The Money Cafe with Kirby and Kohler

This week James Kirby and I discuss the following topics:
  • Trump rattles the saber, and now a preemptive strike seems possible. But the bigger picture is US-China relationship. 
  • The bond market is starting to unravel, but imminent inflation remains a theory.

  • Comyn appointed head of CBA, but the banks continue to be a problem.

  • The future fund is backing shares, big time.

  • Why the main problem with electric cars is pollution. The combustion engine is ultimately doomed. 

  • Bitcoin – why is Facebook banning ads relating to cryptocurrencies? 


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

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

And we are The Money Café.

The Money Café.

Now, Alan, I’ll tell you what, a week is a long time in business news because when we sat here a week ago there was still that sense of summer in the air, summer holidays in the air, but the news has been rolling in this week, these last few days especially, that I think in many ways the year has got off to a flying start and some of the things we’re going to cover today kind of shows that.  The Future Fund, for instance, doing really well.  Some other stocks that are going very well at the moment with a sense of a strong market behind us.  Also, I suppose, the bond market and though the bond market might be in trouble in many ways that’s a reflection of the fact that the shares market has finally come back on stream, hasn’t it?  Why don’t we start with the big news of the day which is not per se business news but it’s news that could really rattle the markets if it went any further.  We’ve just found out about this a few hours ago, this was the Trump State of the Union address, but what did he say about North Korea and what’s the concern there?

Well, he just kind of rattled the sabre again and said they’re being unacceptably belligerent, North Korea, and then by golly we’re going to do something about it.  I did an interview with a guy who runs the United States Study Centre at the University of Sydney this morning and he says everyone is talking about the prospect of a pre-emptive strike.  That’s kind of, in a sense, heightened by there’s some goings on with the proposed ambassador to South Korea for the US who was cancelled and then he went off and wrote an op-ed for the Washington Post arguing against…

You mean his job was cancelled?  He never made it.

Yeah, he’s not going to be sent there anymore.

Yeah.

Then he went off and wrote an op-ed for the Washington Post arguing against a pre-emptive strike against North Korea.  So, the only reason I raise it in the context of our Money Café podcast is that obviously if there’s a pre-emptive strike against North Korea by America that is a big deal.

It is a big deal.

I mean, for investors.

Absolutely, because we all know…

It’s a big deal for everybody.

Yeah, I know.  But, even on the financial side the markets, particularly Wall Street, are just aching basically for a correction, they’ve had a ferocious, what someone called an extreme start to the year so if you ever saw a market that was ready for something to trigger a correction it would be that.  I suppose the bigger game, of course around that is not so much North Korea per se, the state of North Korea, but the relationship between China and the US which will deteriorate if that happens.  Then you’d really have issues on your hands.

Totally, that’s right.  So, I just raise it as something to watch out for.  I don’t know what investors should do about it or how you prepare for a war in Korea, I’m buggered if I know.

Well, I think you’ve got to be prepared for everything, don’t you?  If you remember when the Gulf War broke out once upon a time in terms of a surprise war that was pretty close in recent times and the markets tank immediately.  In many ways it sort of tests people as to their resolve or their nerve or their portfolio construction, which you want to have right when it’s tested.  Now, talking about portfolio construction most people – and I’ve got to admit I’m far behind, when I hear about the bond market I don’t get very excited, I find the bond market not very interesting.  However, a crucial thing has been happening, hasn’t it, in the bond market this last few weeks.  Basically, the American bond rate is going above the Australian one, it’s just about to do it, and that would be the first time in something like 25 years.  It also means that bond yields are going up in the US and so that whole market is in turmoil at the moment, it’s really starting to unravel.  Can you tell us what do you think that means for us here in Australia as investors?

Well, the bond market is a global market and our version of it – we don’t really have retail bonds in Australia, we’ve got bonds obviously and they’re owned by the banks and the institutional investors.  Mum and dad investors tend not to own government bonds, there’s a few corporate bonds that are owned but our bond market equivalent is the bank shares on the stock exchange or more broadly yield stocks, income stocks, on the stock exchange.  What’s going on in America, and globally really, is the prices of bonds are falling and that’s driving the interest rates up, the market yields up.  So, we’re seeing actually German bond yields rising above zero for the first time in ages.

At last, you might say.

Yeah, they’ve been negative for a while.

Yeah.

American bond, the ten year bond yield is up to 2.7% which is the highest it’s been for ages.  The reason that’s happening is both good and bad.  The good reason is that the economy is pretty strong and bond yields tend to rise or bond prices fall when the economy is going well because everyone thinks inflation is going to go up.  The other bad reason it’s happening is because they reckon the supply of bonds is going to increase because the American government is going to increase its deficit because of the tax cuts and that’s going to drive prices of the bonds down because of the increase in supply.

Cut to the chase, is there anything to worry about?  Is there anything actually to worry about because this is all inevitable, isn’t it, that bond yields go up, that bond prices go down?

Sure.

I mean, it is inevitable.

Look, it’s only a problem if there’s a big spike in bond yields, if there’s a big move.  If it’s gradual as it has been so far it’s fine, no problem, because essentially what happens is that as long term interest rates go up share prices come down because analysts’ models have to change the prices of them to reflect the change in interest rates.  But, as long as the economy is growing at the same pace as the bond prices are falling then earnings are rising to offset the adjustment in the price of shares and that’s all fine.  But, if there’s a big jump in bond yields as there was in 1994 that shakes the market up and causes a correction, and that’s what happened in 1994 and it would happen again if there was a big jump.  The trouble is that markets tend not to go in straight lines, they tend to jump around.

Yeah, markets tend to overreact.  Okay, so that’s it in a nutshell then, really.  It is something that’s a concern because when they start to move up they can jump up and if they jump up they cause havoc.

In a nutshell that’s it.

In a nutshell, there you are.

That’s it.

Okay.

So, what’s behind it is the increasing inflation and we’ve seen that in Australia, inflation…

Well, we haven’t really seen it in Australia.

No, that’s what I’m saying, inflation is not moving here, it’s stuck at 1.8% or 1.9%.

So it seems to be, doesn’t it, but that will surely change soon.

But, everyone has been saying that for ages.

I know they have.

All these wise economists with bulging foreheads, they haven’t got a clue what’s going on.

No, but you see we’ve had no wage growth, of course, that’s one huge thing, and also things have been coming down and we don’t tend to notice what’s going down, we tend to notice what’s going up because we don’t notice that car prices are going down, carpet and furnishing prices are going down.  We notice that energy bills are going up.  So, I think sooner or later even if inflation was to come back to normal that’d be between 2% and 3%, that’s what the RBA wants, isn’t that right, between 2% and 3%?

Yeah, but it’s interesting.  Everyone says at some point the tightness of the labour market, falling unemployment, will drive wages up which will in turn drive up inflation except when you look at the detail, as you point out, imported goods have been deflating for years because of the strong dollar and because Chinese products…

China, imported deflation as they call it, yes.

And when Chinese wages go up they move the factory to Thailand or to Africa or somewhere else, so that’s not going to change.  Traded goods have nothing to do with Australian wages, right, it’s all to do with wages overseas.  So, then you go okay, so we stick with TV prices and all that stuff staying in decline so then maybe wages going up will drive up the other stuff, the other prices, to the point where overall inflation actually does go above 2%.  Well, maybe, but…

It’s a long road, isn’t it?

It is. 

Yeah, it’s interesting because it just would not move.  Just to put some numbers on it yesterday they were expecting – it was yesterday’s inflation figures and again it shot under on both the monthly and the year on year basis.  So, this whole theory about rising inflation coming down the line, it remains a theory.  One of the things you’ve said there was about how this whole change in the bond market, and whatever about our own country around the world rates are going up, especially in the US.  Signals again this morning from the Fed the outgoing Chair, Janet Yellen, that they will lift rates later in the year.  When we see this happening and we see bond market yields going up you were saying that’s a proxy, if you like, for a hit on the big yield stocks and the biggest yield stock in the land, of course, is Commonwealth Bank and has been for a long time.  It’s been a great stock for lots of people, all the banks have, particularly Commbank. 

Now, I think this week’s BT Mega Trend, and we are sponsored by BT every week here on The Money Café, the Mega Trend should be, I think, the outlook for banks, the headwinds for banks.  Because, they do seem to be just continually leering, don’t they?  I mean, first of all you have the basic problem with maybe house prices have topped out, then you have the issues of tighter regulation, then you have the issues of a royal inquiry, on top of everything else this week they announce the rate rigging on CBA and they’re talking about anything up to a billion dollar contingent liability sitting on Commonwealth Bank’s books now.  A new Chief thrown in with plenty to do, Matt Comyn.

And everyone is giving him the thumbs down because he’s an insider, everyone reckons they need someone from outside which may be true.

We said that a few weeks ago, we were talking about this and we said Matt Comyn isn’t going to get the gig because he seems to be very impressive and a good guy, certainly presents very well, but how could they appoint him as an insider.  But, they have.

Well they obviously have been listening to our podcast.

Clearly, on the beach.

Kirby and Kohler are saying that they’ve got to appoint him so we will.

So, we will.

He’s got a very fetching shock of white hair in his forehead, I think.

Yeah, we call that a skunk when you have a…

He’s got a bit of a skunk thing going on there.

I haven’t noticed that.  Yes, well we’ll get to know him in the months ahead, won’t we.  But here’s the thing, Commbank, I was looking this morning at the outlook for Commbank, I was looking at the brokers reports.  It’s still up at about $80 and the most recent broker report was Morgan Stanley and they have a price on it of $71, that’s a fair drop from where it is today.  Commbank is the biggest stock on the market, so it has potential not just to be a problem for individual investors in the bank but it could drag the whole market down.

Well, I reckon you ought to be out of the banks, honestly, there’s better yield stocks around.  I mean if you’re after yield it’s true that they’re 5% or 6% fully franked, that’s true but really, you’re going to lose the money.

Yeah, but in reality people don’t go out of the banks because in reality most people have had them for years and people have had Commbank since the float, this is the thing.

I know, and they’ve got capital gains tax, I get that, I understand that.  Most people don’t care too much about the possibility of capital loss because all they’re worried about is the dividend and there’s much less chance of a cut in the dividend than there is a fall in the share price.  That’s true, I get all that.  Okay, so all I’d say is you wouldn’t buy any.

You wouldn’t buy more of them.  I think that’s worth really calling out to people, that there are now major brokers like, as I say, Morgan Stanley with a price of $71 target on Commbank, the biggest stock in the market, and folks, you probably know it’s nearly $80 still.

I was just going to say, we all tend to blindly follow the Future Fund’s asset allocation, do you think the Future Fund has got any Commonwealth Bank shares?  You wouldn’t know, I suppose, would you?

I don’t think they detail to that degree but I’ll tell you something really interesting about the Future Fund.  They told everybody loud and clear that they were raising cash, that is that they were worried about the markets and they were holding more cash.  They had 20% cash last quarter which is a lot.  Do you know, in the three months to Christmas they cut their cash from 20% to 15%, that’s a huge chunk, that’s $2 billion worth of Future Fund money, and it went into shares big time.  They got jump at Christmas, they got that last quarterly jump.

They’re not worried anymore.

They’re not worried anymore.

So what shares are they buying, are they saying what shares they’re buying?

Well, they just said equities, yeah.

They obviously don’t think Trump is going to bomb North Korea.

I don’t think they do, Alan.  You might be in the minority there.

No, I don’t think he will but I think I’m worried about it.

I wouldn’t put it past him, I wouldn’t put anything past him.

I didn’t sleep last night.

What woke me up this morning was this story about the Future Fund.  So, they’re doing 8.8% at the moment which is really good if you think about it, and I always think they’re a great guide.  So, though it’s three months old, folks, they are back in shares big time and a lot of people are back in shares big time and I’m not surprised because the outlook is so good with the exception of some banks and some isolated companies.  This is a market where the main thing is to be in, I think.

Yeah, I think you’re right, you’ve got to be in.

You’ve got to be in because it’s a rising tide really at the moment.  Okay, now we were going to talk about two other things.  Yeah, this is very interesting, we can’t forget Bitcoin, we haven’t talked about Bitcoin.

And we’ve got some questions.

Well, before we jump to the questions – hang on, Bitcoin is in the questions so why don’t we leave that.  We’ll do Alex’s question second and you will do Hayden’s question first.  I’ll call out Hayden’s question which is to you and you can call out Alex’s one to me.  Alright, huge fan of the show, says Hayden.  Why does Alan continue to bang on about electric cars?  They’re 0.1% of all car sales in Australia, Tesla is fundamentally broke, continues to raise capital, without government subsidies the cost is too expensive.  It seems to me 99% of car buyers prefer petrol.  Well, what do you think of that?  To quote a petrolhead there…

Okay, James, listen.  I bang on about everything, pick a subject and I’ll bang on about it.  Look, it’s Tesla envy, basically I want a Tesla and so I keep going on asking about it because I want one.  I had one for the weekend once, it was great.

Yeah.

It was so fast.

Really?  I’d like a Gullwing SUV.

No, it was a Model S, it was great.

I must say it’s a terrible thing to say but it seems to me that there’s more than 0.1% electric cars on the road, the amount I see certainly in central Melbourne, they’re very distinctive.  Anyway, his question is why do you get so excited?

Because countries, including UK, Germany, Norway, China, I think India too, I can’t remember now but a few of them are all saying they’re going to ban internal combustion engines.  There’s no doubt in my mind, James, that eventually every car on the road will be electric, no question about it.  It’s not to do with greenhouse gases it’s to do with the other emissions from cars and the pollution.  So, that’s the reason that countries are looking to ban internal combustion engines because it’s poisoning the children are sitting in childcare centres and kindergartens on the side of busy roads, they’re getting poisoned by all the stuff in the air from the fumes.

I suppose Tesla is the start, isn’t it, it’s the leader.  But, I mean Volkswagen are going to come in, General Motors are going to come in, and they’re going to have electric cars and then it’s going to fly.

Of course, that’s right.  At some point the resale value of an internal combustion car will collapse because if everyone is buying electric cars, as they will be, and indeed countries are banning internal combustion cars, you won’t be able to get rid of yours.

You won’t be able sell them.  It will be like trying to sell a piano in 1961 when television came in.

Precisely.

They used to have piano smashing competitions.

And as the price collapses of second hand petrol cars it’s all over, goodnight. 

So, keep that in mind other James.

So, James, I’m afraid I’m going to keep banging on about it and bore the crap out of you for time to come.  Now, here’s one for you, James.  Happy New Year and a question for The Money Café brains trust, which of course is JK.

From whom is this question?

Alex.  What is the latest update on the interplay between cryptocurrency and gold?  It does not seem that the increase in the value of crypto has had any impact on the value of gold.  Can you share any new insight or thinking on that topic?

I can indeed, Alex.  It just so happens I read a piece over Christmas in Barons and it was on this exact subject.  The issue of was there a correlation between gold and cryptocurrency, Bitcoin.

So, this is the Barons brains trust.

This is the Barons brains trust, which is a very impressive bunch, I can tell you, out of New York.  But, anyway there is no correlation, that’s what I remember very clearly from the article, no correlation whatsoever on a technical basis between the movement of cryptocurrencies and gold.  So, for instance last year gold didn’t do much in the second half and cryptocurrency went through the roof, a good example.  So, there is this talk, I think, that people say you know cryptocurrency could be the new gold and could be used like gold.  Well, I would be waiting a long time before I’d use it as a replacement for gold, I must say, because of course it’s so volatile, because it can be hacked, and a variety of other reasons.  Gold has proved itself for a thousand years.

I think Bitcoin makes an excellent substitute for gold jewellery because you don’t have to wear anything, you can just say you’ve got it.  It’s like the emperor’s new clothes, you can say I’ve got a Bitcoin ring on, everybody, but you’ve actually got nothing and no one can prove otherwise.  What do you think of that?

Well, I think when it all gets very rough I’d like to know that I have my gold under the bed, Alan, that’s what I’d like to know.

Have you got gold under your bed?

No I don’t but I have been seriously considering gold as I see this market going up, I want to have something that’s not correlated and I think from the GFC we all learnt there’s almost nothing that’s not correlated except gold.

I noticed on your list of topics you’ve got Facebook bans crypto advertisements.  Now, I saw that out of the corner of the eye, cryptocurrency advertisements.

Yeah.

I saw that out of the corner of my eye the other day, or last night or something, but why have they done that?  I didn’t manage to read the article.

Well, it seems like there’s a break out of ethics among Facebook senior management because some of the things they’ve left – the whole fake news thing and all the things they’re responsible for on Facebook it seems out of kilter.  But, they announced out of the blue that they thought cryptocurrency adverts were misleading and deceptive, such as – and there are adverts you’ll see here coming out of Melbourne, if you don’t mind, that says retire early on Bitcoin, this sort of thing.  They’ve said that it’s misleading to consumers, it gives them the wrong impression and they’re banning all crypto ads.

I reckon they’ve opened a can of worms there because there’s plenty of misleading ads around.  I mean, what are they going to do?  Goodness gracious.

I don’t know.  It’s a very strange one.  But, anyway folks we know that all our listeners would never ever take an ad seriously that says retire early by getting into Bitcoin.  Okay, we might leave it there for today, Alan.  Don’t forget you can subscribe to The Money Café on Apple Podcasts or an app of your choice, and while you’re there it’s helpful if you leave a review.  We’ve had some great reviews but we’d like some new ones.  Also we’d love to have some questions and keep in mind that we’d love to hear where you are and what you’re doing when you’re listening to The Money Café, I think it will be very fun to hear where you are when you’re listening to us.  Okay, any questions we’ll answer them next week’s episode.  Remember, the questions should be sent to hello@theconstantinvestor.com.  Until next week, I’m James Kirby, Wealth Editor at The Australian.

And I’m Alan Kohler, Publisher of The Constant Investor.