Pete Wargent blogspot

PERSONAL/BUSINESS COACH | PROPERTY BUYER | ANALYST

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Thursday, 30 April 2020

Killing capitalism

Bear rally or raging bull

US stocks have torn higher as there were hopes of treatments for COVID-19 (again), and as the Fed promised to act 'forcefully, proactively, and aggressively' to meet its targets of maximum employment and price stability. 

This led to a torrent of fury on the Twitter, as uber-bearish commentators accused central banks of killing capitalism by unleashing the biggest stimulus ever seen onto global markets, instead of allowing prices to clear and floundering businesses to fail. 

They may have a valid point.

US GDP fell by -4.8 per cent in Q1 on their unusual annualised measure, while the unemployment rate looks set to explode towards 20 per cent. 

As an investor, though, there's no value in getting cranky at the charts...you've just got to stick to your plan!

The recent downturn has given rise to some solid opportunities, but not so much in trendy tech as in the 'Graham and Dodd' type stocks, including in energy, some telcos, utilities, consumer staples, and some financials trading at lower multiples. 

Some of the positions I hold have ripped higher, with thanks to the Fed.

Energy soared even further after hours to be up +70 per cent from last month's lows, as the 'reach for yield' became too strong a lure to resist.  


Shell is up by about +60 per cent from its lows, BP has followed a similar trend, and Occidental is up +70 per cent from its lows (having admittedly looked decidedly shaky under its debt pile). 

Around the world we'll likely see a rush of protectionist measures to shore up desperately struggling oil companies, as globalisation is wound back. 

The FTSE 100 index and the individual stocks I have in the UK have also mostly zipped higher on the rebound in sympathy with the US.

But...

Rule #1: Don't lose money

That's all great, but the honest truth is my recent allocation to equities has only been modest as demanded by my investment plan. 

I believe having an investment plan to adhere to systematically is critical as we sail through these uncharted waters.

Never before in history have we seen such high valuations sustained in the US while the global economy is so obviously heading into an almighty funk. 


Expected nominal returns from these levels over the coming decade might be in the range of 3 to 4 per cent per annum.

The risk, of course, is not that you get annual returns of 3, 4, 3, 4, 3....but instead a nasty drawdown as we've often seen before at these levels.

The potential downside risks in the US are obvious enough.

Of course, Occam's Razor might hold that the CAPE ratio could hold up some way higher than in past cycles due to the unprecedented stimulus, and the relatively low returns from cash and fixed interest. 

World-leading results

We've all read enough doom and gloom to last half a lifetime over recent weeks, but here's a brighter viewpoint.

New South Wales reported a positive test rate of just 0.027 per cent today (i.e. only 2 new cases of COVID-19) from a massive 7,387 tests over the past 24 hours.

Queensland reported zero new cases, and in fact only New South Wales has a material number of live cases now.

There were also no cases in Western Australia, while South Australia hasn't seen a case for 11 days,  and the Northern Territory 24 days.

The Australian Capital Territory reported zero new cases, and zero active cases, which is a tremendous effort. 

Around the country total ICU cases have fallen to just 35, leaving hospital beds empty, and Australia is clearly winning its battle with COVID-19.

This is an emotive subject to say the least, but I expect Australia's economy will now gradually re-open, if only for the simple reason that we've had almost no fatalities under the age of 60.


Source: Aus Gov, Health

Aussie bull market?

Australia's CAPE ratio is far more modest following a dozen years of sub-par returns, which means the expected returns over the coming decade could (indeed should) be materially higher. 

As a commodity exporting country Australia - alongside perhaps Brazil - may be well positioned over the coming decade to capitalise on China's building and infrastructure programs.

Naturally there will be a few challenges in the short term, as reflected in ANZ deferring its interim dividend today.

But, when focusing on statistics over stories, developed equities markets such as Australia and the UK might well have a decent decade of returns lying ahead, alongside a number of the considerably cheaper emerging markets. 

Wednesday, 29 April 2020

Rates on hold until 2023...

Inflation sputters higher

Annual headline inflation hit its highest level in 5½ years in the March 2020 quarter.

The quarterly result of +0.3 per cent saw the headline result at +2.2 per cent, largely driven by tobacco and alcohol, education, healthcare costs, vegetables, and some other foodstuffs. 


The RBA never did get to hit its 2 to 3 per cent target on the core measures, though.

For the wonks, here are the figures for the analytical measures:


The underlying measures have continued to undershoot since 2015.


Despite the stronger figures this quarter, next time around in all likelihood we'll be back to  material undershooting. 

Childcare alone could wipe off a percentage point in Q2, while data king James Foster tells me that Brisbane fuel prices at the bowser plunged as low as 87.9 cents today, so that's another 0.8 or so off Q2 inflation (except perhaps in the unlikely event that oil prices bounce over the coming weeks).

This is great for consumers...it's just a shame we don't actually need any fuel at the moment! 

You can follow James Foster's detailed analysis, as always, here.

The Reserve Bank's inflation target is supposed to be 2 to 3 per cent, on average, over the medium term, but core inflation has barely troubled the target range for the past half-decade as the economy has meandered along.

Given that rates won't rise until there's 'meaningful progress' towards full employment, you can pretty much forget rate hikes for a few years. 

Holding on

Hold or sell?

There's been a fair amount of talk about negatively geared landlords, and whether they might need to sell property during the rental market disruption.

You should never judge a 20-30 year investment on what's happening right now, but it's nevertheless worth taking a look at the current state of play.

With the Airbnb sector effectively shuttered at the present time some areas have seen a 5 to 10 per cent jump in rental listings as landlords seek tenants, especially in areas that are generally popular with students, holidaymakers, or short-stay lets.

With the borders also effectively closed to New Zealanders, tourists from China and India, and international students, there's likely to be a scramble for tenants over the coming months.

On the flip side, of course, Aussies aren't heading overseas either, so the net effect is less pronounced.


The New South Wales State Government looks set to do its part with the apartment overhang by buying up unsold new apartments from developers. 

The compensating good news for landlords is that some of the available mortgage rates have plunged over recent months.

The latest figures aren't available yet, but when they are they'll probably show that interest cost serviceability is back to where it was about 35 years ago.


Some of the 'rack rate' variable mortgage rates are still unreasonably high for investors, but for those taking a  moment to shop around rates may now be very low indeed. 


New owner-occupiers can secure mortgages from close to 2 per cent in some cases, while rates tend to be higher for investors. 

A lot of the statistics quoted on the number of negatively geared landlords are years out of date (the figure was 1.3 million in 2016-17, but interest rates have nosedived since then, so the figure would be lower today). 


Even assuming flat rents, a stylised model suggests that net rental losses will now be the lowest in years.


Most investors own one rental property, and the average net rental losses will probably be about $1,000 to $1,500. 


The detailed Australian Taxation Office statistics do show that many of those investors aged between 30 and 60 choose to hold an investment property with a reportable net rental loss of between $5,000 and $10,000 per annum, partly to reduce their income tax payable. 

Generally this cohort tends to be the white collar set, earning solid incomes in relatively speaking more secure positions.

Depreciation report (MCG)

Moreover, the net rental loss reported to the ATO is not the same thing as the investor's cashflow.

In fact it's possible to be negatively geared from a taxation perspective but still to have a positive cashflow, due to on-paper depreciation benefits and capital allowances. 

MCG's 1000 Assets 2020 report showed that there was a big increase in investors buying new property over a period of four years through the construction boom.

These investors tend to receive very significant depreciation benefits, but I expect there will many investors in this cohort facing negative equity as brand new property tends to...well, depreciate.


MCG's study also found that investors have become more aware of depreciation benefits, and as a result they're claiming deductions sooner than they used to. 


Source: MCG Quantity Surveyors

Some property investors will choose to sell, of course.

But the number of forced sellers will be lower than otherwise would've been the case due to record low mortgage rates, while borrowers have also been extended the option to switch to interest-only loans or take a 6-month repayment holiday. 

A couple of years ago many reports suggested that the interest-only reset would lead to a spike in mortgage arrears, but owners adapted and arrears barely moved. 

Tuesday, 28 April 2020

Lucky country gets lucky again

Property searches surge

Cameron Kusher, now at REA Group, posted an interesting piece on property searches here, which have suddenly spiked again to be some +37 per cent higher than a year earlier. 

There was a notable plunge after the rollicking start to the year, as the shutdown kicked in, but now searches have really been hotting up again.

This has previously been an interesting and useful lead indicator on what's to come for property transactions, as we saw after the May 2019 election and at the beginning of 2020 when markets were surging ahead at a double digit pace. 


Source: REA Group

The increase was mainly driven by Victoria and New South Wales.

Searches for places to rent have followed a similarly rebounding trend at the national level, albeit in a far less acute fashion.

This accords with what we're seeing, which is buyers cautiously returning to searches that they'd previously put on hold.

Why so?

Restrictions eased

The most likely explanation is simply that Australia's containment of COVID-19 in Australia has to date bordered on miraculous, and the states are now set to gradually ease back restrictions on movement. 

There were only seven confirmed cases of COVID-19 across Australia yesterday, and most new confirmed cases are now in known clusters rather than from community transmission.

Remarkable.


Today looks likely to show a similar result from perhaps 15,000 tests, with most states and territories now running at zero or somewhere very close to it. 


Less than a month ago, one report suggested Australia might have the 'world's worst management' of the virus, and yet now it has transpired that our results are among the very best in the world, alongside New Zealand. 

Whether that's by luck or by judgement - or most likely a bit of both - may only be known in the fullness of time.

As to how this is impacting real estate searches, there are three main factors to bear in mind.

Firstly, there are now record low mortgage rates for new borrowers, from just over 2 per cent, and these look set to persist for at least three years. 

Secondly, there's now some potential return for a return of the cobweb effect we saw before the election last year, which may kill new supply, at least in tightly held or blue chip areas. 


Dwelling starts look set to slump to around a 70-year low, and while plenty of aged listings remain on the market, quality new listings are now rather thin.

For example, Real Estate reported that there was just one new apartment listing in Coogee over the course of a week, which is exasperating for anyone wanting for take advantage of the slowdown.

And thirdly - a point I've alluded to previously - while Canada, the US, and many developed European and Asian countries have grappled with the spread of the virus, the two countries which are emerging with enhanced reputations as the most desirable to live appear to be New Zealand and Australia. 


A 'Lucky Country' indeed.

Monday, 27 April 2020

What to invest in, and when (Low Rates High Returns Podcast, Episode 3)

Stock picking

There's nothing wrong with investing in individual companies to invest in, and we still do this today.

But we have learned from painful personal experiences over the years that trying to pick the 'next big thing' can be fraught with danger when the growth wagon stops.

Even the biggest growth success stories of recent decades (think Amazon) have experienced enormous drawdowns, making it deceptively difficult be a successful stock picker consistently, and to stick with the selections through thick and thin. 

And making a mistake can result in a permanent loss of capital.

If rule #1 of investing is 'don't lose money', this is of course what we want to avoid.

Market mispricing

Instead of looking to pick the next big growth stock, we instead look for a market mispricing.

That is, the opportunity to buy a dollar for 50 cents, or as close to 50 cents as possible.

This in turn tends to lead us to the big, mature, and profitable systemic companies, which will throw off huge income streams between now and doomsday.

If you can look towards out-of-favour sectors in out-of-favour countries then this can lead to you to some very lucrative long-term investments.

For example, at the time of writing you might look at telcos, energy, tobacco, consumer staples, or healthcare companies, with the opportunity to harvest consistent 6 to 8 per cent income streams. 

Companies with high leverage or levels of gearing may be best avoided, to manage risk.

Much of Buffett's great genius over the years has simply been displaying the wisdom and patience to look for such proven performers, and the opportunity to buy them at an attractive price. 

And remember the Lindy principle: if a business has been around for 50-100 years and has proven itself to manage capital prudently profitably through multiple cycles, then it's a fair bet that it can continue to do do for another 50-100 years.

Risk hierarchy

The good news is that you don't need to be a stock picker these days if you don't want to be, as you can use indexes or ETFs to invest in countries or sectors. 

Generally speaking, we look towards countries and sectors that are cheaper than their long-run average, rather than more expensive, for obvious reasons.

If you take a global approach there will always be opportunities to buy low (and, later, sell high), every year. 

But as discussed in the previous episodes, it's critical to observe the macro environment, particularly with regards to the US market. 

The US accounts for about half of global market cap and is known to be the single biggest influence on equities markets around the world.

Thus when the US is expensive you need to be aware of the prevailing downside risks and adjust your asset allocation according to your plan. 

When the US market is cheaper, then generally speaking the macro risks for equities may be lower.

Low Rates High Returns podcast

You can listen to Episode 3 of our Low Rates High Returns podcast here at Apple iTunes (or by clicking on the image below): 


You can also tune in at Spotify, Stitcher, or Soundcloud

By the way, you can download a free chapter of our book here (or by clicking on the image below), and pre-order a copy of the book from Dymocks here:


Sunday, 26 April 2020

Money printers go brrr!

Jobless claims reach 26 million

After the initial guillotine strike US stocks have still been levitating at enormously high valuations, after accounting for the inevitable drop in earnings.

And this is in spite of a locked in recession, and a previously unfathomable 26 million folks filing for unemployment across only the past five weeks. 

To put that in context, it took the powerhouse US economy fully 10 years to create 22 million new jobs on a net basis, and just five weeks for 26 million jobs to be wiped out.

We've never seen anything like this before, so it's difficult to say what might happen next. 


The word 'unprecedented' is being bandied around a lot right now, but this is...well...a unique situation.

On to stock markets.

Yes, markets are well down down from the highs, but with earnings getting crushed forward P/E ratios are now trading at 19.1x, which is even higher than the enormously expensive valuations we saw around the turn of the year.

At first blush is mind-boggling given the wrecking ball that has blasted through the US economy. 

In fact, the recent rebound has been the fastest since the Great Depression, following on from the fastest -34 per cent crash on record. 

The forward P/E is now hovering waaay above the 5- and 10-year average, despite the deeply recessionary outlook. 


Source: Factset

Factset reported that year-on-year earnings were already down over four of the five past quarters -even before the Coronavirus recession - which is an interesting insight into how irrational stock prices were becoming.

As Shiller has pointed out previously, it's not the earnings which are much changed much through the market cycle, but rather the increasingly speculative price that people are willing to pay for those earnings. 

Now consider that if earnings were to fall by say, a quarter, which seems likely, then the P/E may in fact be above 25x, which is alarming (refer back to the above Factset chart for some context). 

Analyst consensus is for year-on-year earnings to be down by -32 per cent in the second quarter of 2020. 

Brrr!

Now it's often said that markets are forward looking, so perhaps investors are looking a looong way across the void to such a time when earnings can rebound again. 

Maybe. 

But realistically there can only be one explanation for these outlandishly high stock market valuations, and that's the US Federal Reserve has been expanding its balance sheet at an absolutely furious pace. 


You only need to look at markets which the Fed can't touch (cf. the recent implosion in oil prices) to see the true state of play. 

The question thus becomes: can the Fed overwhelm the natural decline in stock markets by creating more and more money out of thin air?

It's not a bet I would take on - in the last recession the PE ratio fell to 10 - but it will be an interesting one to watch. 

Saturday, 25 April 2020

Why buy & hold doesn't work in expensive markets (Podcast, Episode 2)

Why buy and hold doesn't always work

You can tune in to listen to Episode 2 of our podcast series at Apple iTunes here (or by clicking on the image below): 


Alternatively, you can tune in to listen at Spotify, Stitcher, or Soundcloud

Episode 3 of the series will be released on Monday, where we discuss what you can invest in, and when.

And thereafter, one episode will be released each week on the Monday. 

In the meantime, you can download a free chapter from our new book here


Weekend reads

Must see articles

This week at Property Update, a look at when Australia will reopen and more.

See here for more, or click on the image below:


You can subscribe for the free Yardney podcast here.

Friday, 24 April 2020

Domain Q1 Aussie housing

Domain housing report

There's been very little to discuss in terms of housing markets for a few weeks, with no open homes allowed and just a handful of online auctions.

Domain reported its Q1 median prices this week for houses:


And for units:


Property Observer ran through the numbers and outlook here, including the Domain forecasts for 2020 and 2021. 

Meanwhile Chris Joye reported at the AFR that Sydney and Brisbane prices have continued to rise through March and April, and that there will be no sharp downturn. 

Prices will either be flat or drop by 5 per cent at most, forecasts Joye, before the up-cycle resumes. 

Listing volumes and transactions have been so thin that's it hard to get a read on things. 

There still seem to be plenty of buyers around for apartments in Sydney - just look at some of the prices achieved through March and April - but there's been more caution for homes at the $2 million plus level, and the same is reportedly happening in Melbourne.

This is a very good time to do your own research on what's selling in your local market, with all sorts of different commentators pushing various barrows as usual. 

Podcast episode out next week

Next episode

A sneak preview of our next podcast episode, where we'll discuss the risk hierarchy:


You can listen to Episode 1 of the Low Rates High Returns podcast on iTunes, Spotify, Stitcher, or Soundcloud

As a recap, here's some of what we discussed in Episode 1:


You can pre-order a copy of our new book from Dymocks here (things have been a understandably a little slower than planned, but we're getting there!).


Thursday, 23 April 2020

Exports surge 29pc in March

Exports rebound

Hello...from the ABS:


Source: ABS

Export earnings soared 29 per cent in original terms following the slump through January and February, to be 16 per cent higher than a year earlier. 

The surge was due to coal, gas, petroleum, and especially a big rip in the value of iron ore exports to China. 

Imports also jumped 10 per cent, mainly due to a boost in demand for computers, mobile phones, and electronic goods, as Aussies lurched towards working from home in March. 

Huge job losses in late March

A tiny slither of hope for Q1 GDP, then.

But of course this pales into insignificance next to the job losses over recent weeks.

The ABS reported that employment fell by an estimated 6 per cent between 14 March and 4 April, mainly driven by major job losses in Victoria and Tasmania, and felt most keenly in the under 20s age cohort. 

Noted the ABS:

'The largest impact of net job losses, in percentage terms, was for people aged under 20, for whom jobs decreased by 9.9%.

Tasmania and Victoria had the largest decreases in jobs, down by 7.3% and 6.8%.

The Accommodation and food services industry saw the largest reduction in jobs (decreasing by 25.6%), followed by the Arts and recreation services industry (decreasing by 18.7%).'

The result has been an unprecedented surge in calls to Lifeline and other support groups.

Mercifully Australia is on course another extremely low number of new cases of COVID-19 today, with only 8 new cases discovered from 14,122 tests, for an increase of +0.1 per cent.

99.94 per cent of tests came back negative, for a Bradmanesque result.


There were a couple of further cases related to Newmarch in New South Wales, with one nurse and a paramedic also testing positive, but practically nothing else across the rest of the country.

Hearteningly, Tasmania recorded zero new cases for the first time since March 30.


Australia has smashed - not flattened - the curve.

Employment already fell by 6 per cent over the 3 weeks to April 4, and that was 19 days ago, with huge falls in services and manufacturing gauge activity. 

PM Morrison reported that Australia has minimized the spread of COVID-19 much sooner than expected, so the question thus becomes 'how and when do we re-open?'.

Wednesday, 22 April 2020

Houdini act

Blessed be the hoarders

There was an unprecedented +8.2 per cent spike in the preliminary retail turnover figures for March (charted by data king James Foster below), as Australians rushed to hoard toilet and tissue paper, rice, pasta, home office goods (Officeworks, IKEA), and a range of other supermarket produce and liquor retail. 


This led me to pose the following conundrum during an idle moment: could iron ore exports see Australia post a flat result for GDP in the first quarter (thus dodging the technical definition of a recession in the process)?



It was an interesting technical discussion to which the answer is a mathematically possible but highly likely 'no'.

In any case this is a moot point given that the national accounts for the second quarter are sure to be an abomination, with hundreds of thousands of Aussies not working this month. 

A beautiful set of numbers

In brighter news, the government has apparently pulled off a masterstroke in terms of containing the Australian spread of COVID-19, with an increase of just seven to confirmed cases today, from 12,599 tests over the past 24 hours. 


There were four further cases as part of the north-west Tasmania outbreak, but almost nothing else today. 



Many of the states and territories once again reported a nil increase in cases.


There were another 237 recoveries, and ICU cases fell yet again to 47, as the focus turns now shifts towards how and when Australia can ease its restrictions.


It's unlikely that Australia will pull off the Houdini act of avoiding a technical recession this time around, but the virus figures are so low that a decent rebound in Q3 is a possibility, even if the risk of a second wave of infections remains at large.