Turkey joins the trade-war; the US Dollar is going up; real wage growth is flat; and online fashion is in vogue.

This week in The Money Café, James Kirby and Alan Kohler discuss:

  • Turkey’s economy is weak, what does this mean for emerging markets and the European banks that hold Turkey’s debt? What’s more, it’s just joined the trade war with the US. 
  • The US dollar is going up, which won’t help emerging markets and commodity markets.
  • Real wage growth has flatlined. This may be due to immigration, but immigration might be propping up GDP.
  • Why aren’t the banks’ CEOs more vocal? 
  • CSL’s a great company, but is it overvalued?
  • Online fashion is on the up.


Hello, I am James Kirby, Wealth Editor at The Australian.

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

And we are, once again, The Money Café.

The Money Café.

 I could say welcome back to you, Alan, and you can say welcome back to me.

You were the one who went away, well I was away last week but how was Limerick?

Limerick has improved out of sight I have to say, I must put that on the record, it’s ticking, not ticking like Dublin which is really ticking and flourishing.

These words will go back to Limerick like wild fire, James, they’ll be delighted to hear it.

I know they will.  We have a string of interesting IT companies including, would you believe, Viagogo.

What?

Viagogo, are you familiar with Viagogo?

No.

It’s one of the world’s biggest and controversial ticket companies where they kind of sell second hand tickets and that sort of thing, headquartered in Limerick.

Scalpers?

I wouldn’t describe them in that fashion being a native of the town.

Irish scalpers, would you buy a used ticket off this man.

Anyway, things were improving in Limerick I’m delighted to say at last and Harvey Norman is still there too so there you are.

There’s a Harvey Norman is there?

There’s a Harvey Norman in Limerick and he stuck it out in the bad times and hopefully he’ll be rewarded now.

How about that.

Yeah, how about that.  Now, to bigger and grander thoughts, Alan, while you and I were not available in the last month one very big story kind of appeared and perhaps didn’t get quite the coverage overseas, particularly in Europe, which is Turkey.  Turkey in itself is not the issue, of course, the issue is the economy of Turkey is weak and it’s seen as an emerging market player and if Turkey gets into trouble emerging markets will get into trouble and if emerging markets get into trouble the whole world could stall as it did in 1997.  It seems to me that in the last few days that crisis has eased. 

Crisis averted.  The Turkish Lira has bounced but I don’t think it’s entirely over.  I mean there are fundamental issues here at work that are not to be solved by the short term issues or solutions that the government has come up with.

The first question is is there a contagion risk with Turkey for the global markets that we all depend on?

Well the immediate contagion risk with Turkey is that some European banks are up to their eyeballs in Turkish debt, in particular banks in Spain, I can’t remember the name of it but I had a graph on the news last night, in fact, showing bank exposures to Turkey by country and 25% of the capital of Spanish banks is in Turkey.

Good lord, I never knew there was that sort of relationship.

As I noted on the news if Turkey goes under it’s going to rain in Spain.

It’s going to rain everywhere I reckon.  Some contagion risk is clear and present by the looks of things.

That would be bad.  The Italian and French banks have got about less than 8% or 9% of their capital lent to Turkey banks and Turkish government.  I don’t think anyone is thinking that the Turkish are going to default and all the money is lost or something but it’s certainly the case that there are a couple of problems here.  One is that Turkey’s debt is very high and when your currency goes down and you’ve got foreign currency debt as they have, this is a broad emerging market issue and the essential problem with emerging markets is that their debts are in USD.

And their debt costs go up.

And their currency falls, the debt goes up in local currency terms and that’s what’s been happening with Turkey.  Their currency had fallen before the crisis over the last week or two, their currency has fallen 40% this year and so they were in trouble and then they went and arrested this bloke, Andrew Brunson, the pastor.

Yeah, American pastor.

The American pastor, and they’ve locked him up on espionage charges and so Donald Trump whacked sanctions on them and then he got cross at them.

Then they whacked back to the extent that that ruptures the US, it doesn’t matter.

You pick a fight with America at your peril, especially Donald Trump’s America.  Then he’s doubled their tariffs on steel and aluminium from 10% and 25% to 20% and 50%, so that caused Turkey’s Lira to collapse.  Then they’ve kind of come in with the Central Bank of Turkey providing liquidity, they’ve whacked tariffs back on American products which is like alcohol and cars, and stuff like that.  Now the thing has stabilised and the Turkey Lira has gone up.

It’s stabilised but the issue is for the investor are their cushions in place basically that weren’t there before, is it the case that there is contagion or one of the arguments put forward is that the reserves, for instance, of emerging market countries are better than they used to be in the last time we had a global emerging market crisis.

Turkey’s certainly aren’t good, they’ve got a whopping great current account deficit, 6% of GDP which is the largest I the emerging world, and so they’ve got fundamental problems and a huge amount of debt.  I think the debt is 38% of GDP or something.

You’d be concerned then that it has the capacity to rock the markets again.

Yeah, I think that clearly is the case, they’ve got the capacity to do that.  It’s clearly got the capacity to be another Greece, as to whether that happens I don’t know.  The broader issue is that the USD is going up which is causing problems everywhere in the emerging world for the reasons we just discussed because their debt is in USD.  In general money is flowing out of emerging markets.  The last few years emerging markets have contracted a lot of money because of higher yields and also there’s a lot of liquidity around so now the liquidity is getting dried up, American interest rates are going up and the money is now flowing out of the emerging markets.  I read something the other day saying that Turkey is a big fish but it’s not the whale, the question is what is the whale.  This piece that I read was proposing that the whale is Italy.

It is a very big economy, yeah.

Italy is not part of the emerging world, obviously it’s a part of Europe and the fact that it’s a part of Europe changes things in the sense that it’s unlikely to default so I’m not sure that’s true.  I think the whale could be China because China is suffering a capital outflow now, the Chinese currency is weakening so despite the fact that it’s colossal in size and is tremendously…

But it can respond in a different manner than Italy or Turkey.

It’s got huge foreign exchange reserves…

It’s got huge reserves and it’s got the capacity to respond as a centrally planned economy. 

Potentially but it’s still got a problem, there’s no doubt about it, China has a problem.

We then find ourselves with our dollar at 72-73 cents and we find that our interest rates are lower than the US so is there money flowing out of Australia back to the US?

Yes, there is, and the Australian currency is easing.  It’s not collapsing or anything but the Australian currency is going down.  The problem is that last night the copper price fell 4.6% and commodity prices generally fell a lot last night.  That was as much about concerns about China as it was about the fact that the USD is rising so there’s a direct impact on commodity prices by the USD rising because the commodities are expressed in USD, so as the USD rises the price of those things fall.

The USD rising is bad for commodity players like that aren’t in USD, like us.

Definitely, yes, most definitely.  Particularly those who rely, as we do, on China’s economic health and so there’s some concerns now coming around about China.  Maybe that’ll resolve but there are issues now that the Australian economy has got some problems.  We saw this morning the employment went backwards in the latest months for the ABS data on employment, down for the latest month.

I thought wage growth went ever so slightly up.

Wage growth was slightly better but wages growth was 2.1% which is the same as inflation and therefore real wage growth is 0.  There’s really nothing going on with wages and the overall employment trend is strong even though the latest months it was down because the months before was 58,000 so that was good.  The good thing about the Australian economy is the immigration remained strong, so a lot of people are coming in and that’s a boost to the GDP, most of these people who are coming in are getting a job.

There’s one last point on this domestic front.  Stephen Koukoulas, who you use sometimes in The Constant Investor, has put forward the interesting notion that the immigration flows underpin the fact that wages aren’t going up.

Of course, that’s absolutely true because it’s creating a pool of labour that is holding wages down so the underemployment is quite strong.

There was always immigration.

Not this high, not this level.

Are you sure?

This is now double the immigration that used to be.

Of any period?  The Seventies or whatever?

Obviously there have been spikes.

Of recent times, yeah.

In the last few decades we’re now seeing double the rate of immigration as before which is leading to crackpots like Fraser Anning getting up and talking about the final solution.

Yeah, that’s most unfortunate.

He should be ignored, of course, but it is leading to some tensions obviously in society.

It is.

Nevertheless it is also underpinning GDP, even though wage growth is low, GDP and income per capita is low, the overall thing of GDP is underpinned by immigration and it’s also underpinned by two other things.  One is the infrastructure spending by states trying to build enough roads so that we can actually get around any more.  The other thing is the net exports which are now added to by LNG exports out of Queensland factories that have been built so there’s 1% or 2% of GDP in that to begin with so before you get out of bed we’ve got GDP going okay, hard to have a recession. 

Yes, but hard to get wage growth particularly.

Wage growth, property markets falling, credit growth is down, people are going to have to start converting their interest only loans to principal and interest loans soon, you know about all this.

I do.

That’s going to be an issue.

Absolutely.  In fact, that hasn’t come up at all in the Royal Commission but just looking at it this week I wonder as we enter sort of week whatever it is, 42 or something on the inquiry, the question now I wonder is whether there’s actually an element of fatigue setting in in terms of the degree to which you could be shocked.  It’s very hard to be shocked by a Donald Trump anymore, maybe it’s very hard to be shocked by what we hear in the commission anymore even though it’s quite remarkable what they’re digging up.

I know they’re doing their best to continue shocking us.

Aren’t they just.

I’m not tired of it.

Nor am I.  It’s interesting, I thought with the industry bonds there might be a little bit more to debate and discuss, they left them off but they certainly didn’t have a tough time in there and the banks, particularly NAB and Commbank, that is MLC and Colonial, really got grilled.  They’ve taken half the entire time.

That’s because industry funds are good, banks are bad.

In many ways, Alan, that’s absolutely true.  Though I was looking at some of the newer funds this morning, some of the index funds which banks are offering and they are actually scoring as well as industry funds and their fees are as low but it’s going to take so long for them to present themselves in a convincing fashion at the inquiry.  The other thing is I think really though they said that Chief Executives will be brought in at the end I think those Chief Executives should be in there now and they can go in more than once.  We’re getting people in for the second time, Hagger was in twice for NAB, this woman from Colonial was in twice and Linda Elkins, who’s probably the nearest thing to the most infamous person in the dock.

Why have they got the poo kickers in there instead of the CEOs?

It’s a mystery because they can call them and if they called them they’d come in, and in a way they can’t go in unless they’re called but Matt Comyn of CBA has been mentioned in dispatches several times, Thorburn is mentioned regularly from NAB.

Mr Hayne, his Honour, Mr Justice Hayne likes monstering these poor little…

I think there’s an element of monstering, of mid-ranking executives two or three times in a row.  I think if you’re doing that it’s time to bring in the chief, the chief sitting at home on $4 or $5 million a year, I reckon it’s time to hear from them.  What do you think?

I couldn’t agree more, James, get them in there.

Get them in and if you have to get them in more than once well that’s fine, they can do it, they’re in charge, they are the top brass and they are ultimately responsible.  On affairs of the week did you see the knock out result from CSL?

Yes.

What a company, this is a $200 stock now, this is a $215 stock from $148 six months ago.

Indeed.  I interviewed Paul Perreault, the CEO, when they put their results last year the market capitalisation was $56 billion and now it’s $95 billion.

Their results last year they went down a little afterwards, they weren’t as good as this year.

The profit was $1.3 billion last year, this year it was $1.7 billion.  I’m just trying to remember the percentages but the market cap…

It’s a 30% lift in profit.

How much, 30%?  That’s right, but the market capitalisation is up 70% between the two profits, profit goes up 30% and market cap goes up 70%.

In a year, yeah.

Therefore the market is expecting much more growth in future so how is this bloke going to deliver?  Fair dinkum, what an absolute treadmill he’s on.

He’s on a treadmill but the best companies are.  He’s got a 30% lift in profits, he’s got 30% lift in dividend, he’s got 25% return on equity.

But the PE of the thing is 50 times now.

I know, we’re not used to seeing companies like that especially large caps.

But he’s only going to deliver 20% growth.  He’s kind of saying 20% growth for the future, the market is not going to be happy with 20% if the PE is 50 times.

They’re happy so far.

I’m saying – well, I’m not saying this but it might be a sell, it’s too high.  Fair dinkum it’s that stretched.

I know, if anything it’s priced for perfection.

If anything goes wrong it’s going to come down quite a long way.

The thing with CSL, just to finish on them, is yes, things go wrong and occasionally they peel off then they motor back and they’ve done that all the way, Alan, the whole way and now at, as I say, $215 a share it is extraordinary, it’s bigger than several of the major banks, it’s within shooting distance of being our greatest biggest company.

Yeah.

It’s time for everyone to actually check them out at the very least.

I think it’s a wonderful company and I think Paul Perreault is fantastic in the way that he has continued the culture that McNamee started, I think it’s great what he’s done.

Yeah, he’s an interesting man, very kind of sober and low key but impressive when you meet him. 

I was going to ask you why you want to talk about Woodside and electric cars.

Because I saw all this stuff from Woodside, I saw all the result and the result was pretty good, it’s 10% up on the year which you’d expect on stronger oil prices and some of their major projects, Scarborough and that, starting to come alive.  The interesting thing I saw, which got no attention, is that Woodside submitted to the electric – there’s an electric car senate review and Woodside, the oil company, made a submission to this electric car review and they said that they wanted to see a certain percentage of government cars, government fleet cars, made electric which made me think of a few things. 

What’s it to them?

Good question, Alan.  They are in a position to supply hydrogen cells, hydrogen being the alternative electric car power base to electricity, and they’re trying to push for electric cars, Woodside.

Electric cars or hydrogen cars, aren’t they different things?

They’re electric, at least they’re alternative non-fossil fuelled cars if you want to get all sort of pedantic about it.  Non-fossil fuel cars, Alan, that aren’t reliant on petrol, could be hydrogen rather than electricity which as my brother in law, who is an expert on these matters, a professor in the area in Ireland, has said to me the thing about electric cars is they run on electricity and electricity can come from anything like coal mines.

That’s right.

It’s a good point.

That is a good point, a very good point.  Tell me about Shoes of Prey, we’ve got to go to questions in a minute but…

We’ve got to go questions, well there’s one very good story.  Online fashion has had some very interesting successes in the online selling world, The Iconic for instance is a very interesting and very large company in Sydney doing very well and getting close to making a profit.  The other one that got a lot of attention was Shoes of Prey, now I mean a lot of attention all around the world in the international fashion industry, in the Wall Street Journal across the US and was bankrolled by some big names and raised something like 30 million so far.  In the 3D printing they were leaders in that, they have been seen as a real flagship for Australian tech start-ups.  The problem is they’ve just had their valuation marked down 87% by none other than Blue Sky which is one of their early backers and it’s for sale.  It’d be very interesting to see what happens, the whole business is for sale.

At 13% of what it was?

Yeah.

Bloody hell.

It’s for sale and it’s going to need some working capital so it will be very interesting to see how that one plays out, Shoes of Prey, keep an eye on that one.  Now, do we have some questions?  Just a few, would you like to…

Do you want me to read the first question?

Why don’t you have a go with that one, Rob.

First question is from Rob.  He listens to us every Friday morning on the commute to the city, glad to hear it, Rob, so have a good day today, Rob.  I’ve noticed that the claimed returns on the Sun Super website didn’t get very much over the long term.  The three screen grabs are for Sun Super’s growth, balance and shares option, and showed that the return varies a little over a five year period.  Am I being sold a crock?  I presume what you mean, Rob, is that the returns of the three options are no different from each other and I think that’s correct.  The risk profile for a balanced fund would be very different to a growth or share profile but the return does not support the risk and return model that was rammed down our throats at uni.  Do they give the same product three or four names to fool the consumer into thinking they are making an informed choice when in fact they’re not?  I perish the thought, Rob.  Goodness gracious, are you suggesting that a bank is telling fibs?  What can we say, I’m just absolutely gobsmacked that you would make such a suggestion at this time, Rob.

Rob, the first thing to tell you is Sun Super are fairly good and Sun Super actually come up in the top 10 performing funds very regularly over all time periods.

In fact they’re so good that all three of their options performed exactly the same as each other.

Even if they did it’s not mathematically impossible at over a 10 year period.  It can happen because over the long term a lot of things will average out but you would expect your growth to be sort of a few pips above your balance.

You would, wouldn’t you?

Yeah, you would, but apart from that I wouldn’t fall off my chair about it, Rob, it’s just like one of those things you would have thought.  Something is either performing better than it might have being balanced I bet.

Rob is worried that the riskier option is not getting the return that it should do in order to compensate for the extra risk and that’s a fair point.  The trouble is that it’s possible that they’re not taking any greater risk either, the return is the same because the risk is the same I would suggest.

I hear you, it’s possible.  I’d move for the defence on this one, Rob, and say that perhaps the balance is doing exceptionally well because of private equity, etcetera.

I rise for the prosecution in this case.

Yeah, okay.  I hope you’re happy with the answer, Rob.  We’ve got one more, Alex.  Alan, two weeks ago – when I was not here so I’m innocent to whatever happens next.  Alan, two weeks ago you said Host Plus was the best performing super fund with an annual return of 12.5%.  I have my super with Spaceship which is a new fund but the annual return for 2018 was 19.7%.  Knock my socks off, Alan, 19.7% on a super fund.  Why isn’t my fund on the list of the best performing funds, is it because it’s only existed for less than two years?

Is that right, do you happen to know whether they produced 19.7% last year?

I have not heard that, I would say to you I’d be very careful extrapolating that figure, Alex, especially for a very new, they’re untested, it’s an unproven model, they’re supposed to be heavily into exchange traded and passive with a sort of top up of tech.  It’s possible but if it’s 19.7% it will be over a very short period of time on a very narrow base so I wouldn’t say…

As for why it’s not on the list I don’t know.  The list that we quoted was the super ratings performance rankings of super funds.

Was it one year, was there a one year in it?

They publish one year, three year, five year, ten year.  Host Plus is the top performing fund over all of those years.

Yeah, and I have no problem with the Host Plus numbers because I’ve seen them in APRA, I’ve seen them in Canstar, etcetera.

Yeah, but Alex wants to know why Spaceship isn’t on the super ratings list and we don’t know the answer to that.

No.

Super Ratings was probably too snobby to put it there and is putting its nose in the air.

I don’t know, but I would say, Alan, the 19.7% assuming it’s correct would be a very short period of time to be judging a fund on, very short, so I wouldn’t extrapolate from that at all. 

Yes.

There you are, it was a really interesting marketing innovation on Spaceship, aiming for younger people and all that, and that’s interesting but we have to see how they go with the long term.  Okay we’ll leave it there for today.

Don’t forget you can subscribe to The Money Café on Apple Podcasts or your app of choice and while you’re there it’s helpful if you could leave a review or a rating, it helps listeners find the show and send in a question or two if you like and we’ll answer them on next week’s episode.  E-mail the question to hello@theconstantinvestor.com.  Until next week I’m Alan Kohler, Publisher of The Constant Investor.

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

Talk to you next week.