Three clear and present dangers

Summary: The threat of a US and North Korean war is causing investor nervousness, particularly on Wall Street. Closer to home, looming gas shortages and the Commonwealth Bank's money laundering scandal are also rising threats.

Key take-out: Whatever happens on the global front, the issues impacting AGL, the CBA and other Australian listed companies are also potential problems for investors.

In a strange way we are preparing for wars, both on the global stage and locally. The local wars involve individual companies and are obviously less serious, but no less intense.

But let's start with what is developing into a widely held expectation – a military encounter between North Korean and the US. I wrote about this at length earlier this month (The troubles with war and power plays), and I finished my commentary saying I hoped there would be no war. That is still the case.

But this week we saw nervous investors piling into American bonds, and American shares showing a clear softness. While there is clearly no panic, what is taking place in bonds is exactly the reverse of what the Federal Reserve was aiming for when it announced that it would not reinvest maturing government (and some corporate) bonds. 

From next month the Fed will stop reinvesting $US10 billion in maturing securities. That will rise by $US10 billion each a quarter until it reaches $US50 billion a month, with the aim of reducing the Fed's $US4.5 trillion balance sheet by $US1 trillion in two years. In theory, interest rates should have increased and bond prices have declined, but the rules change when there is threat of war. And, as I pointed out last week, a lot of the quantitative easing money is simply lying in US banks, so it is being shovelled from the banks back into the Federal Reserve. A frustrated Fed chief, Janet Yellen, says cash rates are likely to rise, but bond rates have hardly moved.

We are going to see extended periods of speculation in the markets as the US President and the North Korean leader swap threats. The country with a lot to lose, if there is a breakout of war, is China. It would be flooded by refugees, which would bring instability into large parts of the country. China was hoping to enjoy the spoils of the verbal exchange between the two countries, but increasingly China is tightening its trade embargos with North Korea, which will either cause the North Koreans to attack or come to heel.

They cannot survive an extended period if China keeps the sanctions tight. And, as I have pointed out in previous comments, the last time these sorts of sanctions were placed on an Asian country was in 1941 on Japan, and that triggered the Pearl Harbour attack.

The conflicts over gas

Back to Australia and, although it is nothing like the seriousness of the global confrontation, the Federal Government is now really taking the looming gas shortage extremely seriously.

The three Gladstone consortiums are simply going to have to provide the gas, and they will either do that voluntarily or compulsorily. One would have expected Santos shares to fall, but instead they rose, and I think there are two reasons for that. Firstly, the New South Wales government, which blocked the development of the vital Narrabri gas fields, is going to be forced to do the right thing by its residents and the nation and allow Santos to develop Narrabri as soon as possible.

And secondly, it seems both the Shell and Origin consortiums will share the burden of supplying the east-coast demand. Of course, there are immense reserves of gas in Victoria which have been banned from being developed by both sides of the Victorian parliament. They don't involve fracking and will be very efficient in their extraction. So, solving the longer-term problem is not hard. But out of this emerges a much tougher Malcolm Turnbull, and I think he will turn his toughness onto the power situation and will not allow AGL to play political games. It is always dangerous for listed public companies like AGL to take on the government of the country, head-on, in an arena where power prices are going through the roof. Leave aside your carbon views – AGL is embarking on a high-risk strategy that might go wrong.

Damage control at the Commonwealth Bank

The second war is the attack on the Commonwealth Bank and its action in taking large deposits through ATMs from money launderers who diverted some of it into terrorism.

I have been warning about the dangers facing the Commonwealth Bank, yet the institutions and corporate analysts have been playing down the dangers and accepting the line that the fines placed on the CBA would not be large.

But, this week, Goldman Sachs alerted its client base that the CBA could be facing larger fines than the market expected, and that sent the bank's shares lower to again brush the $75 level. I think Goldman Sachs is absolutely right. The world has turned on the banking community with some vigour, and CBA is simply not going to be able to brush this off as a computer technology glitch.

It wouldn't surprise me if it was fined as much as one or two years' profit, which would require the bank to raise capital. I emphasise that I clearly do not know the outcome but, fairly or unfairly, when a company is ‘on the nose', court cases are very dangerous indeed. I am sure the ATM fee abolition was about trying to get some favourable publicity for the bank and a better climate for the court case.

Calm before the rates storm?

Finally, on the subject of interest rates, I always listen to what Westpac economist Bill Evans says. He usually has a different view to the rest of the market, but he is often right and he loves to remind the consensus view that it was wrong. And so, once again, he is taking on most of the security industry analysts who are forecasting higher rates in 2018 – perhaps by half a per cent.

Evans says the economy is not going to grow at the rate expected by the Reserve Bank and analysts, and so interest rates will not be adjusted until 2019. You would have to say that, if power and gas prices keep rising, this will suck money from all areas of the economy. And, although energy prices will boost inflation, it will be very difficult for companies to pass on the costs.

Investment will be cut back, and in those circumstances Bill Evans will be right. And, of course, if US interest rates do not rise and people rush to buy American bonds, then our interest rates are even less likely to rise. Whether Evans is right or wrong, we can underline the fact that we are not going to see substantial interest rate rises next year.

At the worst it will be half a per cent. Bill Evans will remind you if he is right, but in the past he has always confessed his errors when he gets the market wrong.