Hedge Clippings | Friday, 07 October 2022

For the past 60 years Bob Dylan, arguably the greatest musical influence of our time, has delivered classical and songs, and with memorable lines.  None more so than one from one of his earlier works, Subterranean Homesick Blues, which included the line "You don't need a weather man to know which way the wind blows." Admittedly, much, if not all, of the rest of the song's meaning, remains a mystery to most, us included, but (with apologies for the YouTube ad) the video clip was also an early classic.

Hedge Clippings frequently struggles with the equivalent when it comes to predicting the direction of the economy, and interest rates (and therefore property prices) although maybe it is easier with the benefit of hindsight. However, as the chart below shows the RBA's management of the cash rate seems to have been a case - with a few exceptions - of alternating between pressing the accelerator hard to the floor, followed by slamming on the brakes.

The RBA's media release following their monthly meeting is a master of understatement, but often it is the last sentence which tells which way the wind is really blowing. In March 2020 the RBA dropped its cash rate target to an unprecedented 0.25% with the following comment: "The Board will not increase the cash rate target until progress is being made towards full employment and it is confident that inflation will be sustainably within the 2-3 per cent target band." It's worth noting that back then the objective was to create some inflation...

In November of the same year, the RBA eased further to an even more unprecedented rate of 0.10% with the comment: "Given the outlook, the Board is not expecting to increase the cash rate for at least three years... and is prepared to do more if necessary."  Oops! Where was the weatherman that time?

To be fair to the accelerator/brake analogy, history shows that the cash rate stuck at 1.5% from August 2016 to May 2019, before it declined again through to November 2020 to bottom, and stay at 0.10%. That was until May this year, when it rose by 0.25%, followed by four consecutive increases of 0.5%, and then this week's increase of 0.25%, taking the cash rate to 2.6%.

Tuesday's RBA media release finished with this: "The Board remains resolute in its determination to return inflation to target, and will do what is necessary to achieve that." It goes without saying that the board's intention is to now reduce inflation to 2-3%, which they expect to achieve (just) in 2024.

Part of where we're going with this is not to say the RBA's job is easy, but that the resultant effect of easing or tightening are pretty inevitable (if not immediate) on the economy, and particularly housing prices. To repeat or borrow Dylan's words, when it comes to property prices, "you don't need a weatherman to know which way the wind blows". It stands to reason - actually supply and demand - that a prolonged period of easy money, especially with little or low unemployment - will result in an increase in property prices.  Equally, the lower the interest rate, and the longer it lasts for - or in the RBA's case their November 2020 expectation for "at least three years" - the stronger will be the increase.

While money was easy and housing prices were rocketing, the RBA and media were concerned about housing affordability. Now, with interest rates and repayments rising, and property prices falling, there are dire warnings of mortgage stress and the potential for foreclosure.

So which way is the wind blowing at the moment? This week's rise of only 0.25% against the expectations of 0.50%, although unlikely to be the last in this cycle, did signal a significant shift in the RBA's thinking that this time the peak cash rate should be no more than 3.25%.

That of course assumes that inflation declines. And sometimes that weatherman is not so predictable.

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Hedge Clippings | Friday, 30 September 2022

Amid all the chaos facing the world at present, ranging from nearly three years of COVID, to the invasion of Ukraine and the subsequent threat of nuclear war, surely the most bizarre is the economic and political chaos now facing the United Kingdom.

At first glance, it might seem this has been an instant reaction to a knee-jerk budget from a newly appointed PM, Liz Truss, and her equally new and inexperienced treasurer, Kwasi Kwarteng. Together, and after months of a drawn-out and damaging internal selection process, they announced a mini-budget and tax cuts which prompted an intervention from the Bank of England to prevent a run on pension funds, and a slump in the value of sterling which makes the under pressure Aussie dollar look strong.

Truss didn't improve things in a series of disastrous radio interviews on the BBC by trying to blame Putin for her and Kwarteng's own goal, which also drew a warning from the IMF which issued a statement saying "we do not recommend large and untargeted fiscal packages" at a time of high inflation, and suggesting the UK government re-evaluate its plans. Ratings agency Moody's also got in on the act, saying that the unfunded tax cuts were credit negative, and likely to weigh on growth.

Truss is between a rock and a hard place: Should she back down and admit she's made a serious boo-boo within weeks of being appointed, or continue to brazen it out, and no doubt in due course lose the next election? In reality, this shambles can all be traced back to the chaos created by her predecessor, Boris Johnson. However, somehow he seemed to have the brass, or b---s to be able to bluff his way through countless crises, until finally "Pinchergate" and "Partygate" finally ended his act.

In the case of Truss, there's probably never been a better example of the "Peter Principal" (so named after the 1969 book of the same name written by Laurence J. Peter) which observes that people in a hierarchy tend to rise to a level of respective incompetence. Depending on one's point of view that might also have applied to Boris.

Thankfully, although possibly also depending on one's political point of view, it seems that Albo, our new Prime Minister, has hit the ground running, and in spite of troubling global and economic times has yet to put a foot wrong. Of course, it is early days, and long may it last, but it seems a long apprenticeship, both in government and opposition, and a lifelong career in politics, has benefitted Australia and its 31st Prime Minister.

Changing tack, and back where we belong to financial services: The latest figures from ASIC covering financial advisor numbers in Australia, compiled by Wealth Data and reported in the AFR, show that AMP's adviser workforce has dropped below 1,000 - a 60% decline since January 2019, and a far cry from the 3,329 advisers it had on its books in 2014.

AMP hasn't been the only institution at the "big end" of town to lose advisors, or in the case of the big four banks, leave the business. Over 10,000 advisors have left the sector since the Hayne Royal Commission shone an unwelcome spotlight into some dark corners of certain practices.

Many advisers have left the larger dealer groups to set up on their own or in smaller "boutiques" finding that they had greater flexibility to provide high levels of client advice - particularly at the higher end - in spite of the compliance support (or constraints) previously provided by head office. The risk of course is that with lower adviser numbers, but still with a large number of people requiring financial advice, some of the latter are going to miss out.

Compliance and regulation in the industry are necessary, albeit often tedious. However, the Treasury's Quality of Advice Review is reported to be considering watering down the requirements for financial advice - and general advice in particular - enabling so-called "finfluencers" to flourish.

This would appear to us to be throwing the baby out with the bathwater, but maybe that's the wrong metaphor to use. Let's just say that social media is responsible for enough damage as it is.

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Hedge Clippings | Friday, 23 September 2022

Last Friday RBA Governor Philip Lowe appeared before the House of Representatives Standing Committee on Economics, in part to report, and in part to rebuff suggestions from some quarters that he should resign on account of misjudging the outlook for inflation, and thus his 2021 expectations for interest rates not to rise before 2024.  As he pointed out in his opening statement, much has changed since he last fronted the Committee in February, just seven months ago:

• Unemployment has fallen from 4.2 to 3.5%;
• Inflation was 2.5% - the highest it had been for years, now expected to peak at 7.25% before the end of the year;
• Official interest rates were just 0.15%, and currently sit at 2.35%, with expectations of 3.5% or more by early 2023.

Since his 2021 statement rates have risen five times. Lowe could have used the old, supposed quote from various people, including John Maynard Keynes and Winston Churchill and others, to the effect that "when the information changes, he changes his conclusions". This week he could also use the fact that Australia is just one of 90 countries to have increased interest rates this year as they fight the "scourge" of inflation - even if their economies succumb to a recession in the process. To quote from his prepared statement of last week:

"A powerful lesson from history is that low and stable inflation is a prerequisite for a strong economy and a sustained period of full employment. High inflation damages our economy, worsens inequality and devalues people's savings. High inflation also makes it very difficult to sustain, or increase, real wages. It is a scourge. It is for these reasons that the RBA is committed to returning inflation to the 2 to 3 per cent target range over time."

This week the US Fed increased rates by 0.75%. In the UK the Bank of England, facing inflation of 10%, upped their rates by 0.50%, the 6th increase this year, while Norway, Sweden (+1.0%), Switzerland (+0.75% and now in positive territory for the first time in eight years), plus South Africa, Indonesia, Vietnam, Mongolia, Taiwan, and the Philippines, all increased rates.

Going against the trend, Turkey dropped theirs by 1%, but that was from 13 to 12% in spite of inflation running at its highest for 24 years, and, not surprisingly, in the face of "a loss of momentum in economic activity." Japan's central bank also stood out by not increasing rates, but intervening in markets to support the tumbling Yen. Also swimming against the tide were China and Russia, both of which have their own specific economic and other issues to deal with, and which are also impacting the rest of the world.

China's woes include an ongoing slowdown resulting from COVID restrictions, even as it seems the rest of the world have or are emerging from the worst effects of the pandemic which is generally accepted by all except the Chinese government to have originated in Wuhan, and which is approaching a three year anniversary. According to Noel Quinn, the CEO of HSBC Holdings Plc., the correction to China's commercial real estate market was "massive, faster and more decisive than expected", and may have at least another two years to run.

Also supporting Lowe's explanation of changing conclusions with the change in available information would surely be Russia's invasion of Ukraine, which caught politicians across the western world, and Europe's economy, and energy supplies in particular, off guard. Just to add to the uncertainty, Putin upped the ante this week when facing defeat at the hands of a supposedly weaker, but fully committed opponent, losing face by calling up 300,000 reservists, and threatening the use of nuclear weapons, which would presumably escalate the war, rather than end it.

Australia's economy may or may not escape a recession, but along with the rest of the world's central bankers, Philip Lowe is clear about his priority: The longer term threat from inflation is greater than the shorter term risk of a recession. Which takes us back to Paul Keating's quote of the "recession we had to have".

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Hedge Clippings | Friday, 16 September 2022

In this edition: Inflation, Interest rates, and Recession

In November 1990 then treasurer Paul Keating famously opened a press conference by confirming Australia was in "a recession that we had to have."  

According to Wikipedia, former Reserve Bank Governor Ian Macfarlane said that policymakers did not "set out to have a recession in order to reduce inflation, but that the recession happened because of the unwinding of the excesses of the 1980s, the international recession of the early 1990s, and the high interest rates employed to slow the asset price boom of 1988-89."

It is often said that economic history does not repeat itself, but it often rhymes. We have certainly seen an asset price boom over the last decade, much of it powered by low, and even negative interest rates. What we haven't seen (as yet) is a stock market crash to rival that of October '87, which itself was triggered by an increase in interest rates in Germany and Japan. As a result, the Dow Jones dropped by 25% in a day, and the ASX by 40%. That market crash in turn triggered the global recession, which flowed on to Australia.

Where there is some similarity is the increase in interest rates, albeit not to the level of January 1990, when they hit 17.5%. This time around inflation, which has effectively been dormant in recent times, is the key, and central banks around the world, but particularly the US under Fed Chairman Jerome Powell, are prepared to do "whatever it takes", including triggering a recession, to tame it. The causes of inflation may be different this time, in part thanks to supply chain issues out of China, and energy prices, thanks to Russia's military exercise in Ukraine. However, central banks' only available economic medicine is to raise interest rates to curb consumer spending, all with a view of taming inflation.

Compared with 1990, the world is in a very different place, with the war in Europe, tension over Taiwan and the Pacific, and coming out of (hopefully) a global pandemic. A recession in the US and in parts of Europe seems almost inevitable, and whether Australia can dodge one remains to be seen.

In Australia, with unemployment at just 3.5%, and as yet with limited flow on to wages, inflation is running at an annualised rate of 6.1%, the highest since 1990. (There's that date again). Meanwhile in the US, inflation is 8.26%, admittedly down from an earlier peak of 8.6%, but a long way north of its average of just 2.3% between 1991 and 2019. In parts of Europe, (Portugal, Spain, Italy, and Greece for instance), inflation over the 2 years from Q1, 2020 to Q1, 2022 has ranged between 10 and 20%.

For signals that the US economy is either heading into a recession, or might almost be there, consider a couple of overnight news items: Firstly the yield curve between the US 2 and 30 year bond rates has inverted (generally a reliable indicator of a recession) with the 2 year rate at 3.85%, 38bps ahead of the 30 year rate to 3.47%, the deepest inversion for 22 years. Secondly, FedEx, the global transport giant, operating in an industry which acts as a canary in the economic mine if ever there was one, withdrew its previous earnings guidance, citing softness in its latest quarterly earnings, and foreshadowing further weakness next quarter.  

Meanwhile, the World Bank warned that the three largest economies - the US, China, and the Euro area - have been slowing sharply, and even a "moderate hit to the global economy over the next year could tip it into recession."

If all this seems like gloom and doom, remember there's a whole generation who have never experienced inflation, or higher interest rates, let alone an "induced" recession. Australia, as the lucky country, may just avoid one, but the signs for the US and Europe don't look as promising.

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Hedge Clippings | Friday, 09 September 2022

This week Dr. Philip Lowe copped a fair amount of flak following the RBA's fully anticipated decision to raise rates by a further 0.50% taking the rate to 2.35%. He also signalled further upward movements by stating he was "committed to doing what is necessary" to knock inflation on the head.

That's now five rate rises in five months. There's likely to be a further 2 or 3 increases at least, so even if they're not all 0.5%, or don't come at monthly intervals, the official cash rate is likely to be over 3% by early 2023, if not by Christmas this year. Therein lies the source of the flak: It wasn't so long ago that his "advice" was that rates wouldn't start rising until 2024.

It is probably fair to say it will be a while before Lowe looks that far over the horizon again, as the inevitable political opportunists - whinger in chief of everything, Greens leader Adam Bandt leading the charge - called for his resignation. The problem is (or was) that global central banks also underestimated the threat of inflation because much of the cause behind it wasn't there.

When Dr Lowe made his "steady as she goes until 2024" prediction, Putin hadn't indicated he was going to invade Ukraine and create an energy crisis. China hadn't gone into lockdown and created a supply chain crisis. Wages hadn't spiked upwards (and still haven't) to the same degree as inflation.

So Australia is in the same boat as the US, as well as the UK, or Europe, where interest rates were increased by 0.75% overnight, once again with the message that taming inflation (where it is significantly higher than in Australia) is a greater priority than the risk of a recession.

It is well understood that monetary policy and raising or lowering interest rates is a blunt instrument - and the only one - that the RBA has to counter the multiple inputs that create inflation, and affect the economy. As a result, it is not surprising that the RBA governor rejected calls for his resignation, and pointed to both the difficulties of forecasting in the time of Covid, the strength of the economy, and full employment.

That won't stop Adam Bandt whinging, but following the Queen's death overnight he's wasted no time in changing his angle of attack to target the monarchy. There'll be plenty of time for that debate in due course, but a little bit of respect might have been the order of the day.

Changing tack - Hedge Clippings used to feature a weekly section under the title of "Now For Something Completely Different" to finish the week on a positive note. Given there is now so much content on both the internet and social media, we have let that slide, but every so often an item comes along which we find either amusing or in this case uplifting.

This video of a street singer performing outside London's Covent Garden fits the bill, when he's joined by an actual stage star of Phantom of the Opera, Dutch Soprano Celinde Schoenmaker, for an impromptu duet. Enjoy!

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Hedge Clippings | Friday, 02 September 2022

Pendulums swing much like markets do - or maybe that should be the other way around. In the case of a pendulum, the extent of the swing is known as its amplitude, and once reached, it inevitably reverses according to science, returning back through equilibrium to the opposite amplitude. The time it takes to complete the whole cycle is technically known as the period. Yours truly knows this, not from paying attention in science class at school, but thanks to Uncle Google. Where would we be on a Friday without Google to check facts?  But back to markets...

Markets inevitably swing from one amplitude to the other, however not over a specific period, with the rhythm of science replaced by a multitude of known and unknown unknowns - including human nature and the psychology of greed and fear, economics, inflation, and central banks' reactions. Hence of course why harmonic motion and the pendulum can be taught in a single lesson, but markets continue to baffle and confuse even the experts. The last week has seen a sharp reversal in markets, thanks to comments from Jerome Powell at the Federal Reserve's Annual Jackson Hole Economic Symposium, where he basically said the Fed would do whatever it takes to tame inflation - even at the expense of the US economy being driven into a recession.

Markets take notice of central bankers, whether they're right or wrong, and Peter Costello, in his role as Chair of the Future Fund called out our own RBA this week while explaining the fund's negative return of 1.2% for the year to June. The ex Treasurer's criticism may well be valid, but surely the Future Fund has the resources, data, and ability to judge (or understand) when the RBA is heading in the right - or in this case, wrong direction?  Not only were the Fed and the RBA "caught napping" in Costello's words, but it sounds like the team at the Future Fund was too. Mind you, plenty of investors and fund managers would have been happy with -1.2% to the end of June 2022.

Other pendulums also swing - none more so than politics. The current talkfest in Canberra is a litmus test of the changes following the demise of Scomo in May. Equally in the USA, the swing right to left as Biden replaced Trump heralded a new harmonic motion, although harmony is hardly a word one would use when referring to Trump. This week the death of Mikhail Gorbachev, the last leader of the Soviet Union, also bought into sharp relief the political pendulum's swing in Russia as Putin attempts to turn back the clock and recreate a past empire - preceding even that of the USSR. Putin was no fan of Gorbachev, as evidenced by the fact he reportedly won't attend the funeral. Or could that be on security grounds?

Putin's war is not going well - or as well as he had hoped. Russia's great past victories have been repelling invaders (Bonaparte and Hitler) assisted by a long cold winter. This winter will see the boot on the other foot, but assuming no victory either way by Christmas, the long cold winter will see energy shortages across Europe which will certainly test the West's resolve.

Finally, while still on Russia, Ravil Maganov dies (officially put down to suicide) as a result of another unfortunate window failure and fall from the 6th floor of a Moscow hospital. Anyone who has read Bill Browder's excellent book "Freezing Order" would understand the likelihood of that!

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Hedge Clippings | Friday, 26 August 2022

Newly minted Treasurer Dr. Jim Chalmers set the proverbial cat amongst the superfund pigeons this week by proposing that an (unspecified) portion of all super balances should be invested in "national priorities" - areas like "housing and energy". To ensure his point was made, he was supported by Paul Keating, the self styled grandfather and co-creator of Australia's compulsory superannuation system.

Hedge Clippings can see some merit and logic in this - in fact we have previously proposed that given super's long-term investment timeframe of up to 45 years or more, and the long-term investment needs and nature of infrastructure, the $3.4 trillion in super (forecast to grow to over $9 trillion by 2040, and $34 trillion by 2061) makes an ideal source of capital. Added to that, infrastructure as an asset has the attractive investment characteristics of steady long term income and growth, and in Australia at least, a stable political environment. Whilst slightly out of date (actually we couldn't find any date on the report, except at that stage the total in super was a mere $1.7 trillion) this report by the Financial Services Council and EY considered the issue in detail.  

However, the difficulty, as pointed out by a number of super funds and their trustees, is that they're responsible for returns, not national priorities such as housing and energy. This argument falls down of course when one considers the emphasis on the ESG credentials of many funds, and the fact that they're the beneficiaries of a government legislated stream of fees akin to Norman Lindsay's Magic Pudding. Chalmers will argue, with some justification, that given the government's role in supplying the pudding's recipe, plus its generous (but complex and changeable) tax concessions ingredients, that they're entitled to stipulate how and where it is invested.

Up to a point Lord Copper, as Mr. Salter would say. The danger of giving politicians of the day the power to direct which "national priorities" are important is obvious. One would imagine Scomo's priorities for instance might be somewhat different to someone (probably anyone) else's.

Moving on.  

Last week we noted that a strategy paper delivered at the Portfolio Construction Forum (PCF) by Marko Papic put forward the view that President Xi would not invade Taiwan as it would cause China itself too much damage - political, military, economic and social. One alert reader of Hedge Clippings (thank you!) pointed out that the same Marko Papic had apparently prepared a similar presentation for the February PCF, espousing the view that Putin would not invade Ukraine as it would cause Russia itself too much damage - political, military, economic and social. Needless to say, as the Russians invaded Ukraine on 24th February, and the PCF was held on the 25th, we understand there was some deft adjustment to the agenda. This time around we hope his thesis is correct, but hope, as they say, is not a reliable strategy.

Which brings us to anniversaries: As above, his week the war in Ukraine passed the six month mark, when most - but particularly Putin - thought his "military exercise" would be over in weeks. Sadly, next week also brings up the 25th anniversary of the death of Diane, Princess of Wales. But on a happier note, (for those old enough to remember) August 24th was the 50th anniversary of one of the greatest rock concerts of all time - Neil Diamond's "Hot August Night" held at the Greek Theatre in Los Angeles. The resulting live recording was made into a double album running over an hour and a half. Here's a link to Crunchy Granola for old time's sake.

It must be the cry of generations: Oh! for the days when music was music!

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Hedge Clippings | Friday, 19 August 2022

This week in review:

Scomo..... what was he thinking? Let's not go there... Neither in our view should further time and money be wasted on having an inquisition. It would seem nothing Scomo did was actually illegal, but the lack of transparency defies logic, and will define Scomo for ever. If nothing else, it at least shows the dangers of having a popularly elected President - if Donald hasn't already proven that.

Moving onwards and upwards - hopefully in more ways than one...

Markets bounced in July, with the ASX200 Accumulation Index rising 5.75%, after falling 8.77% in a horror June, while the S&P500 bounced 9.22% to make up for its June fall of 8.25%.  Funds generally enjoyed the ride, with 80% of the funds on  FundMonitors.com having reporting their July results, with those hit hardest in June enjoying the best of July. Having been on the nose in June (and if it comes to that for the past 6-8 months) growth stocks, and the funds investing in them, were the big winners, although in many cases they have a long way to catch up to their previous highs. There's no doubt there was some irrational selling, particularly in the small/mid cap space, as stretched valuations, gearing, year end tax selling etc., saw some companies trading close to or below cash backing.

While we (and others) tend to focus on "performance" and top performing funds, there's a risk doing so at the expense of looking at risk and drawdowns. When the ASX200 fell 8.77% in June, 72% of equity based funds outperformed (i.e. fell less than the index). In July's market rally of 5.75%, only 40% of equity based funds managed to outperform the ASX200. Over the past few weeks we have been publishing our "Spotlight" series of articles exploring quantitative assessment of funds' returns to create a top performing portfolio. For those of you who have been following these articles, chasing top performing funds over the short term (say 1 year) is not the solution.

The problem is that taking a longer term view (say 3-5 years) involves a variety of economic and market conditions, when funds with different styles, (for example growth or value) and strategies, perform very differently. In the past 3 years alone we've had 2 "bear" or negative equity markets. Extend that further, and the Global Equity Index benchmark (effectively the MSCI) was in negative territory on a cumulative basis from late 1999 through to the start of 2014 as shown by the chart below of Platinum's International Share Fund (blue) vs. the Global Equity Index (red), showing the effects of the dot com bubble of the late 1990s, the resultant "tech wreck" in 2000, and then the GFC in 2007-08. By comparison, the recent downturn (so far) puts things in perspective.

There's a lesson in this for markets - a bubble always bursts, and the bigger or longer the bubble, the greater the burst.  As for fund selection the lesson is equally clear: Protecting the downside through active risk management should, over time, result in good long-term performance.

This week Hedge Clippings attended the Portfolio Construction Forum, as always expertly managed and MC'd by Graham Rich, with the addition of a variety of excellent speakers and panels covering (as one would expect) Portfolio Construction. The underlying theme over the two days was "The future ain't what it used to be". Given the above chart showing the variable market conditions experienced over the past 25 years, it's no surprise that asset allocation decisions (equities, bonds, alternatives, etc) are vital, but that requires a crystal ball. Having set asset allocations according to forward looking projections, the actual stock (or in our case fund) selection for a diversified portfolio is made based on backward looking history, namely the fund's track record.

Nearly every advisor and fund manager we know (understandably) relies on past performance, but if "the future ain't what it used to be" is correct, it doesn't make fund selection, or portfolio construction, any easier!

Of the many speakers at the forum, one of the most insightful was Marko Papic, Partner and Chief Strategist of the Clocktower Group in Santa Monica, who challenged the view often held in Australia that conflict over Taiwan was inevitable. His view (as my takeaway) was that the cost to China, and not just in economic terms, would far outweigh the strategic or geographic benefit of a military outcome.

We hope he's correct, otherwise the future's not only not going to be what it was, but it's looking decidedly uncomfortable.

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Hedge Clippings | Friday, 12 August 2022

Following last week's rate increase of 0.5% by the RBA, and the inevitable flow-on from the big banks, various sections of the media made a song and dance about how much higher mortgage rates are likely to go, and how much stress that's going to put on homeowners, and thus push the economy into a recession. This week therefore, it is worth taking notice of comments by the CEO's of the CBA and ANZ, both of whom are more optimistic than the economic doomsayers. Given that between the two of them they have their fingers on the pulse, or at least the numbers of the bank statements of half the population, they should know.

ANZ's Shane Elliott thinks an Australian recession is "extraordinarily unlikely", while Matt Comyn doesn't believe there will be widespread mortgage defaults within CBA's home loan book.

Given the sensitivity to any interest rate increases from the record lows of the past few years, the facts would appear to support Comyn's view that the RBA will only need to raise official rates twice more, once by 0.50%, and a final 0.25% before Christmas. 40% of CBA's mortgage customers have fixed loans, and most won't be affected for another 18 months. Added to this almost 80% of CBA's borrowers are ahead with their payments, and around one third are two years ahead. Finally, the CBA, along with other banks, have been tightening mortgage eligibility for a while in anticipation of higher rates.

As we see it, the biggest risk for homeowners is that property prices fall significantly (say more than 20%), whereupon banks, who have a habit of wanting an equity top up from their stretched borrowers, demand just that. Hopefully this time around prices won't fall that far, or if they do, banks will hold their nerve.

Meanwhile, the above scenario (official rates to be limited to 2.75% or say 3% as a maximum) relies on inflation peaking and therefore falling into the RBA's "transient" category. It's well accepted that to date, rather than being wages driven, much of the inflationary pressure is either climate based (fresh fruit and veg for example), caused by supply chain disruption, and/or energy prices, thanks to the war in Ukraine.  As noted last week, there's probably a number of opportunistic price rises by some businesses being slipped in there as well.

As a result, Australian equity markets have continued to rally after their EOFY sell off, which particularly hit last year's winning peer group of small and mid cap managers, and their funds, which judging by the results below rebounded strongly. Even cryptocurrencies have stabilised, which has seen Bitcoin back above $24,000 from below $19,000 in early June. Equity markets seem to have ignored the war in Ukraine, as they did with this week's ramping up of action, and rhetoric, by the Chinese leadership over Pelosi's visit to Taiwan.

Coupled with the effects of climate change in Europe, which is threatening further supply chain disruption as the Rhine and Danube rivers become un-navigable in places, macro issues such as the threat of an all out war between China and the US (and allies) would put everything more in perspective.  Except that the markets, by and large, seem to be ignoring the storm clouds.

At their peril.

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Hedge Clippings | Friday, 05 August 2022

This week, to the surprise of no-one, the RBA increased interest rates by 50 bps to 1.85% in an effort to curb inflation and "to return it to the 2-3 per cent range over time, whilst keeping the economy on an even keel." The statement from the RBA's Governor, Philip Lowe was full of caution, and we'd suggest he's covering his bets when it comes to economic forecasting, and probably with good reason: Firstly, it's a pretty uncertain world, and secondly, his track record in the economic forecasting area hasn't been exactly spot on over the past couple of years.

The RBA cited a variety of reasons for the widespread inflation, but omitted to mention "commercial opportunism to increase prices" which anecdotally also seems to be a contributing factor.

Encouragingly (subject to his previous track record) the Governor expects inflation to peak later this year and then decline back to 2-3%, although he was careful not to put too tight a timetable on that, expecting 7.25% over 2022, falling to "a little over 4%" over 2023, and around 3% over 2004. That's mild given some forecasters are expecting UK inflation to top 15% within a year. The RBA is expecting a sharp slowdown in GDP growth from 3.25% this year, to just 1.75% over 2023 and 2024, as the effects of the rate hikes to date (plus those still in the pipeline) start to take effect. As above, given there have been calls from some economists for his resignation, Philip Lowe is covering his bets, stating the bank is "not on a pre-set path" and will be "guided by the incoming data".

That's a little harsh, but it's probably a lesson in caution when predicting the economic future while the likes of Putin and Xi remain in power. Putin's foray into neighbouring Ukraine was probably unexpected. Xi's ambitions in the South China Sea seem much more clear cut and more a case of when, not if, China will move on Taiwan.

Elsewhere this week, the ever ebullient and litigious Clive Palmer copped a paltry $20,000 payment to WA Premier Mark McGowan, who was ordered to pay Clive $5,000 in return in their joint defamation case. Given Palmer's reputation for having a thick skin and broad back, not to mention plenty of front, metaphorically as well as physically, he copped an equally paltry serve from Justice Lee, who "did not consider it safe to place any significant reliance upon Mr. Palmer's evidence". That would appear to indicate that he thought Clive was telling fibs, or dealing leniently with the truth, something most Australians worked out a long while ago. Most would be embarrassed to have been so described - Clive probably wears it as a badge of honour. Meanwhile, we wait to hear about costs, likely to dwarf the amount of damages, but probably not either of the litigants' egos.

More importantly, and probably of more concern to Clive, was news that Environment Minister Tanya Plibersek has proposed the rejection of his Central Queensland Coal Project due to its likely damage to the Great Barrier Reef, which lies just 10 km away. Nothing is certain, as there are 10 days of further consultation and public comment.  

Uncharacteristically, Clive hasn't (to our knowledge) commented to date, but no doubt this will change in time based on his past history. One thing is certain however: If Tanya's rejection comes to fruition, it's going to cost Clive a motza, whatever the cost of his antics in WA's legal system, but unlikely to change his demeanour.

This week we also released our Spotlight article on the FY 2022 Peer Group Analysis, covering the past 12 months, 5 and 10 years. While the past six months has been difficult for most Peer Groups there have been some encouraging signs that June may have marked a base, with some early July performances reflecting improved equity markets.

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