The phoney US-China tariff war. Why tech stocks are suddenly on the nose.

This week in The Money Cafe, James Kirby and I discuss the following:

  • US and China declare a trade war but people don’t seem to care. Had the market already priced in a fight? 
  • Regulators are circling, is the golden era of the tech stock over? These companies are cash incinerators, and the market has woken up.
  • Australia’s vastly entertaining fight over coal.
  • Blue Sky hits back in a fight for its life.
  • Afterpay gets dinged for a wine misdemeanour, a sign of a trigger happy market.
  • James cops a “vicious, shocking” fact check from a reader .
  • Some curly questions on franking dividends.


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.

And I’m back from a few weeks off, James, great to be here back in the café.

Welcome back Alan.  Great to see you, and we have many of the usual sights in the café including a baby in a pram and as we know from previous episodes they can often join us later audibly.

What do they say, never work with animals and children?

Yeah, well here we are working with them again but in any event…

But, look there’s been a shit load going on while I’m away.

Exactly.

Am I allowed to say that?

Well, you can though it’s frowned upon by some, including me. 

A manure load is better.

But, considering it’s the week after Easter it’s true.  I mean I was just looking around this morning and saying my oh my there are so many big items and stories running, which will we pick?

So, let’s start global and talk about the trade war which so far is not yet a trade war.  I think where it stands is that Trump has said he will put tariffs on all these Chinese items by the end of the month or something like that – no, at the end of May.  So, basically they’ve got a couple of months to do a deal.

But then they have said, that is China has said, if you do we will put – and they have named their list which comes to almost the same breath, if you like, of economic goods because it’s about $50 billion worth of goods.  You can see the two lists online which is fascinating.  But, I was surprised because I thought when China responded yesterday that that would really trigger a sell off.  I thought Wall Street was going to be down heavily this morning.

But, it’s already down, I mean it’s basically pricing in a bit of a trade war, at least it’s pricing in uncertainty about trade.

Yeah, it is, but I just actually think their response is kind of muted actually about the trade war.  I mean it’s those big Facebooks, etcetera, the FANGs that are really pulling down the American market for a number of reasons that aren’t necessarily a trade war.

That’s right.  But, the trade war situation I think – the market, I guess, is inclined to think surely it can’t happen, surely these people aren’t such idiots.

But, gee, surely it can happen.  I mean he can’t back down now very easily, it will be a game of diplomacy but…

Well, it’s a negotiation, isn’t it?

Yeah, it’s a negotiation.

Basically, it’s a deal, they have to come to a deal and it’s true that China does have to give a bit in some way.  If China doesn’t give at all – this is in terms of the IP theft.  The thing about this is it seems to me that everyone knows it’s true what China is doing.  I mean, they are stealing IP.

Yeah, don’t dispute that, they are.

They need to change their ways a bit.

But everyone is co-dependent in our globalised world and on top of everything else they hold enormous amounts of US treasuries which they could – if things spiralled.  What would you reckon is worst case scenario, how would it spiral if it did spiral?

Well, the amount of trade declines, the amount of global trade declines and that would drag down global GDP.

And would it necessarily lift prices, that is lift the price of goods?

Well, obviously tariffs lift the price of goods to the people in the country that has imposed the tariff, right.

Yeah, so you’re going to get inflation.

So, both sides increase the prices of the imported products in order to discourage them.

Yeah.

And so yes, there’d be a once off inflation, it wouldn’t be an ongoing inflation, it’d be a once off.  So the Federal Reserve probably…

Yeah, but trade wars can be long, I mean historically, and I know history doesn’t repeat in economic history anyway.

I’m just saying that in terms of inflation it’s a once off change to prices which I imagine, maybe wrongly, but the Federal Reserve probably wouldn’t respond by putting up interest rates.

Tariff wars don’t end fast.  I mean, they tend to be elongated affairs.

That’s true, and they don’t end well.

Yeah.

Now, let’s move onto the FANGs because you were talking about the fact that the tech stocks are down for other reasons, what are those other reasons, JK?

Well, I haven’t seen any particular convincing reason, actually, except for the fact that they ran so hard.  I mean, obviously there’s another thing, a very interesting cultural thing going on where Facebook is losing its cool status and that’s actually enormously important in tech circles.  If you think a company like Spotify came on the boards just this week, a $25 billion float in the middle of what seems to be a turn away from a very bad week for the markets.  So, they were able to do it but then a company like Facebook is very much on the nose right now and Zuckerberg has been asked to testify and said he will testify after holding out for a while in Congress and you have all sorts of activity.  EU regulators are especially moving on Google and moving on Facebook.  So, there is that sense that maybe the golden era of the big tech wonder stocks is passing.

Yeah, and I wonder whether what’s going on is that the market is changing its view about the way these businesses operate which is that they – I mean it isn’t true of Facebook, it’s to some extent true of Amazon, which is that they burn cash rather than generate it.  For them cash is a thing that you get from investors and then you incinerate it.

But the deal is the share price keeps going up so the investor doesn’t mind.

That’s right.  So, Netflix, for example, is a huge burner of cash as is Uber as is Tesla, all these companies.  I mean, Facebook is making a cash profit, so is Amazon, but not much of one.  They’re not making anywhere near the profit they should make given the amount of revenue that they generate.  So, what that tells you is – and it’s true of Netflix and the others as well, is that their costs are too high.  I mean, Netflix has got a huge number of subscribers, they’re making a lot of money revenue wise but they’re burning it in costs.

Well, they’ve got 400 features in production, Netflix, at the moment.  So, that’s the scale of it.

Yeah, so all these companies they’re just running so hard on sort of a gold rush or a land grab to grab market share and I think the market seems to be coming to the view that actually come on…

Well, maybe the market and the numbers and the interpretation numbers is going on and equally politically and culturally they’re also offside, certainly Facebook is.

Exactly, and they’re about to get done with regulation and Facebook certainly is going to be regulated.  So, it’s going to be limited in the amount of information on its subscribers or its users that it’s going to be able to give away.  So, it’s probably going to make a bit less money than it used to in the past I would say.

I think that’s perhaps our Mega Trend moment of the week, the Mega Trend is sponsored by BT Financial Group as our listeners know but that actually would be it.

What’s the Mega Trend, enlighten me?

That the FANGs, the big tech companies, they are under attack basically from all sides and this year may prove to be the year that the market turned against them, that the world turned against them.

Could be.

In a way that never happened so far.

So, this is a possible Mega Trend, this is the maybe Mega Trend.

The mini trend.

The maybe Mega Trend, I like it, it’s good.

Okay, meanwhile in Australia we’re fighting over coal.  Mind you it’s not a surprise because we have coal but my gosh it’s a very strange fight going on about coal at the moment.  Have you been following that?

Well, I have and that’s been vastly entertaining and best of all has been the Monash family coming out and saying stop using our name, change the name of your Monash forum if you wouldn’t mind.

They never asked them, I suppose they never thought of asking them.  That’s right, was it the grandson, would there be a grandson of John Monash.

Yeah, they’re all horrified.

And they said not only do they not like it but they want the name withdrawn.

Yeah, and so Barnaby Joyce has said it’s okay, we don’t care, we’ll call it what we like, it doesn’t matter.

Yeah, well it was a bad start for the very unusual coal lobby group that wants to build new coal power stations.  It’s interesting, here in the real world in the financial markets Rio just last week sold their last significant coal asset.  Now Rio, when Stephen Mayne was here last week we talked about this, that Rio is now out of coal and actually Rio may have a premium of being a miner that doesn’t do coal.

So, I rang up the one Cabinet Minister I know well.

Your source.

My one cabinet source.

You only need one.

So, I rang him and I said are these 20 coalition right wingers in the Monash Forum, do they really think they can build another coal-fired power station, Hazelwood 2.0, or are they just trying to drag down Malcolm Turnbull.  He says no, they really do want to build another coal-fired power station.  Well, I don’t know what’s more disturbing, that or that they would want to just try and tear down Malcolm Turnbull.

It’s more disturbing, that’s for sure, it really is.

Because they’re complete blithering idiots.

Well, it’s so politicised, I can see no rational economic rationale in there at all.  BHP, who still do coal, they pulled out of the World Coal Council this afternoon, it’s just come up a few minutes ago before we came in.  But, you see Rio pulling out of coal and Barnaby Joyce and Tony Abbott rushing into it and you make your own conclusions, I think, about that.  Let’s talk about some of the big share stories around because of course the one we haven’t talked about because you were off was the reappearance of our old friends, Glaucus, the American shorting power house who virtually wiped out – when they announced Quintus last year as their number one target a year later Quintus was in administration.  A lot of people don’t like this, a lot of people are saying to me this is immoral, these guys are bullies, etcetera, but here they are again with Blue Sky.

Yes, well I’m a very small shareholder in Blue Sky alternative fund.

Are you really?  And you’re down 40% since last Tuesday afternoon.

I’m down 40% thinking crikey, what the hell happened there and what have I missed.  I mean I haven’t read the Glaucus research thing, I’ve been too busy with other stuff, and you apparently have.

I have, yeah, it’s an extraordinary document.  I must say, of course, we’re all used to reading ASIC regulated stock broking research reports which are damn dry but these American reports, the short seller report, it’s like a brokers report but they basically don’t have to be reasonable.  So, it’s done in a very sort of florid dramatic language, so they don’t hold back.  But, they must pull out ten different instances where Blue Sky really have a case to answer.  Blue Sky played a very clever – not clever, actually, apparently sophisticated game over the Easter break where they obviously contacted a lot of fund managers and journalists, and they hit back and I thought it was clever.  They really hit back harder than Quintus, they want the regulator to examine Glaucus which I thought was an attack.

But now Glaucus has this morning come out with a response to Blue Sky’s response.

They have, yeah, what did they say?

I haven’t read that either but I’ve read the preamble to it and they said that basically Blue Sky is not answering their questions.

Yeah, and it’s not answering their questions.  They’ve come up with some strategies, they haven’t even answered one question.

With Quintus in the back of my mind I’m thinking crikey, maybe I just better run away.

Well, you’re down 40% now, maybe you might stick it out now.

No, but it might go down to zero.

Yes, that’s entirely possible.

Or is it?

No, it’s not possible to go down to zero because they’ve got properties.

Because this is a listed investment company, they own assets.

Yeah, they’ve got properties, the issue is the valuation of them and the way they’re doing it and how they’re adding it up.  In some cases they really seem to be gilding the lily in terms of how they estimate how much things are worth like their Mexican restaurant chains or some of the way they do their property calculations.  I think they’ve really got to come out and answer.  I was looking at the most shorted stocks and Blue Sky isn’t there, curiously.  It isn’t in the top 20 for instance which means…

Yeah, but nobody knew that it was a stinker apparently.

Yeah, but it’s been a week now, and do you think other shorters would sort of go in for the ride?

Yeah, maybe, that’s right.

But, I’ll tell you who is in the top most shorted stocks is Afterpay.

Just before we move onto Afterpay I have put in bids to interview both Rob Shand of Blue Sky and the guy from Glaucus, so hopefully I’ll get them between now and next Thursday and I’ll tell you all about it.

Yes, it will be good.  You’ve talked to the Glaucus guy before, haven’t you?

I have, I interviewed him before.  This was when he first came to Australia and he said in that interview, he said I’ve got two Australian stocks in my sites and he wouldn’t tell me what they were and it turned out to be Quintus and Blue Sky.

But Blue Sky is much more interesting because it’s much more widely held, much more widely held.

And it’s kind of this iconic – well, not iconic but certainly…

I know what you’re saying, it’s the most visible alternative investments operation.

But also you thought that they were squeaky clean, you know.  Quintus – well, the plantations, but Blue Sky.

Well, it turns out it’s unlikely to have been true.

He’s such a nice boy that Rob Shand, you know.

There you go.  Yes, well you have to be more sceptical, Alan, about these guys, you do.  But, I was going to tell you something there about Afterpay, that’s right.  So, in among the most shorted stocks, though Blue Sky isn’t there oddly, Afterpay is in there.  Afterpay, if people don’t know about this for all the attention about FinTech stocks and FinTech companies the outstanding FinTech play has been Afterpay which is a very simple buy now pay later online system, payment method, listed on the stock exchange that went basically from $2 to $7 last year and then got confirmed, if you like, at that level by a Silicon Valley private equity group coming in at around the $6 mark and taking a stake in them.  So, they looked really interesting but more recently they’ve been shorted and people are saying well where do they go from here, they’re supposed to move into the US and that can be very hard.

And the price has come down quite a lot, what is it now?  Is it $4?

It’s around 5-something from 7.  So, it’s falling and interestingly one of the things that pushed it down this week was ownership matters which is one of those proxy advisor companies.  Is that the one with Dean Paatsch?

Dean Paatsch, yeah.

Well, the son – that is a teenage son, of one of those guys, he went on Afterpay just to show – I presume it was suggested to him by his family – just to show how weak the regulation was around Afterpay this kid went down and he ordered $300 worth of wine and there’s no checks it turns out, there’s no checks or balances all the way through and it all went through Afterpay and it was on its way to the house.  Then Ownership Matters stepped in and pointed this out and the stocks fell straight away.

You mean Dean Paatsch’s teenage son?

I don’t know if it was Dean Paatsch’s but it was one of the Ownership Matters people’s son.

I see, who was under 18.

Who was under 18.

I see.

But that and that alone…

So, Afterpay have sent him all this wine.

Yeah.

Well at least it wasn’t bloody crystal meth.

That’s right.  I mean, you know, how bad is that?  I mean once upon a time it was quite easy to go into Coles or Woolies and buy wine if you were 17 before they started asking for IDs, it didn’t mean the next day the stock price fell of Coles.  So, we’re in a very sort of trigger happy world here but anyway there’s the other shorting story of the week, Afterpay.

But the thing is Afterpay is another of these companies that’s burning cash and I think it and a few others in Australia – there’s another one called Live Hire which is a terrific business also burning cash, in both cases Afterpay is making a lot of revenue but it’s spending more than it’s making.

It’s amazing, they say they’ve got 25% of all online fashion sales in Australia, that’s really something, being put through Afterpay. 

So, it’s a good business, I think.  I mean I think it’s a stretch to call it a tech stock to be honest, it’s a lay-by business.

It’s a consumer finance stock.

It’s a consumer finance business, just because it’s done online big deal, who cares.

Yes, I suppose we’re pushing it to call them tech stocks in this day and age.  So, they were the two big shorting stocks of the week and the other thing we might have before we go to questions, and back on the coal, so what do you think of the Liddell Coal Station being sold?

Well, there’s no offer yet.  I mean, Alinta said it might.

It only said it might.

It said it might make an offer and AGL said if they make an offer we’ll consider it.

That’s as far as it went?

Yeah.

I see, and also we should mention to everybody about Santos which is also a fascinating story, and I wonder will that get rejected by the government, the offshore bid for Santos, which has been such a disappointing stock for so long.

Well, it’d be very interesting if they did because Alinta, which they’re trying to encourage AGL to accept the offer from, is owned by a Chinese business so I think it’d be somewhat hypocritical if they knock back Santos while carrying on like pork chops about how Alinta should be able to buy the Liddell Power Station.

Well, I would not rule it out.  Okay, have we questions?

Anyway, we have questions.  Okay, this one is addressed to you, James.  Hi James.

Yes, and it says urgent as I recall, does it?

Well, no.  Anyway, this one says hi James, in last week’s podcast you answered Alistair’s question about the relationship between a lowering of the corporate tax rate and value of franking credits by saying if the tax rate is lower the dividends won’t be quite as good.

Yes, I did say that.

And I do not believe this to be the case, says Tim.

Yeah, apologies, Tim.  I’ve read your question and indeed, mea culpa, I did say that, I shouldn’t have said that, I should have said the franking credit would be lower if the corporate tax rate was cut and then also as I recall I jumped pretty quickly and made some assumptions that basically the whole franking policy wouldn’t be as good for you as a shareholder if they cut taxes.  What I meant by that was the point you make is true, that if all stays the same, if everything stays the same, it doesn’t make a difference what the tax rate is.  If the company continues to pay dividends, the same dividend policy, same payout ratio.  The point I was making was that if they do have their taxes cut they’re probably going to invest more, they’re probably going to have difficulties maintaining those dividend payout ratios. Having said all that…

I’m on your side, James, I’m going to defend you against this vicious shocking attack from Tim.

No, fair enough Tim, and by the way it’s all hypothetical because the company tax rates are off the agenda, they never got them through.  Now they don’t get a chance again until May.

By then they’ll get voted out.

You know, we’re talking about a ten-year plan anyway.  Well, it’s interesting, Peter Dutton seems to have given up already or is he playing games saying that Labor are a sure thing?

Peter Dutton playing games, hardly, can’t believe it.  Question from Gabby, hi Alan and James – at least I get a guernsey this time – thank you for such an informative and entertaining podcast.  I have listened to you since episode one.

Good for you.

Gabby, that’s great, well done.  We’ve been doing it since episode one.  I have a question about ETFs and dividends and I’m hoping you can answer.  When a company A goes ex-dividend it loses its value by the dividend amount in addition to normal stock price movements.  This implies that an ETF that holds that company A would also reduce in value by a proportionate amount depending on percentage contribution of company A to that ETF.  At the same time when the ETF pays its dividends it also drops in value by the dividend amount even though the companies inside might not drop on the day.  So, my question is does this mean the ETF loses value twice?

That’s a good question, isn’t it?

When the company goes ex-dividend as well as when the ETF goes ex-dividend.  We don’t think so.

I think the companies inside would not affect the ETF so much because they’d never hold more than 7% or 8% of one company.

But, here’s the thing, the company, when it goes ex-dividend, is paying the dividend to the ETF so the money stays in the ETF.

Yeah, well I think she’s onto something, the mysteries of ETFs.

But the money goes from the company into the ETF and the ETF then pays that to the ETF shareholder.  So, it only goes down once, Gabby.

Yes, it only goes down once.

It has to go down once, not twice.  Question from Abe, hi fellas, hope you had a tonne of chocolate over Easter – yes, probably I did in fact.

A tonne of everything you could think of, yes, beer, wine, champagne, the lot.

Well, I think Haigh’s should be banned, Haigh’s chocolates should be banned, it’s very dangerous.  Like everyone else in this country I’ve got a lot of questions about the Labor Party’s proposed changes to the double taxation system, franking system.  What about mum and dad businesses that operate through a private company structure that pays dividends back to its own shareholders?  What about that?

I expect the same rules apply for everybody.  If you’re retired you’re retired and…

Sure, but a franked dividend is a franked dividend so if a small company, having paid 30% tax pays a dividend to its owners, even if they’re a mum and dad milk bar, then that dividend is franked.

Yeah, except I would say that the small company invariably…

Doesn’t pay tax.

No, the mum and dad, if they’re working, would have deductions to make and if they’re retired they wouldn’t be in the company in reality. 

No, that’s true, of course.

But a good question and we might have a second look at that.  I didn’t see much coverage of the private side of things.

Final question here from Fifi.  Hi James, last episode your guest mentioned AFIC when you were talking about direct shares like CSL but AFIC is diversified, isn’t it, and so it’s quite different to direct shares.

Yes, AFIC is – to clarify for people, is the Australian Foundation Investment Company, one of the big old LIC companies and it has…

LIC stands for listed investment company.

And it has about – pick a number but it has at least 40 shares inside at any given time and is well diversified so don’t worry about that, Fifi.  Yes, if you have AFIC it is by definition diversified.

So, it’s actually not like investing in direct shares, you’re investing in a fund.

You’re investing in a basket of direct shares.

No, but you’re investing in a fund as opposed to investing in direct shares.

Yes.

Direct shares is if you invested in direct shares.

Yeah, but the fund is investing in direct shares, yes.  I hope we haven’t over-engineered the answer there, Fifi.  Thank you, and that question came through Twitter by the way.

Well, there you go.  So, you can send your questions via Twitter and we’ll get them, everybody.  Well, it’s great to talk to you, James, it’s great to be back in Saporito Café in South Melbourne.

Great to have you back, Alan.

I reckon we’ll do it again next week, what do you think?

Absolutely.

Don’t forget, everybody, you can subscribe to The Money Café on Apple Podcasts or your app of choice and while you’re there please leave a review or a rating because it helps everybody find it and send a question in and we’ll answer it in next week’s episode.  So, you can send the question to hello@theconstantinvestor.com or do it on twitter with the hashtag themoneycafe, all one word.  Until next week, I’m Alan Kohler, publisher of The Constant Investor.

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