US GDP, Nine eats Fairfax, Investment fees, new Macquarie CEO, AMP, Trade Truce, and more

Last Night's Markets
US GDP
Nine eats Fairfax
Investment fees
Macquarie and Shemara Wikramanayake
AMP
Trade Truce
Listed Investment Companies
Research and Diversions
Facebook Live
Next Week
Last Week

Last Night's Markets

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US GDP

The headline number released last night of 4.1% annualised growth in the second quarter is pretty good, no doubt about that - almost as good as the Bombers magnificent win last night!

But don’t forget it’s the Commerce Department’s first wild stab, using about 25% of the data it needs to get it right. The Australian statisticians, by contrast, work for two months and generally come out with a figure that doesn’t change. (China’s statisticians, on the other hand, work for two weeks and also come out with a figure that doesn’t change).

I remember the first estimate of US GDP growth for March quarter of 2015, released in April. It was 0.2% annual rate which was reported, rightly, as being near recession. Eventually, that was revised up to 3.2% - an entirely different story!

That was the biggest over-estimate, but the first guesses are often out by 1-2%. And around the GFC and 2011, the first guess was often UNDER by 3-4%.

Anyway, President Trump has naturally taken the number at face value and declared that “This is an economic turnaround of historic importance,” and "These numbers are very, very sustainable.” But most of the commentary I’ve read this morning suggests that it’s not sustainable and 4.1% is likely to be the peak, and probably isn’t right anyway.

On a positive note, the trend is definitely upwards:

The other very positive thing is that household consumption is strong – 4.3%.

But exports jumped 9.3% and net exports contributed 1% to GDP growth. With Trump doing his best to shut down global trade, that’s unlikely to last.

Grumpy Dave Rosenberg of Gluskin Sheff says: “Let’s not forget the real number was 3.5% for the second quarter once we strip out the doubling in soybean exports which we know had more to do with transitory effects related to tariff schedules as opposed to any dietary changes abroad.”

But the big fundamental problem is slow wages growth and therefore incomes. Real personal disposable income growth fell from 4.4% in Q1 to 2.6% in Q2, which is below the average quarterly pace of 2017.

Here’s a graph of wage growth:

Source: Quartz

And don’t forget this is after Trump’s tax cuts, which were meant to lead to wage rises for workers. It looks like the tax cuts were a “sugar hit” that lifted spending, but not wages.

Also, business investment didn’t pick up either. The company tax cuts are being pocketed by shareholders.

Nine eats Fairfax

I’ve spent 26 years working for Fairfax, including six as editor of two newspapers, the Australian Financial Review and The Age. I formed life-long friendships and had wonderful mentors who were decisive in my development, like Bob Gottliebsen and Max Suich.

Will I be sad to see the Fairfax name disappear? Yeah nah, as a footballer would say.

I knew the place before 1987, before the great, great grandson of John Fairfax, Warwick Jnr, became “The Man Who Couldn’t Wait” and borrowed too much money to take it over. The company itself really was something special in those days, over and above each of the newspapers it owns.

After that, not so much. The Age, the Sydney Morning Herald and the Financial Review became treasures in a dank cave, diamonds on a brass ring.

The individual masthead brands have been preserved by dedicated editors and journalists while the company around them has been laid waste by carpet-baggers and fools. The disappearance of that company and its name will be no big deal and has been inevitable for a while, if only to save the $20 million or so per year in corporate overheads.

It seems to me two questions arise for investors out of Thursday’s announcement: will there be an auction for Fairfax so the price goes up from here, and will Nine’s Hugh Marks and Peter Costello make a go of it, so the stock is now a buy?

Both are possible, but on balance I think the answers are no and no.

Private equity might come in with cash, but I doubt it. Greg Hywood has been his own private equity manager and slashed costs already, so there’s unlikely to be much left on that score. And as for revenue growth, every part of the business is struggling to get any momentum and that’s not going to change for a while and private equity fund managers certainly won’t do it.

As for Nine as the new owner of Domain, The Age, the SMH, the AFR and 100% of Stan – CEO Hugh Marks and the board led by Peter Costello will need to get their heads around being a profitable number 2, which won’t be easy.

As discussed in my interview with Hugh Marks for TCI in February, Channel Nine regained top spot in the ratings thanks mainly to “Married At First Sight”, the show about love and fairy tales, as Hugh put it.

Before that, Nine had spent years as runner-up to Seven. Profits were flat and the share price declined steadily. To achieve profit growth, Nine had to become No. 1 again and Marks pulled it off.

Neither Domain nor Stan will ever be number one.

REA is dominant and, if anything, pulling away from Domain. The best the new CEO Jason Pellegrino from Google can do is to ensure it’s a profitable second-place.

And Stan will never knock off Netflix in Australia – the American company’s brand is too strong and the cash it is ploughing into original productions is colossal, designed to obliterate rivals.

With the newspaper mastheads, it’s all about website ratings these days. Nine’s website is currently no.2, after Murdoch’s news.com.au, according to Nielsen. The ABC is third and smh.com.au is fourth. The Age is outside the top 10.

Would the consolidation of nine.com.au, smh.com.au, and theage.com.au take the combined website to no.1? In theory, yes, but there might be a lot of duplication and post-merger drift, so it’s impossible to be sure.

It doesn’t matter much anyway: free journalism websites are a tough business and don’t make much money. Even if nine.com.au went to no.1, it wouldn’t really move the dial on group earnings.

The Fairfax radio stations, 2GB and 3AW, are already no.1 in their category in Sydney and Melbourne, so the only thing Hugh Marks could do is muck it up and lose that spot.

The final, and most important question is whether a media conglomerate combining TV, radio, newspapers and digital – the thing that was banned until Malcolm Turnbull finally repealed the Keating media laws last year – can create a greater sum of the parts revenue and market value than the individual parts themselves.

Maybe. Offering a full range of advertising possibilities increases reach and will appeal to big agencies and their clients. The combined sales force will work that angle hard and will no doubt gain some traction.

But longer term the advertising business is in trouble. Google and Facebook have destroyed yields and they are never coming back. The traditional classified ad business was first destroyed by REA, Seek and Carsales, and now same has happened to display advertising.

All of the businesses in which Nine will operate, with the possible exception of radio, will have to shift towards subscriptions instead of advertising.

That has already been happening to newspapers and their websites, although Fairfax has messed it up by trying to keep a foot in both camps: that is, raise money from subscriptions while still selling a lot of ads. But it doesn’t work – you have to choose.

Free to air TV ratings, and therefore advertising revenue, are being preserved by anti-siphoning rules on sport and cheap reality shows like Married At First Sight and My Kitchen Rules, where you don’t have to pay actors and scriptwriters. Who needs scripts when random people are prepared to debase themselves on national TV?

But Netflix and Amazon Prime are monsters, chomping into viewers’ time. We’ve all got the internet connected to our TVs now and my remote control has prominent “Netflix” and “Amazon” buttons on it. When there’s nothing on free to air, we hit one of them and there goes the evening.

So media businesses like Nine and Fairfax have a similar set of problems to retailers: they are being disrupted by powerful, cashed-up foreign competitors. At the same time as having to defend and invest, they have to switch mindset and culture.

For retailers the switch is from stores to websites, from training counter staff and designing nice shops to the complexities of technology and “traffic funnels”.

For media there are two shifts: first, from ink on paper and signals beamed to aerials from towers on a nearby hill to packet switched data transmission via optic fibre, and second, from advertising to subscriptions.

Both transitions are tremendously challenging. The first of them is just about done now, although when I went for a walk yesterday morning I passed a few houses with rolled-up newspapers in the driveway, and lots of people are still watching Ninja Warriors, Married At First Sight and Masterchef on free to air TV, and some of them might even be doing it live rather than taped, so they can skip the ads.

I can say from personal experience that running a subscription business is totally different to one that relies on advertising. You have to know your readers and look after them carefully, individually; with advertising you have to know the agencies and marketing managers, and look after them, and give the agencies kick-backs. The readers are just numbers.

It requires a whole different business culture and a different bunch of people on staff.

Can Hugh Marks and Co pull that off? Maybe, but there are surer bets around than Nine.

Investment fees

In the back of Darren McShane’s 232-page report to ASIC on investment fees this week is a list of stakeholders he consulted. There are 151 of them, and by the way the report is written in the first person singular, not plural, so he did it alone, in eight months. Not a bad effort: he’s been busy.

But not one of the stakeholders listed was an actual consumer – that is, an individual human being, an investor, a super fund member or even a body representing the species. It was a list of 151 super funds, banks, industry associations and fund managers.

The closest we get to customers is Federal Treasury and, for some reason, the Department of Treasury and Finance, Northern Territory, but government bureaucrats are arguably further removed from consumers even than bank executives are.

These days McShane himself works for the industry as a consultant, having spent 15 years at Hong Kong’s pension fund authority. Before that, he was a director of ASIC.

In other words, McShane appears to have spent eight months talking to his clients about what regulation about disclosure of their fees they’d like to see, taking notes.

Having said that, some of bits of the feedback that he wrote down did contain some confessed truth: that the fees and costs regime “should be more prescriptive”, “does not meet consumer needs”, and comparisons have been made more difficult, to quote the “summary of comments received from stakeholders” even further back in the report.

Darren McShane agrees and recommends that “ASIC work with industry to improve consistency in the way that fee information is set out…” and he does recommend some more prescriptiveness in the ASIC rules.

But ask ASIC to actually prescribe what the fees should be? Perish the thought.

And there, as I see it, is the fundamental problem with super and investment fees: it is an essential service, nay a compulsory one, yet the price is unregulated, left to competition and disclosure to sort out.

That would never do with other essential services like electricity, the price of which is set by the ACCC, although as the ACCC itself noted two weeks ago the system is hopelessly complicated and corrupted by an oligopoly.

And to some extent, it is an invalid comparison: electricity is supplied by far fewer firms than superannuation and investment services, for which there are many, many thousands of snouts the trough.

But it is an overflowing, government-mandated trough, plenty for all, and more to the point, competition doesn’t work properly when the buyers of the products don’t understand the first thing about it. You don’t need a monopoly, or even an oligopoly, to achieve price-fixing: just confused consumers and suppliers not rocking the boat.

This week the Westpac subsidiary, BT, did actually rock the boat, cutting the fees on its Panorama platform by an average of 40 per cent, maybe starting a price war.

Platforms are what advisers use to administer their clients’ money. It channels it into various investments, usually managed funds, and most importantly, carries out the fee extraction.

Some of the platforms are owned by businesses that also provide the advice and manage the money – the vertically integrated operators like the banks, including Westpac/BT, AMP, and Macquarie. Other platforms, such as Netwealth and Hub24, are independent and provide administration and ticket-clipping services for the rapidly growing army of independent advisers.

Their share prices dropped sharply this week in anticipation of a price war, but so far BT is the only to have moved pricing. The others are waiting to see what happens.

And rightly so. This may not be a very price-sensitive market, but then again it might be. The clients are advisers, not the ultimate consumers, and any cuts in platform fees will probably find their way into the advisers’ pockets, not their clients.

And when you add up the three layers of fees that are charged – platform, adviser, fund manager – a few basis points off the platform bit is neither here nor there. But then again, advisers might be attracted to the extra margin and might make the switch. It’s tense.

In general, fees are probably coming down, but it’s hard to tell. The platforms have a complicated sliding scale of fees that, even if ordinary mum and dad clients were told what they are, which they’re not, they wouldn’t have a clue what to make of them.

Disclosure of the advisors’ fees is enforced but inconsistently. If clients were inclined to shop around on fees, it would be virtually impossible.

Most of the fund managers I speak to charge a base fee of 1-1.5 per cent and many charge performance fees that could be anything, based on any benchmark. Again, shopping around on fund management fees requires both true grit and a mathematics degree.

Investment consumers – that is, all of us – should be told one fee that includes everything and it should be both consistent across the industry, so consumers can compare them, and easily available.

Darren McShane kind of recommends that, but not in so many words.

In my view, there should be two more changes that I am not holding my breath for: fees should be regulated and capped by the ACCC because it’s an essential service, and they shouldn’t be calculated as a percentage of the total funds under advice/administration/management as they are now.

That is the greatest rort of all. The fee is a percentage of the clients’ total wealth! By the time you add it all up, we’re talking 2-3 per cent, sometimes more, extracted each year from the clients’ wealth by the obliging platforms no matter what return is conjured up. It’s simply taken from the total, as a percentage! Not from the return that the industry actually provides.

Investment fees should be an amount of money, not a percentage, invoiced monthly and not simply taken out of the account, so clients can see what it is. For someone who has retired with the maximum tax-free super account of $1.6 million, that might be $2,500 per month. At the moment they don’t see it; if they did, and had to pay it, I’d say it wouldn’t take long for the eyes to narrow and the phone to be dialled.

That’s my view anyway, although none of Darren McShane’s stakeholders seem to have suggested that.

Macquarie and Shemara Wikramanayake

Since Nicholas Moore took over as CEO in May 2008, Macquarie has produced a capital gain of $71.68 and dividends of $30.82, so a bit more than $100 for each share bought then for $50.

That’s a compound annual return of 11.6%, bearing in mind that it included the GFC, during which MQG’s share price got down to below $17. From that point, capital growth has been 25% p.a.

Moore transformed and internationalised the business, and is rightly held in high regard everywhere. So is his successor, Shemara Wikramanayake.

She has been with Macquarie for 31 years in virtually every part of the operation and has been running the asset management division, the largest revenue earner, since 2008. I think it says good things about Macquarie’s culture that she was nurtured, given responsibility and will now lead the business.

Nicholas Moore finishes on a pretty high note: over the past three years, earnings have grown 59%, of which only 18% can be attributed to revenue growth. Unsurprisingly, MQG’s price slipped back since his departure was announced; is it a buy now?

I suspect the best that can be said is that it’s not a sell, especially if that crystallises capital gains tax, as it would.

All asset managers and banks are entering challenging times. What Macquarie has going for it is that it’s the only Australian bank with a truly global business – the income spread is quite even: 33% Australia, 29% Europe, Middle East and Africa, 27% Americas and 11% Asia.

Moore has also built its annuity-style income to 70% of the total.

Against that is a lot of its revenue is from fees that are now coming under pressure, more so next year when the Royal Commission reports, and it can’t really be counted as an income stock. Yield is currently 4.3%, which is not too bad, but it’s only 45% franked.

That said, if you must own a bank this may be the one to own, because of its strong, stable culture and geographical spread. Just don’t expect 25% p.a.

AMP

AMP, on the other, is confined to Australia, has a terrible culture and no CEO at all, let alone a smooth internal succession.

Yesterday acting CEO Mike Wilkins revealed what he called “action to reset business and … an update on 1H 18 results.” The stock fell 4%.

Unless he plans to become the permanent CEO, the idea of an acting CEO “resetting the business” is ridiculous. Someone else will soon show up and reset it all over again.

Mind you, he’s not too old to be CEO – in his early 60s – so maybe yesterday’s “reset” is a signal that chairman David Murray has persuaded him to stay on.

The share price fell because profit guidance was lowered and a possible dividend cut was flagged, but longer term the big issue for AMP is whether an “aligned adviser network” is viable any more.

AMP’s core business model is using aligned advisers – some employed, but most just operating under its licence – as a “distribution network” for its wealth management products.

It’s hard to see how that can work anymore given that advisers must act in the best interests of clients and after the Royal Commission ASIC will be all over them like a rash.

In yesterday’s statement, Wilkins said they had put aside $290 million for remediation as part of ASIC’s demand that they “look back” over 10 years of advice to make sure it was all “appropriate”, but the statement added: “A significant portion of the provision relates to compensation for potential lost earnings.”

I presume that means they think the way they use the adviser network has to change, although it’s not spelt out. What Wilkins does say is: “As one of the first instances of applying the ‘look back’ to an aligned adviser network, discussions with ASIC remain ongoing in relation to the detailed scope and methodology.”

Yes, well, 10 years is an awfully long time to be reviewing whether financial advice was any good or not. I’d certainly hate to be doing it. And if that doesn’t convince AMP to give up on the advice business, nothing will.

Trade Truce

This week US President Donald Trump met with European Commission President Jean-Claude Juncker and came away declaring peace in our time. “Great to be back on track with the European Union. This was a big day for free and fair trade!”, he tweeted.

And then: “European Union representatives told me that they would start buying soybeans from our great farmers immediately. Also, they will be buying vast amounts of LNG!”

But it’s a bit too early to write-off the risk of a general global trade war. US tariffs on steel and aluminium remain in place, as do the EU’s retaliatory tariffs on US goods. Also, Trump’s threat of tariffs on $335 billion in car and car part imports from Europe is only on hold, not gone.

Apart from Trump’s tweet about soybeans and “vast amounts of LNG”, the statements out of the meeting with Juncker were vague, unspecific and non-committal.

The best case from here is that it shows American business interests are getting somewhere in their efforts to change Trump’s mind about tariffs and the idea that trade wars are cost-free and easy to win.

If that’s true, the Trump-Juncker truce could evolve into a series of lower-level negotiations to reduce trade and regulation barriers between the US and Europe, and – best case of all – a joint approach to dealing with China’s many misdemeanours on trade.

Worst case is that Trump just forgets the whole thing and goes back to being at war with Europe because he believes it will play well for the mid-term elections in November. More likely, perhaps, is that this changes day by day, tweet to tweet.

As for China, it seems fairly certain that another $200 billion worth of imports will be hit with tariffs in September/October, on top of the $34 billion already tariffed and $16 billion announced.

The US Trade Representative has published a list of the $200bn and will hold public hearings in August. Businesses will kick up about it, and will be ignored because Trump will probably judge that more tariffs against China will help the Republicans keep control of the House of Representatives.

The bigger question is whether he goes ahead with the tariffs on cars. If so, all bets are off.

Listed Investment Companies

As promised in the Facebook session on Thursday, here is the latest report on LICs from Independent Investment Research. IIR generally charges companies to be researched, so it’s not exactly independent, but its work on LICs is good, and about the only comprehensive one around.

Research and Diversions

Research

Beach flags are there for a reason, they protect you from turbulent currents that could suck you out to sea. For the stock market, the warning flags are overvaluation and slowing growth and investors should take heed when they are waving. They are waving now, says Jason the of Vertium Asset Management.

And another one: Chris Manuell of Jamieson Coote Bonds asks “Is the party about to end?” And of course whenever you read a headline like that, you just know the answer is “Yes”.

This is an incredible piece. I have linked to it before, but just in case you missed, here it is again. “Last year, I got invited to a super-deluxe private resort to deliver a keynote speech to what I assumed would be a hundred or so investment bankers. It was by far the largest fee I had ever been offered for a talk — about half my annual professor’s salary. But I just sat there at a plain round table as my audience was brought to me: five super-wealthy guys — yes, all men — from the upper echelon of the hedge fund world.” Their question? “How do I maintain authority over my security force after the event?” The event. That was their euphemism for the environmental collapse, social unrest, nuclear explosion, unstoppable virus, or Mr. Robot hack that takes everything down."

The Luddites had a point: during the industrial revolution, while output per worker increased by 46%, real wages rose by just 14%. But as working hours also increased by 20%, hourly wages actually declined in real terms.

I’m not sure I agree with this, but in the interests of diverse opinions: “Blockchain is not only crappy technology but a bad vision for the future. Its failure to achieve adoption to date is because systems built on trust, norms, and institutions inherently function better than the type of no-need-for-trusted-parties systems blockchain envisions. That’s permanent: no matter how much blockchain improves it is still headed in the wrong direction.”

And here’s another piece that says it’s not crappy: “To date, blockchain technology has been used primarily to record transactions in cryptocurrencies, most notably in bitcoin. The scope of applications of blockchain is much broader, though.”

The true revolution in transportation—the one that mattered for nearly everyone—came not in the 1830s with the railroad, but rather later, with the iron-hulled ocean-going coal-fired steamship.

What you need to know about medical cannabis (according to New Scientist).

Adam Smith vs Karl Marx. The dramatic rise of China over the past four decades not only has rocketed China's economy to the top of the world, with no end in sight, but also is ending western dominance over the past 200 years, at least. This post is about economics. It highlights two giant economists: Adam Smith behind the West's economy and Karl Marx behind Chinese economy.

Why do industry super funds perform so well?

Economics explains away complicated realities, ignores culture, and exalts reductionism. Can it be saved?

“There is a complete and utter lack of respect for the individual or person in China. People do not have innate value as people simply because they exist. This leads most directly to a lack of respect for the law/rules/norms.”

Climate change is coming for the internet. Rising sea levels could critically damage and disrupt the core backbone of the internet. While many understand the internet is literally a giant network, most generally think that the traffic gets passed through satellites. Not so.

Kara Swisher’s now notorious interview with Mark Zuckerberg. Topics include free speech, election-hacking, Russia, Myanmar, China. “I think it’ll take about three years to fully retool everything at Facebook to be on top of all the content issues and security issues. But the good news is we’re about a year and a half in.”

10 value investing beliefs, by Steve McCarthy of DMX Asset Management.

Democrats are now a little better than 50-50 to win the House. This is the first time this cycle we’ve gone beyond 50-50 odds on a House turnover.

Roger Montgomery: Where to next for Qantas? The Qantas share price has soared 600% since 2014. This has surprised many long-term investors, who view airlines as a bit like the Bermuda Triangle – a place where money is lost and never seen again.

The world is hot, on fire, and flooding. Climate change is here. “This is already Greece’s hottest year on record. Although the last few weeks have been mild and wet, it’s nearly certain that warm weather has played a role in drying out forests throughout Europe, where the number of fires this year is 43 percent above normal.

Diversions

Hey, remember Dream Academy’s “Life in a Northern Town”, from 1985? I just listened to it again the other night. It’s wonderful.

I knew there was a reason I didn’t retire when we sold Eureka Report! This story says early retirement kills men.

Pope Paul’s 1968 encyclical forbidding contraception, Humanae Vitae, started a culture war inside the Catholic Church. “Humanae Vitae led to surprise, followed by disappointment, frustration, disillusionment and even defiance. This was the moment at which divisions between ‘progressive’ and ‘traditional’ Catholics began to carry serious meaning.”

Why is Google Translate spitting out sinister religious prophecies?

The amazing journey of sleep. Nearly every night of our lives, we undergo a startling metamorphosis. Our brain profoundly alters its behavior and purpose, dimming our consciousness. For a while, we become almost entirely paralyzed. We can’t even shiver. We are sexually stimulated, men and women both, repeatedly. We sometimes believe we can fly. We approach the frontiers of death. We sleep.

A TCI member sent this link to me – it’s Eric Clapton doing I Shot The Sheriff, live. So great. As she said, after 5:15 in comes “spiritual enlightenment” (it’s his guitar solo).

A profile of Mel Brooks at 90: “He has blue-gray eyes and a rakish smile; the voice remains powerfully hoarse. No one is ever likely to miss a Mel Brooks joke, since he speaks, sometimes roars, with great precision. His normal speaking voice could be called classical Brooklyn, the sound I remember as a New York kid from encounters with taxi drivers, baseball fans, and teachers. Those men had a definite flavor, and they meant to be understood.”

Let’s look at bureaucracies. Some people fear them; they fear “the Machine.” What is a bureaucracy? A bureaucracy is an automated system of people created to accomplish a goal. It’s a mech suit composed of people. 

Is one life worth more than another? How police set cash rewards.

I found this piece by Toby Young very interesting, and salutary. He describes, in some detail, his public shaming 10 years ago.

The latest MyHealth statistics – yes, but what they’re not disclosing is the number of people who have opted out. They’re keeping that till the end.

Man Bites Prawn. Said to be the late Jonathan Gold’s finest column, his review of the Living Fish Center, a Koreatown restaurant where the specialty is live prawn. “I bit into the animal, devouring all of its sweetness in one mouthful, and I felt the rush of life pass from its body into mine. It was weird and primal and breathtakingly good, and I don’t want to do it again.”

What it is to love an old dog. “His accidents in the house grew more frequent. His walks became tentative. He could no longer wag his tail.”

A place has opened up in New York where you can go for a nap – for $25! What a good idea. There should be one here.

July 28 – on this day both Antonio Vivaldi and JS Bach died, nine years apart in 1741 and 1750. This is a day for big deaths. Also Cyrano de Bergerac, Maximilien Robespierre (who got his head chopped off) and Thomas Cromwell.

But let’s focus on the two great composers. You just can’t help loving “Spring”, from Vivaldi’s Four Seasons, and check out Glenn Gould doing the Art of the Fugue (Bach). He’s incredible – you feel like you’re intruding on someone making love.

But the best of Bach is Jesu Joy of Man’s Desiring, and Air on a G String, IMHO.

https://www.youtube.com/watch?v=ZS-HWIFyLsE

Oh and don’t forget the Brandenberg No.3 Love it!

https://www.youtube.com/watch?v=QLj_gMBqHX8

And, yes, I’m a Bach man, more than Vivaldi.

Ever wonder what the hell a 4th cousin once removed actually is? Then this helpful chart is here to help.

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=F2ury-1Ou0c

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, CommSec

Australia: Which state will come out on top?

• The handover from July to August occurs with a data deluge. The CommSec State of the States quarterly report is followed by housing, manufacturing and service-sector gauges, new vehicle sales and the retail trade report. 
• The week kicks off on Monday with the release of the CommSec State of the States report. The report tracks the economic performance of the states and territories across eight key indicators.
• On Tuesday, building approvals, private sector credit, new home sales and the regular weekly gauge on consumer confidence from Roy Morgan and ANZ are all released.
• On Wednesday, CoreLogic releases the July data on home prices. Based on daily data released so far, home prices have fallen by 0.5 per cent in the five mainland capital cities to stand 2.3 per cent lower than a year ago.
• Also on Wednesday both AiGroup and the Commonwealth Bank release survey results on manufacturing activity. And the Bureau of Statistics (ABS) issues its Selected Cost of Living indexes for the June quarter, detailing changes over time in the purchasing power of the after-tax incomes of Aussie households. 
• On Thursday Australia’s international trade balance for June is issued. The trade surplus rose from $472 million in April to $827 million in May. It was the tenth surplus in 12 months. Annual exports to China rose to US$102.65 billion in May – a new record high.
• On Friday the Federal Chamber of Automotive Industries releases the July sales data for new vehicles. And the ABS issues June data on retail trade. The growth in retail spending has lifted over the past nine months, led by the food and clothing categories. And as tax return time draws closer, the end of financial year new car sales will be closely monitored. SUV sales are at record highs, but passenger vehicles sales are declining.
• Also on Friday both AiGroup and Commonwealth Bank release their services sector activity gauges.

Overseas: The US Federal Reserve and jobs data trumps China manufacturing activity

• Over the coming week the US Federal Reserve meets to hand down its latest interest rate decision. And the US non-farm payrolls (employment) report is released. The Chinese manufacturing survey is also a key release.
• The week kicks off on Monday in the US when the June index of contract signings to purchase previously-owned homes (pending sales) and the influential Dallas Federal Reserve manufacturing index are issued.
• On Tuesday China’s official purchasing manager’s indexes are released. A further slowdown in manufacturing activity is tipped. In the US, attention will turn to the S&P/Case-Shiller 20-city home price gauge, the Conference Board’s consumer confidence index and the regular weekly data on chain store sales.
• Also on Tuesday, the influential Chicago manufacturing survey and the personal income/spending report are issued. The Fed’s preferred measure of inflation – the personal consumption expenditure deflator – will be keenly observed. The deflator is expected to increase by 0.2 per cent for a second successive month in June.
• On Wednesday policymakers at the US Federal Reserve hand down their interest rate decision. No change in the Federal Funds rate target range of 1.75-2.00 per cent is expected by economists after June’s increase. Additional rate hikes are forecast in September and December. 
• Also on Wednesday weekly data on new mortgage applications, the ISM manufacturing index and the ADP private sector employment report are issued. Earlier in the day, China’s Caixin manufacturing survey is released.
• On Thursday US factory orders are scheduled for June. Manufacturing activity has been supported by strong domestic demand. But growing worker shortages and import tariffs are starting to strain the supply chain. The regular weekly data on new claims for unemployment insurance and the ISM New York index are also issued.
• On Friday China’s Caixin services gauge is released for the month of July, together with the June international trade data (exports and imports), the ISM services index and the all-important US non-farm payrolls (jobs) report. In June, 213,000 jobs were created and economists expect a further 195,000 jobs were generated in July. Average hourly earnings are tipped to lift by 0.3 per cent, with annual growth remaining at 2.7 per cent.

Financial markets

• The Australian earnings season is approaching, coming at a time when the Aussie sharemarket has been trading at 10½-year highs. With a valuation of 15.5 times estimated earnings, the ASX200 index is trading around its 5-year average. And at 4.1 per cent, dividend yields for the benchmark are twice that of equivalent US benchmarks.
• Corporate balance sheets are in good health, profits are near record highs and the lower Aussie dollar may boost the offshore earnings of some companies. Earnings growth expectations are broadly improving, supported by the resources sector.
• On Tuesday Credit Corp Group and Alacer Gold report. On Wednesday, BWP Trust, Genworth Mortgage Insurance and Rio Tinto all report. On Thursday, earnings are due from ResMed.

Last Week

Investment markets and key developments over the past week

• Share markets mostly pushed higher over the last week helped by good US earnings news and a US/European trade agreement. This saw solid gains in US and European shares which helped the Australian share market. Chinese shares also benefitted from more stimulus talk. But Japanese shares fell slightly on talk of the Bank of Japan reviewing its monetary stimulus. Bank of Japan speculation (which I suspect is overdone) along with the “risk on” tone generally also helped push up bond yields. While oil prices fell slightly, metal and iron ore prices rose but a rise in the $US and slightly softer inflation data saw the $A fall.
• At last some good news on trade with the US and the European Union agreeing to work towards resolving their differences on trade and hopefully head off a trade war between them. At this stage its only a deal to start negotiating, the negotiations will have a long way to go and don’t forget that China and the US had a “trade war on hold” deal back in May that got trashed a week later. So it’s too early to break out the champagne. However, it shows that Trump is not anti-trade per se and does actually want zero trade barriers, it’s a big move in the right direction and it will probably be easier for the US and the EU to work through their differences as they start with similar average effective tariff rates and US gripes with Europe don’t run so deep. Having started down this path there is a reasonably good chance of success leading to the removal of the auto tariff threat and the reversal of the steel, aluminium tariffs. No US/EU trade war would significantly reduce the trade threat to global growth. After “wins” in relation to North Korea and Europe, Trump will no doubt see vindication of his “maximum pressure” negotiating stance – which will embolden him to continue with his tough trade stance on China.
• Speaking of which, there is still no sign of negotiations with China on trade and China’s decision not to approve US chipmaker Qualcomm’s bid for its rival NXP signals that China is digging in further. To counter the trade threat, China’s shift to policy stimulus is continuing with a shift to “more proactive” fiscal policy with a focus on tax cuts, and infrastructure investment. Don’t expect a mega stimulus like seen in the past (there is no need) but combined with monetary stimulus the authorities are determined to support Chinese growth. This is a positive for Chinese shares after their 24% fall and a forward PE of just 10.7 times.
• Middle East tensions hotting up again – upside risk to petrol prices. President Trump’s tweet threatening Iran that it “will suffer consequences the likes of which few throughout history have ever seen before” if it threatens the US again highlights that tensions between the US and Iran are hotting up again. Attacks on Saudi tankers by Yemeni militia are arguably reflective of this. Of course, it’s worth recalling that Trump also threatened North Korea with “fire and fury” and that much of this is bluster aimed at applying “maximum pressure” to get what he wants. It may be a bit harder with Iran though, so the risk of tensions in with Iran – eg threats to close the Strait of Hormuz – at a time of constrained global oil supply pose upside risks to oil prices. This will be good for energy stocks, but not so good for Australian motorists given the risk of another up leg in petrol prices beyond their recent high averaging around $1.53.
• Another round of US tax reform on the way, but don’t get too excited. The US House of Reps looks like having a vote on more tax reform, the main item of which will likely be to make permanent the personal tax cuts beyond their 2025 expiry. It has little chance of passing into law before the mid-terms but is an election sweetener for the Republicans.
• If you want to see an example of the downside of momentum investing which can get amplified in passive funds, just look at Facebook. While tech stocks are nowhere near the bubble they were in 2000 (their PE is around 27x versus around 100x at the tech boom peak) they have been huge beneficiaries of the easy money environment of recent years meaning a passive investor will have seen a steady increase in exposure to them which is all good when momentum is your friend but when it turns it can turn quickly as Facebook did falling more than 20% in a flash on Thursday.

Major global economic events and implications

• US economic data remains solid. Home sales fell in June, but home prices are continuing to rise, the July Markit business conditions PMI remains strong, capex orders are rising and jobless claims are ultra-low. Reflecting strong demand imports rose in June leading to a wider goods trade deficit.
• Despite disappointing revenue results at Facebook, US June quarter earnings reports remain very strong. Of the 244 S&P 500 results so far 88% have beaten on earnings with an average beat of 6.5% and 73% have beaten on sales. Earnings look to be up around 25% year on year.
• As expected the ECB made no changes in monetary policy and anticipates keeping rates unchanged at least until September 2019. We don’t see an ECB rate hike until 2020. Meanwhile, Eurozone business conditions gave up some of their June bounce, but they remain strong.
• In contrast to the US and Europe, Japan’s manufacturing conditions PMI in July fell to its lowest since November 2016. It’s still consistent with modest growth but suggests a greater sensitivity to trade fears than in the US and Europe.

Australian economic events and implications

• Australian inflation remains subdued, no early rate hike in sight. June quarter inflation data confirmed yet again that price growth is only running around the low end of the RBA’s 2-3% target band. Core (ex food and energy) inflation is just 1.6%. And were it not for more rapid price rises for government administered or affected items like tobacco, health, utilities and education along with petrol, inflation would be running closer to 1%. There are no signs of any significant near term rise in underlying inflation pressures, particularly with subdued wages growth, competition and technological innovation remaining intense and producer price inflation running at just 1.5%. The risk is that the longer inflation stays at or below the low end of the target range the harder it will be to get it up as low inflation expectations are becoming entrenched. As such, we remain of the view that the RBA won’t raise interest rates until 2020 at the earliest and the next move being a rate cut cannot be ruled out.
• Meanwhile falling skilled job vacancies add to signs from other jobs leading indicators that employment growth may slow a bit.

What to watch over the next week?

• In the US, the Fed and jobs data will be the key focus. The Fed (Wednesday) is expected to leave interest rates on hold but confirm that it remains on track for another hike in September consistent with ongoing strength in the US economy and inflation being around target. July jobs data (Friday) is likely to show another solid gain in payrolls of around 190,000, unemployment falling back to 3.9% and wages growth remaining around 2.7% yoy. Meanwhile, June core private final consumption inflation is expected to stay around the Fed’s 2% yoy target, June quarter growth in employment costs is likely to be around 2.8% yoy and consumer confidence is likely to have remained solid (all due Tuesday), the ISM manufacturing conditions index (Wednesday) is likely to remain strong at around 56 and the trade deficit (Friday) is likely to worsen. Data on pending home sales and house prices will also be released and June quarter earnings results will continue to flow.
• In the Eurozone, June quarter GDP (Tuesday) is likely to be around 0.4% qoq or 2.2% yoy as the March quarter slowing in growth continues but Eurozone economic confidence (Monday) is likely have remained solid and June unemployment (Tuesday) is likely to have edged down to 8.3% (from 8.4%). Expect core CPI inflation to edge back up to 1% yoy.
• The Bank of England (Thursday) will consider another rate hike to take the policy rate from 0.5% to 0.75%.
• The Bank of Japan meets Tuesday but while it may signal a fine tuning its unlikely to signal any exit from ultra-easy monetary policy. With the BoJ likely to revise down its inflation forecasts and inflation running a long way from target any changes it makes will be aimed at improving the sustainability of its ultra-easy monetary policy as opposed to ending it. This could take the form of greater flexibility on its bond yield target, possibly contingent on higher inflation. June jobs and industrial production data will also be released Tuesday.
• Chinese July business conditions PMIs will be watched for signs of an impact from the trade skirmish. Expect manufacturing PMIs to fall slightly but services PMIs to be little changed consistent with a slight slowing in growth to 6.5%.
• In Australia, expect a 2% bounce back in June building approvals after two very weak months and continued moderate growth in credit (both Tuesday), CoreLogic data (Wednesday) to show another small fall in capital city home prices for July led by Sydney, a slight increase in the trade surplus (Thursday) and a 0.1% rise in June retail sales (Friday). Manufacturing and services PMIs will also be released. Super Saturday by-election results could raise early election risks if they favour the Coalition, but an early election is unlikely unless overall polling moves to be in the Government’s favour.
• Australian June half earnings reports will start to trickle through with Rio, Janus Henderson, and Genworth reporting on Wednesday and Resmed on Friday. We are expecting 2017-18 earnings growth to come in around 7%, with resources earnings rising around 20% (albeit down from 130% in 2016-17) thanks to solid commodity prices and rising volumes and the rest of the market seeing profit growth of around 4.5%. Strong results are expected for insurers, health care, gaming, building materials and utilities offsetting softness for telcos, banks and consumer stocks. Dividend growth is likely to remain solid. 

Outlook for markets

• While we continue to see share markets as being higher by year end as global growth remains solid helping drive good earnings growth and monetary policy remains easy, we are likely to see ongoing bouts of volatility and weakness between now and then as the US driven trade skirmish with China could get worse before it gets better and as worries remain around the Fed, President Trump in the run up to the US mid-term elections, China, emerging markets and property prices in Australia. Our year-end target for the Australian ASX 200 index of 6300 is looking too conservative as the market has already reached it.
• Low yields are likely to drive low returns from bonds. Australian bonds are likely to outperform global bonds helped by the relatively dovish RBA.
• 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 as the air continues to come out of the Sydney and Melbourne property boom and prices continue to fall, but Perth and Darwin bottom out, Adelaide and Brisbane see moderate gains and Hobart booms.
• Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.2%.
• We continue to see the $A trending down to around $US0.70 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. Solid commodity prices should provide a floor for the $A though in the high $US0.60s.