The Money Cafe with Kirby and Kohler

This week James Kirby and I discuss the following topics:
  • The US and Australian corrections.
  • Why rates are all over the place, and its affect on bonds.
  • The opposite positions of miners and banks, typified by CBA and RIO.  
  • And why the Future Fund has become a guide to approaching the market.  


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.

Well, it’s been a huge week, James, since we last met.

A lot has happened, hasn’t it, in seven days.

A lot’s happened, it all happened after last Thursday.

There we were sitting calmly like a little boat approaching a little waterfall.

And we need to acknowledge perhaps that we did say last Thursday that people need to be in this market.

We did.

Did we?  We did.

Yes, and I have no problem…

And what we meant was in this market after the weekend, after a few days, that’s what we meant.

No, I have no problems standing behind it, I’m happy to repeat it.  If you’re not in you can’t win.  These are good years for share investors, last year was very good, this year I’m certainly comfortable will be good.  It will be rockier than last year and the point I make is if you’re not in it you can’t win.  I suppose what I’m thinking of there is the huge holdings in cash that people have.  They show these SMSF surveys constantly showing people have enormous amounts of cash and they’re getting nothing for them, I mean they’re barely equalling inflation.  So, if you’re not in you can’t win, Alan.

There you go, folks, you’ve got to be in it to win it.

But you’ve got to be tough when you’re in there on a day like Monday and Tuesday.

Well that’s right, and I do think that if you aren’t constitutionally capable of withstanding a 5% correction or even a 10% correction you really shouldn’t be in the market because that’s what happens all the time. 

It just hasn’t happened for a long time.

That’s the nature of investing in shares and if that upsets you too much so that you can’t sleep you should go and do something else.

Or get someone else to do it for you.

Whatever, I mean sure.

Because that’s the nature of it.  But, were you surprised?  There was a few hours on Tuesday, overnight Monday, where Wall Street did kind of lose it for a few hours, dropped 1,000 points, the biggest.  Were you surprised and did you think it would go off the rails at any stage?

No, I never thought that.  It’s probably worth reviewing just what happened, which was that the day after we last spoke on the Friday, which was actually the Friday night in New York time, the latest employment data came out for the US economy which showed that the new jobs was 200,000 which was a bit more than expected, 180,000 was the market consensus for December and the number came in at 200,000.  But, more importantly, and that sort of thing had been going on pretty well month after month, but more importantly wages growth was 2.9% which was the strongest – this is for the year or annualised – and that was the strongest it had been for about eight years since the GFC.  That kind of started getting people thinking well inflation is on the way back, inflation is waking up, it’d been dead for ages, asleep, inflation is waking up and so there was an adjustment of people thinking about interest rates.  So, the ten year bond yield spiked up and also expectations or forecasts for the Fed funds rate there, their version of our RBA cash rate, also went up. 

What happened was that even though the forecast of profits hadn’t changed, forecast of profits in the US are still very strong, is much stronger now, was much stronger on Friday than it has been at the start of the year.  There’d been a big increase in analyst forecasts of profits, they hadn’t changed.  What had changed was the multiple, the way that they were valued, those future profits were being valued.  Because, the valuation of future profits depends on interest rates.  So, if interest rates go up then the present value of future profits goes down.  So, that’s what happened on Friday night US the share market fell a bit, not that much.  I think it was like 3%, 2% or 3% or 2.5%, that was a fair bit and everyone kind of sat up and took notice.  Then obviously on Monday New York time it was more than 4.5%.  So, the Dow Jones fell 4.6%, S&P 500 4.1%, that was on the Monday.   That was pretty big and that was actually after a lower trough during the day.  So, in the morning the thing fell out a bit and then recovered a bit in the afternoon.

But, the worst thing for Australian investors, and all Australians really, is we’re sitting here and our market of course goes along and falls in tandem with Wall Street like copycat, tic for tac, and thing is we don’t have 2.9% wage growth, we don’t have official rates rising but we’re paying – isn’t that the case, that we’re getting it in the neck because of what’s happening in the US?

Well, that’s one way to look at it, another way to look at it is that it’s a global share market now.  There really are no borders in capitalism.

Yeah, but most Australians aren’t in Wall Street, they’re in the ASX.

Yes, of course, but the ASX has a lot of overseas investors in it.  It’s not just the Australian investors who are investing in the ASX, it’s overseas investors who are definitely influenced.  Yes, of course the valuation of Australian companies shouldn’t change as much although there has been a bit of a flow on firstly to Australian bond yields which have gone up in tandem with American bond yields and also there is some rethinking of the Australian cash rate going on and people are starting to bring forward their estimation of when interest rates in Australia will start to rise.

Well, what have you seen that’s different, have you seen anything significant about when rates will go up here, official rates?

They’re all over the place to be honest, some of the economists and forecasters are talking about nothing until 2019 but I spoke to Paul Bloxham from HSBC this morning and he is taking about third quarter this year as being the first rate hike.

But, to put people in perspective and to be fair to Paul he was talking about first quarter this year a few months ago.  He’s sort of at the head of the heard of the callers and he has been for some time.

He is.  But, he is very optimistic about the economy, he is forecasting 3.2% economic growth in Australia for this year.

Okay, that’s top of the spectrum then.

And that’s top of the spectrum, and it actually – I mean the RBA is forecasting 3% economic growth but most of the economists are below 3% with their forecast and Paul, as you say, is at the top.  Anyway, the correction peak to trough, this is to say an intra-day peak to intra-day trough, in America was 8.5%.  In Australia in peak to trough it was 5.5%, so much less.

Yes, so we didn’t quite get it in the way I’m saying.  The other thing I explained to people as well, and it’s really worth thinking about, is that it’s not even, technically at least, it’s not even a correction.  A correction is 10% from top to bottom, on Wall Street the worst thing that happened, the worst part of it if you like, was 8.5.  Our own market fell 5.5.  So, if you want to be really sort of crude numbers on it we only had half a correction on the ASX.

Well, I’m calling it a correction.

Yeah, but it wasn’t though.

It’s a bit of a correction.

Well, it’s technically a pullback.  I thought looking at it – because I was looking at it every day…

So, you’ve been looking at the Australian market pretty closely, what’s been happening?

I had, yeah, basically for the Australian through the week I was basically doing markets every day so I was looking at them very closely and there was a few very interesting things.  For instance there’s always been this theory that there’s going to be a swing away now from income stocks and there’s going to be a move towards growth stocks.  Well, property trusts, AREITs, all the big property trusts, they barely moved in the drop.  They didn’t drop as much as the index.  I would have expected them to drop more than the index.  That’s a very important sort of observation and principle that’s coming across, and it suggests because our rates are so low people are hanging onto income producing stocks, traditional income producing stocks like property trusts.  Now, I would think I wouldn’t be as confident at all about property trusts, commercial property trusts, but that’s what people are using for income and they didn’t seem to change. 

The other really interesting thing was the banks.  The market bounced but banks didn’t bounce, none of the four banks matched the index bounce on Wednesday and a little bit of action on today, Thursday.  But, this whole notion that the banks are facing headwinds, that seems to be really coming into view now with the Commbank result.  I mean, look at the Commbank result, look at the Rio result.  The Commbank result all the key numbers are down, cash profit is down, return on equity is down and the dividend was lower than expected.  Rio is the other way around, everything is more than everyone expected including the dividend.

Yeah, well see I think that difference is going to persist all year. 

Do you think the big miners are going to carry us this year?

Absolutely.

Yeah?

Well, I think it’s just a continuation of the proposition really that the global economy and the global market is going to do better than the Australian economy and the Australian market.

And the banks are not globalised and the miners are?

That’s right, well the miners are global businesses, they happen to be based here but really Rio and BHP are global businesses, all of the Australian listed global businesses…

And I suppose all the miners take global prices, that’s the thing, all the commodities are set in US Dollars.

Of course, that’s right.  Well, Rio and BHP and the other miners are pretty focussed on China so it’s all about China really.  So, just back to Paul Bloxham, his optimism about the Australian economy is largely all about China and HSBC generally, that is to say one of the world’s biggest banks if not the biggest, well certainly one of them, a Hong Kong based bank is optimistic about China, more optimistic than consensus about China’s economy.  So, in a sense that flows through to Paul’s forecasts for the Australian economy and he, in a sense, is a taker of the global HSBC forecast for China which he has to put into his models for Australia.

Yes, he has to.

And that results in the 3.2% GDP growth number that he comes up with for Australia but it actually is salutary in terms of thinking about what influenced the Australian economy.  Of course, it’s all about China.

Well, it might be the case, too, that for most people in the market who the banks had been their core portfolio money maker for years now and BHP and Rio have been off the pace for some time, last year there was a rebound but this year there are signals that they’re going to come into their own, that Rio and to a lesser extent BHP are going to be very important to everybody including the market.  If they are then you’ll find that also the other ones come in, the Fortescues for instance, so some of the midcap miners.  The other thing that’s yet to even happen big time is the next layer behind that which is the mining services companies, Orica, Monadelphous.  If history is a cycle the last time we had a good run on commodities the mining services stocks ran hard after the miners.

Yeah, well they absolutely did.

In 2005 to ’07.

They did, and they ran too hard and then had a crash and a few of them went broke, it was a shocker.

That’s the way it goes.  As long as you knew that at the end of the road that it’s cyclical…

You’re talking about income stocks and the banks and the property REITs, retail investment trusts, I do think we’re at a point where some of those mining companies are better income stocks than those traditional income stocks.  I’m thinking specifically about Fortescue here which has a fully franked yield of 9%.  Now, if you’re an income investor boy oh boy, 100% franked 9% yield.

I know, but they don’t have the track record of the banks, that’s the thing.

That’s true, but they’re selling iron ore to China.

Yeah.

So, I just make that point.  There’s a lot of other quite interesting income stocks that people need to look at in the Australian market if you’re into income.

Yeah, but the other thing is the whole market is into income whether we like it or not, our market has a 4.5% dividend yield and it tends to underpin the returns just about every year, so those income stocks will always be dominant.  As we say it looks like this year perhaps there’s a swing around to miners and even on the income side there’s a swing around to miners.  Why don’t we just look at the two results, Alan, CBA and Rio, because they really typify the whole market.  If you take it that the market is banks and miners then CBA is the biggest of the banks and Rio, I would argue anyway, is the better of the miners though BHP I think is still a bit bigger.  But, CBA, what do you think of the last hurrah from Ian Narev?

Well, I think it was what everyone expected, things aren’t great.  They’re down everywhere.  I was a bit surprised at the dividend, what about you?  Were you surprised at the dividend?

Well, it was just unexpected.  It was supposed to be about $2.07 and it came in at $2.  Yeah, custom is that CEOs who’ve had a really good run, and he had a really good run on the numbers, I mean, strictly on the financial numbers, that he would go out with a bang, that he would go out with a big result.  He didn’t actually, he went out with kind of a damp squib of a result.  So, that was interesting, I didn’t expect that.  It will be interesting to see if the other banks do any better, we don’t know because they’re in a different cycle.  Commbank are on a different cycle, they do their full year results now, the other three do their full year results to September.

I haven’t had a chance to look at the Rio result, so what did they come up with?

Rio is an absolute corker, I mean it’s a huge number.  It came in this morning and they have had the biggest dividend I think they’ve ever handed out, they’ve announced a buyback which I think is something to the order of a billion dollars and the new head, Jean-Sebastien, is saying that they really are in a strong position.  The only thing he did also say though, bringing it back to where we were at the start, is he’s worried about wages, that wages are under pressure right across the group.  Which, again would sort of fit into a historical pattern that wages will break out in the mining sector faster than any other sector.

They’ve got nothing but robots now.  I mean, I don’t know what they’re talking about, I didn’t think they employed people at all anymore.

They employ people, but they never employ a lot of people.

All their trains run by themselves, all the big trucks in the mine, they all run by themselves, in fact they’re driven by somebody sitting in Perth, did you know that?

The Rio ones?

Yeah.

So, the driver is in Perth in a control booth?

Yeah, driving the trucks and trains.

Wow.

And, that’s a little way away.

Well, they have the money to invest even further now in the robotization.

Obviously, the person sitting in Perth driving all the trucks and the trains is demanding quite a bit of money.  Speaking of which, did you see – this is not on our list but did you see Elon Musk’s pay packet?

Pay packet, no I didn’t.

They’ve announced his pay packet which is, wait for it, zero for ten years.

Yeah, this is another publicity stunt.

You cynic.

I am a cynic.

You are such a cynic JK.

I am, actually.

He is getting paid zero dollars for ten years and he’s going to be all paid in options which turn into shares at certain very high targets for Tesla’s market value.

Is the target including that they actually make a profit?  Because they don’t.

Yes, of course.

Right.

They have to make a profit and the company has to be worth $650 billion, which is something like 10 times what it’s currently worth, in 10 years.  Then in that case he makes $70 billion, so he cleans up. 

I see.

But, the thing is first of all I thought what’s the poor bugger going to live on, I mean he’s going to get paid no salary, how is he going to pay for the baked beans?  The answer of course that he’s worth $20 billion, he owns four mansions in Los Angeles.

Right.

He hasn’t got one mansion, he’s got four.

The scale of this stuff is unbelievable.  Someone was talking about the Tesla being put in the rocket to go to Mars during the week.

Yeah.

Which is a marvellous publicity stunt, another one from Elon Musk, and gives rise…

I thought that was a great achievement.  Elon Musk is my hero, don’t you talk him down.

Well, here’s the other side of the coin, a chance to tell the listeners one of the very rarest of things, a stockbrokers joke about Tesla.  The joke is the Tesla car will get to Mars before Tesla makes a profit.  Do you like that?

Very funny.

Well I’ll tell you, they’re miles away from making a profit, those cars are virtually hand made as they say.  I know they’re lovely cars and all that but it’s by no means a General Motors.

Have you driven one?  I’ve driven one.

Yes, I know you’ve driven one, you’ve shown off about this before.  No, I haven’t driven one, but the question is would you buy stock in Tesla?

Probably not, but I’m happy to be a Tesla bore.

Okay, well you’re getting there.  Have we got some questions this week?

Yes, we have.  Here we go, here’s the questions.  First one is from Fiona, she says I love the podcast, we love it too Fiona.  I’m studying economics at age 45, good for you, Fiona, this is a good age to study economics because you’ll approach with the right sense of scepticism if I may say.  At age 45 you’ve seen a bit and you know that a lot of it’s rubbish but good on you for studying.  Can you explain the significance of the Future Fund?

Yes.

Go on.

The Future Fund, yes Fiona, the Future Fund is the…

What is the significance of the Future Fund, JK?

Well, it’s very significant because our public servants in Canberra, they were facing a difficulty with their pension, their pensions weren’t going to be paid basically if someone didn’t get a grip on the finances for the pension so Peter Costello created a fund called the Future Fund.  It’s not really a sovereign wealth fund like other countries have but it’s a proxy for one, it’s the government’s fund.  It has a target of about 7.5% I think and they’ve been doing really well, really well this year, they’re doing about 8.8 at the moment.  They’re also seen as a sort of barometer of how to invest for Australia.

It was designed as a repository for budget surpluses, as you point out, to pay for or to fund public servant pensions, right?

Yeah.

And, there weren’t too many surpluses, it must be said.  Money stopped flowing into the Future Fund fairly quickly, it didn’t flow out the other way when there were deficits which is a good thing because they would have had absolutely zero money left in there, but it’s got quite a lot of money now.

The other way it’s become important, I suppose Alan, is as a guide to everybody as to how to approach the market.  They’re very conservative but they do very well and what’s very interesting is just last week we mentioned how they cut their cash from 15% to 10% recently and they have been building up.  They would have got hit this week because they built up their shares and their shareholding in recent times but it does show you that every investor, even the Future Fund, has a core confidence about shares at the moment and a reversal like we had this week will be taken on the chin by everybody including the Future Fund. 

I also think it’s worth mentioning that it also shows the importance of branding of the Future Fund because if the government had called it the Public Service Pension Fund nobody would have taken any notice of it and it would have been terribly boring.  But, they called it the Future Fund.

That’s true, it was good branding.

And it’s called the Future Fund, everyone goes it’s the Future Fund, and everyone thinks it’s a sovereign wealth fund and it’s terribly important, it’s about the future, but it’s not actually.  It’s just about public service pensions.  I’ve subsequently had a conversation with Peter Costello about it, he thinks, and he’s written in the newspaper – I can’t remember which newspaper, whether it was your journal or not, JK, but he has written that the Future Fund should actually have its mandate extended to become the national superannuation fund.

And didn’t he get shot down fast on that?

Well, I think he’s right.

I think he’s right too but nobody wanted to know, especially – you know what, for once the industry funds and the retail funds agreed on one thing, that they didn’t want the future fund stealing their business.

No, they certainly didn’t because the Future Fund does better than they do.

I tell you what, if I had a fund doing 8.8% and it was run as well as the Future Fund I would almost, Alan, almost be happy to hand over my self-managed super but I’d probably never be happy to do that.

Indeed, because you’re having too much fun with it, aren’t you?

I’m having great fun.  Now, we have another type of question, what was that one?

Travis says Alan and James mentioned that there aren’t many stocks if you want to buy into the crypto craze.  Using the old adage that in a gold rush the people who get rich are those selling shovels the two companies that produce the graphics card chips by which most of the cryptocurrencies are mined, with which they are mined, are Nvidia and Radeon and there’s a worldwide shortage of graphics cards.  So, you would hope that both company’s balance sheets are looking good.  Disclaimer, he says, I don’t know.  Well, neither do I and in fact I didn’t even know, and still don’t know, what a graphics card is.  So, if you tell us there’s a worldwide shortage, Travis.

We’ll believe you.

We believe you.

He sounds like he knows what he’s talking about.  Actually, Alan, our production team here, the marvellous Greg and David, knew what graphics cards are and they’re to do with digital imagery in computers, they’re like an accessory, it’s sort of a circuit board type thing.  So, they’re circuit board makers that Travis is talking about, and they’re listed in the US.  So, as a way into crypto, well maybe it is.  Though, I’ve got to say just now I’m a little bit worried about crypto.

You’re a little bit worried, are you?

I am, yes.  I never thought it would fall this far this fast.

What are you worried about, you don’t own any?  What’s your problem?

I do feel a bit sorry for the people who rushed in there pre-Christmas when it was at 20,000.

They’re kind of buyer beware I say.

Yes, very true, I know.

You were saying to me, I interviewed this woman, Emma Channing.

Yes, who is she exactly?

Well, she’s one of the burgeoning army of people in the US, in California, who are engaged in some way or other in making money out of the crypto craze.  She is essentially an investment banker who’s involved in initial coin offerings, ICOs.  So, investment bankers do IPOs of companies, she does ICOs and charges about the same, which is about 6% or 7% of the amount being raised.  Anyway, I flung at her in the interview that you, last December when Bitcoin was $19,000 US a pop, you said that Bitcoin was going to $50,000 in the middle of this year, 2018.

She said this to you the previous time?

No, I read that in researching the interview, there I found this quote from her, I threw it at her in the interview and said you said that, what do you think now that Bitcoin is $8,000?  And she says it’s still going to $50,000 in the middle of this year.

Well, it’s going the wrong way, it’s heading in the wrong direction.

And I said well you must be buying like mad at $8,000 if you think that, and she said she is, yes she is.

Okay.

So, there you are everybody.

There’s someone out there buying Bitcoin.

There’s plenty of people buying Bitcoin because every time a Bitcoin gets sold someone buys it.

Well, very true, thank you for that observation, we know that.  Maybe we leave it like that for the week.

Well, that’s where we should leave it for today, James.  Don’t forget, everybody, you can subscribe to The Money Café on Apple Podcast or your app of choice, while you’re there please leave a review or a rating because it helps us, only if it’s a good review or rating.  Don’t leave any bad ones, that’d be bad, we wouldn’t like that at all.  Anyway, send in the questions as well and we’ll answer it in next week’s episode.  E-mail us on hello@theconstantinvestor.com and we’ll get your questions as we did with Fiona and Travis today.  Until next week, I’m Alan Kohler, Publisher of The Constant Investor.

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

Talk to you next week.