Hedge Clippings | 26  April 2024

The "stronger for longer" inflationary thesis gained further strength this week both locally and in the US, with the added problem that growth is slowing while inflation refuses to do so.

In Australia YoY CPI fell in March to 3.6%, down from 4.1% in December, but the March quarter figure of 1% was up from the previous quarterly number of 0.6%. That in itself may well be down from the quarterly peak of 2.1% in December 2022, but it's still a long way north of where the RBA would like to see it, or the average during the Halcyon inflationary days between 2014 and early 2020 when the annual figure averaged less than 2%. Back then the RBA's challenge was how to stimulate growth, with the result that rates, both in Australia and around the world, effectively dropped to zero.

Fast forward and the RBA is also faced with a growth problem. 12 month GDP growth was 1.5% to December, but only +0.2% in the December quarter, on top of which per capita GDP fell 1%, and GDP per hours worked fell 0.4%, while real unit labour costs rose 3.7%. Unemployment is at historically low levels at 3.8% and with wage increases still flowing through the system there doesn't seem to be good news on the horizon.

With GDP slowing to a snail's pace, the concern as the RBA defers any rate cut until inflation is tamed will be negative GDP - possibly only saved by high levels of net migration keeping the economy from a recession.

In the US the issue sounds the same - expectations for rate cuts, which were widely forecast for May or June, are now being pushed out until November or even December. US GDP unexpectedly fell to 1.6% in the March quarter, down from 3.6% in December, while inflation was higher than expected. The US economy appears resilient, and company profitability appears equally strong, but how long that scenario remains under the "higher for longer" interest rate environment remains to be seen.

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Hedge Clippings | 19 April 2024

US Fed Chair Jerome Powell has been walking back - or talking back - expectations for an imminent rate cut in the US for some time now. At the end of last year, market expectations were for the Fed to cut up to six times this year. Following the Fed's March meeting Powell told a Senate committee hearing that they (cuts) were "not far" which resulted in the market expectations being reduced to three. At the beginning of this month, Powell was saying cuts were still likely, but only "at some point". This week he's saying rates can stay at current level "for as long as needed" if higher inflation persists.

And it seems it is.

Based on the latest US figures, the economy is running well, and as a result annual inflation to March came in at 3.5%, up from 3.2% a month earlier. There's even talk that the next move from the Fed may be up, which would require a major change of view from Powell from just three months ago.

Our view has long been that following the spike in inflation post Covid, and then the seemingly quick reversal, the final one to two percent reduction to a hard target of 2% was always going to be difficult, unless of course there was a recession or hard landing. Currently, that hard landing scenario seems unlikely both in the US and locally. Even though March unemployment rose slightly in Australia to 3.8%, it is still a long way from the level Michele Bullock indicated it would need to be to cause an issue.

Still at home, Australia's CPI numbers are due next Wednesday and will be crucial to the RBA's thinking. February's seasonally adjusted CPI number year-on-year was 3.7%, up from 3.5% in December, and just as it is in the US, that's heading in the wrong direction. There's a real risk that consumers get used to inflation between 3-4%, possibly just thankful it's half the level it was a year  ago. With wage rises well above that in many sectors, along with government largess and generosity, and Stage lll tax cuts just around the corner, the RBA's fear of entrenched inflation of 3-4% is all too real.

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Hedge Clippings | 12 April 2024

It was only a couple of months ago that the "market" (i.e. bond traders and economists) was firmly of the opinion that the US Federal Reserve would cut interest rates up to six times this year - starting about now. Fast forward to "now" - actually last Wednesday - and the market views that the cuts, or possibly cut, (singular) won't arrive until much later in the year, possibly not until November. Some - including former US Treasury Secretary Lawrence Summers - warned that the next move might even be up, not down.

The cause of this market re-think were the US CPI numbers for the 12 months to March which rose by 3.5% over the past 12 months, up from 3.2% in February, having previously peaked at 9.1% post COVID back in 2022. Excluding volatile items such as food and energy it left core inflation unchanged at 3.8%, but for a market that was hoping for, (but not expecting) a reduction, this was not the news they were looking for.

Aside from higher food and fuel prices, the strength of the US economy, and the jobs market in particular, is not helping the Fed's task of cutting rates following their next meeting on the 1st of May. Over 300,000 jobs were added last month in the US, the largest gain in almost a year, against expectations of just 200,000 resulting in a jobless rate of 3.8%. In turn, this cast doubts on the argument that continued high US interest rates of 5.25% to 5.5% would damage the economy. Simply put, it seems that while the Fed is concerned about inflation above 2%, the average consumer is not - or is at least dealing with it, particularly if they have a job, which most do.

Much the same logic applies in Australia, albeit the numbers are a little different.  December quarter CPI was 4.1%, and on a monthly basis in the 12 months to February it had dropped to 3.4%, although excluding volatile items such as fuel, fruit and vegetables etc., it was higher at 3.9%. Unemployment is low at 3.8%, or seasonally adjusted 3.7%. The RBA's cash rate is at 4.35%, and with some inflationary pressures coming through from recent wage decisions, higher oil prices, and July's Stage lll tax cuts, prospects for a rate cut aren't looking too good.

However, looking at the latest Housing Finance figures for February, this doesn't seem to be holding most borrowers back. Year on year, total housing finance rose 13.3%, with investors leading the charge up 21.5%, versus owner occupiers at 9.1%. However, all this is likely to do is confirm, or continue, the chronic housing shortage in Australia, as evidenced by the Building Activity statistics released this week. On an annual trend basis to December the number of total dwellings commenced fell by -15%, and the number completed fell by -2.4%.

Meanwhile net overseas migration rose by 518,000 in 2023. As such, that level of increase will keep the economy growing (as it has done for decades), make the RBA's inflation target of 2.5% harder to achieve, and underpin, if not continue, to increase property prices.

As in the US, while sections of the media and social services point to high inflation, maybe the average consumer is learning to live with it, and just get on with life.

In turn that can lead to entrenched inflation, above the RBA's target, hard to achieve - a situation they're keen to avoid.

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Hedge Clippings | 05 April 2024

US Federal Reserve Chairman Jerome Powell pushed back expectations for an early (and multiple) cut to interest rates, saying they're still likely, but only at "some point" this year, saying that "solid growth, a strong but rebalancing labour market, and inflation moving down towards 2 per cent on a sometimes bumpy path" was going to make the timing of an easing - and possibly even the outcome - anything but certain. The same can be said about the timing of a rate cut in Australia, with expectations being pushed out, and the market pricing in only a 10% chance of a move (down) at the RBA's May meeting. The AFR reported this week that the median forecaster in their survey of 39 economists is tipping November before there's a cut, but their expectations have been extended for the past year.

Other uncertainties remain - including significant geo-political risk as a result of the horrors of Gaza, and the war in Ukraine which has now dragged on for 2 years. (Actually, 10 years if you include Russia's annexation of Crimea in April 2014, and their invasion of Ukraine's Donbas region in August of the same year. In fact, according to Wikipedia the last 10 years have just been the tip of the iceberg as far as Ukraine's invasion record is concerned, with the Mongols laying siege to Kyiv way back in 1240, and the Russians first invading in 1654.

Fast forward, and closer to home, this week former RBA Governor Philip Lowe left the golf course and weighed into politicians over the way Australia's taxation system works, which he said was not fit for purpose - specifically that the GST is too low, and income tax is too high. Longer term readers of Hedge Clippings will note this has been a regular and recurring theme of our Friday afternoon soap-box, but Lowe acknowledged that his call was likely to fall on deaf ears in Canberra. Former Treasury Secretary Dr. Ken Henry - author of the 2009 Henry Tax Review and its 138 (mostly ignored) recommendations - would no doubt agree, although his Review's terms of reference specifically excluded changes to the GST.

That didn't stop Henry demanding change at a book launch earlier in the week, saying that successive governments (of both persuasions) have been and are wasting time, saying we shouldn't be surprised if Australians "avoid and evade tax whenever and wherever they can." Personal income tax accounted for just over 50% of Commonwealth tax receipts in 2023, and are forecast to rise to over 58% in 40 years' time, by which time the "economic dependency ratio", which measures the number of people aged 65 and over relative to those of any age who are employed, is expected to increase from 33.2 per cent to 45.4 per cent. Needless to say we won't be around to witness that in 2064, but we're not leaving our children, and their children, in a very good place.

Incremental changes aren't the answer according to Henry: One hundred thousand years of incremental reform won't get us where we need to be in five years," he said. Sadly, his call for urgency will end up in the waste bin, along with the recommendations in his tax review 15 years ago.

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Hedge Clippings | 28 March 2024

Taylor Swift saved the day for February retail sales - or possibly just diverted the consumers' spending away from their normal patterns. Without the one-off impact of 600,000 "Swifties" (including Albo, who took time off from the affairs of State to attend at least one of the seven concerts) the month's retail sales at 0.1% would have only just made it into the positive. Add in the combined effect of concert tickets, clothing, merchandising, accessories, and dining out, and the number nudged up to 0.3%. While some of that would have diverted spending from other outlets and spending, much of the hard earned cash of the Swifties would have left with Taylor herself partly as ticket sales, and partly royalties on clothing and merchandise.

Hedge Clippings - unlike Albo - didn't get swept up in the hysteria, although we have to admit that many years ago there was a phenomenon known as Beatle Mania which did get our attention. Having not heard much of it we can't comment on Taylor's music, but amazingly still remember the words of most Lennon & McCartney numbers from many years ago.

Meanwhile, household wealth data, also released today continued to rise strongly in the December quarter, up 2.8% on the back of strong residential property (+1.2%) and share prices, locally and overseas which added another 1.3% to the total. Monthly CPI came in at 3.4% in the year to February, which is the third flat month in a row, a fact that won't be lost on the RBA when they next meet in May, missing the April meeting under the new schedule. The RBA has been fence sitting for a while (since last November in fact when they increased rates the last time) and they won't be happy until the inflation number shows real progress. That progress may be delayed by recent and upcoming wage increases, plus Stage lll tax cuts due to flow from July.

During the week we had a glimpse into the thinking behind the outcome of November's US election result courtesy of an invitation to Kings Gate Capital's Expert Investor Panel. The logic went thus: Both candidates are clear contenders for their party nomination - although with an outlier that Trump still has some legal and financial hurdles to overcome, and Biden still has to ensure he doesn't stumble and mumble (or worse) too badly before then.

Assuming each overcomes their respective issues, there are two factors which may/will affect the outcome: Firslty ad spend, which Reuters expects to increase by one third over the previous campaign in 2020. Biden is outspending Trump by a significant multiple, and assuming the advertising works - otherwise why would they do it - that will have some effect.

Secondly, and possibly more importantly with voting not being compulsory, will be the voter turn-out numbers - not necessarily the total, but the numbers from each side of the electorate. While Trump has his Republican MAGA followers, who will always support him, there are a group of died-in-the-wool Republicans who, while they'll never vote Democrat, can't bring themselves to vote for Trump.

Equally, Trump's combination of personality and legal issues will encourage normally non-voting Democrats to turn out to vote on the day, even if they're not convinced by Biden's candidature to do so.

Of course that makes Trump the dominant player on the day - just as he'd like it. Unless the outcome is the same as in 2020!

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Hedge Clippings | 22 March 2024

While everyone (or nearly everyone) is comfortable that the direction of the next interest rate move is downwards, anyone hoping for clarity on the timing of a cut in Australia would have been disappointed by the RBA's post meeting statement this week. Just take the final paragraph of Michele Bullock's media statement:

"While recent data indicates that inflation is easing, it remains high ... it will be some time yet before inflation is sustainably in the target range. The path of interest rates that will best ensure that inflation returns to target in a reasonable timeframe remains uncertain, and the Board is not ruling anything in or out ... and will rely upon the data and the evolving assessment of risks.

In other words, we a) either don't believe the numbers, or b) don't want to fall into the trap that Philip Lore did, and make any prediction.

Over in the US Jerome Powell wasn't much more helpful: While noting that inflation has cooled considerably from its peak, he added, "inflation is still too high, ongoing progress in bringing it down is not assured and the path forward is uncertain."

"The risks are really two-sided here," Powell said. "We're in a situation where if we ease too much or too soon, we could see inflation come back. And if we ease too late, we could see unnecessary harm to employment." In spite of Powell's two-bob-each-way comments, the market took notice of the US Fed's "dot plot" that there would be three movements of 0.25% later in the year.

To be fair to the RBA, there are still some known knowns and resulting known unknowns clouding the issue. In July the Stage lll tax cuts take effect, last week aged care workers were (deservedly, in our opinion) awarded wage rises of up to 28%, and there's a risk of flow ons to other sectors as a result. On top of that unemployment unexpectedly fell to 3.7%, in spite of Australia's population growing by 2.5% to September 2023, 83% of which came from net overseas migration totalling 548,800 people. Given housing starts have been inadequate for the past 10 years to cater for the increase in population, that's likely to keep the cost of buying - or renting - a home higher, adding to the inflation pressure.

Hedge Clippings has been saying for a while that inflation's "last mile" down from 3.4% to a sustainable 2.5% is going to be a slow process, and the RBA's comments above would seem to bear that out.

Meanwhile back to one of our regular, and we have to admit favourite subjects on a Friday afternoon, "The Donald." Trump, who along with his adult sons, is facing somewhat of a liquidity crisis as he battles multiple court cases, ranging from fraud over the value of his New York property empire (bond required of US$355 million, plus interest), through to damages and defamation of E. Jean Carroll following a finding of sexual assault.

To give an Australian flavour to the Donald's news feed, this week he gave a little slap to another of our old favourites, ex PM and now ambassador to the US, none other than Kevin '07 Rudd. It turns out that like us, Rudd has been less than complimentary in the past when referring to Trump, who in turn has added our Kevin to his "List" of those he thinks poorly of. The only hope for Kevin is that while Trump is quick to add names to his list, he is equally quick to remove them if it suits the moment.

Hedge Clippings has an old (nameless) friend who has also been known to add the names of those who have displeased him over the years to his own list, but unlike Trump, once on, the names very rarely, if ever, are taken off!

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Hedge Clippings | 15 March 2024

You can take your pick when it comes to forecasts for inflation in both the US and Australia. The general consensus being that while declining from the levels of 12 months ago, the rate of decline is slowing. The same goes for Europe - according to forecasts from the Federal Planning Bureau in Belgium, (surely the World's centre of bureaucracy and bureaucrats) the average CPI in 2024 should be 3.0%, dropping to 1.8% in 2025, compared to 4.06% in 2023, and 9.59% in 2022. While European inflation has been more severe than either the US or Australia, we live in a global world and the overall trend is likely to be much the same.

Although the latest US figures, at first glance, looked bad, with February's core inflation only declining slightly, the real issue was that the consensus expectations were they'd be better than 3.8% and there's still a long way to go to get to the Fed's target of 2.0%, so don't expect a rate cut next week on Wednesday following their two day meeting.

Locally we'll have to wait until towards the end of the week after that before the ABS releases February's Australian CPI numbers (Wednesday 27th) followed by December Qtr National Accounts, monthly Retail Trade, and Labour Force numbers the following day, just before the Easter break. As a result, without the benefit of that information, the outcome of next week's RBA's board meeting is likely to be up in the air - although we don't expect an early easing here either.

Although inflation has fallen considerably to January's 3.4%, the mainstream media (at least the ABC if they can be called "mainstream") still like to refer to it as if it is closer to double digits, but that's probably the news cycle. Inflation makes a good news grab - although obviously not as good as a poorly photo-shopped happy (?) family snap from Kensington Palace. One wonders, given all the serious issues in the world, what is so important about said photo - while one also wonders what must be so secret?

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Hedge Clippings | 08 March 2024

This week saw a slew of  Australian economic data released, including Housing, Labour and Employment numbers, and National Accounts.

Housing first - According to the ABS, January's total housing finance fell 3.9% in January, coming after a fall of 4.1% in December 2023. Even though that's still 8.5% higher than a year ago, owner-occupied housing fell 4.6% and was only 3.4% higher than January 2023.

Today's Labour figures for the December quarter showed actual hours worked dropped by 0.3% - the second quarterly drop in a row. This was the first time since March 2014 that two consecutive quarterly falls had occurred, excluding the COVID era. Job vacancies also fell by 5.6% for the quarter, the fifth consecutive quarterly fall, although again COVID related issues have played havoc with trend numbers.

Both of these followed on from the release of the National Accounts on Wednesday. While overall the economy grew by 0.2% in the December quarter, the rate of GDP growth declined for the fourth straight quarter.

It seems the multiple rate hikes to date from the RBA are having the desired effect, so the question now is how soon before they might start to cut rates? Probably not at the next meeting, unless the board changes their tune the week after next, or fall in line with US Federal Reserve Chairman Jerome Powell's comments that the Fed was close to being able to reduce rates. The RBA's minutes of the February meeting were customarily cautious, noting that there had been "further progress towards their objectives, but that more progress was required, and the outlook remained uncertain". One known unknown, or uncertainty that the RBA noted that they were going to have to grapple with was the effect that the revised Stage 3 tax cuts, due from July 1, will have on spending.

Moving overseas, Trump's legal issues continue to mount even as his GOP nomination is confirmed. AP News even has a dedicated web page to track his various court cases. Like him or loathe him, and there's seemingly plenty in both camps, the fact that he's still in November's US presidential election race is extraordinary. US TV show host Jimmy Fallon summed it up well in this TikTok clip which even if you're a fan of the Donald, is pretty clever.

In Australia, even a (relatively speaking) minor mis-step, such as Barnaby having one too many drinks and having to lie down on the footpath while he phoned his wife, would spell curtains for higher office. Equally extraordinary is the reality that Joe Biden, if elected, will be 86 by the time his second term ends, while Trump himself will be 82.

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Hedge Clippings | 01 March 2024

This week's inflation figures were encouraging, but unlikely to prompt the RBA to change their approach at their next board meeting. Annual inflation stayed steady at 3.4% in the 12 months to January, well down from the peak of 8.2% in December 2022, while the number for underlying inflation, excluding volatile items, dropped fractionally to 4.1%, also well down from its December 2022 peak of 7.2%.

We have long held the view that getting inflation down the "last part" to the RBA's target of 2.5% will be the most difficult, and the RBA has been consistent in its guidance that they won't be rushed into cutting rates too soon - at least not until they are convinced the battle has been well and truly won. So while there will be calls from some quarters for a cut sooner rather than later, the RBA is more likely to reverse that, (i.e. later rather than sooner) particularly as the Wage Price Index (WPI) for the December quarter came in at 4.2% - indicating that wages rose faster than inflation. Until the RBA sees the unemployment rate, currently 4.1%, nudge higher they're not going to feel comfortable cutting rates and sending a signal that the inflationary problem is over - even if the actual inflationary cycle has turned.

Normally we'd be waiting until the RBA's meeting next Tuesday, but under the board's new structure the normal first Tuesday of the month meeting is now postponed to 18-19th of March, by which time the ABS will have released a slew of data to keep economists busy, with next week seeing National Accounts (including GDP) on Wednesday, and of particular interest to Hedge Clippings, the statistics on the Managed Funds sector due on Thursday.

Elsewhere next week our attention will be piqued by Super Tuesday in the USA, when 16 states vote for their preferred Republican and Democratic candidates. Both Joe Biden and Donald Trump would appear to be a shoe-in for their respective party's nominations, with Nikki Haley hanging in there in the hope of a Steven Bradbury like finish if Trump can't overcome his multiple issues with various court cases, and Joe Biden just hoping to hang in there, full stop, or as they say in the USA, period! Both Biden's and Trump's greatest hope for a clear - if not clean - result in November, would seem to be the other's failings.

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Hedge Clippings | 23 February 2024

This week for a change, Hedge Clippings is going to ignore the Reserve Bank, inflation, interest rates, and even politics, as Barnaby's retired to the bush, and Donald Trump has seemingly even gone quiet as he considers his next legal option. Instead, we're reverting to our bread and butter, the performance of markets and managed funds.

It's been just over 3 months since the extraordinary rally in equities kicked off last November. At the end of October last year, the ASX200 Absolute Return Index (ARI) was negative (just) YTD since January 2023, and up only 2.95% over 12 months. By the end of December, the index was up 12.4%. Things did slow down somewhat in January, with a return of 1.19%, by which time the 12 month rolling return had fallen to 7.08% thanks to its performance in January 2023 "falling off" the 12 month's numbers.

In the small cap sector, the numbers were even more extreme as risk appetite among investors, plus limited liquidity in most stocks in the sector took a toll. At the end of October '23, the ASX Small Ordinaries ARI was down 6.05% YTD, and -5.11% over 12 months. By the end of December, it had risen over 14% to finish the year up 7.82%, before dipping to a 12 month number of +2.09% by the end of January. Small caps of course are notoriously volatile: In September 2022 the index was down 22% over 12 months, but a year earlier, September 2021, the index was up 30.4%, having risen no less than 52% in the 12 months to March '21 in an amazing rebound from the initial depths of COVID in March 2020 of -21% over 12 months.

Experienced investors and advisors will correctly point out that when investing in the market, and managed funds in particular, it's the long (term) game that counts. Most offer documents (and ASIC) suggest a 5-7 year term to ride out the swings and roundabouts. Taking that approach, and the long term suggests an 8-9% annualised return (including dividends) from the Australian equity market and 10-12% from global equities based on the MSCI All Countries World Index. Over the same 5-7 year period, managed funds in AFM's Equity Peer Groups - both Large and Small/Mid Cap - have on average largely provided the same returns after fees as the index:

The issue of course is volatility, or standard deviation of returns, but as shown below, so is the concept of average. Many will correctly point to the fact that individual stocks and fund's performance varies dramatically and with careful selection, performance can far exceed the above (although passive investing in an index ETF doesn't provide this, but that's a discussion for another day).

Of course equities aren't the only game in town, particularly in volatile markets. Over the past 2-3 years, Private & Hybrid Credit funds have proven that they can return the same as equities (8-10% plus) with a fraction (or none) of the volatility, plus a regular income stream paid monthly or quarterly. We're currently preparing our Fixed Income Private Credit Sector Review to shine a light on this emerging, and increasingly popular sector which features a surprisingly diverse range of strategies and underlying assets.

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