Immigration and unemployment – a new theory. What wages growth? RBA late to the party on interest only loans.

This week James Kirby and I discuss the following:
  • RBA dishes out some belated warnings on interest only loans. 
  • Is there any convincing sign that wages sign that wages have turned a corner? Macroeconomics have stopped working! 
  • Is there any evidence that immigration cuts wages?
  • Should we block SMSFs from investing in property?
  • BHP’s war in the press is bad news for its investors.
  • Speculating on the outlook of Australian goat milk company Bubs. 
  • Analysing the Woodside rights issue. It’s a fork in the road for James as a shareholder!
  • More feedback on ETFs. Sounds like the listeners are on #teamkirby in this fight.
  • Why the hell would you lend stocks to shorters?


Hello, I’m Alan Kohler, publisher of The Constant Investor.

And I’m James Kirby, Wealth Editor at The Australian.

And we are The Money Café.

The Money Café.

Today, James, well as always, we’re going to talk a bit about the economy and then specifically about wages growth, and also the RBA’s minutes this week where they’re warning about – it’s not just the minutes, it’s a speech as well, they’re warning about interest only loans which is interesting.  We’ve got the BHP result, we’ve got a bit about GetSwift which is the company that was suspended for quite a long time.

They got swiftly suspended.

And you want to talk about Bubs and goat milk.

Well I do, there’s a little bit to mention there about the goat’s milk success, goats milk to China success, yes indeed.

And it’s all happening in Money Café everybody, as you can hear this week, there’s plenty of noise and we’ve just had a big party move in so they’re all catching up, shall we say.

It’s a good atmosphere in here today, Alan.  Now, the RBA we should probably start with…

So, what’s going on with the RBA, James?

The RBA, yes well they, a little bit late in the day you might say, have sternly warned everybody that when all these interest only loans run off what’s going to happen of course is that the people who took them out, and they were running at 40% of some bank loan books at one stage about a year and a half ago, when they come off these people are going to find themselves faced with instantly higher rates whether they stay fixed or whether they go to variable which I thought would have been entirely logical.  But, the RBA have chosen to warn us about it now.  I think it would have been much better to warn the banks about it at the time they were dishing out 40% of their books to interest only.

Yes, well APRA has been on about it for a while, so obviously APRA has dug the RBA in the ribs.

Yeah, it sounds like that.  Anyway, the thing is I won’t say it’s all over but ANZ results the other day showed that they were only running their interest only loans as a percentage of all their loans at about 15% which is way, way down from where they were a while ago.  So, it does seem like that whole thing has slowed down.  So, you and I have bravely said that if you can get them, if you’re an investor, well why wouldn’t you.

Well, indeed.  My view is that interest only is of course the proper way to have an investment loan.

If you can get one.  On a macro basis if everybody had one then prices would really rocket.

But, what’s the point of paying off principal off an investment loan because the reason you pay off principal is because you’re going to pay off the loan over 25 to 30 years, but that’s not what investors are on about.

Yeah, because it’s not going to be your home.

Not going to be a home, people aren’t paying off the loan, they’re investing for a capital gain, right.  In my view – and I know this is not a popular view – but I reckon that all investment loans should be interest only.

I imagine your average banker would happily agree but they’d have to price them accordingly and they’d be considerably dearer than long loans.

Yeah, you’re probably right.

So, that’d probably be the smartest way to sort that one out but that’s the RBA for you.  Also, you mentioned there was some wages growth figures.

Well, the December quarter what the ABS calls Wage Price Index.

By the way, first thing is first, there is wage growth is there?  Because I didn’t think there was any.

Well, yes.

What kind of wage growth?

But, the question is whether it’s a real wage growth, that is to say greater than inflation and the answer is no, it’s 1.9% for the December quarter which is basically what the inflation rate is.  The interesting thing I think is that it’s all in the public sector.  So, private sector wages growth is 1.9%, public sector wages growth 2.4%.

I see, so the little bit of energy there is actually government.

The governments, exactly.  So, they’re the ones kind of carrying the hopes of the side.

So, they’re actually isn’t any – in terms of real business there isn’t any sign yet of wages growth.  This is such a big issue, Alan, I think it should be this week’s Mega Trend, and the BT Group of course sponsors our Mega Trend every week, BT Financial.  On that issue if you looked at the figures is there any convincing sign that wages have turned the corner?

No, not convincing, I mean you could sort of poke in there and go maybe there’s a sign but actually nothing that you’d say yeah, it’s all turning around.  So, there’s nothing in there that would lead you to conclude that interest rates are going up this year yet.

Yeah, but what on earth is going to break this freeze, if you like, this de facto freeze on wages, what’s going to break it?

We need macroeconomics to start working again.  Macroeconomics has stopped working, the whole thing.

Have they stopped working because there’s no industry wide wage agreements anymore which seems to accelerate the pace of this sort of thing?

Well, there’s this thing called the Phillips Curve which was invented in the 1950s by a New Zealand economist named Mr Phillips, Bill Phillips.

Yes, haven’t heard that one.

And the Phillips Curve, which has been the basis of macroeconomics ever since then, and the basis of central banking, proposes that there is a direct or indirect link between unemployment and inflation through wages.  As unemployment goes down inflation goes up and the other way around.  As unemployment goes down, inflation goes up, unemployment rises inflation goes down, caused by the flow on of wages.  That has stopped working.  So, central bankers and macroeconomists the world over are at sea, they don’t quite know what to make of it.

And is this notion that there’s a breakdown in what you might call collectivised wage bargaining, is that just too simple an explanation for this?

Well, I think it’s one of the explanations.  I mean obviously everybody who has a point of view, that has an axe to grind, says that their explanation is the explanation.  So, naturally the union movement says it’s all because unionisation is down, well I think that is a part of it for sure.

Yeah, and there’s de-regulation of labour and a whole contracting boom.

The other part of it is technology and workers being replaced by robots.

Yeah, but they haven’t settled on this, they haven’t settled on – there isn’t a sort of consensus explanation.

Your economic community and the central bankers are basically just waiting for it to start working because particularly in the US unemployment is 4.1% but here it’s 5.5%.

But they are seeing some wage inflation there, aren’t they, they are seeing some.

They are starting to see it, so they’re all going hooray, it’s happening.

Yeah, they’re hanging onto that.

We can’t actually say that we’ve got full employment in Australia, it’s true we haven’t, but employment growth has been quite strong for quite a while now and the government has been skiting about it.  I think we’ve had 16 continuous months of employment growth or something and so you would expect to see wages growth more than a couple of percent by now, 1.9% by now, but it’s not happening.

Well, we have to think that hopefully it will happen and we will follow the US though that’s not a directly comparable economy.  What else have we got on the agenda today?

Well, just as a continuation of that subject one of the issues that’s been raised this week about what’s causing wages to go down is immigration, and Tony Abbott has come out and said immigration should be cut from the current level, 170,000 a year to 110,000 a year.  He is saying that immigration at that high level is responsible for unaffordable housing and low wages growth.

Or you could say it’s responsible for the lift in house prices.

That’s what he’s saying.

Which a lot of people benefit from and will continue benefitting from.

Well that’s right, there’s two ways of looking at high house prices, it’s either good or bad depending if you own one or trying to buy one.  But, he’s also saying that it’s responsible for low wages growth because it’s bringing all of these people under the housing market and then Scott Morrison, the Treasurer, has come out today and said that that’s all rubbish, I was Tony Abbott’s Immigration Minister and he told me to keep immigration up.

But, taking the politics out of it is there any evidence that immigration cuts wages?  Did he produce any evidence to that effect?

No, well Tony Abbott is just shooting his mouth off but if you’re asking me I think that it definitely does.  I think that John Howard increased the immigration, he doubled immigration, from 100,000 a year to 200,000 a year for the purpose of killing the unions.  I think that was what happened.

Well, it might have been an outcome.

I think he did it on purpose, I think that’s why he did it.

That is an interesting notion, Alan.

You don’t know what to say, you’re absolutely speechless.

I’m going to leave that one sitting out there to harbour like a very big ship and move along, will we. 

I could talk about that all day, do you want me to though?

No, I don’t.

Okay.

What about some of the big stories of the week.

Now, you’ve got something here about the big end of town moves against SMSFs, what are you talking about?

I’ll tell you what I’m talking about, I’m talking about property.  If you look at SMSFs, and there’s over 1,000,000 SMSFs and I reckon that self-managed super – DIY supers are one of the best things that have ever happened in these here parts.  Now, for perhaps five years, probably longer, it’s been nothing but bad news for SMSFs, continually crimping what they can do and then last year really coming in hard and cutting how much you could contribute, imposing tax obviously for the first time and all sorts of continual cut backs, if you like, in the SMSF sector.  But, one of the few breakthroughs in effect a few years ago was letting people at last borrow in their SMSF funds if they want to buy property.  It’s been relatively successful and absolutely by no means a runaway success but it’s moving along in a sensible fashion.  Now ASFA, which represents of course the big super funds as against the mum and dad super funds and SMSFs, have put in a pre-budget submission in early and they’ve said cut it, cut this allowance, don’t let people borrow in super anymore.  I think it’s really unfair.

Why not, the swine, what’s the matter with them?

Well, I think the argument is really sort of old fashioned almost patriarchal argument which is that they can’t be trusted, that these people cannot be trusted to manage their own money and that what’ll happen is they’ll blow it and they’ll all end up back on the pension.  That’s the argument put forward by ASFA.

Well, what’s it to them, anyway?

Well, they’re worried, Alan, they’re worried that the little guy is going to blow up on them.  But, I think they’re worried that the SMSF is too successful and it’s stealing business from under their nose.  I think that’s definitely an interpretation you can take.  So, I hope they don’t get that one up but of course David Murray is in there behind them always pushing for it too.

Yeah, big end of town.

Big end of town.

Speaking of which, BHP…

The big Australian, or what used to be called the big Australian, BHP.

You know they have these TV ads now, BHP – can you believe it, they’re having TV ads.

They have TV ads because the anti BHP people have TV ads, the anti BHP squad have TV ads.

Yeah, and they’ve bought trams.  I was standing on the side of the road the other day and a tram went passed with ‘think smart’ on it and it was something to do with BHP.  I’ve looked at it, what?  There’s a BHP ad.  It was Elliot Management, the hedge fund activists, they’re trying to get BHP to get rid of the dual-listed structure.

But you know, while that’s no good for you if you’re sitting and holding BHP, it’s like BHP, the board, is fighting with an activist fund and they’re all spending millions on ads in a propaganda war.  It is no good to you holding BHP shares.  Then, this week they’ve come in with yet another not great result, yet again.  The worst thing is its costs are blowing out, this is before the boom even gets going this cycle.

This is where we might have to disagree, James, because I want to talk about expectations.  Because, what’s happened is they come out with all the brokers saying they didn’t meet expectations, well what the hell are expectations?  I mean, honestly.  Because, what’s going on is that these brokers, stockbrokers, are talking crap.

Well, this may very well be the case however I don’t even know what the expectations for BHP were, I just saw their result in absolute terms and there’s the costs blowing out at the very start of the cycle.

It’s only caused by the Australian Dollar, they’re not actually losing control of the costs.

There is multiple layers of costs, it wasn’t just currency related.  But, I take your point.

I just think the result was great, I mean it was a terrific result, they’re churning out $4.9 billion free cash flow, they’ve increased the dividend.

Yeah, but it’s all relative, it wasn’t as good as Rio’s result.

They’re paying a 55 cent dividend, 72% payout ratio.

As they should be, they’re sitting on a highly cyclical mining operation which is common rite.

Well I know, but all of a sudden they’re an income generator for investors, it’s great.

Well, they are again and if you happen to hold them…

Everyone should stop picking on them, especially you, James Kirby.

No.  They are disappointing continually and I’m afraid to say yet again with the start of what looks like a new cycle in mining they’ve disappointed again.  If you look at the Rio result you can see what’s wrong with the BHP result, put it that way, Alan.

Okay, everybody, we disagree there.

What else have we got?

Well, before we get onto the other subjects do you want to do some questions now or do some other stuff?

Let’s just mention two or three things before we do the questions, the questions look great.  I thought we should just mention to everybody two interesting stories this week.  One was the mildly comical explanation from GetSwift, the hot technology stock that was suspended for I don’t know how long, when they finally came to clarify what they were suspended about and their stock fell 50%.  They clarified that a lot of the contracts that they were excited about and mentioning last year in stock exchange announcements are in what they call pre-revenue phase.  Do you know those sort of contracts, Alan, have you got any of those that are in pre-revenue phase?

Yeah, see I wouldn’t call them a contract at all.

They have no money in them.  So, watch for that, folks.  If you watch stock exchange announcements if you see anybody…

I haven’t read the thing yet but did they talk about the contract they did or the deal they did with Amazon which was the thing that sent their stock up a lot?

Yeah, I don’t know if they specified what contract, such as Amazon, I don’t know if they did that.

Because the Financial Review picked on them for some other contracts, smaller contracts they did…

That they found out were lost and hadn’t been announced as lost, yes.

That’s right, but they weren’t that big.  I mean, the big one is Amazon, everyone got terribly excited about that.  But, I haven’t seen any announcement, I haven’t seen anything about that as to what’s going on with that.

I haven’t seen them specifically talk about Amazon but if it’s one of the pre-revenue generation contracts then it is what it is.

Well, you’d have to be suspicious about that, wouldn’t you, you’d have to think well…

And this is interesting, this is a segue which I hadn’t planned, but you talked a few weeks ago about a company called Bubs, and that they were the – were they the number one stock last year, is that right, on the stock exchange?

The largest increase on the stock exchange last year, Bubs Australia, which is a Sydney based company.

Goat milk producer.

Goat milk producer.

That’s since got an infant formula, is it?

Yes.

But it’s goat’s milk infant formula to China, is it?

Yes, to China.

Is that right?

Pretty sure.

It’s goats milk, I know that, and I expect they’re in the infant formula game.

They sell infant formula to China.

Yesterday they jumped by about 20% and it’s a pretty hot stock anyway, and it was on the basis of an announcement of a contract with the very big China based distributor, it’s JD.com.  Just again I think we’re at that point in the market where you have to be very careful.

It wasn’t a pre-revenue contract, was it?

Well, I don’t know, I don’t know what sort of contract it was.  I hope it wasn’t a pre-revenue generating contract and I don’t expect it was.  But, I think when you get to the point where shareholders or investors are getting excited about individual contracts that a fast growing company announces to the stock exchange it’s getting very speculative anyway.

Well indeed, there’s lots of speculation on the stock exchange.

Yeah, well some smaller cap companies are much more leveraged to it than others.  What have we got on the questions?

Charles has a question.  So, we have tonnes of questions, have we got time?

Yeah, I think we can get through them.

Charles says what do you think of the Woodside entitlement offer?  Now, you’re a Woodside shareholder aren’t you?

I am, yes.  It’s a one for nine offer, Charles, and the offer is at $27 and the stock is coming up to $30 just now.

That’s a no-brainer isn’t it?

Yeah, it is a no-brainer on a one month outlook or a one week outlook.

But you take your one for nine and sell them and make 10% on your money, that’s a beautiful thing.

Yes, if you’re a trader you do that, Alan, I’m not a trader I’m an investor.  I’ve had Woodside for 20 years.  Looking back on it it’s a very slow growing stock and interestingly the market didn’t like this rights issue at all and the analyst didn’t like it anyway.  But then when it went out the institutional take up was 90%, Charles, so I would expect it’s going to be fully taken up.  You can make $2 to $3 a share on each share you hold instant profit there if you were the type to do that and wanted to do that.  So, that’s there if you wish.  Longer term it’s a bet on oil really and Woodside is a very conservative company.

Yeah.

So, I think it’s a fork in the road for people, whether they’re going to stay with them or not, actually.

Really?

Yeah.

That’s a big call.

Yeah, it is a big call, fork in the road for me anyway, Alan.

You’re standing at the fork in the road?

I’m thinking about it.

To the left means…?

I think it was BP this week said peak oil 20 years’ time but the point is it’s demand.

Peak oil 20 years’ time?

Yeah, but it’s demand, it’s the demand for oil because electric cars removes the demand.

Yeah, but what about peak gas?  Because Woodside is a gas company.

It is primarily a gas company. 

Anyway…

I’m sorry to be not as enthusiastic as you might think, Charles, but Woodside – you often find rights issues looked on as the perfect time as the stock has been drifting for years.

We’ve got a couple of questions and comments about ETFs which we have been squabbling about, you and me.

That’s right, yes, I like them more than you do, would that be fair to say?

I like some ETFs.

Yeah, okay.  Conceptually I like them more than you do, yes.

Question from Jose.  I would like to explore something you guys touched on last episode, this is the topic and he put in brackets I am with James on this one, that most people would be much better off spreading their money into national and international ETFs and maybe a bond ETF than picking stocks or actively managed funds.  The numbers speak for themselves, he says, for example according to CNBC over a 15 year period more than 90% of active managers failed to beat the market.

So, what’s the question?

There is no question, Jose is just in furious agreement with you, James, so I just thought I’d read that to you to make you feel better.

Okay, thank you Jose, it does make my day, yes indeed it does.

Joey says hi Alan, thanks to you and James for a wonderful Money Café podcast, you’re welcome Joey.  I thought I would chime in with a case where ETFs have been particularly helpful, so someone else agrees with you, dear oh dear.  I’m a property owner in Sydney and hence a large amount of my portfolio value is tied up in the Australian property market specifically and the Australian economy generally.  Being able to invest in ETFs to tap overseas economies gives me an easy way to diversify into not only different sectors but also overseas economies.  So, another statement.  Joey, I’m with you, the ETFs that I like are international ones.  So, I think that’s a good way to invest in overseas markets.

Yeah, to do something selective like emerging markets or going to the US or whatever.  I mean people could never do that before in such a fashion so I think they do have a plus, yes.  They’re not perfect, by the way, I never said they were but I think for a lot of people, especially people that don’t know an awful lot and aren’t up to their necks in the markets like we are every day, they are a great way in.

Final question from Penny came in today.  I’m trying to understand the shorting of stocks.  From listening to you and others it sounds as though there are traders who are out there on a large scale take a negative position in a stock by borrowing the stock from a holder, often a substantial holder, paying the holder some sort of payment for the opportunity.  The trader then sells that stock and where possible tries to paint a bleak picture of the stock and where possible get some media traction culminating in the share price falling, thus giving the trader an opportunity to buy the stock back at a much lower price making a nice profit and then returning the stock to the original owner.  So, I reckon, Penny, you fully understand it.

Penny understands it perfectly well.

You’re there.

I’m interested, Alan, that she even picked up on the fact that the media is now willingly or not a part of the process.

Unwitting partners.

Maybe witting.

Witting you reckon?

Perhaps, at times.

Well, maybe you lot at The Australian, well I’m at The Australian too.

You lot at The Constant Investor.

That’s right.  Anyway, Penny’s question.  My question, says Penny, is why would you lend stocks to such a person, what is the benefit to you apart from the payment made when the shares are borrowed.  If the trader has been successful he or she has created a huge loss in your portfolio.  In the case of some very vulnerable stocks recently the trader has wiped out the value of your holding.  I struggle to understand why the stock is lent.  Is there something I’m missing, is the likelihood of success by the trader so low that the stock lender thinks on balance he’ll be ahead by taking the payment and lending the stock?

That’s a super question.

Great question.

It cuts to the heart of a lot of it.

So, go on, James.

Well, the first thing to tell Penny is that one of the big lenders – everyone says how do you short and who would lend you stock anyway, well the short answer is superannuation funds.

Yeah.

And, the big industry superannuation funds are on the record as lending stock.  You’ve got to think even if they win on the shorting they lose on the other side if they hold a stock.  So, let’s say they had MFS just for theoretical sake, if they had MFS or TFS, the sandalwood guys, if they lent money to short that and they made money from shorting they’d still lose money on the other side even if they had it in an index fund. 

Well, the industry funds don’t do shorting, they lend it to a hedge fund who does the shorting.

They enact the process.

They enable it, sure.

They enable the process.

And they get a fee, they get a fixed fee for that.

Yeah.

But I think it is true, Penny and James, that most shorting is unsuccessful.  I think it is true that they all are trying to talk the stock down, that’s true, but most of the time they don’t succeed.  So, actually the lenders are preserving the value of their portfolio and getting paid a fee that improves the return on the stock for them.  The fee is quite reasonably substantial so they actually improve their returns and most of the time, but obviously not all of the time, most of the time it doesn’t reduce the value of the stock in their portfolio.

But she has a point that when it happens they shoot their own foot basically and they actually enable this.

I suppose I’m partly basing this on the proposition which may be wrong, that the people running big super funds are not complete idiots and I may be wrong.

And they say look, hey, we’re making money and if we didn’t do it someone else would, I suppose that’s their approach.

No, well they say they’re making money and most of the time it doesn’t make any difference to the value of the shares we own.  I’m pretty sure that they’re not just opining that, they’re actually basing it on research, they’ve got numbers on it, Penny.  They’re fully aware of what they’re doing and they’re really kind of keeping an eye on it.  I’m pretty sure they would not lend stock to a hedge fund to short if it was going to cost them in net terms.  Just saying…

Perhaps.

But, maybe I’m being too generous to them and they are actually idiots.

I’m sure that’s their plan, Alan, I wonder does it always work that way.

Well, James, that’s where we should leave it for today.

Yes, indeed.

Don’ forget you can subscribe to The Money Café on Apple Podcast or any app you choose, while you’re there it’s super helpful if you can leave a review or a rating for us.  It helps listeners find the show.  Also, send in a question and we’ll answer it on next week’s episode.  E-mail us on hello@theconstantinvestor.com.  Until next week, I’m Alan Kohler, Publisher of The Constant Investor.

And I’m James Kirby, Wealth Editor at The Australian.

See you next week.