- Scepticism from James about mortgage stress. When we say people are under mortgage stress we have no idea what their conditions are.
- How are people supposed to choose between 4,000 super funds? The future fund could be the answer.
- Trump vs Puerto Rican bonds: could a president allow part of the US to default?
- The thing that bond ETF spruikers never tell you.
- Regulating commodities: a real solution to the LNG market problems?
- Solly Lew’s correspondence with Richard Umbers.
Hi. I’m James Kirby, Wealth Editor at The Australian.
And I’m Alan Kohler, Publisher at The Constant Investor.
And we are The Money Café.
The Money Café.
Well, now Alan I am delighted to say that we are back in the saddle this week with some really interesting issues, an amazing week actually and I think the listeners will find that we are – we’re finding it hard to find a running theme this week, folks, because there was quite so many interesting stories. I’m also delighted to announced that our sponsor, BT Financial, is back with us and our Mega Trend Minute will be reappearing, and it will appear some time in the next half hour. But just to kick things off, Alan, it’s Thursday afternoon at 3:00 and we’ve just seen the retail sales numbers come out. Now I thought the retailers were saying that they were expecting a fairly good Christmas. What’s the retail…?
Well they might be, they’re always expecting a good Christmas, retailers, otherwise they’d go out of business.
I thought the retailers never did anything but moan.
Well the reason they’re in business is because they expect a good Christmas. But so the ABS numbers for retail sales in August came out today, down 0.6% overall. But the interesting thing was that cafes and restaurants were down quite a lot, 1.3%, food in general down 1%, so it was quite – all these things were quite strong previously. Department stores had been very weak and they were a bit stronger.
But overall retail sales worse than expected and I think it’s quite clear, you look at the longer term data, that retail sales started heading down in April which was really a month after interest rates started going up, of the banks. Obviously the Reserve Bank interest rate…
It hasn’t changed.
…hasn’t changed for 14 months.
Yeah, but most families don’t care what the RBA rate is, they care what is their mortgage rate, and their mortgage rates have been inching up.
That’s right, and the RBA overnight cash rate is not as influential, is not the main influence at the moment, on mortgage rates.
The main influence is what APRA is doing which is forcing the banks to start rationing and cutting back in investment lending, and in particular interest only. And so what we’re seeing beginning in March was a quite steep increase in the interest rates on interest only loans. Principal and interest loans…
Are you suggesting that then these people are spending less because their mortgage costs have gone up?
They are, it’s quite clear, the retail sales have responded so what we’re seeing is a taste of what’s to come because interest rates will start going up. We don’t know when that will happen. Some people say it’ll be in the first half of next year, other economists…
And how high could they go. How high can they go from here? If they’re 5% on average for the average mortgage and official rates and only 1.5 where might they go?
Well what the Reserve Bank calls the neutral interest rate is somewhere around 3.5% to 4% which is 2% to 2.5% more than what it is now. I think the expectation would normally be we’ll see an increase in interest rates of 2% over the next couple of years.
Yeah, that would bring the mortgage rates up to 7.
That’s right. I mean there has been a study done of what 2% on mortgage rates would do to people’s household balance sheets or household spending and the answer is quite severe as you’d expect. The problem is that there’s so much debt, right, so we have household debt as a proportion of income is the highest it’s ever been and the highest in the world or one of the highest in the world, like 170% or 180% of income. But in some ways that in a sense protects households because the Reserve Bank is terrified about putting up interest rates.
And I’ve got to say one other thing, I would never equate household debt with mortgage stress but people do, and you know, mortgage stress, we see this thing, 800 thousand people under mortgage stress, now it’s going to be a million under mortgage stress. I know there’s problems out there but I’m actually sceptical about this mortgage stress figure.
On what basis are you sceptical?
Well on the basis, first of all that it’s not an economic figure, it’s actually completely flexible, all sorts of different definitions. Roy Morgan has a different definition than the Housing Industry Association.
But have you seen any counter-data on this?
Well what I am saying is I am seeing a variety of data and calling it – all called mortgage stress, that’s the first thing. The second thing is that when we say people are under mortgage stress we have no idea of their circumstance, we have no idea whether they have got two or three investment properties and what’s making it difficult for them to pay their own mortgage is that they’ve also got investment properties. So it’s a very raw number.
A lot of people have.
Well millions of people have investment properties. I’m just saying of course there are problems but I am actually very sceptical about this mortgage stress figure. Not the household debt figure, the mortgage stress figure.
I think I’m with you, I’ve had mortgage stress all my life.
But it doesn’t actually mean you really were struggling to pay your whole mortgage, it meant you had ambitions beyond paying…
But it’s stressful.
I know, yes. But they’re making it out like all these people – and I’m not saying that none of them are but I am very sceptical that there’s a million households in Australia struggling to pay the mortgage, I think they are struggling to keep up with the lifestyle they may aspire to which is a very different thing.
There was an interesting thing the other day about liar loans. I think we’ve been talking about it.
I think UBS put out that report about how many people are lying on their mortgage applications. Those people are probably stressed if they have been fibbing.
I think they are very rubbery figures from UBS, I’ve got to say, and they’re making all sorts of assumptions. I think they’re making assumptions and I would have expected more from a global investment bank, than just sort of loose assumptions.
Well they’ve backed it up this week with a second report on liar loans.
Yeah, that’s even more of an assumption than the first one actually, that people didn’t understand the loans. If you look at that closely – I looked at that quite closely yesterday and I wouldn’t come to the same conclusion that they did actually, I reckon most people know what they’re doing. I wouldn’t underestimate people’s ability to understand what they walk into in an interest only loan.
Now what about industry funds, one of the things that you’ve been on about is that industry funds aren’t really better than commercial funds, is that right, or retail funds? What have you discovered?
Yes. Well we’ve always been led to believe that industry funds…
Well that’s based on real data from Chant West and SuperRatings, all that data clearly shows it.
The first thing is that the top performing funds are invariably industry funds and the worst performing funds are invariably bank owned funds, that’s right.
Well, open and shut case right there.
No, it’s not an open and shut case at all I’m afraid. Because if you look more closely one of the things – one of the big industry service, Stockspot, who are usefully neutral here, they’re not an industry fund and they’re not a mainstream retail fund, they’re a Robo adviser. Stockspot, Chris Brycki.
Stockspot, what are they doing looking at super funds?
They’re doing this for five years. Well of course they’re in the game right, so they want to invest but they’re neutral as in regards to the two notorious factions in super, industry funds and retail funds.
Okay, and what have they found?
They have found when they went through 4,000 funds over five years that when you look at final after field returns in all the different fund categories that the difference in outcome of all the funds, 4,000 of them, was tiny in terms of their ability to produce after key returns.
And the difference between the industry funds and the retail funds.
And the difference between industry funds and retail funds was 10 basis points.
That’s a 10th of a percent. So, look, it’s interesting, I’ll tell you why, because one of the things that they suggested in this report is that industry funds – you know the adverts on television which of course drive the retail, the AMPs etcetera of this world go crazy when they see the industry funds showing these ads about the fees and one person pays less fees than the other. They are not incorrect but how you classify fees is really up for debate. There’s a new rule coming in next year, 2018, it’s called RG97 – are you impressed by that? That I remembered the code.
I’m very impressed with that, very impressed.
It sounds good doesn’t it, RG97.
OG – what does OG stand for? Come on…
R – R for Robert.
RG, what does it stand for?
I don’t know what it stands for. However, the RG97 is coming in and what it means is full fee disclosure and everyone has to account for their fees and present their fees in the same fashion, which they don’t at the moment.
And Stockspot believe that when the industry funds are compelled by law to present their fees in the same fashion as their rivals, the retail funds, that this narrowing – the difference will really narrow and show what they’re showing in this report. They won’t be able to do those ads anymore.
The number that you just quoted that I found most interesting was 4,000.
What are we doing with 4,000 funds, that is so stupid.
It’s life. There’s probably going to be 4,000 DCFs in the end.
Well I mean how are people supposed to choose between 4,000 funds.
I know. Because what happens is everybody tries to do everything, so each house tries to do the works and they all end up with millions of funds because they do tiny variations.
They’re all over the place and it’s an absolute lottery. I’ve been on about this before as you know.
And what a lottery it is.
It is, and it’s actually…
We need one national super fund.
So you say.
But the Future Fund don’t want to do it, is that right, or they can’t?
No they’re prepared to do it. They don’t want to become a super fund themselves but they’re prepared to manage the money if the government sets up one national super fund.
Yeah, if they put up a structure for them. I reckon mum and dad Australia would rush into a future fund driven national default super fund., wouldn’t they?
Of course, the future fund’s performance is great.
But it could never perform as well.
The problem in my view is that having to choose between superfunds and you don’t know what you’re getting, and you don’t know what basis on which you’re choosing, means that everyone has different retirement outcomes.
So all these people – not based on any sort of difference in expertise or any inherent basis for it there’s this vast inequality going on about retirement outcomes that is simply based on a lottery which is kind of an outrage.
Well it’s the dark side of de-regulation, people never realise that mum and dad would end up trying to choose between 4,000 funds with no idea how to choose. But how about if the Future Fund, being realistic, if the Future Fund ended up running a national default super fund, could they feasibly get the same sort of retirements they’re getting on the Future Fund?
Well they’re too big now to get the sort of returns they used to get or that anyone gets when they’re small. Obviously small funds get better returns or should get better returns than big ones.
That’s what I’m inferring.
That’s true, but once you become $100 billion the difference between that and being $1,000 billion is not that great. I happen to know the government is actually looking at this.
Actually but isn’t it the case that if you invest around the world it doesn’t matter how big you are. I mean if you’re in the global market…
Well pretty much, that’s right.
And they’re really – the global market – I mean the Future Fund – I’m thinking out aloud here, but the Future Fund – their Aussie shares is only something like 9% or something of the entire portfolio.
They are, exactly.
So it’s not that a national default fund would swamp the local market, they would just allot in the Future Fund. Talking about the Future Fund and their portfolio is a lovely segue into our Mega Trend Minute. This week the Mega Trend Minute is sponsored by BT Financial Group. I think we might talk about the bond market and bonds. Now we might start at the pointy end with Donald Trump but we’ll bring it into land with the ETFs in a second. But you wanted to say something about Donald Trump and Puerto Rican bonds from Puerto Rico. What’s happening there?
Donald Trump is busily laying waste to what’s left of his reputation in any kind of sense in Puerto Rico where he showed up firstly to say that this wasn’t a real catastrophe, that was Katrina, and what’s your body count here in Puerto Rico, only 16? Goodness gracious.
Did Melania show up in heels or did she wear appropriate footwear?
No, she didn’t show up at all but Donald Trump has been putting his foot in his mouth. So, what he said was…
Tell me about the bond market and what he’s done.
Well what he said was by the way all you bond investors in Puerto Rico, you’re going to get wiped out, I’m afraid we’re going to have to wipe you out. I don’t know whether you’re Goldman Sachs or whoever you are, I’m afraid you’re finished.
So, he said to Wall Street?
He said to the owners of the bonds, the Puerto Rican bonds, the bond prices – the prices of Puerto Rican bonds promptly fell 30% but they didn’t go to nothing. They didn’t go to zero but they immediately fell 30%. Then the Whitehouse had to come out and say well we shouldn’t really take too much notice of what…
Of what the president says?
What the president says.
What was he talking about, government intervention? Or what was he talking about, that they might…
Well I think he was talking about whether or not the American government would bail out the Puerto Rican bondholders in the event that Puerto Rico defaulted which must be regarded as a possibility now.
That’s whacko. I mean it’s whacko in that it’s so out of – if you think of what happened in Europe, if you think of what the Europeans did to not upset bondholders in the GFC, what the Irish government or the Italian government or the Greek government did not to upset commercial bondholders. Then Trump of the US comes out and says we’ll interfere with it.
No, we’re not going to interfere, we’re just going to wipe you out. Now the Puerto Rican bonds are selling for 30 cents on the dollar or something, they’re probably yielding 55%, goodness gracious.
Who knows. But the question is whether they’re a buy or not. Usually in that situation they’re a buy, it is possible, I guess it is possible that the things go to zero and you lose your 30 cents.
If you can’t trust the US President in the bond market…
Well that’s right, Puerto Rico is a part of America. It’s a part of America. Is he going to allow a part of the United States to default? Can you believe it?
It’s virtually a protectorate.
Well they’re all citizens.
Like most people including the White House representative who came out and spoke after him I can’t fathom what on earth he might be talking about. But talking about bonds…
Yeah, the thing is that Puerto Rico bonds have been good yielding bonds and bond fund managers and bond ETFs have been into them because of the yield.
Just like Greek bonds or Italian bonds are when things go wonky, but it’s risk money.
Yeah and that’s part of the reason why – and you’ve been on about this I think, that bond ETFs have been preferred in some ways to banks because they have good high yielding bonds in them.
Well what’s happening is there’s a major change happening. We’ve been talking for a few weeks about how bank stocks were proxies for bonds. So people were buying the banks and they were using them as bonds because they were getting 5% and 6% on their yield at the same time the shares were going up, so it was a beautiful thing. Now that bank stocks are going off the boil, they really are going off the boil and one of the key analysts this morning has come out and downgraded all the EPS estimates again on the banks. I’m not personally that negative on banks but you’ve got to say the people who were looking for yield in the banks, once upon a time their only option was bonds. But most private investors can’t afford bonds, they just can’t get near them being realistic about it, they’re 50 grand a pop. People can’t buy bonds unless you’re very wealthy.
But ETFs have come in place at this perfect timing, ETF Bond Funds are being launched at quite a rate in the local market. You had something on a floating rate bond and you might have met someone who had issued a floating rate bond recently.
Yeah well there are floating rate bonds around.
I mean a floating rate bond ETF and of course that’s very attractive because you don’t have to worry about rates going up, it should move, it should move with the market. But I would caution people about bond ETFs and it’s something that no one says and certainly the ETF providers will never say it but at the end of the day an ETF is listed on the ASX and if there’s a crash everyone panics and people don’t behave rationally, and they’ll sell off the bond funds just as fast because you can sell it because they’re liquid. I just think it’s something that’s really looming, that people are really moving into ETFs and now they’re moving into ETF bond funds. So that’s one to keep an eye on.
Now there’s two other things. That was our Mega Trend Minute, folks, and I suppose the issue or point being made there was about the bond market and that the retail bond market in Australia is changing and the ETF brigade have entered it probably at a very good time.
We have a question.
We have two other issues and a question. Let’s do the question now, and it has a link with one of our subjects today. The question is from Paul. I’ll ask the question, Alan, and you can answer it. Paul says should we be concerned the government tries to artificially manipulate the price of commodities such as the LNG proposal this week. Is it possible to regulate these prices without serious knock on effects and market distortions? Is it possible to regulate prices like commodities and not distort the market, Alan?
Well price regulation is a market distortion. The first thing to say is it is a market distortion. Now the question is whether it’s justified or not and the fact is we regulate lots of prices. The price of electricity is regulated. The price of…
And companies can still make big profits on it.
Well yeah, of course. I mean the price of most utilities are regulated in some way, the price of telecommunications, the price of milk…
Pharmaceuticals. There are lots of prices that are regulated and it’s because the government’s decided that there’s some sort of market failure and it needs to be regulated because it’s an essential service or product. LNG prices are set on market parity at the moment, or supposedly…
Sorry, what does that mean?
Well global prices – the trouble is…
They’re set on international markets, real markets.
They’re set on the international contract prices. The trouble is that the international contract prices are not necessarily in line with international spot prices which have fallen. Our prices in Australia have gone up so one of the clearly aberrant things that has occurred in Australia is that we’re paying more for our gas while the rest of the world pays less, even though we’ve got tonnes of the stuff.
And it’s because there’s a cartel. So, Paul, I would say that LNG prices ought to be regulated more than they are because – well at least local gas prices. LNG prices are export prices so they’re not…
You wonder after this whole debacle around energy supply and LNG and the Liddell power, and then the government trying to make a gas company keep a coal station going, whether that will be the ultimate outcome. Did you meet Spark Infrastructure – talking about energy did you meet the Spark Infrastructure people of late?
Yes, I interviewed Rick Francis, the CEO of Spark Infrastructure, yesterday.
Now, remind us who they are.
So it’s just part of The Constant Investor’s Daily CEO interview.
No, I meant you to remind us who Spark Infrastructure are, if you would.
Right. I thought I’d better remind you about why I’m talking to these people.
No need to remind us, yes.
Spark Infrastructure is a deliverer of electricity, they own the power poles and wires in Victoria and…
It’s a listed stock and they own – but what’s their brands?
Powercor and CitiPower in Victoria.
They’ve also got South Australian Power. I can’t remember the brand in South Australia but there’s South Australia. They’ve got recently – a couple of years ago they bought TransGrid in New South Wales which is a regional distributor of electricity. Now what I found interesting about them is that all of what they do in Victoria, South Australia and New South Wales with the power grid is regulate it. They have to go along to the regulator and they get told what their price is. The price is determined according to how much capital they’ve got invested and they are given a return on their capital by the regulator.
Which is reasonable, right? A big part of the reason we’ve got high electricity prices is because, not them, but the New South Wales and Queensland Government owned distributors have spent too much, so they’ve invested too much capital on the poles and wires and the regulator has agreed to provide them with a return on that capital which has meant high prices. But what Spark is doing now is there’s this scramble going on to connect solar and windfarms, big solar farms and windfarms, to the grid.
And it’s being done by Spark Infrastructure and others like them who are connecting these private windfarms and that to the grid, and they’re unregulated.
Whereas Spark gets a return of 7.5% on its regulated infrastructure…
They can get as much as they can squeeze on the…
And they are getting more than 10%, low double digit returns on the renewables. So they love renewables.
Interesting. It’s interesting because people would see them as a utility.
Well they are.
I know, they would see them as an income producing utility stock traditionally, you wouldn’t expect any surprises but that’s a surprise.
Well and it’s an upside surprise in the sense that they’ve got this income, their yield is set at 5.9%, good yield, a stable company, regulated monopoly and all that. It’s a better yield than the banks.
But they may actually get price growth now as well.
Well they’re getting growth, they’re getting growth from renewables.
Yeah, interesting. One last thing we should complete, if you’d like, this week was when we spoke last week our old friend, Solomon Lew.
Yeah, what’s happened now?
The retail billionaire had…
You’re on top of that and I’m not.
Made an extraordinary outburst as the biggest shareholder in Myer and said Myer was a disgrace, that the clothes were fit for an op-shop. Everyone was baffled really about this and Richard Umbers, if you remember, the Myer CEO, came out and said well we’d like to talk to our shareholders and we’ll deal with them. It turns out my colleague, Eli Greenblat on The Australian, got a great story during the week where he somehow intercepted a letter or an e-mail was sent to him. And it was an e-mail that Solomon Lew had sent to Richard Umber many weeks ago. All this stuff that came out was no surprise to Richard Umber because Solomon Lew has been telling him this for weeks and weeks by e-mail saying I’m going to the shop – he says to him in the e-mail I go and I walk the shops on a Sunday morning – this is what the billionaire, Solomon Lew, does on a Sunday morning. He walks department store floors and he has been watching Myer basically go down the drain.
He was well warned, Richard Umber, about Solomon Lew. The other thing that’s happened since we spoke is that Solomon Lew has called for the share register.
He’s called for the share register?
He’s called for the share register, which he is allowed to get of course as a major shareholder. He will now have the address of every very disappointed…
What do we think he’s going to do, try and sack Richard Umbers, have a proxy fight?
At the very least he’s going to have a roll at the board and become Chairman I would think. What do you reckon?
I reckon he ought to hop on his yacht and head to Monaco. I mean hasn’t he got better things to do?
Well he’s a born retailer, that’s his thing.
He is, and he loves it.
He can’t stop and he is going to – I would think he’s going to make Myer turnaround if it’s the last thing he does.
Eli has discovered that poor old – that Solomon Lew has been driving poor old Richard Umbers mad in the last few weeks with e-mails.
It’s only recently that he has decided to make his displeasure public. There you go, folks, well thank you very much. We might leave it there for today. Don’t forget you can subscribe to the Money Café on Apple Podcasts or your app of choice. While you’re there it’s super helpful if you can leave a review or a rating as it helps listeners find the show. Also send in a question and we’ll answer it on next week’s episode. Send in lots of questions, we only had one question this week, what’s going on? And of course, e-mail us with those questions at firstname.lastname@example.org. Okay, until next week I am James Kirby, Wealth Editor at The Australian.
And I’m Alan Kohler, Publisher of The Constant Investor.