We are too big to fail, Everything is disrupted, Yield Curve Ball, Budget, more

Last Night's Markets
We are too big to fail
Everything is Disrupted
Brexit Latest
Yield Curve Ball
The Budget
My Retirement Income Proposal
Research and Diversions
Facebook Live
Next Week
Last Week

Last Night's Markets

We are too big to fail

On Thursday UBS put out a note that said Australia’s household debt to income ratio had hit a record of 199%. This graph went with it:

Yes, it might have peaked, and might be starting to fall, although we can’t be sure. What a relief! Perhaps it’ll fall to, what, 180% of income? Well that’s alright then (not).

And the interest payments to income line – down from a peak of 13% to about 8.5% now, the same level as in 1988, is hardly cause for relief and celebration. It is simply the reason debt has been able to reach 200% of income – that is, because interest rates are so low – but to me that just displays the household sector’s vulnerability.

However the whole thing is potentially a cause for celebration for investors, which might sound weird, but let me explain.

Australian households, and the western world’s for that matter, have become “too big to fail”.

Remember when banks were described as too big fail during and after the GFC? They were bailed out by governments amid a debate about whether such a thing was a good idea, whether it would lead to moral hazard (banks taking greater risks because they knew they would be bailed out).

Moral hazard indeed abounds, but the banks are simply too big to fail, so it doesn’t matter. They had to be rescued, and still would have to be if it happened again.

The nation’s households – voters and consumers – are now also up to their eyeballs in debt, and are also in strife, but they are also too big to fail and they are a far bigger deal than the banks.

If Government and central banks were prepared to do anything to save the now-hated banks, what would they do for the beloved voters?

Having spent the past 10 years furiously encouraging debt-driven consumption and asset price bubbles through low to zero interest rates and quantitative easing, global central banks are now in a bind: they can’t possibly do what would otherwise come naturally, which is to normalise interest rates even if it means a recession - as they used to do regularly - because the social consequences this time would dire.

As a recent note from Macquarie Wealth Management put it: “household savings are (now) regarded as a deduction from growth, to be discouraged.

“The drivers that make this debt ‘merry-go-round’ possible are a permanent state of asset price inflation and a controlled slow-burn default, to make room for new waves of leveraging & consumption.”

In Macquarie’s estimation there are three “perverse outcomes” of this state of affairs, worth quoting in full:

• First, it magnifies inequalities, as households that have the greatest exposure to assets do much better than those relying on wages and household chattels. Today, the top 1% of US households own ~40% of wealth, up from 27% in the ’80s, while the bottom 50% own 2%. Globally, the top 1% own 50% of wealth, up from 35% in ’00. Hence, the bottom of the pyramid is driven into debt slavery;

• Second, the only reason why current assets are worth even a fraction of today’s valuations is because since ’80s, money supply has grown much faster than nominal GDP. The difference are assets that facilitate leveraging and consumption. However, leveraging implies that cost of capital must continue to fall forever (as we must generate more liquidity than required in order to reduce vols and ensure price reflation). This in turn prevents clearance, keeping zombies alive and generating disinflationary pressures, that central banks are condemned to fight.

• Third, rising assets and declining cost of capital accelerate pace of technological progression, hence, magnifying disintermediation of businesses, brands and labour. This further damages the middle-class while lowering labour & corporate marginal pricing power, adding further disinflationary pressures for CBs to fight.

All very interesting and caustic, but the point is that investors are riding a “merry-go-round” that can’t be allowed to stop for fear of unacceptable consequences.

What would those consequences be? Well, simply that a significant increase in interest rates would result in the evaporation of savings and retirement accounts, as well as the total collapse of household consumption and business investment.

Nor can they allow a recession – that is, a significant increase in unemployment and decline in small business incomes, for the same reason.

So those things won’t happen. That’s why last week’s yield curve inversion in both the US and Australia is likely to have been a false signal: there can neither be a recession to justify the decline in long bond yields nor a sustained rise in short term interest rates. Simply can’t happen.

That’s not a reason to be complacent as an investor, just that a recession isn’t the thing to worry about in my view, at least not for a while. The thing to worry about is whether the companies you have invested in are any good, or are about to be disrupted.

At some point, there may be a grand reckoning, as many people described as inevitable and imminent, but the plan of central bankers – to the extent they have a plan at all – would be to gradually inflate away the debt over decades.

The last thing they, or anyone else, would want is for the debt to be expunged through a major default event. Can that be avoided? A lot of doomsayers say it can’t; I believe it can, and will be, for longer than they or you think.

Not that there is nothing to worry about. There’s disruption for a start…

Everything is Disrupted

Digital disruption tends to have the effect of overvaluing everything.

Companies being disrupted get overvalued because the market – and the companies themselves – take a while to understand what’s happening, and the disruptors are overvalued because the market (and the companies themselves) get carried away with the possibilities.

Yesterday’s IPO of Lyft in the US is a case in point.

Last year the company lost US$911.7 million. It listed last night at an opening value of US$25 billion, priced by public auction, not someone’s wishful thinking. It jumped at market open and held on to rise around 15%. It’s basically a taxi company losing pots of money.

Sean Aggarwal, Lyft’s first outside investor, put in $30,000 in 2007 and now has a stake worth $100 million. Floodgate Ventures, another seed investor, has seen a nearly 10,000% return on its roughly $1 million investment. Then there is Mayfield Fund, which invested a total of nearly $15 million in the first four venture rounds, giving it a stake now worth about $600 million.

Uber, the disruptor that Lyft is trying to disrupt, is also going to do an IPO this year and estimates put its value at US$120 billion. It’s losing about a billion dollars a quarter, not per year. It’s also a taxi company.

These businesses are getting these valuations because they are not regarded as taxi companies, but tech companies, to which old rules don’t apply. They get to call themselves tech companies, and everyone goes along with this, because they use digital distribution – that is, they have an app.

Mark Zuckerberg has always been desperate to define Facebook as a tech company, which used to be about valuation, but no longer – now it’s about trying to avoid the regulation and censorship that normal publishers and broadcasters are subject to.

Five years ago Facebook was earning profits of $1 a share and the share price was $60; now eps is $7.57 and the share price $165, for an almost modest P/E of 21 times.

So Facebook’s profits did catch up with the valuation – it’s an enormously profitable business now, although it’s facing immense challenges to its business model because of regulation.

Over the past 10 years Australia’s big three media disruptors – REA, Seek and Carsales – have returned 32.6%, 20% and 12.8% per annum respectively. Big differences there, but each of them has returned well above the ASX200 compound growth rate of 5.6% over the same period.

Having gone from $5 to $74 in 10 years, REA is sitting on a P/E of 70 times. Can that be justified? Maybe, but it’s clearly a stretch for a big, mature business that is arguably no longer a tech disruptor but just a classified advertising publisher.

The point is that, over time, digital disruptors will come to be defined by their basic business rather than the means of distribution, which happens to be digital.

How long this will take is anybody’s guess, but these things always take much longer than you think. And there are always new waves of disruption to keep everyone excited – the latest being AI.

I’m not suggesting that digital distribution is irrelevant to legacy businesses and their investors, far from it. Fairfax Media’s business was destroyed by REA, Seek and Carsales simply because they were digital and it used paper. Encyclopedia Britannica was destroyed by Wikipedia for the same reason.

Brett King referred to this in my interview with him about the disruption of banking for Talking Finance on Thursday: “You’ve got two main factors that are influencing how banking will change structurally and how it’ll change in relation to customers lives. The first is this global shift from physical distribution to digital distribution, the Amazon’s, Uber’s of the world – so this shift towards anytime, anywhere, instant gratification available through e-commerce.

“Then the other aspect is from a high-friction, high-touch environment, to low-friction, low-latency, expectations around banking. If you were to sort of track that on a graph, you could see that [my book series] 2.0, 3.0, 4.0 were all on that trajectory where ultimately banking just becomes a core piece of utility embedded in your world around you for when and where you need it.”

He’s referring to the fact that there are two stages of disruption: first, digital distribution destroys the old business models, and second, the fact that it’s digital becomes both irrelevant and invisible – it’s just another product or service and it becomes embedded in our lives.

The first stage sees a huge transfer of wealth from the old to the new; the second stage is where the valuations of the new businesses readjust, either because the profits catch up (Facebook and Google – for the moment, at least) or because the share prices come back to earth (Tesla).

Brexit Latest

As you would have heard or read, the British Parliament has voted against Theresa May’s Brexit deal for the third time. It has now voted against everything; the UK polity is frozen, lost in space, and has been for some time.

Yet here are 12-month charts of the FTSE 100, and the British pound vs the US dollar:

FTSE 100

GBPUSD

The pound took a bit of a hit last night, but nothing drastic: clearly the markets are still confident there will be no hard Brexit on April 12, which is the new deadline (it had been this morning at 10am our time).

Should markets be so confident? Or is the UK the greatest shorting opportunity in our lifetimes?

I remain (pardon the pun) convinced that the two most likely outcomes of the next two weeks will be either a long extension of negotiations, and possibly another referendum, or a very soft Brexit, with Britain deciding to stay in the EU customs union.

Although the mad Nationalists in the Conservative Party have caused all the trouble, are continuing to divide the party and have now brought down the PM, they simply don’t have the numbers in the House of Commons to force a no-deal Brexit.

But we’ll see – accidents do happen. Meanwhile this has replaced Donald Trump as the greatest political show on earth, although One Nation gave it a run this week.

Yield Curve Ball

Back to the yield curve, and the Inversion. Should we be worried? No - alert, but not alarmed, will do.

The version of the yield curve that has been the focus of attention this week has been the spread between the 10-year US bond yield and the 3 month T-bill, which briefly went negative a week ago, and is now zero (both at 2.39%).

Gerard Minack says he prefers to watch the 10/2 year spread because “the 2 year note does a better job anticipating Fed action than the T-bill, and it has given fewer false signals than the 10 year/3 month spread.”

But in any case neither version of the yield curve has given a false signal since the late 1960s, and only one since the 1950s. His chart is illuminating:

Sorry if it’s a bit small: the yellow lines are the point of first inversion and the grey panels are the recessions.

The yield curve has inverted before every recession and only once did it happen without a recession following soon after (1966). The average lag is 15 months, and the average wait for a downturn in the sharemarket is around 9 months, since equities are slower than bonds to anticipate recession.

So even if a recession is coming, equities can continue to rally for quite a while after the yield curve inverts.

The important question for investors is whether there is going to be a US recession next year, as the curve appears to be predicting. As discussed in today’s first item, I think not because the authorities (Fed and Government) can’t allow it.

But the yield curve is both cause and anticipation: banks fund short and lend long. If long term interest rates are below short term ones, their business model doesn’t work and they don’t lend. We’ve seen in Australia what sort of impact that can have on house prices and the economy.

The Budget

I bumped into Treasurer Josh Frydenberg in the airport lounge on Sunday morning. I was on my way to the football in Sydney to watch Essendon play GWS in the first game of the season (a decision I came to regret) and Josh was on his way to spend eight days cloistered in a room in the Treasury building in Canberra studying the budget.

Apparently there is a suite of offices in Treasury that is used once a year (only) for the Treasurer and his staff to work on the budget.

“Don’t you already know what’s in it? I mean, didn’t you do it?” I asked, a bit surprised.

“Of course,” he said. “I’m already up to version six of the speech. It’s that I have to know every bit of it, every programme and every portfolio, so I can answer questions.”

“Gosh Josh,” I said, with sparkling wit. “You’re cramming for an exam.”

“What’s in it?” I added, dreams of Laurie Oakes’ famous leak of John Howard’s entire 1980 budget floating before my eyes.

“Ha ha,” he said. “Nice try”.

Anyway, we all know what he’s going to say: the strong economy, thanks to the splendour of the Morrison Government, has resulted in a balanced budget for 2018-19, a decent surplus for 2019-20, and an even bigger one for 2020-21.

But most of all he will talk about the tax cuts and extra spending that has been enabled by the “strong economy”, probably totalling $5 billion or so next year and $20-30 billion across the forward estimates.

ANZ’s Cherelle Murphy has produced some guesstimates of how much is available for spending:

Of course, whatever the Coalition has to spend, the Labor Party will have too, plus a bit more from the tax increases on negative gearing capital gains tax and dividend franking, so the political advantage will be fleeting.

But of course what is producing the faster return to surplus and the cash windfall is not the strong Australian economy, but the strong Chinese economy, although Josh probably won’t highlight that.

Something else he won’t highlight is the fact that it’s also the product of a rapid increase in income taxes in Australia, in turn caused by bracket creep, as noted by RBA head economist, Luci Ellis in a speech this week that contained this chart:

Last year gross household income rose 3.5% and taxes paid rose 8%. That plus a surge in profits by iron ore and coal miners has unexpectedly lifted government revenue by $4-5 billion.

And by the way, the increase in taxes weakens the domestic economy and the increase in exports doesn’t help it.

But as Josh said in the airport, nominal GDP is strong which means government revenue is strong as well, so the budget that is likely to be his first and last (according to the polls) is going to be a lovely one, with Josh sprinkling money and smiling all the time. The sales roadshow afterwards will be pleasant and happy, rather than stern and responsible.

However, it is NOT fiscal stimulus; if anything it’s the opposite. At the risk of being a bit black and white, fiscal stimulus happens when the budget deficit increases or the surplus reduces – that is, the government is putting money back into the economy rather than taking it out.

The Morrison/Frydenberg Government is reducing the deficit more quickly than anticipated, so fiscal policy is contractionary, not expansionary.

Josh will try to persuade us otherwise next week, saying they’re being responsible AND doing handouts, but it’s rubbish. The handouts are merely giving back some of the bracket creep, as usual.

The only counter to that is where taxes from booming mining company profits are also handed back to consumers, because that genuinely is manna from heaven.

On the whole, fiscal policy is on the sidelines: the Reserve Bank is on its own trying to prevent an economic slowdown, which is presumably why bond yields have fallen so much.

My Retirement Income Proposal

I was asked about my column in The Australian last Saturday during the #AskAlan Q&A on Thursday, and I said I’d summarise it in the Weekend Briefing today for those who don’t subscribe to The Oz, but what the hell – here’s the whole thing!

I have a modest proposal for solving the mess that is Australia’s retirement system, as exposed by the royal commission into misconduct in banking, financial services and superannuation.

It is, if I do say so myself, both brilliantly simple and blindingly obvious: the Government should sell increases in the old age pension.

It would be a form of government-guaranteed annuity, without the risk or fees of private operators, and it would be a way to turn the current superannuation lottery into more of a defined benefit scheme, although not entirely of course.

It would solve longevity risk, since the old-age pension is for life, and also solve the problem of the financial advice industry, which remains deeply conflicted after Kenneth Hayne decide not to recommend the structural separation of advice and wealth product. Let me explain my reasoning.

It’s not so much Hayne’s decision, although as discussed here before, it was a shocker, but the failure to deal effectively with the problems of financial advice in general. Nevertheless regulators and policy makers will need to focus on this soon.

Hayne’s most controversial recommendation, later rejected by the Government, was that mortgage brokers should be paid by borrowers not banks. With financial advice, that happened a while ago when Labor’s Future of Financial Advice legislation banned trailing commissions.

That did not mean the end of financial planning as an industry, as it would do for mortgage broking, because advisers get to hang onto their clients’ money and can painlessly deduct large percentage fees. Trailing commissions simply became “fee for service” and life went on.

But it’s becoming clear to all now that financial advice is too expensive, and as compliance grows ever more onerous, especially after the royal commission, it will only get more so.

Also the rapid increase in educational requirements are going to result in a big exodus of people from the industry. Fewer advisers and more education and compliance mean only one thing: skyrocketing price – of something that’s already far too expensive.

An initial Statement of Advice can cost $5-6,000 and ongoing fees can deduct 1 per cent and more from the account. It’s not so much the fact this is $833 per month on a $1 million retirement balance, which is a lot of money, but the fact that it compounds because it’s a percentage rather than a fixed dollar sum, and can up costing far more than the number years times the amount.

The policy imperative is to look after retirees better. Most of them still get a lump sum from their super fund and hand it over to a financial adviser, saying: “here, can you look after this for us please, and pay us something every now and again until we die, if there’s any left by then.”

Apart from a small minority of true SMSF operators who invest their own retirement capital, the management of self-funded retirement in Australia is in the hands of financial advisers who are on the whole, with honourable exceptions, insufficiently qualified and too expensive, and they provide an unfairly wide variety of experiences for retirees, from great to horrible.

What’s more they are about to become harder to find and more expensive as many of them retire or quit.

So if advisers are not going to be stopped from being employed by wealth managers because Hayne didn’t recommend that, what, if anything, is going to be done to ensure Australians who have saved 9.5 per cent of their salary for 40 years get a secure and comfortable retirement without being ripped off?

My suggestion: the Government should sell increases in the old age pension.

At the moment the pension – what you get for nothing - is $24,081 per year for a single and $36,301 for a couple. There could be a menu of increases in that amount – payable for life of course – for a range of prices.

It would reduce the need for means testing because instead of reducing the pension, extra assets could be used to increase it by handing them over to the government.

The prices of the various pension increases would have to be worked out actuarially, and in a sense it would represent a bet against longevity. If someone lives a long time, they win; if they die quickly, other taxpayers win.

That makes it sound a little frivolous, but I think it might be the best way for the government to run a serious government annuity operation: instead of sending retirees off, perhaps with tax incentives, to buy annuities from private operators who charge whopping fees, simply build it into the aged pension system.

And the best thing would be that there would be no risk at all – the amount would be government-guaranteed for life.

The money would have to be invested by the government, but that could be done by the Future Fund, which is mandated to fund fixed commonwealth pensions. In a way, increases in the old age pension bought with retirement savings would just be an extension of what it does already.

Those who want to leave some money for their descendants could use only part of their retirement lump sum to buy extra pension, and invest some separately. But I reckon the time to give that money to the children is when you retire, which is when they need it, if not before.

I have previously suggested that there should a single government-run default super fund, so that savers don’t get ripped off by poorly-performing industry funds and high fee retail funds, but that’s never going to happen.

Selling increases in the pension would leave the super industry intact, and leave it up to retirees to decide whether either to a buy bigger government pension with zero risk and no fees, give the money to a financial adviser to invest for income and plenty of risk (and fees) or buy a private annuity, also with risk and fees.

Research and Diversions

Research

Peter Martin: Frydenberg should call a no-holds-barred inquiry into superannuation, now, because Labor won’t.

Why the NZ shooting video keeps circulating. “…the ability to train algorithms to accurately recognize extreme violence without anyone having to flag it in the first place is still very far off—even the most advanced AI can’t distinguish between a real shooting and a movie scene…”

Instagram is the internet’s new home for hate. “Instagram is teeming with these conspiracy theories, viral misinformation, and extremist memes, all daisy-chained together via a network of accounts with incredible algorithmic reach and millions of collective followers, many of whom are very young.”

How the pros invest in a slowing economy.

What is surprising about the four-page letter that was issued by Attorney General William Barr on Sunday afternoon is what it lacks. The summary of the principal findings of Robert Mueller’s investigation contains no reference to President Trump’s businesses. 

A hour-long documentary about the Mueller inquiry by PBS, in two parts, if you’ve got the time. Here’s Part 1, and Part 2.

The scandal is how much of the corruption Mueller exposed turns out to have been perfectly legal.

An interview with one of the people who developed the computer systems that can speak, and respond to spoken commands. “What do you make of Siri, Alexa, and other personal assistants?” “It’s funny to talk about, because on the one hand, we are very proud of this incredible progress — everybody in their pocket has something that we helped create here many, many years ago, which is wonderful. But on the other hand, these programs are so incredibly stupid. So there’s a feeling of being proud and being almost embarrassed. You launch something that people feel is intelligent, but it’s not even close.”

The news industry took a bucket of cold water in the face on March 25, 2019, as media outlets around the world reported Apple's vision of their own future. Although supposedly a convenient, new channel for the consumption of a centuries-old medium, Apple's News will of necessity change the architecture of news production and dissemination.

The speech by RBA Assistant Governor, Luci Ellis, this week. Worth a read. “What is noteworthy is that for all of the past six years, growth in tax paid has exceeded income growth by an above-average margin, at a time when income growth itself has been slow.” 

Interesting piece about the Murray Darling Basin problem: it’s because the floodplain water harvesters to the north – cotton etc – are diverting water before it gets to the south. “While their catchment structures are legal…water users to the south of these catchment areas believe the behaviour of large upstream irrigators is morally wrong and performed with a disregard for environmental consequences.”

Livewire’s 10 most topped stocks for 2019 – they’re already up 25.6% this year so far.

Self-driving cars are out. Micromobility is in. It’s a story about scooters.

From The Economist: America is rattled. An investigation is under way that is expected to conclude that China’s theft of intellectual property has cost American companies around $1trn; stinging tariffs may follow. As so often, Mr Trump has identified a genuine challenge, but is bungling the response. China’s technological rise requires a strategic answer, not a knee-jerk one.

The truth about neoliberalism. “Hayek & Mises invented neoliberalism because they were hostile to nation states. They saw national sovereignty as an impediment to economic freedom. Their favoured alternative to the nation was a mix of world government with individual consumer sovereignty.” I guess that means they were anarchists, and neoliberalism is anarchy.

The history and practice of bankruptcy, drawing on books by David Graeber, Honoré de Balzac, Elizabeth Warren, and others. “In earlier times bankruptcy was a collection device, whereby the creditors clubbed together and picked the debtor up by the heels and shook him to see what rolled out of his pockets.

Capitalism is becoming less competitive. How different countries are tackling a growing economic problem.

Roger Montgomery: Around the world, car sales are declining. From the United States to China, car lots are suffering from increasing unsold inventory. But it is in Australia that declines have been the steepest.

Battery power’s latest plunge in cost threatens coal and gas.

Diversions

Jonathan Pie explains Brexit. “They (the politicians) broke the contract, between the citizens and the government. Austerity broke the contract. The UK has ceased to function. Where’s Guy Fawkes when you need him”. Etc etc. He’s fairly brilliant, this bloke, the way he raves eloquently for 7:45, seemingly without autocue, although he’s possibly got that. I’m not sure. He’s outdoors, but it’s possible.

China’s 50-lane traffic jam. Crikey! And I thought Punt Road was bad.

Demand for vasectomies goes up by 50% just before the “March Madness” basketball tournament in the United States. Apparently, for some exhausted dads, the chance to watch more TV is a fair return on elective surgery. “If ever there were a three-day window to be trapped on the couch with an ice pack, it’d be during the tournament.”

“The 21st century is going to the end of one chapter of humanity’s story — and the beginning, maybe, of another. It is going to be the end of the first chapter of humanity’s story — it’s roiling, joyous, painful birth and adolescence — and, if we are wise, its transition to becoming a mature species. Let me explain what I mean by that.”

Fast forward to post-Brexit Britain. “The new politicians are spread across parties, and some sit as independents. Each of them sees that democratic renewal will be necessarily woven around the technologies that have already changed so many parts of people’s lives. Collectively, these politicians become known as the Digital Democrats. Once in Parliament, they start to change how politics works.”

On Transgender athletes and performance advantages: “I’m going to try my best to offer the full 360 degrees on the issue of male to female (MTF) transgender athletes. So bear with me – my intention is to explain, not to convince. I have no specific ideology on this, just an opinion, and it’s an opinion that matters less than the logic of how we discuss this issue.”

Jacinda Ardern has rewritten the script about how a nation grieves after a terrorist attack.

A cartoon video about the origin of consciousness. It’s interesting, if a little basic – written for kiddies. Maybe you’ve got a kiddie you can show it to (and learn something yourself).

ISIS still has lots of money. Even without a physical state, the Islamic State can still fund its main product: political violence.

Wonderful interview with poet, W.S.Merwin. “When I wrote The Lice, I thought that things were so black, that what we as a species had done was so terrible that there was very little hope, and certainly not much point in writing. The arts really were over; the culture, the salutary role of the arts in our lives—that was finished. There was nothing left but decoration. I’d become more interested in raising vegetables. In some ways, I think it’s even worse now. But I don’t think you can get stuck with just plain anger. It’s a dead end in the long run. If the anger is to mean anything, it has to lead you back to caring about what is being destroyed.”

We may venerate him as the greatest writer of all time, but there are a lot of things Shakespeare left out of his work. Mothers, for instance.

A British man has been arrested after trying to escape Australia on a jetski – to Papua New Guinea. He didn’t make it.

What is the world to do about gene editing? “CRISPR works by repurposing parts of an ancient bacterial immune system to make the job of editing genes in almost any organism unprecedentedly simple and accurate. If CRISPR has an agreed-upon red line, it is human germline editing (which, in effect, entails editing human embryos to create babies that will carry the edits in all of their cells, and will pass the changes on to any offspring they have). That line was crossed in November at the Second International Summit on Human Genome Editing in Hong Kong…”

“I thought I was paranoid but now I’m 100% sure our phones are listening to us – and I’ve got proof.”

Human contact is now a luxury good. Life for anyone but the very rich — the physical experience of learning, living and dying — is increasingly mediated by screens. They are quickly becoming a new class divide. Avoiding them is a status symbol.

Just because you’re paranoid, doesn’t mean the algorithms aren’t out to get you. “…who — if anyone — should be prosecuted for price fixing when the bots work out how to do it without being told to do so, and without communicating with each other?”

“Young people are fragile and needy when they start college; they cannot stand to have their idealism challenged. “From the time of Socrates until about 2014, it was okay to be provocative as a professor, and if a student got upset by it, well, that upset could be productive and you could work through, like, ‘What’s going on here? Why do you think it is?’ You could have a debate or discussion. But I wouldn’t try that now.”

The IQ swindle. “The IQ test is “a stale test meant to measure mental capacity, that, in fact, mostly measures extreme unintelligence, as well as, to a lesser extent, a form of intelligence, stripped of second order effects — how good someone is at taking some type of exams designed by unsophisticated nerds.”

Forgotten but not gone. A review of six books about ageing. ““Age only matters while one is ageing”, said Picasso, at the age of eighty. “Now that I have arrived at a great age, I might as well be twenty.” Well, bully for him.

The town of Jucuapa, El Salvador, has 18,000 people and 30 coffin factories. The murder rate in El Salvador is around 11 per day, the highest in the world on a per capita basis, having peaked at 18 per day in 2015. Coffins are known locally as “wooden pyjamas”

Happy Birthday Saint Eric Clapton, 74 today. For me, he’s an Old Love.

And it’s also Tracy Chapman’s 55th birthday. Fast Car is a wonderfully miserable song.

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 there's also the Facebook Livestream page where you can also opt to just listen to the questions and answers.

If you’re not on Facebook and would like to #AskAlan a question, please email it to askalan@investsmart.com.au (new email!) then keep an eye out for the Facebook Live video in next week’s Overview.

Next Week

By Craig James, Chief Economist, CommSec.

Australia: Budget time again

In Australia over the coming week, the handing down of the Federal Budget and the Reserve Bank’s interest rate decision both dominate. Tier-1 data includes retail and international trade, home prices and business confidence.

The week kicks off on Monday when CoreLogic releases its estimates of home prices for March. In February, the CoreLogic Home Value Index of national home prices fell by 0.7 per cent to be down 6.3 per cent over the year.

Also on Monday,NAB issues its March business survey ahead of the Federal Budget. Business confidence fell to three-year lows of 2 points in February. Political uncertainty, challenging retail conditions, drought, falling property prices and slowing domestic demand are weighing on sentiment. The AiGroup and CBA also issue their manufacturing activity gauges. 

On Tuesday, the Bureau of Statistics (ABS) publishes the building approvals data – a key leading indicator for home building. And the regular weekly reading on consumer confidence is published by ANZ and Roy Morgan.

The Reserve Bank Board meets on Tuesday but no rate change is expected.

Also on Tuesday, the Federal Budget is handed down at 7.30pm AEDT. The Federal Budget is seen as a once-a-year event. But in reality the government’s finances can be tracked over time.

The government’s finances are better-than-expected. In the twelve months to February 2019, the Budget deficit stood at $953 million (0.05 per cent of GDP) – the smallest rolling annual result in a decade. Over the same 12-month period to February, the fiscal balance was in surplus by $7,445 million with the net operating balance in surplus by $10,219 million.

The budget is in good shape because consumers are still spending, people are getting jobs, companies are generating profits and commodity prices - especially iron ore and coal - have been lifting on Chinese stimulus and supply disruptions. With a Federal election due in May, the budget will likely be focused on tax cuts for individuals and business, combined with more infrastructure spending.

On Wednesday the ABS issues the international trade and retail trade data for February. Consumer spending is a key uncertainty for the interest rate outlook. But Australia’s trade position is in good shape with the biggest surplus in two years posted in January ($4,549 million).

Also on Wednesday, new vehicle sales data is issued with sales down by 5.2 per cent over the year to February.

On Friday, the AiGroup’s construction gauge is also issued. Residential housing construction activity is slowing.

Overseas: US jobs and retail spending in focus

US reports on jobs and retail sales are the key interest points in the coming week. Manufacturing and services activity gauges in the US and China will also be keenly observed.

The week begins on Monday in the US when retail sales, the Institute of Supply Management (ISM) manufacturing gauge, business inventories and construction spending data are all released. US retail sales are forecast to lift by 0.3 per cent in February after increasing by 0.2 per cent in January. The ISM manufacturing index is tipped to increase by 0.6 points in March after falling to a two-year low of 54.2 points in February. 

On Tuesday in the US, weekly chain store sales, durable goods orders, the ISM New York Index and vehicle sales data are scheduled. New orders for core capital goods rose by 0.8 per cent in January - the most in six months - and shipments increased. But durable goods orders are forecast to fall by 0.8 per cent in February.

On Wednesday in the US, weekly mortgage applications, the ISM non-manufacturing business activity index and the ADP employment data are issued. ADP private payrolls are forecast to have lifted by 180,000 in March after a similar 183,000 jobs were added in February. Private sector labour market demand remains solid with broad-based gains from construction to professional and business services.

On Thursday in the US, the usual weekly data on claims for unemployment insurance is released with the Challenger job cuts figures. In February, US employers announced the largest number of monthly job cuts (76,835) in more than 3½ years.

On Friday in the US, the all-important employment report is released for March. Only 20,000 jobs were added in February – the least since September 2017. Winter weather likely reduced payroll growth with construction jobs down by 31,000. But the unemployment rate remained steady near five decade lows at 3.8 per cent. And average hourly earnings grew by 3.4 per cent over the year to February – the strongest growth rate in a decade.

Also on Friday, consumer credit data is scheduled. Credit is forecast to lift by US$15 billion in February after rising by US$17.05 billion in January. 

In China over the week, Caixin releases its private sector manufacturing and services sector activity gauges for March.

Last Week

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

• Share markets were mixed over the last week as global growth worries continue to impact. US and Eurozone shares rose a bit, but Japanese and Chinese shares fell in lagged response to the previous week’s falls in the US and Europe. Australian shares were little changed. Bond yields generally continued to drift lower, commodity prices were mixed with oil and copper up but gold and iron ore down and the $US rose which left the $A little changed.
• Share markets saw a strong rebound in the March quarter with US shares up 12%, global shares up 11% and Australian shares up nearly 10%. For Australian shares this makes it the best 3 months since September quarter 2009. Of course, this was after a huge plunge in the December quarter which saw investors get too negative and it still leaves markets below last year’s highs. We continue to see share markets moving higher by year end, but expect much slower gains from here and after the huge rise since their December lows shares are vulnerable to a short term pull back particularly as global and Australian economic data remains soft.
• Five reasons not to be too concerned by the latest plunge in bond yields and a negative yield curve in the. First, while a negative yield curve has preceded past US recessions the lag averages around 15 months, there have been numerous false signals and following yield curve inversions in 1989, 1998 and 2006 shares actually rallied. Second, other indicators are not pointing to imminent global recession. In particular we have not seen the sort of excess – overinvestment, rapid debt growth, inflation, tight monetary policy – that normally precedes recession. Third, bond yields lag shares with the bond market catching up to last year’s growth scare that depressed share markets. Following the February 2016 low in shares bond yields didn’t bottom until July/August 2016. Fourth, the retreat from monetary tightening has been a factor behind the rally in bonds but this is actually positive for growth. Fifth, part of the reason for the rally reflects investors unwinding expectations that central banks would continue pushing towards tightening. What the decline in bond yields reminds us though is that the constrained growth and low inflation malaise seen since the GFC remains alive and well. The latest plunge in bond yields will keep the “search for yield” going for longer which is positive for yield sensitive investments like commercial property and infrastructure. That said if the momentum of global data – particularly global business conditions PMIs - doesn’t soon start to stabilise and improve as we expect then the decline in bond yields will start to become a deeper concern. Either way share markets remain vulnerable to a short term pull back.
• Brexit took another twist over the last week with the UK Parliament taking control, but via a series of indicative votes, confirming that there is (as yet) no majority support for any one option. However, its not as bad as it looks with the votes indicating little support for a no deal Brexit, a soft Brexit looking preferred and some support for putting the preferred options to a referendum. If the withdrawal agreement in PM May’s deal finally gets supported Britain will likely exit on May 22 but if not the UK will have to decide to ask the EU for a long extension or to crash out on April 12. Going by the indicative votes a long extension is more likely but this opens up a hornet’s nest of the UK participating in EU elections in May, new UK elections and another referendum. But just remember that the Brexit comedy is just a sideshow for global investors. What happens in the Eurozone is far more significant to us (sitting here in Asia) than is Brexit.
• The Australian Federal Budget to be handed down on Tuesday will have three obviously overlapping aims: to provide a fiscal stimulus in the face of flagging growth; to reinforce the Government’s budget management credentials by keeping the budget on track for a surplus in 2019-20; and to help get the Government re-elected in a most likely May 11 or 18 Federal election. In all of this it has been helped by a revenue windfall mainly due to higher corporate tax receipts on the back of higher commodity prices but also higher personal tax collections due to stronger employment growth and lower welfare spending, although this will be partly offset by reduced growth and wages forecasts for 2019-20 and 2020-21. This is likely to see the budget running around $5bn better than expected in the December MYEFO for 2019-20. However, given the need for a fiscal boost in the face of an ailing economy and pre-election sweeteners the Government is likely to “spend” the bulk of the revenue windfall. We expect around an additional $6bn pa in personal tax cuts (including the roughly $3bn pa already allocated for tax cuts in December’s MYEFO ie under “decisions taken but not yet announced”). Coming on top of the $3bn pa of tax cuts already legislated for following last year’s budget this is expected to result in total personal income tax cuts of around $9bn pa from July. These are likely to be skewed towards low- and middle-income earners. The additional tax cuts could involve some combination of bringing forward some of the 2022 tranche of already legislated tax cuts and a further lift in the Low Income Tax Offset. There are also likely to be one off cash payments to pensioners, an expansion of the instant asset write-off and extra spending on health and infrastructure. Key Budget numbers for 2019-20 are expected to be: a budget surplus of around $5bn after budget handouts (or $10bn before any stimulus), real GDP growth of 2.5%, inflation of 2.25%, wages growth of 2.5% and unemployment of 5%. The deficit projection for 2018-19 is expected to be $1bn up from $5.2bn in MYEFO.

Source: Australian Treasury, AMP Capital

• The upside of the Australian Government’s Budget strategy is that a budget surplus is within sight after a record 11 years in deficit and the household sector will receive a boost just at the time it needs it given falling house prices and likely rising unemployment. The downside is that the tax cut boost to the household sector will like be small at around 0.5-0.6% of GDP in 2019-20, there is less assurance of a boost to the economy from tax cuts as opposed to “cheques in the mail” or increased government spending, the election means greater uncertainty about whether and when the stimulus will actually be delivered and the budget projections will come with a high level of uncertainty as the revenue boost from higher iron ore prices may prove temporary and slower economic growth will weigh on revenue. The stimulus is unlikely to be enough to head off the need for RBA interest rate cuts.

Major global economic events and implications

• US data was a mixed bag with a fall in consumer confidence albeit its still solid and falls in housing starts and pending home sales but continuing gains in house prices, falling jobless claims and a reduced trade deficit indicating that trade will likely contribute to March quarter GDP growth.
• ECB President Draghi and various ECB officials made various dovish comments pointing to: more generous terms for the next round of cheap back financing (TLTROs); the ECB standing ready to ease further if needed with the full range of instruments available; and the ECB considering applying negative interest rates on bank reserves only above a certain level rather than on all reserves. The latter is designed to encourage banks to lend out more but not penalise them for keeping required reserves. Meanwhile economic sentiment readings provided a confusing picture.
• Japanese data for February showed continuing labour market strength (helped by a declining labour force) and a bounce back in industrial production but its still down 1% from a year ago.

Australian economic events and implications

• Australian job vacancies rose 1.4% over the 3 months to February suggesting the jobs market is still strong and growing but momentum has slowed from 5.2%qoq a year ago and annual growth at 9.9%yoy is slowest in 2 years, indicating that jobs growth is likely to slow. Meanwhile growth in private credit remained modest in February with investor credit stalling and slowing to a record low of just 0.9%yoy.

Source: RBA, AMP Capital

• Household wealth is reported by the ABS to have gone backwards in the December quarter by 2.1% as house prices and share markets fell. Since then share markets have bounced back but house prices have continued to fall. With the RBA estimating that each 10% decline in net housing wealth knocks around 1% off consumer spending falling house prices will act as a significant drag on consumer spending in the year ahead.
• Of course, the Federal Budget will try and offset this with tax cuts, but interest rate cuts will also be needed. And on this front there is some good news as falling bank funding costs should contribute to lower mortgage rates. From a high earlier this year of around 0.59% the gap between the 3 month bank bill rate and the expected RBA cash rate has fallen to 0.32% pointing to scope for the banks to reverse the 0.1-0.15% mortgage rate hikes they put through in response to rising funding costs around last August. However, just as last year’s hikes lagged the spike up in funding costs any cuts will likely lag the recent fall to make sure its sustained. That said falling funding costs indicate that the banks will have little excuse but to pass expected RBA rate cuts on in full.

Source: Bloomberg, AMP Capital

• Meanwhile it looks like the Reserve Bank of New Zealand is showing the way for the RBA: "Given the weaker global economic outlook and reduced momentum in domestic spending, the more likely direction of our next OCR (overnight cash rate) move is down."

What to watch over the next week?

• In the US, the focus is likely to be on March jobs data (due Friday) which is expected to show a rebound in payroll growth to 175,000 after the depressed 20,000 gain reported for February, unemployment remaining at 3.8% and wages growth remaining at 3.4% year on year. Meanwhile, expect a solid rise in February retail sales and the manufacturing conditions ISM remaining around the 54 level (both due Monday), a further gain in underlying durable goods orders (Tuesday) and a fall back in the non-manufacturing conditions ISM index to around 58 (Wednesday).
• Eurozone core inflation (Monday) is likely to have remained stuck around 1%yoy in March and unemployment for February (also Monday) is likely to be unchanged at 7.8%.
• Japan’s March quarter Tankan business conditions survey (Monday) is likely to show some deterioration in conditions and expectations. Data on household spending and wages growth will be released on Friday.
• China will see a continuing focus on business conditions PMIs with the Caixin PMI for manufacturing due Monday and the services PMI on Wednesday, with both expected to show a stabilisation or slight improvement in response to recent stimulus measures.
• In Australia the focus will be on Tuesday’s Federal Budget but just before we get to that the RBA is likely to announce that its left interest rates on hold again for the 29th meeting (or 32nd month) in a row and that it retains a balanced or neutral bias in terms of the outlook for rates. While most economic data has been soft over the last month and there is a case to cut rates now to avoid having to do more later, the RBA still appears to be reasonably upbeat on the outlook, the further fall in the unemployment rate to 4.9% has arguably given it a bit more breathing space and it probably wants to see what sort of fiscal stimulus comes out of the budget and the election. Ultimately, we see the RBA cutting rates but the first move looks unlikely to come until around June or July.
• On the data front expect CoreLogic data (Monday) to show another fall in house prices for March, the March NAB business survey (also Monday) to show continued softness in conditions and confidence, February building approvals (Tuesday) to fall 1.5%, retail sales to rise 0.2% and the trade surplus (both Wednesday) to fall back to around $4bn. Various business conditions PMIs will also be released.

Outlook for investment markets

• Share markets – globally & in Australia - have run hard and fast from their December lows and are vulnerable to a short-term pullback. But valuations are okay, global growth is expected to improve into the second half of the year, monetary and fiscal policy has become more supportive of markets and the trade war threat is receding all of which should support decent gains for share markets through 2019 as a whole.
• Low yields are likely to see low returns from bonds, but they continue to provide an excellent portfolio diversifier and bond yields could still fall further in the next few months. Expect Australian bonds to outperform global bonds.
• Unlisted commercial property and infrastructure are likely to see a slowing in returns over the year ahead. This is particularly likely to be the case for Australian retail property. Lower for even longer bond yields will help underpin unlisted asset valuations.
• National capital city house prices are expected to fall another 5-10% into 2020 led by 15% or so price falls in Sydney and Melbourne on the back of tight credit, rising supply, reduced foreign demand, price falls feeding on themselves and uncertainty around the impact of tax changes under a Labor Government.
• Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 1% by year end.
• The $A is likely to fall into the $US0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will likely push further into negative territory as the RBA moves to cut rates. Being short the $A remains a good hedge against things going wrong globally.