US Jobs, Gimme Shelter, How To Respond?, Brexit, Australian Economy, Checklists, and more

Last Night's Markets
US Jobs
Gimme Shelter
How To Respond?
Brexit
Australian Economy
A checklist of checklists - 1
Guru Winnie
The TCI App
My DNA
Research and Diversions
Ask Alan
Next Week
Last Week

Last Night's Markets

US Jobs

It was August payrolls day in the US last night and the result was quite mixed and the market reaction quite subdued.

The headline employment number came in soft – 130,000 versus 160,000 expected – and the numbers for June and July were also revised downwards by 20,000, but wages growth, at 0.4% for the month, was the largest since February. Unemployment stayed at 3.7%.

All of which allowed President Trump to tweet: “The Economy is great. The only thing adding to “uncertainty” is the Fake News!”

Of course, he is still calling on the Fed to cut by 100 basis points, so not that great. But after last night’s data the universal expectation now is for a 25bp cut at its September 18 meeting.

So to sum up: weak employment data, but not catastrophic; Fed to cut this month.

Gimme Shelter

The week began with a barrage of “risk-off” geopolitics: the US and China both imposed new tariffs, British PM Boris Johnson took on Parliament and was clearly going to lose, it was another weekend increasing violence in Hong Kong, Argentina imposed capital controls, and for good measure it looked like the fragile Italian government coalition would fall apart, and the right-wing AfD made telling gains in Germany. Markets went down.

By the end of the week, the clouds had parted and the sun was shining through. Trade talks were back on, the pound was surging, Hong Kong’s extradition bill was withdrawn so the Hang Seng was on the march, and equities were back in “risk-on” mode. Markets up.

Investors are paying too much attention to geopolitics, I reckon, understandably perhaps given all the media attention, and paying too little attention to interest rates, which are the big story.

I believe the bubble in bonds which has now taken more than US$16 trillion worth of bond yields negative is the biggest bubble in history, bigger than the tech boom of the 90s, bigger than the Australian nickel bubble of the 60s, probably bigger even than the tulip mania of 1636-7.

Can’t prove that, of course, but the bond bubble is clearly the most significant thing going on at the moment. It is amazing – almost thrilling in a way, at least for a journalist – and frightening, for investors. What I don’t know is whether it is a quickie, like the stockmarket bubble and crash in 1987, or a secular, long term, perhaps almost permanent change, as in: this time really is different.

They say that those four words – this time is different – are the most dangerous in investing. But I think it’s unquestionably true that in some ways, this time is different.

Let’s examine the causes of the bond bubble and see if we can come to a conclusion on that.

There are five, which also overlap:

1. Quantitative easing
2. Demographics
3. The “Japanification” of Europe
4. Trade war and fears of a US recession
5. Secular stagnation

Let’s take them one at a time.

Quantitative easing

As Donald Amstad of Aberdeen Standard Investments points out in the video that I link to at the start of R&D below, during the 1998 Asian crisis the IMF and the western central banks sternly told Asian central banks to not dare print money, or they would end up like Zimbabwe.

But when the GFC hit the west, what did all of the main central banks do? Print money. And what did they do with the money thus printed? Bought bonds.

The bond market has become the slave of central bank policy. Another way to put that is that the bond market is simply trading on what it thinks the Fed is going to do over the next few years. That can be seen graphically by comparing the US 10-year bond yield with 5-year futures of the cash rate:

In a conference on Thursday, Anatole Kaletsky of GaveKal said the reason for this is clear: “bond yields, are now largely determined by investors who are price insensitive.”

That is, it is liability driven investment by insurance companies, pension funds, banks responding to capital ratio demands and the central banks themselves. “Liability driven” simply means that these investors have to match their known liabilities and capital requirements with riskless investments.

Says Kaletskey: “the very fact that the ECB has acquired roughly a quarter to a third of the European bond market means that even if it doesn't buy any more bonds ever again it is continuing to exercise a major influence on bond prices and through that on the economy by the mere fact that it is sitting on such a high proportion of the bond issue.

“Because what that means is that most of the price sensitive investors, who are likely to respond to small changes in economic conditions, have already sold their bonds to the ECB and are no longer in the market. The ones that are left in the private markets are the ones whose investments in bonds is price insensitive because it is driven by liabilities, banks regulation and so on and so forth. And that means that when the central banks acquire such a high proportion bond issue, the bond market ceases to be the effective economic forecaster that it used to be in the past.”

That view is supported by the fact that US data has not weakened sufficiently to support the predictions of a recession, which means something else is going on with bonds. I’ll get on to the recession talk in a moment.

Demographics

The demographic issue is partly to do with the baby boom bulge, which began entering middle age in the 1980s. Middle-age people tend to produce more than they consume, so they save. As a result, from the 1980s onwards global population tended to skew towards higher saving, which pressed down interest rates.

At the same time, population growth started to decelerate:

That combination of demographic factors led to a 40-year trend of lower inflation and lower interest rates:

From here on the demographic forces will start to conflict with each other.

The bulge of middle age savers are now retiring. Older (and younger) people tend to consume more than they produce, and so they use more capital than they supply – the opposite of what’s been happening over the past 30-40 years.

On the other hand, as the chart above implies, the slowdown in population growth is likely to continue. That’s because it’s a function of female emancipation and education, and the developing countries like Africa, that still produce big families, are catching up on that score and will continue to do so. In the west, the new trends in gender confusion are likely to mean continued slowdown in population growth and therefore downward pressure on inflation.

Europe

Charles Gave, Kaletsky’s colleague at GaveKal, reckons he can explain the mystery of the US bond market with the European bank share index:

“In recent years global panics have coincided with European bank stocks falling to a critical threshold, shown as 80 on the chart. On each occasion some central bank policy stimulus response has helped them recover. 

“The problem is that each rebound has been less convincing. It now seems that eurozone banks are in a death spiral and this is spurring a flight to safety in all of the world’s major bond markets.”

The key issue at the moment is Italy, not so much because of the political turmoil there (which is normal) but because of its debt. The government’s funding costs must remain below nominal GDP growth or the place will go into a death spiral of its own.

That flows through to German bund yields because Italian yields are set as a premium to them – usually 160 basis points. It means German bund yields have to stay low to keep Italy, and therefore the European dream alive.

Mind you, Italian 10-year bonds are yielding less than Australia’s at the moment (0.94% versus 1.06% yesterday), and have come down a long way, so that’s one problem out of the way for the Italian Government:

An Italian bond yield below 1% takes a lot of pressure off everyone in Europe, and seem to have even helped destroy Matteo Salvini, the right-wing anti-EU leader who has been kicked out of the Government.

The reduction in the government’s borrowing costs increases Rome’s fiscal room for manoeuvre. With the cost of servicing its debt down more than expected this year, the Italian treasury will be able to adopt an easier stance next year.

So some good news in Europe at last, although whether it means Charles Gave is wrong about the death spiral of the banks is another matter.

The basic problem in Europe has been that the northern Governments, led by Germany, have been running fiscal policies too tight while the European Central Bank has stimulating like mad – negative policy rate and quantitative easing. It’s like what’s going in Australia, but on steroids. That’s leading to what many are now calling the “Japanification” of Europe – long term disinflation and secular stagnation. 

Both fiscal austerity AND low interest rates are suppressing activity.

Growth and inflation have been stuck for 10 years and because the only policy effort has been monetary, the negative interest rates and flat yield curve have crushed bank margins and killed the animal spirits of business. European investors are looking everywhere but Europe for yield and capital growth.

Trade war and US recession

This week the US ISM manufacturing slipped below 50 for the first time in three years, bringing a chorus of “I told you so’s” from the recession-predictors, who had been previously enlivened by the inversion of the yield curve.

But while it’s true that every recession in the US has been preceded by a yield curve inversion, it’s not the case that every inversion has been followed by a recession.

In Australia, the yield curve has been inverted for roughly a quarter of the last 17 years, but there hasn’t been a recession at all. In Britain, the curve was inverted for a third of the time between 1992 and 2007, which was a period of uninterrupted growth.

As for the data, there is no doubt that the US economy is getting weaker, but not enough to predict a recession. 

Also, the American ISM index frequently goes below 50 without being the harbinger of recession:

As for the trade war, as I have argued here before, it is not a trade war but something much deeper and therefore longer-term. That’s both bad news and good news.

It means the underlying issue – the inconvenient success of China’s communist governance model – is not going away in hurry, if at all, so the American conservative political classes that would like to bring it down will keep at it.

But it also means the immediate issues of trade and current account balances don’t really matter and can be resolved fairly easily, whenever Trump feels it’s politically convenient. That might take a while but I don’t think Trump and his advisers will allow it to cause a recession – that would be putting a gun to your head and saying: “do what I say, or I’ll shoot”.

Secular stagnation

I think the main cause of what is called secular stagnation (low growth and low inflation) is the rise in debt. For that reason, it started as an effect rather than a cause of low interest rates, but has now become a cause.

What I mean is that the collapse in interest rates after 1980 led to a multi-decade rise increase in borrowing and global leverage. That caused the GFC, but then it was accelerated by it because of the medicine that authorities applied – zero interest rates and quantitative easing.

After a pause in 2009-10, global debt took off again:

But the decline in interest and rise in leverage has also been associated with a trend decline in investment spending. Why? Because, as Gerard Minack explains, the private sector has been using debt to buy or leverage existing assets, including share buybacks, rather than create new ones.

I think another big contributor to secular stagnation has been the decline in productivity, which is difficult to explain given the explosion in new technology.

One explanation might be the rise in the gig economy and under-employment. As they are replaced by machines and algorithms, people are not going on the dole but into less productive jobs, driving Ubers, delivering food, cleaning, and so on. They are counted as employed, so it’s not a recession, but they are underemployed, both in hours and, importantly, in the productiveness of the job.

How To Respond?

I think one way to express the key shift for investors is that bonds – that is, tradable fixed interest - now offer equity-like risks without the returns.

That applies equally to bond-like equities. In Australia, that means banks and infrastructure.

Over the past 30-40 years of falling interest rates and, more recently since the GFC, secular stagnation, the best performing assets have been those with reliable yields.

More recently, since 2017, growth assets have outperformed.

Recently I’ve been recommending a focus on real assets – property and infrastructure in particular – as a way of protecting against market volatility, but we need to careful of bond proxies. The bond market is now both dangerous and unlikely to produce good returns from here.

That means investments that rely for capital growth on falling bond yields, either because of their dividends (ie listed banks and infrastructure stocks) or because of the way the assets and their future cash flows are valued using the bond rate (ie unlisted infrastructure) could find it challenging in the years ahead.

I don’t know when – or even whether – there will be a bond reversal, but I think there are good reasons for thinking the Great Bond Bubble is coming to an end.

If I’m wrong, and there is a recession, then the bond bubble will keep going for the duration. That’s because the Fed would probably take the cash rate negative and start buying bonds again with printed money (QE). But that aside, the demographic factors that are partly responsible for the decline interest rates are starting to reverse and there’s a fair chance of a burst of fiscal stimulus next year which would likely result in inflation, and higher bond yields.

Brexit

All the media focus has been on the humiliation of Boris Johnson with his four losses of the floor of Parliament this week, including this splendid front page by The Sun:

But we need to remember that this is all a game of three-dimensional chess, with plenty of moving parts, and not a piece of theatre.

The Parliament voted this week to take control of the process and to NOT have a general election. That means the most likely step from here is a law passed next week to delay Brexit beyond the October 31 deadline. 

If Johnson tries to turn that into an issue of confidence, it would probably bring down his Government. At least four Tory MPs have said they are prepared to boot out Boris and even accept Jeremy Corbyn as interim PM, so he is unlikely to try that.

So another delay now looks the most likely scenario.

If there is an election for some reason, the outcome is impossible to predict, although it’s fair to say that the old political divisions in the UK – in the world for that matter – between capital and labour, right and left, Tories and Labour, have been completely replaced by nationalism and globalism.

The reason for this is immigration. It’s why Brexit got up in 2016, it’s the reason for the rise of all the right-wing parties in Europe, it’s one of the key reasons for Trump’s election and possible re-election, and it’s the key thing dividing the right and left in Australia. This past week, for example, the dominant political issue in Australia has been the Tamil family that settled in Biloela and is now on Christmas Island awaiting deportation.

There are only two parties in the UK that are not divided and confused on the subject of Brexit and immigration – the Liberal Democrats (stay) and the Brexit Party (leave).

I’m not suggesting that means a UK election would be between those two parties, but I think the destruction of the two main parties, the Tories and Labour, is possible given the way the country has become so divided on the issue of Brexit and how that has become so dominant it is almost the only political issue that matters.

How could anyone on either side of that divide actually vote for either the Conservatives or Labour? They have no idea where they stand.

Boris Johnson strategy all along has been to go into negotiations with the real prospect of leaving without a deal. That’s because although a No Deal Brexit will hurt Britain, it will really hurt Europe.

Britain is Europe’s second-largest market, accounting for 12% of the Eurozone’s total exports, almost double the exports to China, and only slightly behind the US.

For Europe to risk a rupture with its second-biggest customer would be a bad idea while the US-China trade war is going on, and with Germany on the brink of recession, France riven by civil disobedience, and Italy in constant revolt against EU rules. 

What’s more Ireland, the EU member most directly affected, would be hit harder than any other country by No Deal, and not only because of the disruptions in trade and transport across the border with the north.

Ireland is far more exposed than Britain to logistical disruption after Brexit because it relies on the land-bridge across Wales and England for most of its trade with the rest of the EU.

So Johnson has been relying on all that to strengthen his hand in negotiations, but it only works if he can threaten to exit without a deal, which would, he believed, have led to a last-minute deal. That now looks impossible because the majority of Parliament hasn’t got the nerve.

Either way – if Johnson wins, or Johnson loses – I think a No Deal Brexit is, and always has been, the least likely outcome of all this.

Australian Economy

Here’s my little collection of charts from this week’s National Accounts which are self-explanatory, and probably all you need to know:

That last one is key, I think.

The red line of GDI (gross domestic income per capita) is basically the terms of trade, ie commodity prices. GDP per capita is flat-lining. The only things contributing to growth are commodities and population growth – plus, in the latest quarter, government spending.

A checklist of checklists - 1

Jonathan Tepper, the founder of research company Variant Perception, posted his collection of investment checklists the other day, which is worth passing on. It’s long so I’ll do it over a couple of weeks. Here are the first four:

Joel Greenblatt (founder of Gotham Funds, which returned 40% p.a. from 1985 to 2006)

• What are you paying? EBIT/EV (earnings before interest and tax and enterprise value)
• What are you getting, ie how good a business is it? Normalized EBIT (NWC Net equipment) 
• What is normalised EBIT in three years?

Charlie Munger (Berkshire Hathaway)

• Can you understand the business? Is it in your circle of competence?
• Avoid industries where you know little. E.g. technology biotech.
• Does the business have a moat? Does it have a durable competitive advantage?
• Avoid perfectly competitive and high fixed cost businesses.
• Does it have managers who behave as owners and are wise capital allocators?
• Do insiders own their own stock and are they buying back shares?
• Does the company have a lot of debt? Any lost list of numbers multiplied by zero is always zero.

Bruce Berkowitz (founder of Fairholme Capital Management)

• Can you kill the investment? Is their adult supervision in the company?
• Is the company essential? Does it depend on the kindness of strangers?
• What can the company make? Reasonable profitability for the owners?
• How are the owners paid? Distributions?
• Management – honest in the past and present?
• Does the accounting reflect reality?
• Does the balance sheet match up with the income statement?
• Catalysts – buybacks? Misunderstood? Is enterprise having a big problem that is fixable?
• Are irrational fears of current headwinds? That is, is everyone who has been burned by the stock afraid to buy it?
• Does the business have pricing power or unit growth?

Lou Simpson (ex Berkshire Hathaway now running SQ Capital)

• Does management have a substantial stake in the company?
• Is management straightforward in dealing with the owners?
• Is management willing to divest unprofitable operations?
• Does management use excess to repurchase shares?

Guru Winnie

This question came through from Winston for my #AskAlan chat on Thursday, but it was too long to read out, and not really a question anyway. I promised to include it in the Weekend Briefing, because it was worth sharing with everyone, so here it is.

Winston: Hi Alan, My name is Winston Anderson, a long term InvestSMART tragic. I have only written fan mail about 5 or 6 times in my life. What has prompted me here is your magnificent and informative article. What a month etc…The first question is how many months did it take you to write? I was particularly amazed at the sub “The Advantage” Overall the article has given me an understanding of “Why Xi & Trump are behaving the way they are”. My first job in life was to work in Contract Notes Department at A.C. Goode & Co. 1968. The so called Poseidon boom. A love for investing in shares has never dimmed and in most cases profitable. Over the past three years I have been researching for shares that are, or could be a takeover target for quite obviously the reason of increased value of the shares or a pecuniary gain. I have made up five rules that guide me. These have been applied to two sections of the market, food and drugs plus one other one off. The success stories so far have been Patties Foods PFL, Glencross, GXL and Fantastic Furniture. The share that has me very interested at the moment is Sigma.

Rules:

It has a healthy financial position.

The share price has a history of being 100% plus higher.

The current price if a takeover were it to be offered gives the opportunity so that to offer 100 per cent plus to the price, it is going to be well worth it. Room to do it but only paying what the shares are really worth. 

Units and numbers of investors wanting shares has over the past six weeks far outweighed sellers. This same situation happened with the aforementioned Companies.

Bonuses: It has been a takeover target. It has sorted out Chemist Warehouse situation which was costing it a lot of money. A lot of people thought this was a negative. Also they have gone looking for markets, such as Hospital Pharmacies. The shareholders meeting is the 5th September. This coming week. So we shall see if more light is shed on the companies position. Any thoughts Alan. Once again thanks for you article. One of the best I have ever read. With apologies to Gaurav signed as my accountant refers to me…Guru Winnie.

My thoughts: You are a Guru, Winnie! How about I interview the CEO of Sigma, should be a good one.

TCI app

For those who use The Constant Investor app on their phone, please be aware that it’s being phased out. All the content is already on the InvestSMART app and will continue to be.

The fine developers here at InvestSMART Group have been toiling to make it all work, and have done an excellent job so I think it will be seamless. If not please let us know.

My DNA

By the way, I spat into a bottle and sent it off to ancestry.com to get my DNA results (Deb insisted, she had done hers and wanted to know if we were compatible. Bit late for that now, I’d say, and I’m not that interested). 

And surprise, surprise – I’m 10% Norwegian. I knew I was mainly German and British, but Norwegian? I’ve decided to identify as Norwegian now. You may call me Knut.

Research and Diversions

Research

This video of David Amstad of Aberdeen Standard Investments has gone viral, understandably. It is clear, compelling and scary. I’ve been asked a few times: do I agree? (That we’re on the brink of catastrophe?) I don’t know. Just watch the video and make up your own mind.

The commuting principle that shaped cities. When everybody walked, save for a few on horseback, the practical limit to the size of a city was two miles across. The game-changers were the bicycle and the streetcar. “Developable areas grew exponentially. A walking city 2 miles in diameter covered only a little over 3 square miles; a streetcar city 8 miles in diameter could cover 50 square miles.”

Old power lines in the bush, where the wind and solar farms located, are holding back the renewable energy boom.

10 years after the crash, we’ve learnt nothing. This piece is a year old, but worth revisiting.

Nice piece by my old mate Glenn Dyer on an earnings season to forget (Glenn was my chief of staff when I was editor of the Financial Review in the mid-80s).

Value is dead. Long live value. “It is a common refrain that ‘value’ is under-performing ‘growth’. Few bother to articulate why a low PE stock should outperform a high PE stock, or indeed, why the opposite happens so often.

3 results that caught our eye (says Ben Clark of TMS Capital). They are: Altium, Seek, Wisetech.

The Big Mac index suggests that the Australian dollar is 25.8% undervalued. 

Economics lost much of its richness and openness when post-war practitioners demanded a place for their discipline among the exact sciences. They disowned the origins of economic thought in literature and philosophy. They adopted mathematics as their language and mathematical modelling as their method. But economics was not ready to be a science. Science requires a consensus as to what is true. Economics imposed one by stifling dissent. 

Peter Thiel: “A parliamentary democracy works (by) a group of people sitting around the table, they craft complicated legislation, and there's a lot of horse trading, and as long as the pie's growing, you can give something to everybody. When the pie stops growing, it becomes a zero-sum dynamic, and the legislative process does not work.”

With thousands of students of economics around the world now engaged in an open revolt against the teachings of mainstream economics the position that ‘all is well in economic theory’ is no longer tenable.

There won’t be billion-dollar beverage brands in the future. It seems to be about the influence of Instagram.

Thinking that the ineffectiveness of printing money will be solved by printing more money (helicopter money, MMT etc) is simply insane.

How Commodore Vanderbilt’s railroads conspired with John D. Rockefeller’s Standard Oil to create a fuel monopoly with twice the revenues of the US government. 

Not that it’s directly relevant, but Dubai house prices have crashed to the lowest level since the GFC in 2008.

The logic of buying Greenland. Trump’s offer to buy Greenland was ridiculed, but it’s not a stupid idea. Why? “Location, location, location. It is located between Russia and North America, close to the straits that connect the Arctic Ocean and the North Atlantic. The United States has been present in Greenland since World War II. When Denmark was occupied by Germany in 1940, the United States seized control of it.”

Kissinger: we are in a very, very grave period. “The grand consigliere of American diplomacy talks about Putin, the new world order — and the meaning of Trump.

China’s massive investment in artificial intelligence is changing the world at an accelerating rate. Just like climate change is accelerating, so is AI.

Central banks are fighting fundamentals: they are “living out the adage that when the only tool you have is a hammer every problem looks like a nail.” 

Can we survive the heat? Humans have never lived on a planet this hot, and we’re totally unprepared for what’s to come.

The death of the internal combustion engine. It had a good run. But the end is in sight for the machine that changed the world.

Diversions

We did Yuval Noah Harari’s “Sapiens” in my book club a few months ago, and it was a big difficult read. Not many of the blokes made it through, me included, but someone named Neil Kakkar has summarised it – superbly. Harari’s main points are preserved but the padding is removed. It’s great! And it really is a wonderful book.

A sea of fresh water has been found under the ocean! Well, it’s “low salinity”, whatever that means.

The scourge of worker wellness programmes. God save us from them.

I’m putting this under “diversions” because I’m not sure about it. It’s a 45-minute documentary about the future of money and how bitcoin and blockchain will become the world’s currency. It’s pretty glib, but interesting, and if you’ve got nothing to do for three-quarters of an hour, worth a look.

Ahem … Bitcoin bank accounts are now available in Europe.

I’ve always wondered about this: why did Christianity thrive in the United States?

Very nice video by Insiders’ Huw Parkinson about Trump wanting to nuke hurricanes.

The unbearable rightness of Seth Abramson. I’ve been following this bloke on Twitter for a long time – he writes about Trump and the Mueller investigation, and has written a book I’ve read as well. He’s great. This piece explains him.

Here’s a New Yorker piece extolling one of my favourite TV shows – Grantchester. “James Norton looks fantastic in cassocks, suits, and a priest’s collar; his sensitive hunkiness greatly enhances the appeal of this particular reverend, who, for good measure, is also a Scots Guards veteran who broods, fornicates, drinks whiskey, wheels around on a bicycle, and listens to unbelievable amounts of jazz, a genre that only he, in all of sleepy Grantchester, understands.”

The Amazon is not the earth’s lungs. Humans could burn every living thing on the planet and still not dent its oxygen supply. We’d starve, but be able to breathe.

“I was swallowed by a hippo.” What else is there to say?

The paradox of Peanuts. “A Peanuts narrative is the opposite of a fairy tale. In the latter, good generally wins out, however messily: Dragons get slain, witches are shoved into ovens, simpletons land fortunes, and so on. In Schulz, no one wins and everyone is thwarted, not only in love, but also on the baseball field or in the classroom or, where Snoopy is concerned, in the skies over World War I battlefields.”

"One realizes that human relationships are the tragic necessity of human life; that they can never be wholly satisfactory, that every ego is half the time greedily seeking them, and half the time pulling away from them."

How the prison economy works. (This is good.)

Ricky Gervais sums up Twitter (very funny).

Have you heard Cream’s version of Stormy Monday? It’s great (in my humble opinion).

And what about Eric Clapton and Lenny Kravitz doing All Along The Watchtower? Oh my.

It’s Chrissie Hynde’s birthday today – 68. Here she is out front of The Pretenders, live in Sydney in 2010 doing Back On The Chain Gang.

And tomorrow is the 178th birthday of Antonin Dvorak, the great Czech composer. Here’s his beautiful Song To The Moon, sung by the sublime Renee Fleming.

Ask Alan

In this week's Ask Alan livestream, Alan Kohler looks into the trade war between the US and China, runs through how analyst briefings and investor roadshows work, and more.

Don't forget the weekly #AskAlan livestream has migrated to Eurek Report at InvestSMART, which can be found here. And if you would like to #AskAlan a question, please email it to askalan@investsmart.com.au.

Next Week

By Craig James, Chief Economist, CommSec

Australia: Business and consumer confidence in focus

• In the coming week there will be more insights into the economic environment in terms of business conditions and consumer sentiment. Home lending data will be scrutinised for a continued stabilisation in housing finance commitments. And the deceleration in Chinese tourist arrivals is expected to continue due to slowing Chinese economic growth and retail spending.
• The week kicks-off on Monday when the Australian Bureau of Statistics (ABS) issues new lending data for July. Property market conditions and activity have improved, boosting hopes of a continued stabilisation in housing finance approvals. But the all-important spring selling season is crucial to the demand outlook.
• On Tuesday weekly consumer confidence data is issued by ANZ and Roy Morgan. Sentiment is around long-run average levels with volatility in sharemarkets, Aussie dollar weakness and elevated petrol prices counterbalanced by lower mortgage rates, tax cuts and a bottoming in home prices.
• Also on Tuesday NAB’s August business survey is released. Australia’s business sector lost momentum prior to the federal election. Forward looking indicators – particularly trading conditions and profitability – don’t point to an improvement in the near term. Global trade frictions are also weighing on sentiment, but lower interest rates and tax offsets are expected to eventually feed through to firms.
• On Wednesday, monthly consumer confidence data is issued by Westpac and Melbourne Institute. Sentiment lifted by 3.6 per cent in August – the biggest lift in six months – propelled higher by a pick-up in consumer views on home purchases. Sentiment towards buying a dwelling is the most positive in 5½ years.
• Also on Wednesday, tourism data is released by the ABS. In June, a record 11.2 million annual trips were made by Aussies - 5.4 million more than 10 years ago. But the annual growth rate for Chinese tourists travelling to Australia was just above 9-year lows at 1.4 per cent.
• On Thursday, the Reserve Bank issues updated credit and debit card lending data for the month of July.

Overseas: Inflation data issued in the US and China

• In the US, the two stand-out economic data releases in the coming week are consumer prices (inflation) and retail spending. In China, the focus is on international trade and inflation data.
• The week begins on Sunday in China when the National Bureau of Statistics issues international trade data for August. Exports unexpectedly rose by 3.3 per cent in the year to July, with goods shipped to the European Union and South-East Asian nations lifting, offsetting a decline in US exports due to rising tariffs. 
• On Monday in the US, July consumer credit (or lending) data is also issued. Consumer credit card debt rose by US$14.6 billion in June – the weakest amount in three months – perhaps due to greater economic uncertainty. 
• On Tuesday in China, consumer and producer prices data are scheduled. Consumer prices are lifting due to elevated fruit and meat prices. But the drop in producer prices signalled that China’s industrial sector had slipped back into deflation due to lower automobile and raw material prices.
• On Tuesday in the US, the regular weekly reading on US chain store sales is due together with the JOLTS series of job openings report. The number of job vacancies (7.3 million) remains above the number of unemployed (6.1 million) in the US due to a skills shortage and tight labour market.
• Also on Tuesday, investor attention will be on the reaction of the US small business sector (NFIB survey) to the latest escalation in China trade tensions. The details of the survey will be scrutinised, especially with respect to new business investment intentions and capital spending plans amid rising political uncertainty. 
• On Wednesday in the US, the weekly reading on mortgage applications is issued as well as producer prices and wholesale inventories data. Core producer prices unexpectedly declined by 0.1 per cent in July – the first fall in two years – as costs declined for guestroom rentals, loan services, physician care and truck freight transportation. 
• On Wednesday, Chinese data on new vehicle sales is expected.
• On Thursday, the weekly figures on jobless claims are issued in the US, along with consumer prices and the monthly budget statement. US core inflation rose by 0.3 per cent to 2.2 per cent from a year earlier in July, above economists’ expectations. Rising shelter, medical, clothing and used car prices are challenging US policymakers’ view that a return to its 2 per cent inflation target would take longer than previously anticipated. Rising tariffs on goods could limit the case for additional US Federal Reserve rate cuts, despite weakening business investment.
• On Friday, the all-important US monthly retail sales report is issued. In July, consumer spending lifted by 0.7 per cent – the most in four months – as Amazon Prime Day sales boosted online sales. Job and wage gains have buoyed consumer sentiment, despite concerns about the levying of import duties on consumer goods prior to Thanksgiving and Christmas.
• Also on Friday, the University of Michigan’s preliminary consumer confidence survey for August is issued. The survey was at 7-month lows in July, contrasting with near-cycle highs for the Conference Board measure.
• US trade prices are also released. Import prices rose by 0.2 per cent in July after falling by the most in seven months in June with US dollar strength keeping a lid on import costs. 
• On Friday in China, money supply data may be released.

Last Week

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

Investment markets and key developments over the past week

• Good news week! It certainly seemed that way for financial markets with a lot of relatively small positives – the US and China indicating that face to face trade war talks will start again next month, Hong Kong withdrawing the extradition bill, the UK parliament standing up to block a “no-deal Brexit” and confirmation that Italy has a new government without another election – all serving to drive “risk on”. This saw share markets rise, bond yields move up sharply, commodity prices rise with the exception of gold, commodity currencies like the $A rise and the $US fall. Australian shares followed the global lead higher led by IT, consumer stocks, the miners and financials but bond sensitive property, telco and utility stocks all fell in value as bond yields rose.
• Good news on trade but just recall we have seen this movie several times before. The news of the resumption of the trade talks is good and likely follows China’s decision a week ago not to retaliate against the latest round of threatened tariffs from the US, which provides hope that with China playing the adult in the room maybe the situation can start to de-escalate. President Trump is likely also under a lot of pressure given the increasing recession talk in the US. He even noted for the first time that were it not for his trade war US shares would be a lot higher which by implication means that he must also acknowledge that the US economy would be a lot stronger. But while the resumption of talks (assuming it happens) is good this will be the fourth attempt with the previous three ending in a twitter tantrum and more tariffs and so it would be wrong to get too optimistic just yet. No doubt we will hear lots of “the talks are going well” and “they really want a deal” from President Trump again. But we need to see clear evidence that both sides are prepared to compromise. Share markets may still have to fall further to pressure Trump to resolve the issue.
• It may be wrong to say that they are connected but China’s more conciliatory approach on trade a week ago and now a more conciliatory stance on Hong Kong with support for the withdrawal of the extradition bill are positive signs given that a week ago hardly anyone expected such a concession. On the one hand the protest leaders have said the move is not enough. On the other, HK leader Carrie Lam has said it’s only the “first step” to resolving the political, economic and social issues causing the deadlock so maybe the risk of military action to put down the protests is receding.
• The Brexit debacle is getting up there with The Party for laughs. Looks like PM Johnson’s move to suspend Parliament has backfired with those opposed to a “no-deal” Brexit in Parliament (ie leave the EU without a free trade deal) moving to block such an exit on October 31 and to move to block the PM calling an early election. The strategy looks to be to only allow an early election if a no-deal Brexit is off the table. Financial markets like that because of the fear that a no-deal Brexit would reap havoc with the UK economy as 46% of its exports go to the EU. So, the British pound rose. The only thing is that the Brexit comedy has a long way to go yet so it’s too early to go long the pound. But it does seem that the risk of a no-deal Brexit has receded a bit and no Brexit at all remains possible.
• Another word on Italy – Itexit remains as far off as ever! It’s questionable how durable the new Italian coalition government will be. However, recent events highlight several positives. First, the Northern League (NL)/Five Star Movement (5SM) government showed that Italy’s two main populist parties are pragmatic to the point of working with the European Commission to avoid a financial meltdown. Second, 5SM has shown the same again in being able to cooperate with the Democratic Party (PD) to form a new coalition. Third, the new 5SM/PD government will likely push for fiscal stimulus but this is coming at a time when the rest of Europe is likely to be a bit more flexible given the economic slowdown. Finally, polls show that 68% of Italians support the Euro which is why 5SM and NL had to drop their anti-Euro stance to get a decent share of the vote in the first place. Barring a big economic downturn in Italy and a big new surge in immigration, those waiting for an Itexit to pose a threat to the Eurozone will continue to be disappointed.
• Per capita GDP growth – how does Australia compare? Ultimately its real per capita economic growth (or economic growth per person) that matters for material living standards as opposed to just real GDP growth. The problem in Australia is that per capita GDP declined over the last year by 0.2% thanks to headline economic growth of just 1.4% which is less than population growth of 1.6%. While the damage was done in the September and December quarters last year growth in per capita GDP has been trivial so far this year. The next chart compares per capita GDP growth across Australia, the US, the Eurozone and Japan. As can been seen Australia (the blue line) is the weakest over the last year highlighting the real slowdown in Australia. But it can also be seen that all countries go through periodic soft patches so its important to get a longer-term perspective as well. For the whole period shown per capita GDP growth in Australia of 1.3% pa has exceeded that of the other comparable countries. That said over the last decade per capita GDP growth in Australia has slowed to 1% pa which puts it ahead of the Eurozone (at 0.9% pa) but behind the US (1.4% pa) and Japan (1.3% pa). The slowdown in Australia partly reflects payback for the mining boom driven outperformance seen last decade. To get growth in per capita GDP (and hence material living standards) back up in Australia will require a mix of cyclical policies to boost short term growth and structural reforms to enhance productivity which has also declined over the last year. Interesting to note that after allowing for Japan’s falling population it has been doing a lot better than often credited in the last decade or so.

Source: ABS, Thomson Reuters, AMP Capital

• A “stronger” inflation target for Australia with talk from the Treasurer suggesting it will remain 2-3% (I would hope so -otherwise it will lose credibility) but that it may be strengthened by requiring an explanation when the target is missed. I am not sure that this would change things that much, but it could see the RBA getting more aggressive to bring inflation back to target whenever it is outside it (like now), which is contrary to the more flexible approach adopted just three years ago.  

Major global economic events and implications

• US economic data got off to a bad start with a sharp fall below the 50 level in the manufacturing conditions ISM and weak construction spending. Against this though the non-manufacturing ISM rose and is strong. The trade deficit also narrowed slightly, and jobs indicators remained solid.
• Final composite business conditions PMIs in the Eurozone and Japan were confirmed to have risen in August with the services sector still doing better than manufacturers. China’s Caixin PMIs also rose in August. Consequently, despite a fall in the US, the global composite business conditions PMI fell only slightly in August and has been tracking sideways over the last few months holding out a bit of hope for the global economy despite all the talk of recession. It still looks like the slowdowns around 2012 and 2015-16 rather than the slide into what became the GFC recession.

Source: Bloomberg, AMP Capital

• The key message out of Chinese policy makers over the last week is that more policy stimulus is on the way with the threat to growth clearly remaining a big concern.

Australian economic events and implications

• The past week saw June quarter GDP data confirm the ongoing weakness in the Australian economy. June quarter growth wasn’t as bad as feared but it still showed that annual growth has slowed to just 1.4% year on year, its weakest since the GFC and were it not for strong growth in public demand and net exports the economy would have gone backwards. What’s more retail sales continued to fall in July and industry data showing softness in car sales into August raise questions about the impact of the tax and rate cuts – but maybe it’s a bit too early to tell yet.  And ANZ job ads fell anew in August pointing to much slower jobs growth ahead as does the huge disconnect between GDP growth of just 1.6%yoy and employment growth running at 2.4%yoy.
• But there was also some good news. First, the current account returned to surplus for the first time since 1975. While the trade surplus remained strong in July its likely to decline given the recent plunge in iron ore and coal prices suggesting a return to a current account deficit. However, its likely to remain a lot smaller than seen in recent decades and means that Australia’s dependence of foreign capital is much reduced. Second national average house prices have started to rise again and while its hard to see a return to boom time conditions the threat of a debilitating negative wealth effect on consumer spending looks to be receding.  Finally, the AIG’s manufacturing and services conditions PMIs rose in August, but this needs to be taken against the CBA’s versions that fell and on average they are pretty soft.
• The bottom line is that while recession remains unlikely, growth and activity is well below where it should be and this means ongoing upwards pressure on unemployment and subdued wages growth and inflation. This is consistent with the Melbourne Institute’s Inflation Gauge running at just 1.7% year on year in August. So while the RBA left rates on hold in September and seemed a bit oblivious to the run of negative domestic and trade war news over the last month we remain of the view that it will need to ease further and still see the cash rate falling to 0.5% by year end.

What to watch over the next week?

• The key focus of investors over the week ahead will be the European Central Bank on Thursday which is expected to deliver a much-anticipated easing of monetary policy designed to deal with weak growth and inflation chronically below target. We expect the ECB to announce a package of rate cuts, tiering of negative rates on bank reserves and renewed quantitative easing which will result in asset purchase of around €30bn a month.
• In the US, core CPI inflation for August (Thursday) is expected to show a small rise to 2.3% year on year and retail sales (Friday) are expected to show reasonable growth. Small business confidence and labour market indicators will also be released on Tuesday.
• Chinese data is expected to show a slight dip in CPI inflation (Monday) for August to 2.6% year on year, continuing low underlying inflation, some slowing in exports and imports (Tuesday) and a rebound in credit growth.
• In Australia, expect to see a modest bounce in July housing finance commitments (Monday) and the NAB business survey (also Monday) and the Westpac/MI consumer survey (Wednesday) to show confidence remaining around average levels. 

Outlook for investment markets   

• Share markets are still at high risk of further weakness/volatility in the months ahead on the back of the ongoing US/China trade war, Middle East tensions and mixed economic data as we are in a seasonally weak part of the year for shares. But valuations are okay – particularly against low bond yields, global growth indicators are expected to improve by next year and monetary and fiscal policy are becoming more supportive all of which should support decent gains for share markets on a 6-12 month horizon.
• Low yields are likely to see low returns from bonds once their yields bottom out, but government bonds remain excellent portfolio diversifiers.
• Unlisted commercial property and infrastructure are likely to see reasonable returns. Although retail property is weak, lower for longer bond yields will help underpin unlisted asset valuations.
• The combination of the removal of uncertainty around negative gearing and the capital gains tax discount, rate cuts, tax cuts and the removal of the 7% mortgage rate test are leading to a rise in national average capital city home prices driven by Sydney and Melbourne. But beyond an initial bounce, home price gains are likely to be constrained through next year as lending standards remain tight, the record supply of units continues to impact and rising unemployment acts as a constraint.
• Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 0.5% by early next year.
• The $A is likely to fall further to around $US0.65 this year as the RBA cuts rates further. Excessive $A short positions, high iron ore prices and Fed easing will help provide some support though with occasional bounces and will likely prevent an $A crash.