrency, I do think it could create the winner–let’s call it “USDC” for US Digital Currency.”

Instead of trade, Mohamed El-Erian sees the major risk for the market in the next six to nine months coming from the growing divergence between the U.S. and the rest of the world both in economic performance and in monetary policy.

The US Government will soon spend more on interest than the military.

Machines and automated software will be handling fully half of all workplace tasks within seven years, a new report from the World Economic Forum forecasts. It’s called the “Future of Jobs 2018” Here’s a story in Fortune about the report, and here’s the report itself.

Speech recognition is tech’s next giant leap says Google: “But there are lots of hard problems such as understanding how a reference works, understanding what ‘he’, ‘she’ or ‘it’ refers to in a sentence.”

Here's Jeff Bezos at The Economic Club Of Washington, where he was interviewed for over an hour. From the 10m 27s point, he talks about focusing on customers, rather than competitors. It's a very good hour, but this one clip stands out. 

A close look at US exports to China, from the St Louis Fed. “In 2017, the top export category to China was civilian aircraft, at around $16.26 billion, followed by soybeans, at around $12.25 billion. The third-highest export was motor vehicles, at $10.3 billion, and fourth was electronic integrated circuits, at around $5.29 billion.”

We’re not getting faster software with more features. We’re getting faster hardware that runs slower software with the same features. Ever wonder why your phone needs 30 to 60 seconds to boot? Why can’t it boot in one second? There are no physical limitations to that. Web apps could open up to 10 times faster if you just simply block all ads.

How a small corner of the US mortgage market nearly brought down the global financial system.

"Renewables are a public opinion juggernaut. Being against them is no longer an option. The industry’s best and only hope is to slow down the stampede a bit (and that’s what they plan to try)."

The death of privacy in China – the government is now going to incredible lengths to keep an eye on its citizens: “China has reportedly begun deploying flocks of drones disguised as birds to surveil its citizens. The drones have wings that flap so realistically they’re difficult to distinguish from actual birds. In fact, animals on the ground often can’t make the distinction, and even real birds in the sky sometimes fly alongside the drones.”

Then again…Beijing’s plans to blanket China with 400 million high-tech surveillance cameras have hit a snag because it’s having trouble importing key components from suppliers in the U.S. and Europe

How Russia helped swing the election for Trump – a meticulous analysis of online activity during the 2016 campaign.

Robert Mueller has a novel PR strategy: silence.

“My Button Works!”: Trump’s belief that presidential authority is practically monarchical, his belligerent posturing toward countries such as Iran and North Korea, and his cavalier disregard for legal procedure have made many observers wonder if he will try to start a catastrophic war, and what safeguards exist to constrain him if he does.

Japan has enough nuclear material to build an arsenal. Its plan: recycle.

TCI member Barry told me about this Background Briefing programme on radio National, about a financial scandal in which the retirement savings of more than 100 investors was used as a piggy bank for company directors who borrowed funds to cover cash flow problems and even a divorce settlement. 

Peter Switzer: “Where Bill (Shorten) has got it wrong is that he’s treated all self-funded retirees as rich.” 

“Australian organisations need to move more rapidly into using artificial intelligence applications to automate and augment manual processes, as well as skilling up an AI workforce as the technology becomes as fundamental to society as basic utilities.”

How much money do private equity firms make? The best funds have great returns, but the asset class has actually underperformed the S&P 500.

China installs enough solar panels to cover a football pitch every hour of every day.

Diversions

One of the best pieces this week on the ABC mess. Waleed Aly: this is about more than the ABC - we’re in an age of “total politics”.

Aha! I asked last week how a bat can poo without it running over its face, since they hang upside down, and a helpful reader sent me this video of a bat pooing (Americans call it pooping of course, which a lot of misguided Australians are now picking up). But anyway, mystery solved!

The political theology of neoliberalism.

Why suffering outweighs happiness in nature: “The mechanisms that determine which individuals come into existence are such that far more individuals come into existence than can survive with the resources available. Due to this, most of them will suffer and die shortly after being born”

Australia is a beacon of stability: it hasn’t changed leaders in 30 years.

This is very nice – a Japanese sound garden, playing Bach. But at the end, it turns out to be a 3-minute ad for a phone company! But still, very nice.

The best piece on Michelle Guthrie’s sacking as MD of the ABC, by Margaret Simons.

I am a Neanderthal: “Once a week I get an email from 23andme updating its reports on my five-year-old spit sample. The only thing that changes is my percentile score for Neanderthal admixture, and it only ever increases. It checks out aesthetically — like the Neanderthal, I flush easily, am deeply intolerant of heat, and scientists are still debating whether I am capable of complex symbolic thought.”

Of course! Coca Cola is now eyeing an entry into the cannabis market.

This guy is really good at impressions – Ross Marquand.

The awfulness of social media: “To be alive and online in our time is to feel at once incensed and stultified by the onrush of information, helpless against the rising tide of bad news and worse opinions.”

Humanity’s enduring legacy is not its alteration of the environment but that the extinctions we have precipitated will have left behind an array of empty niches, to be filled by whatever adaptable species are able to take advantage of them.

A great photo essay from the Caspian Sea: “People go to Naftalan to bathe in the crude oil that pours like brown sludge from overhead tanks through gurgling pipes into stained baths, hoping to benefit from its alleged healing properties. It strikes me as a kind of gritty Soviet counterpoint to the pure spring water of Lourdes.”

"If towing icebergs to hot, water-stressed regions sounds totally crazy to you, then consider this: the volume of water that breaks off Antarctica as icebergs each year is greater than the total global consumption of freshwater. And that stat doesn't even include Arctic ice. This is pure freshwater, effectively wasted as it melts into the sea and contributes to rising sea levels.”

Billions of humans eat meat. “To provide it, we raise animals. We control, hurt, and kill hundreds of millions of geese, nearly a billion cattle, billions of pigs and ducks, and tens of billions of chickens each year. If controlling, hurting, or killing animals is wrong or if the production of these environmental effects or effects on people is wrong or if consuming the meat produced is wrong, then a breathtaking level of wrong-doing goes on daily.”

How cauliflower took over your pizza, your kitchen, the world. “Cauliflower seemed to rise out of nowhere — you weren't eating it, and then you were. But to the people who track these things, both chefs and trend forecasters, the rise of cauliflower is a perfect illustration of how food trends evolve."

No significant birthdays this week (or at least none that I want to celebrate) so here’s some Leonard Cohen. He has performed many versions of "So Long, Marianne," but this one is special. The 1993 Oslo concert rendition includes not only a radically different arrangement but also two verses not found on any album. The impact is dramatic. (Thanks for this Andrew Grant)

Facebook Live

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

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

Next Week

By Craig James, Chief Economist, CommSec

Australia: ‘Top shelf’ indicators are expected

• The calendar clicks over from September to October – the scary thing being that there is less than three months to Christmas. In the coming week the Reserve Bank Board meets and retail trade and building approvals data are released with international trade.
• The week kicks-off on Monday when CoreLogic releases the Home Value index. Also Commonwealth Bank/Markit and Australian Industry Group (AiGroup) release their separate purchasing manager indexes (PMI) for the manufacturing sector.
• Based on the daily data, home prices probably fell by around 0.4 per cent in September with Hobart and Brisbane prices out-performing other capital cities. Capital city home prices similarly fell by 0.4 per cent in August.
• The AiGroup PMI rose from 52.0 points to 56.7 in August. And the CBA/Markit PMI rose from 52.4 points to 53.2 in August. Both readings were above 50 points, indicating that the manufacturing sector is expanding.
• On Tuesday, the Reserve Bank Board meets but no change in rates is expected for the 26^th straight month.
• Also on Tuesday the regular weekly reading on consumer confidence is published by ANZ and Roy Morgan.
• On Wednesday, the Australian Bureau of Statistics (ABS) release data on dwelling approvals – approvals of building applications by local councils.
• Council approvals to build new homes fell by 5.2 per cent in July to be down 5.6 per cent over the year.
• Also on Wednesday the Federal Chamber of Automotive Industries (FCAI) release the VFACTS report on new vehicle sales. And Commonwealth Bank/Markit and AiGroup release their separate survey results of purchasing managers in the services sector.
• New vehicle sales in Australia dropped 1.5 per cent on the same month in 2017, with new registrations totalling 95,221 units.
• On Thursday the ABS release the August international trade data – the export and import figures for the month. The trade surplus eased from $1,937 million in June to $1,551 million in July. It was the 12th surplus in 15 months. The rolling annual surplus rose from $6.219 billion to $7.408 billion.
• And on Friday, the ABS release the August data on retail trade or sales while AiGroup releases the Performance of Construction index. Retail trade was flat in July after rising 1.3 per cent in the previous three months. Annual spending growth rose from 2.8 per cent to 2.9 per cent.

Overseas: US jobs data hogs the limelight

• The monthly jobs data in the US (non-farm payrolls) is generally regarded as the pre-eminent monthly indicator. And it is released on Friday in the coming week. There are also various ‘top shelf’ indicators to watch.
• The week kicks off on Monday in the US with the release of the ISM purchasing managers index for manufacturing and data on construction spending. The ISM PMI stands at a 14-year high of 61.3.
• On Tuesday the September data on new vehicle sales will be issued. And on the same day, the regular weekly data on chain store sales are also released.
• On Wednesday the ISM PMI for services is issued – a survey of purchasing managers in the services sector. On the same day the regular weekly data on new mortgage applications is also issued. The ISM services PMI stood at 58.5 in August – well above a reading of 50, signifying expansion. Little change is expected in September.
• On Thursday in the US the Challenger report on planned job cuts is released, Data on factory orders is also issued. And there is the regular weekly data on new claims for unemployment insurance.
• Employers announced job cuts of 38,427 in August, the most since March. Factory orders may have risen 0.9 per cent in August after a 0.8 per cent fall in July.
• On Friday in the US, the non-farm payrolls report (employment and unemployment) is issued for the month of September. And on the same day, the August readings on exports and imports (international trade) are also released.
• The US job market is strong. In August, employment rose by 201,000 – a record 95^th consecutive lift in jobs. Unemployment stood at 3.9 per cent (just above 18-year lows) and annual growth of wages stood at a 9-year high of 2.9 per cent. Economists tip a 185,000 lift in jobs in September with the jobless rate down to 3.8 per cent. But the wage data may get most interest. A further solid lift in hourly earnings would point to further rate hikes ahead as well as a firmer US dollar (or greenback).
• And the US trade deficit may have edged higher from $50.1 billion to $50.2 billion in August.
• In China, the coming week kicks off on Sunday (September 30) when official purchasing manager index (PMI) results for both manufacturing are services sectors are scheduled. The manufacturing PMI rose to 51.3 points in August, up from 51.2 points in July, remaining above the 50-point mark that separates growth from contraction for a 25th straight month. After these data releases, the next figures aren’t due until Monday October 8.

Last Week

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

Investment markets and key developments over the past week

• While US shares fell slightly over the last week most major share market saw gains. Bond yields fell a bit in the US and Australia but rose elsewhere. Oil prices rose after OPEC left output unchanged, but metal and iron prices fell. The $US rose, particularly as the Euro fell on renewed Italian budget worries, and this saw the $A slip back to around $US0.72.
• Although major global share markets performed well in September, defying seasonal weakness, Australian shares fell after reaching a ten year high in August as defensives, consumer stocks, financials and high yield sectors came under pressure not helped by rising bond yields.
• The trade threat from the US has not gone away. While markets saw a relief rally in response to the latest tranche of US/China tariffs being less than feared its clear that the issue is far from resolved. The proposed fifth round of US/China trade talks didn’t happen. China has released a defence of its position and is going down its own path on the trade issue by announcing a cut to its average tariff to 7.5% from 9.8% and reducing non-tariff barriers and seeking to offset the impact of US tariff hikes by policy stimulus rather than engaging with the US on its gripes. And tensions between the US and China appear to be rising with the Trump accusing China of interfering in the mid term elections and some low-level signs that military tensions may be rising too. Our view remains that while the tariffs actually implemented so far are relatively small further escalation in the US/China trade conflict is likely with a negotiated solution still a way off. Meanwhile, the risk is rising that Canada will not agree to a revamped NAFTA deal with the US, the US and Japan are now to enter new trade talks with Trump clearly wanting concessions from Japan and French President Macron said he would not agree to a new EU trade deal with the US unless the US commits to the Paris climate agreement. Of course, Trump wants to get US allies on side so he can focus on China but there is still a long way to go on that front too. So, trade will remain a periodic issue for markets.
• The US Fed provided no surprises, hiking rates by another 0.25%, describing the economy as strong and indicating that further gradual rate increases are likely. While the Fed is no longer describing monetary policy as “accommodative” its far from tight either and Fed officials’ interest rate expectations (the so-called dot plot) point to rates rising above the Fed’s estimate of the long run neutral rate which is currently at 3%. We expect another hike in December and, like the Fed, three more hikes next year. Market expectations for just over two more hikes over the year ahead remain too dovish. Continuing US rate hikes mean ongoing downwards pressure on the Australian dollar and the risk of more out of cycle rate hikes by Australian banks to the extent global borrowing costs rise. Trump’s criticism of Fed rate hikes are clearly not having any impact though with Powell indicating the Fed’s focus is keeping the economy healthy and that it doesn’t consider politics.
• The issues around Brett Kavanaugh’s nomination to the US Supreme Court add to the risk that the Republicans will lose control of the Senate as well as the House. While this will not change our views around Trump and his economic policy – there is a good chance he will get impeached but there still wouldn’t be enough votes in the Senate to remove him from office and Congress won’t change or reverse his economic policies – it will be something that markets will worry about in the run up to and after the November 6 mid-terms.
• Italy targeting a higher budget deficit – a negative for the Euro, but nowhere near as bad as feared. News that the Italian coalition Government will target a 2019 budget deficit of 2.4% of GDP has pushed the Euro down and is a negative for Italian shares and bonds. This is not low enough to reduce Italy’s public debt to GDP ratio and will lead to some conflict with the European Commission. However, its far less than had been feared a few months ago and is not high enough to see the rest of Europe pressure Italy too much (particularly as France and Germany don’t want to fuel Italian anti-Euro populist sentiment). Rather the rest of Europe is likely to leave market forces via higher Italian bond yields to discipline Italy. So not good for Italian bonds but no disaster for the Eurozone. 

Major global economic events and implications

• US data remains strong with a new 18 year high in consumer confidence, strong durable goods orders (although underlying orders were a bit soft) and rising imports. The US housing sector is far from its pre GFC boom though with a soft trend in sales and continued modest growth in home prices – but that is probably a good thing.
• Eurozone economic sentiment slipped in September but remains strong and private lending continues to accelerate.
• The Japanese labour market remained strong in August, industrial production rose and core inflation in Tokyo edged up to 0.6% yoy. but its still a long way from the BoJs 2% target.

Australian economic events and implications

• In Australia, there was good news on the budget, but the risks around house prices appear to be mounting and rising petrol prices pose a threat to consumer spending power. First the good news from the last week:

• The 2017-18 budget deficit came in at $10bn which is $8bn less than expected in May. While part of this owes to spending delays, the Government has announced more spending ahead and risks remain around wages growth, it nevertheless indicates that the Government has some scope to provide more stimulus ahead of the next election.
• And ABS job vacancy data remains very strong up 16.5% yoy, albeit it did slow down a lot in the 3 months to August.
• Against this though:
• The risks around the housing market are continuing to mount with more banks withdrawing from SMSF lending and signs of a crackdown on property investors with multiple mortgages as the banks move to comprehensive credit reporting (ie sharing info on customer debts) and focusing on total debt to income ratios. The latter is significant given estimates that nearly 1.5 million investment properties are held by investors with more than one property.

• Credit growth to property investors remains very weak as tighter lending standards & falling investor demand impact.

[caption id="attachment_172701" align="alignnone" width="511"] Source: RBA, AMP Capital[/caption]

• Petrol prices over the last week have pushed higher on global oil supply concerns with more upside likely as supply from Iran and potentially Venezuela is cut. The weekly Australian household petrol bill is now running over $10 a week higher than a year ago. So, while higher petrol prices (if sustained) will add to headline inflation, they will also cut into household spending power and dampen spending elsewhere which will keep underlying inflation down.

[caption id="attachment_172700" align="alignnone" width="511"] Source: Bloomberg, AMP Capital[/caption]

• For the RBA, these considerations largely offset each other for now so we see no reason to change our view that it will remain on hold for a lengthy period. I am even tempted to the RBNZ approach that the next move in rates “could be up or down”.

What to watch over the next week?

• In the US, it’s back to focussing on jobs and wages with September labour market data due Friday expected to show another strong 190,000 gain in jobs and unemployment falling to 3.8%, but wages growth slipping back to 2.8% year on year, albeit maintaining a gradual rising trend. In other data expect the September ISM manufacturing index (Monday) to fall back to a still strong reading of 60, the non-manufacturing ISM index (Wednesday) to remain around 58 and the trade deficit (Friday) to worsen.
• Eurozone unemployment (Monday) is expected to fall to 8.1%.
• The Japanese September quarter Tankan business conditions survey (Monday) is expected to remain solid.
• In Australia, the RBA will yet again leave interest rates on hold when it meets Tuesday. While recent economic growth and jobs data has been good, we are still waiting for inflation and wages growth to pick up and the slide in home prices risks accelerating as banks tighten lending standards which in turn threatens consumer spending and wider economic growth. As a result it would be dangerous to raise rates and we don’t see the RBA hiking until 2020 at the earliest and still can’t rule out the next move being a cut. Meanwhile, on the data front expect CoreLogic data (Tuesday) to show another fall in home prices for September, August building approvals (Wednesday) to show a 2% bounce, the trade surplus (Thursday) to fall slightly to $1.4bn and retail sales (Friday) to rise 0.2%.

Outlook for markets

• 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. However, the risk of a correction over the month or so still remains significant given the threats around trade, emerging market contagion, ongoing Fed rate hikes, the Mueller inquiry in the US, the US mid-term elections and Italian budget negotiations. Property price weakness and approaching election uncertainty add to the risks around the Australian share market.
• Low yields are likely to drive low returns from bonds, with Australian bonds outperforming global bonds.
• 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 10% or so, but Perth and Darwin property prices bottoming out, 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%.
• While the $A is working off very negative short positions it’s still likely to fall to around $US0.70 and maybe into the high $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.