- Myer’s in trouble, before Amazon even arrives
- APRA’s announcement of a higher capital ratio is hard to understand
- Reserve Bank’s neutral rate has fallen. Is it time for a permanent lowering of the potential growth rate?
- How boring do you have to be to be a reserve banker? Bernie Fraser vs. Janet Yellen
- BHP issues 2-fingered salute to Elliott with a blog post on potash
Hello, I’m Alan Kohler, publisher of The Constant Investor
And I’m Stephen Bartholomeusz, economist with The Australian.
And this is The Money Café.
Money Café, yeah.
Okay, well, James Kirby’s away and so therefore I’ve invited Stephen Bartholomeusz into The Money Café today and we’re going to discuss a whole lot of things but it’s great to have you Steve, thanks for joining us.
Thank you, Alan.
Stephen, of course, was my colleague on the Business Spectator which we sold in 2012 Newscorp and we both became part of The Australian then. Steve’s still there, and I’m not. Well I’m still there a bit; I’m still there as a part-timer.
Amongst other things.
Amongst many other things, including, of course, The Constant Investor. Now, we’ve got a bunch of things to talk about today. So much going on. As Eddy McGuire might say, it’s been a big week in finance. But let’s kick off with Myers, Steve. Now they had a downgrade. Was that a surprise, because the share price fell quite a lot, but was that a surprise?
It shouldn’t have been. We saw the David Jones quarterly sales numbers recently and for the first time since the South Africans acquired David Jones their comparable store sales went backwards. So quite clearly, conditions out there in retail land, particularly for discretionary retailers, fashion retailers have been quite torrid.
Is this the cycle or is it the structural?
I think a bit of both. This particular episode where they’ve hit a wall in a sense in June/July, the stocktaking sale period which is the same thing that happened back in January in the Boxing Day sales where all the retailers were forced into heavy, heavy discounting because of the conditions and the weak consumer demand. So there’s an element of cycle, a soft economy, cautious consumers, but there’s also this long term structural shift as people buy more and more online and more and more brands that used to be stocked by department stores are now available online so people comparison shop as well.
Yeah, and everyone’s scared to death about Amazon coming or are carrying on about Amazon coming, but Myers profit’s going down before Amazon comes.
All the retailers profits are going down, and it’s in advance.
Well that’s right, we’ve seen that at Myers today, but they’re all in trouble already, this is before Amazon arrives.
Yeah but I think if you go back to the financial crisis for instance as a starting point, conditions for retailers changed then and we’ve seen waves of collapses of retailers of all types since then because consumers have become risk averse, more cautious about where they spend their money, more selective about how they spend their money.
Yeah, well look, it’s hard to see times getting better for retailers, I must say. Do you think the cycle will change and the structural issues will go away at some point? Do you think that life is going to at some point improve for retailers?
I don’t think it’s going to get any easier quickly. If you look at the US where the impact of technology has been much more profound people are talking about the death of shopping malls. All the big retailers in the US are in trouble and they’re all trying to find a new model. It’s a bit like we’ve been through it in the media where you can see the world’s changing and you can see that it’s changing in a way that’s unfavourable to the incumbents. But the incumbents have great difficulty in making a transition to this new world played by different types of competitors.
Well it’s very difficult isn’t it? It’s terribly hard for them.
Well it’s particularly difficult for established businesses, listed businesses, because they’ve got to actually produce quarterly profits, they’ve got to actually have profits. Whereas at Amazon they don’t care whether they make money or not. What they’re after is world domination and they’re quite prepared to throw cash at loss-making businesses to establish themselves.
Well Myers wouldn’t mind world domination either, but they’re not going to get it, are they? Now, I must say it’s been a fascinating week in banking land and interest rate land. I must say the APRA announcement of yesterday, I’ve found incredibly difficult to understand. Firstly, what exactly is going on – they’ve talked about 10.5% tier one capital ratio. But is that an increase? They’ve talked about it being an 150 basis point increase. They’ve also talked about it coming from 9.5%, that’s 100 basis points. Anyway the banks are all sitting on 10% plus capital ratios now and APRA and the banks are all saying it will be fine, no problem, and the bank share prices are all up 5-6% in a couple of days. So everyone’s having a blast, Steve.
I think everyone who saw that announcement yesterday was initially quite confused. You may remember earlier in the week bank shares were sold off quite sharply in expectation that that announcement would have two elements to it. One was this financial system enquiry recommendation that the banks should be unquestionably strong which everyone took to be a common equity tier one ratio, they call them, of at least 10.5-11%. The second one was APRA said it’s going to introduce a new set of regulations later this year to reflect the final recommendations of the BASEL Committee in Switzerland, which is the global banking regulator, on things like risk weighting of assets. So again, remember in 2015 APRA introduced a floor for the major banks on the risk weighting of their home loans, a 25% floor. Effectively that forced the banks to raise more than $20 billion of capital very quickly. So the market was fearing that there’d be two elements: one, they need to raise a lot of capital – $8-10 billion to get their common equity tier one ratios up. And then a second wave to conform to a higher floor under the risk weighing rules.
So when we saw that announcement earlier this week the initial response was the commitment the banks would have to meet on the common equity tier one ratio, that’s not so bad, that’s as we thought, $8-10 billion, but there must be another $8-10 billion coming. And it wasn’t until later in the day I think people understood that APRA was saying the banks were only going to have to raise $8-10 billion to cover both those requirements; that the risk weighting changes and any other changes that come along between now and 2021 will be absorbed by this additional bit of capital, which is quite modest for banks that have $250 billion worth of shareholders’ funds.
So basically what’s happened is bank investors have been able to cross off a potential headwind of capital that needs to be raised over the next few years to meet all sorts of requirements both from APRA and from international regulators about risk weightings and all that stuff. So that seems to be out now, they’re not going to have to worry about it, they’ve got other headwinds of course but that one’s fine.
Well as a number of people have noted for the first time since the financial crisis we have now in effect an end to the re-regulation of banks. We have a finite number to put around how much capital the banks have got to hold. Now that may change. If we have an economic downturn next year and the banks’ loan losses start to soar they’ll have to raise more capital. If there’s another financial crisis they’ll have to raise a lot more capital. So the numbers aren’t static but in terms of APRA’s response to the financial system enquiry and the financial crisis we’ve now got a punctuation point of sorts.
Speaking of interest rates, what did you make of the RBA minutes which caused a bit of a flurry on the markets with their discussion of what is the neutral cash rate which they seem to be suggesting that it’s 3.5%, 2% above the current cash rate of 1.5, and everyone’s gone, oh, that means rates are going up 2%, heavens above! The dollar shot up…
Market rates went up.
Market rates went up, everything’s – I can’t understand why that was any kind of surprise to anyone. I mean really, I suppose it’s interesting that the Reserve Bank is saying that, but really…
Well the fact that it was in the minutes, which means it was actually discussed at the monetary policy board meeting, I think gives it a kind of credibility and clearly the board would not have said anything about the neutral rate if it didn’t want the market to realise it was thinking about the neutral rate. To me, this is not a new discussion, it’s been held overseas for some years now. I think it was back in about 2013 Larry Summers who used to be the US Treasury Secretary, caused the ignition of a really large discussion about this. He asked the question are we facing a permanent period of secular stagnation and in that instance what’s the new neutral rate? What’s the new normal for monetary policy? In the past in the US it used to be around about the same sort of levels that the Reserve Bank is now talking about plus 2%. It’s what they call the equilibrium rate. It’s where the economy is kind of balanced; savings and investments balanced. You’ve got full employment and controllable levels of inflation.
To me, our current interest rate settings are a function of what central banks have done since 2008/9 onwards. So it’s this unconventional monetary policies, quantitative easing, absurdly low, historically unprecedented low interest rates. So there are two questions here: has that created a permanent change in the landscape by itself or has it coincided with the kind of structural change we were talking about in retail, but there’s structural changes of course occurring across the landscape. You’ve written a lot about productivity and technology and employment. Has that created a permanent lowering of the potential growth rates in the economy and impacted what we can think about in terms of full employment? Does it take inflationary pressures out of the economy? So therefore when central banks think about where interest rates ought to be, are they permanently going to be lower than they would have been in pre-crisis era and the answer is probably yes.
Yeah I personally think our betters and central banks are at sea; they don’t really know what’s going on. They don’t know what to think, they don’t know what to do. I mean if you read the Reserve Bank minutes where they talked about the 3.5% it was terribly couched in uncertainty and they kind of admitted openly that they have no idea really. I mean they think that it might be 3.5% but it’s as they put it, subject to a great deal of uncertainty. So they don’t know, and 3.5% by the way is a fair bit below what it used to be, so it’s actually an announcement that the neutral rate has fallen.
Yes, the neutral rate used to be closer to 5%.
That’s right. So they’re actually announcing in a sense, that the neutral rate has gone down.
Well they are and I think that was perhaps what they were trying to signal. The timing is interesting because there’s a real focus in the States not just about whether they’ll have a third increase in the US version of our cash rate this year, but more particularly about when the Fed will start running down its balance sheet. Because its balance sheet went from US$900 billion before the crisis, to US$4.5 trillion today and until now they’ve been reinvesting the proceeds from maturing securities. The Fed has flagged they’ll start winding that back some time this year. So they’ll start shrinking their balance sheet which is a fundamental change in these sort of post-crises monetary policy settings.
The ECB has also said it may reduce the scale of its bond purchases and they’ve already reduced it once from €80 billion a month to €60 billion a month, Euros obviously. They’re now talking about perhaps a further contraction. So all of a sudden they’re reaching that point, which is a very delicate point in this post-crisis period, where those central banks who turned the spigots on and left them open from 2009 onwards are now talking about actually turning them back the other way. So with the Reserve Bank you say, well our rates were driven down to levels we’ve never seen before not because of anything that we did in our economy but because of what central banks elsewhere did. As central banks elsewhere start to pull back then our rates may be able to normalise. And I think that’s an early warning signal to the markets that we’re not going to get a rate rise any time this year, maybe not even next year, but there is one on the horizon if the other central banks keep going in the direction they now seem to be going.
Yeah, well what if the Australian dollar keeps going up? I mean it’s nearly touching 0.80, at some point you’d think the Reserve Bank are going to have to think, hang on, wait a minute, maybe we’ll have to cut rates again to bring the dollar down. I mean I actually don’t think they will because apart from anything else, I think if the Australian dollar was surging up to 85 cents for example because of a decline in the US dollar, which is what’s going on now, then a rate cut by the Reserve Bank here won’t make any difference to it and they’d know that, so they probably wouldn’t do it. But it would mean that you are right in the sense that the interest rate, the cash rate here is going nowhere for 12 months because they can’t cut really, and they can’t hike. So nothing to do really. They might as well just give it away for a while.
I mean it’s interesting this morning the dollar had another twitch with employment coming out; a huge increase in full time jobs.
If it weren’t for the sort of general pessimism that pervades the national discussion, and that’s partly because of the dysfunction in Canberra, we’d say we’re actually doing okay. Commodity prices are pretty good, the economy – the growth rate is pretty solid. Employment, as you say is pretty strong. Retail is not looking so hot, but generally given the condition of the rest of the world, we’ve actually had a pretty post-crisis period.
Just getting back to the dollar for a second, they’re calling it a dilemma because they might like to raise rates to help avert the threat of a housing crisis, to dampen down the market a bit. But they won’t do it while the dollar is heading towards 80 cents. If they cut rates, they’d set off the housing market again. It would be absolutely alight, which is the biggest systemic risk we face. So you wouldn’t want to be a Reserve Bank Governor would you?
No, no I certainly wouldn’t. No, I’ll pass on that, thanks very much. I don’t think I could talk quite as boringly as I’d need to!
A lot of training goes into that!
I know they’re incredible aren’t they? Phil Lowe’s actually not that bad and the worst, the most monotonous talker was, of course, Bernie Fraser, who took it up to a whole new level of monotony, did he not?
He had the most interesting delivery. You obviously haven’t spent enough time listening to Janet Yellen.
No that’s true, and what Bernie said, actually, was quite interesting. He had this fantastic – we’re off on a tangent here – but Bernie had this great ability to talk boringly about quite interesting things. So it was hard to actually pick up what he was saying.
I think there’s a school for central bankers, but to be fair to them, they’re well aware that every syllable, not just every word, they utter is pored over by the markets looking for any nuance, any sort of direction that they can get out of it and they can set the markets in either direction quite violently if they misspeak.
So they do need to be very careful. Sometimes I think they’re overly cautious.
Well it’s a bit like us, you know, I mean me and Kirby, it’s probably got to be the same for you, the markets pore over every word of this Money Café. They get the transcript and looking for the nuances in all of the words that we speak to.
They’ll have to look hard today!
I think we’ve given them plenty of ammunition. I reckon the dollar is going to leap about as soon as we publish this. But look, finally, tell me what’s going on with BHP? I saw something out of the corner of my eye, but I couldn’t see what was going on. And Elliott’s had a bit of a whinge about it too, as I see. What exactly are they whinging about?
They’re whinging about a lot of things, Elliott. But the most recent whinge relates to – and I wrote about this earlier in the week – BHP publishes a blog periodically, almost on a weekly basis these days, and the most recent one written their potash policy analyst, was about the Jansen project in Canada. Do you remember Marius Kloppers once bid $40 billion to PotashCorp in the States?
This is in Marius’ insane period?
It was during a period of general euphoria in the mining industry and it was knocked on the head by the Canadian government, otherwise he probably would have got it. Preceding that, BHP spent some time and got a lot of money exploring and acquiring potash leases in Saskatchewan in Canada, which is sort of the heart of the potash industry in North America. The best of those resources is a thing called Jansen and BHP has spent the best part of US$3.8 billion sinking shafts. You can’t get potash out of the ground without sinking these huge refrigerated shafts.
How do they do that?
Don’t ask me why I’m not an engineer. But they are refrigerated and they’re very expensive. So they’re heading up towards US$ 4 billion of investment in these shafts.
I didn’t know that they had to be refrigerated shafts, goodness gracious!
Water destroys potash, right. So you need to make sure there’s no water contamination. About 5 million tonnes of potash a year of production disappears because it’s been contaminated. So it’s a very interesting resource, potash. But BHP’s fascination with potash, and the reason they’ve kept spending on Jansen even they’ve cut back on capex on everything else, is that if you look long term, there’s a rise in middle class in the developed world, particularly in China and India. As people’s incomes increase so does their calorie intake. And yet, as the world’s population keeps growing the amount of arable land per capita keeps shrinking. Obvious demand for nutrients, you’ve got to improve crop yields. BHP looks at this and says by 2040-50, there is going to be a desperate need for fertilisers and potash is one of the obvious sources, and it fits their skillset: large capital intensity, highly technical exploitation and bulk materials and it would differentiate them from their current portfolio.
So they’ve kept spending at Jansen. Elliott doesn’t like the fact that they put this blog out. I think the blog’s timing is deliberately provocative.
What’s wrong with the blog?
Well, I think the fact that they basically talked enthusiastically about Jansen and there’s another piece coming next week about the supply side in the industry. The fact that they talk enthusiastically about it, I think was a signal to Elliott and the market of intent. We’re saying we’re going to keep considering big investments for long term shareholder rewards, regardless of Elliott’s push for capital returns and high dividends and the rest.
Oh I see, so…
So there’s this collision between BHP’s commitment to investing for the future and future shareholders and Elliott and its supporters’ demands that all the cash that the company generates should return to them even if it means that in a decade or two’s time there is no BHP.
Right, so the blog was basically a ‘stuff you’ to Elliott.
A two finger salute, yeah.
It was a two finger salute to Elliott and Elliott saw it that way?
Straight away labelled it this is going to be BHP’s next US onshore, shale oil and gas disaster.
Yeah, well could be right.
They could be which illustrates one of the most interesting things about the resources sector. You’re talking, for a Jansen, $4 billion just to put the shafts down. Probably another $8-10 billion at least to actually develop a proper mine. Wouldn’t start producing, if they gave the go ahead next year and Andrew Mackenzie said he might ask for a go ahead from his board next year – wouldn’t start producing until 2023 and would take another four or five years to scale up to full production. So you’re talking very long lead times, very, very large investment and you won’t know whether the thing’s properly economic for a couple of decades.
That’s the resource sector.
Yeah, well it’s interesting. We could sit here all day and talk about this conflict between the need to pay cash to current shareholders or to invest for the future, which is the resource company dilemma isn’t it?
It’s the dilemma and it’s the balancing act the directors have got pursue. But it is interesting that only 12 months ago, BHP shareholders are putting pressure on the BHP board to ditch the progressive dividend policy. In effect they were asking the BHP board to absolutely decimate the amount of dividends that are going back to shareholders.
Now you’ve got a shareholder activist, supported by some BHP shareholders, saying, “no, no, give us a lot more!”
Well Steve, we’re going to have to leave it there now and all I’ve got to say is you’re going to have to work on your Irish accent!
The impenetrable accent of James Kirby!
It’s not impenetrable it’s delightful but he’s in fact over there brushing up on his Irish accent in Limerick as we speak.
He’ll be even harder to understand when he gets back.
That’s probably true. He’s actually going to Scotland so he’ll probably be speaking with a Scottish accent as well. But thank you for listening and thanks to Steve for filling in for Kirby and I’ll be back next week with Elizabeth Redman who is a specialist in property. So if you’ve got any questions about property email us on firstname.lastname@example.org and we’ll endeavour to answer those at the time.
Until then, please subscribe to The Money Café on iTunes, leave us a review and tell your friends, we’d really appreciate it. Also, just a little plug for The Constant Investor, it’s our first anniversary today on The Constant Investor and we’ve got a special offer. So if you’re interested, go to our website, theconstantinvestor.com, and it’s $250 special price for 12 months and you get some eBooks as well. So there you go, a bit of a plug from the non-sponsor.
I’m Alan Kohler, publisher of The Constant Investor.
And I’m Stephen Bartholomeusz from The Australian.
We’ll see you next week.