A road to nowhere…?

A recent article on the nab asset management website entitled "The Grumpy Australian Consumer" concluded that given the rapid rise in the cost of electricity and health, coupled with subdued income growth and high household debt, Australian consumers are entitled to feel grumpy, and that these pressures can account for the recent retail spending figures as well as the modest performance of the Australian sharemarket in 2017.

The article had a series of excellent charts and tables, the most worrying of which was this one provided by the RBA, and dated March 2017. With household debt having climbed dramatically, and interest payments as a percentage of disposable income having fallen courtesy of low interest rates since 2012, it is not difficult to see the Reserve Bank's dilemma - It won't take much in the way of an increase in interest rates to dramatically increase the percentage of disposable income consumed by mortgage repayments, creating even more grumpy Australians, particularly if consumer confidence remains low.

At least investor confidence has been given a boost recently with the ASX finally touching the 6000 level, albeit still 10% below its all-time high in 2007. TheAustralian market is frequently negatively compared to the S&P500, but it is worth remembering that the ASX delivers Australian shareholders a dividend income of 4%, much of it also having the benefit of franking, whilst US companies distribute just 2.5% to shareholders as dividends.

The NAB article above referred to Leonard Cohen's song Anthem,

"You can add up the parts,

You won't have the sum"

Which is perhaps why we have economists to help us.

In Hedge Clipping's opinion a further reason for Australians to be grumpy, and thus the low levels of consumer confidence, is the lack of direction coming from Canberra, which might be equally summed up by the title of Talking Heads' 1985 hit song "A Road to Nowhere". The title is where the similarity ends, as the words to the song run:

"Well, we know where we're goin'

But we don't know where we've been

And we're not little children, and we know what we want

And the future is certain, give us time to work it out"

Unfortunately, if all the reported talk in Flemington's Birdcage on Derby Day was anything to go by, the words could be changed to:

"Hey, do you know where you're goin'

Do you know where you've been?

And you're not little children, and you should know what we want

And the future's uncertain, you've had time to work it out"

Meanwhile some managers certainly knew where they were going in October, in a strongly rising market.

A lawyer at the helm of the FED

Overnight Donald Trump announced the appointment of Jerome Powell as the next chairman of the US Federal Reserve, replacing Janet Yellen, and swapping an economist for a lawyer in the process. That's not meant to cast aspersions on either of them, or on their professions generally, it is just a point to note, as is the fact that there are four other vacancies around the Fed's board table over the coming months which will further shape future policy.

Hedge Clipping's take is that Powell is measured, experienced and unlikely to make any sudden changes, with a gradual approach to encouraging the economy to grow, and adjusting interest rates and the Fed's balance sheet over time in line with growth/inflation. In other words, steady as she goes - which is what markets like. Growth is gradually picking up, inflation is low, as is unemployment. All looks to be set for a continuation of what's now the third longest US economic and market upswing, even though there are some forecasts of three or four rates rises ahead in 2018.

As has been pointed out frequently both here and elsewhere, markets have been driven by central banks' intervention, which some considered to be a dangerous precedent. In due course it may prove to be so, but in the meantime one would have to take the view that the US Fed has successfully managed the recovery from the GFC. Everything seems to be reasonably in balance, even if those on the wrong end of low wages growth (both here and in the US) might not appreciate the benefits.

However, as noted previously economic expansion doesn't die of old age, but of sudden shocks and asset bubbles. While there are those that believe the US market is overpriced (which it may be on a historical basis) this doesn't seem to be caused by the irrational exuberance and lack of caution which preceded shock events such as the market crash of 1987 or the GFC in 2008, but more by the exceptionally low interest rate and low inflationary environment.

The danger lies in the event that in the event that either shock or bubble do occur there's little in the Fed's arsenal with which to counteract the unknown.  Steady as she goes is what's required, provided the economy, markets and politics don't upsets the apple cart.

Locally the week saw weak retail sales figures, presumably as a result of low consumer confidence. And why not? Wages growth is low, household costs from over indebtedness and increasing utility prices are increasing, resulting in reduced or limited discretionary spending.

At least we have the Melbourne Cup next week to take our minds away from the ongoing uncertainty coming out of Canberra - which also can't be helping consumer or business confidence.

Depending on one's point of view, today's news that five federal politicians are ineligible to stand in parliament will result in cheers of joy or derision, with none other than the Deputy PM facing a by-election at the beginning of December.  Whichever side of the political fence one sits on the disappointing reality is that this will further hinder the course of stable government and policy.  As such it further erodes consumer and business confidence, and thus investment.

In particular it damages the perception, reputation and attractiveness of Australia as an investment destination from a global perspective, irrespective of the final electoral outcome.

On a more positive note, although it has taken a long time since Mark Johnson released his report "Australia as a Financial Centre: Building on our strengths" in 2009 (if you're historically minded you can find and download a copy here) it seems his recommendations for making Australia's funds management and financial services sector more competitive on the global stage are finally bearing fruit. It may have taken the passage of eight years and no less than five prime ministers, but in this year's budget the current government finally started the ball rolling.

As a result yesterday ASIC released Consultation Paper 296 regarding Corporate Collective Investment Vehicles (CCIVs) and the Asian Region Funds Passport, seeking feedback on the regulatory and compliance environment which will encompass the legislation once in place.

Without going into the details of the Consultation Paper, or the proposed changes, there are two things that are blatantly obvious: Firstly Australia needs to be part of the global financial services industry. Therefore to attract offshore investors, and to be able to market to them, there must be appropriate structures and legislation in place. As a result, provided the regulatory requirements are not excessive -and the opportunities therefore only applicable to the large end of town - the changes are both welcome and long overdue.

Secondly, there will be significant changes to compliance and regulations as a result. The risk is that this will certainly make it difficult or onerous for boutique Australian managers whose main focus is on performance and attracting Australian investors.

Anniversary, yes. Celebration? No!

It is understandable that those who survived the October '87 crash would want to remember its 30^th anniversary, less understandable that many, if any, might be celebrating the event itself. Remembering the past is a useful lesson when trying to avoid making the same mistakes again, although there is no doubt that it is only a matter of time before the next major market event occurs.

October '87 was the most significant market shock since the crash of 1929, but there have been a series of market shocks since, all of which were preceded, to a greater or lesser extent, by irrational buying, thereby creating the necessary asset price bubble before the inevitable pop. While the details of each event differs, the underlying causes do not: Asset pricing ceasing to reflect reality.

Looking at current Australian equity prices it is difficult to argue that the market is in bubble territory, even if valuations in certain sectors are certainly stretched on a historical basis. While the US market has certainly steamed ahead by comparison, a market pullback of 25 to 50% would seem unlikely based purely on stretched valuations. If anything is going to upset this market, (leaving aside Trump or North Korea) one would assume it is going to be driven by excessive debt, a tightening of credit, or higher interest rates, be that in the US, Australia or China.

Having said that, while it seems certain that the next move in interest rates will be up, it is difficult to see rates moving so sharply that they would create an equity market crash. However, with rates having been so low for so long, even a small (say 2 to 3%) increase could magnify the relative effect on a number of asset classes, particularly Australian residential property, and the banking sector as a result.

This is what concerns the RBA, but the difficulty would seem to be how to resolve the dilemma.  As usual it will be those who are over-geared who will pay a price and learn the hard way.

"Same old, same old" vs. "In with the new…."

Over the past 12 months the top 20 ASX stocks - which make up 55% of the market cap of the ASX200 - have risen a paltry 3.45%. The ASX200 index itself has not surprisingly fared little better, rising 4.52%. Dominated as it is by the big four banks and BHP, and now to a lesser degree by Telstra, (the market cap of which has fallen by almost one third over the past 12 months), it is no wonder the Australian market is locked into a tight trading range.

Compared with the S&P500, which has risen 19% over the past 12 months, the local market has been a great disappointment. One of the great differences is that the US market is now dominated by new economy growth stocks, or the so called FANG's, namely Facebook, Apple, Netflix and Google, which have risen 33%, 33%, 97% and 24% respectively over the past year. Not only are these new economy companies, they're new businesses and, with the possible exception of Apple, had hardly been heard of by the average investor 10, and certainly not 20 years ago.

Australia's banks, plus Telstra, are driven and supported by dividend yield - or not in the case of Telstra - which results in the ASX200 having a total return over 12 months more than double that of its simple return based on price. Meanwhile the FANG's reinvest their profits in growing their global and industry domination.

The bottom line would seem to be that any upward driving force for the local market as a whole is limited accordingly. The banks are not only under pressure from Canberra, but their upside would seem to be constrained by a housing market that has been driven by easy credit and offshore property buying. Judging from today's Financial Stability Review published today by the RBA, the outlook for the banks at best is as good as it gets, and faces significant risks, even if the RBA did note the sector was well capitalised. And if the Treasurer is overseas spruiking that our banks are as safe as houses, you can bet your bottom dollar it is because he's not preaching to the converted.

So where do investors look for attractive returns, assuming index managers will be locked into market returns albeit with low fees - although as Hamish Douglass from Magellan points out in today's AFR, there are many active managers "dressed up in drag" charging plenty more while still hugging the index.

The answer surely lies in active management, be it a concentrated long only portfolio, probably outside the ASX100, or market neutral or long/short. Alternatively funds investing offshore, be it in Asia or Globally.  A quick scan of AFM's database of top performing funds demonstrates the benefit of either approach.

Say or think what you like about him, but it's pretty obvious Donald Trump doesn't believe in the softly, softly approach! So the bold announcement to reduce US corporate tax rates to 20% certainly fits his style. Of course what remains to be seen is his ability to deliver, and if he manages to do so, what will be the flow on effects on both the US, and then the global economy.

Given this was a Trump announcement there was of course more rhetoric than detail, and the answer to the first question lies in the ability to deliver politically. We will leave the judgement on his political ability to others and take just a quick look his ability to deliver economically:

We're assuming Trump's working on the premise that a corporate tax rate of 20% will "make America great again" by incentivising US companies to invest in America, and subsequently to hire American workers, leading to growth. As a result he's hoping the circle will be complete, and the budget will balance. However that's not a fait accompli, and the question will be how's he going to pay for it?

From a market perspective the risk lies not in the potential that the equity market doesn't like Trump's lower corporate taxes, but that the bond market doesn't. Bond markets have a nasty habit of upsetting equity markets, so it's worth keeping a close eye out for higher than expected interest rates.

Domestically in Australia Trump's move has put our antiquated, overly complicated and damaging taxation and political position into stark relief. The current government aims to reduce the corporate tax rate to 25% over 10 years, and isn't even assured of getting that past the cross benches in the Senate.

As Hedge Clippings has banged on about for as long as we can remember (which isn't that long these days) Australia's taxation system is a dud thanks to successive governments of both political persuasions which have failed to grasp the nettle, preferring to dilly dally around the edges, and adding complication onto complication.

Where's Donald when we need him - or on second thoughts, let's not go there!

Markets are once again focusing on the potential for a rate rise after Janet Yellen's comments flagging a US tightening later in the year, with 12 out of 16 of the Fed's members expecting a rise by December. However it should be remembered that rate rises have been on the cards for some years now, but each time the expectations have not been met with actions, with markets, hooked on QE, unable to accept the effects of withdrawal. This time it may be a little different as there does seem to be a gradual robustness in the US economy - with the accent on gradual, and robust being a relative term.

Coupled with those comments from the US, the Reserve Bank governor also came out with the seemingly obvious statement that interest rates in Australia were unlikely to fall from here, while also issuing a caveat that rate rises when (and it is when, not if) they occur are going to bite hard on those who have extended themselves to borrow for Australia's housing market.

Meanwhile Australian equity markets continue to go nowhere, which can't be pleasing the passive index following funds - or their investors. YTD in 2017 to the end of August the ASX200 has risen just 3.88% on an accumulation basis, compared with the S&P500 which is up around 12%. Actively managed equity funds have fared slightly better on average, up 4.98% year-to-date to the end of August, although as we always point out, averages can cover a multitude of individual performances, both good and bad. Whilst almost exactly 50% of funds in AFM's database have outperformed the ASX200 (and therefore by definition 50% have underperformed) almost 25% have posted year-to-date performances of 10% or more, with the best performing fund up 30% year-to-date.

Finally a matter closer to home: Today's report on CNBC that fine wine has provided the best luxury asset price growth (+ 25%) over the past 12 months. In the same report jewellery has been a poor investment by comparison, only rising 4%, while coloured diamonds (which luckily she has never quite understood the attraction of) have not appreciated at all. Possibly connected with the increase in wine prices was the statistic that Chinese ceramics had fallen by 12% over the past 12 months.

Hedge Clippings is sad to admit that fine and collectible wines do not feature in the domestic cellar as a result of impatience, and rarely on the wine list of any establishment we visit as a result of the disparity between the budget and the bill. However we will be happy to avoid future purchases of jewellery and coloured diamonds on the basis that they're no better as an investment than the ASX200!

A tale of two sucess stories

Company reporting season is coming to a close, happily for some, not so happily for others. As noted in last week's Hedge Clippings it is, or can be the "moment of truth" for many companies, and therefore for their investors. Fund managers have had their head's buried in the results for the past month or so and will no doubt be looking forward to the end of it and a return to normality - until the next time.

As listed companies a number of managers have played a dual role, not only studying the results of others, but having to report the results of their own funds management businesses, including two of the largest, Magellan and Platinum, whose Managing Director and founder, Kerr Neilson provided some insights into the way he's thinking, and in so doing reflecting perhaps on competitor Magellan at the same time.

It is worth noting that while both are highly successful operations, and have been particularly successful at attracting investors, there are some significant differences between the two. Following a stellar career as a fund manager with BT, Neilson left and founded Platinum in the early to mid-90's before listing the management company on the ASX in 2013, and has approximately $22 billion in funds under management investing globally across a range of long-short funds, regions and sectors. Performance has been excellent over the long term, although both performance and FUM suffered in the GFC, but has recovered strongly since.

Magellan, headed up by ex-investment banker Hamish Douglass launched Magellan in 2007, just ahead of the GFC, and also listed the management company in 2013.  In another of Australia's financial services success stories, Magellan has amassed $50 billion in FUM from local and global investors. Interestingly over time, albeit that Platinum has a significantly longer track record, the performance of each manager's flagship funds are similar, although they vary from year to year.

Back to Neilson's comments made with the release of Platinum's results: Acknowledging the reason some investors might have recently shorted Platinum, he was keen to point out that as the funds' investment performance had been strong over the past year, performance fees would add significantly to the bottom line. Equally FUM has recovered from the dip in 2008/2009, and even though management fees across the sector are under pressure, he is not keen to join the "race to the bottom".

Magellan's performance fee income has been under pressure recently, (as has its share price) and management fees are also reducing, although both managers, with $22 and $50 billion in FUM, have a significant annuity income stream - provided, as Neilson pointed out, performance is maintained to ensure existing investors remain, and new investors invest.

The major difference in approach, as Neilson was keen to point out, even if not naming Magellan, was the approach or focus in staffing in their respective investment and sales & marketing operations, where Magellan has built a significant distribution machine. At the end of the day it is difficult to criticise either given the successful business each has created.

Platinum also referred to the current active vs passive management debate, and while acknowledging the funds flow into the latter, suggesting that the key to active management is to pick the right active manager.

Hedge Clippings would agree, and argue that we have been beating that particular drum for over a decade.

Reporting season - An opportunity or a threat?

George Colman from ARCO Investment Management (formerly called Optimal Australia) probably summed up reporting season best by referring to it as "the moment of truth".  Although the fund had negotiated it well so far, he expected the full season unlikely to be so easy.

Midway into reporting season 2018 and it would seem that Telstra has grabbed the most headlines in the media, and occupied the minds of investors more than most, although whether positively or negatively would depend on their position - long or short.

While many long term retail investors are understandably keen to hold onto their Telstra shares for the (shrinking) dividend, and others may buy it based on its yield, no one could complain the decision to reduce the dividend wasn't well flagged to the market. A payout ratio of 100% was unlikely to be maintained, and Telstra Chairman John Mullen did indicate in a recent interview that if nothing else the issue was one the board was looking at. For the many fund managers who were short the stock it will no doubt be a "told you so" situation, but it does indicate the dangers that investors face as companies delight or disappoint the market.

Particularly so long/short managers who are taking multiple bets, some long, some short, or just to not hold a position in a stock. Not only do they need to get their call correct, there's no guarantee the market will always react to good news positively, or alternately to bad news negatively. Add this to a normally concentrated portfolio, and full year reporting does indeed risk becoming a moment of truth, and not an easy one at that. For those on their game the moment can make them, for those that aren't it can take a while to catch up.

While on the subject of catching up, past mistakes and a lack of judgement regarding issues such as Storm Financial, CommInsure and AUSTRAC all culminated in the board of the CBA taking it one step further for embattled CEO Ian Narev this week, flagging his departure by next July. Any sooner would have smacked of panic and given insufficient time to find a replacement, but following legal action from AUSTRAC, pending investigations from ASIC, and almost unprecedented negative comments from the RBA's Governor Dr Philip Lowe, there was only going to be one outcome for the Kiwi born CEO.

Hedge Clippings assumed that radio host Alan Jones' suggestion today that Narev would be well qualified to take over the CEO's position of the equally inept Wallabies' management was a joke, but on reviewing the article and video it appears not.

Maybe he would indeed be perfect, but would anyone notice a difference?

A glance in the rear view mirror...

Every so often Hedge Clippings likes to track through our prior meanderings. There are a number of reasons for this - not wanting to repeat oneself too often and thus become tedious is one, or regurgitate last week's views and be considered forgetful, or worse, being another. However now and again we like to check that our weekly gibber is not overly gibberish, and that what we might have written in the past remains relevant.

Of course, if one of our past editions was shown to be completely incorrect we might not highlight the fact. However, in this case we looked at a "Hedge Clippings" from early June when we mentioned, amongst other things, the possibility that North Korea might overstep the mark.

Far be it from us to try to predict who will win the chest beating exercise between North Korea's presidential nutter, Kim Jong-un and his US counterpart, Donald Trump, but it would seem that neither is renowned for stepping back from a fight, even if in Kim's case it is one that numerically only one side can win, while everyone else also loses. However it has finally jolted markets and the VIX out of their low interest rate stupor. Kim cares not a jot for world opinion, and based on his previous rhetoric, Trump not a lot more. However, we would agree with Trump that a line has to be drawn in the sand somewhere, and as previous US administrations have failed to do so, we are reminded of the old saying that "people behave the way they're allowed to".

In the same edition we also commented on the seeming malaise in Australian politics, and this week's decision (or abdication of one) to resolve the same sex marriage question by holding a non binding, non-compulsory, postal opinion poll seems to personify the issue. Without wanting to enter the debate on either side, the process seems to be symptomatic of the current disconnect between business confidence and household sentiment.

Business confidence is high as a result of low interest rates, low inflation, low wages growth,little in the way of labour shortages, and the use of technology to reduce costs. The other side of the coin is that consumer sentiment is low due to high housing costs, low wages growth, uncertain employment prospects, and looming high utility bills. However we suspect that's not all that is troubling the average household. There would seem to be a lack of clear national direction, which is also affecting the widespread optimism that was apparent when Tony Abbott was removed as PM, and could it be a reflection of the fact  - or perception - that in reality he's still there pulling strings?

Finally, while on the subject of malaise, a word on corporate governance at the big end of town in a week where it was announced that in the US since the start of the GFC 10 years ago, financial institutions have paid fines totaling US$150 billion for the various misdeeds of management. More correctly the shareholders of those financial institutions have presumably paid the $150 billion in fines. Full marks therefore to the board of the CBA for at least slapping the wrist of a few senior executives. However, in reality, and as one who has spent some considerable time and effort to keep up to date with the AUSTRAC Anti Money Laundering (AML) provisions, those responsible at CBA must have either been asleep on the job, or incompetent, (or both) to have permitted such extensive and long running cash deposits to have occurred right under their noses.