Investment research mouseEvery bull market has it's pin up boy.  In the early 2000's, it was the technology stocks where we witnessed companies 'reinventing' themselves by adding .com to their name, accompanied by large share prices increases.

Today, the Technology companies that are rising rapidly are underpinned by significant growth in revenue and profits, something that was missing from much of the tech sector early this century.

But there is a new 'Next Big Thing' that is attracting investment, probably from many who have not seen market cycles before, or fads come and go.  We are of course referring to Crypto currencies, led by Bitcoin.

At this point we wish to make the point that when discussing crypto currency it is important to separate the technology behind crypto currency from the currency itself.

The technology behind Bitcoin and other crypto currencies, known as Blockchain, is real and likely to influence the financial system around the world as banks, stock exchanges and share registries are investing heavily in the technology.  Put simply “The blockchain is an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value.”

Picture a spreadsheet that is duplicated thousands of times across a network of computers. Then imagine that this network is designed to regularly update this spreadsheet and you have a basic understanding of the blockchain.

Information held on a blockchain exists as a shared — and continually reconciled — database. This is a way of using the network that has obvious benefits. The blockchain database isn’t stored in any single location, meaning the records it keeps are truly public and easily verifiable. No centralized version of this information exists for a hacker to corrupt. Hosted by millions of computers simultaneously, its data is accessible to anyone on the internet.

So the technology behind Bitcoin and others is real and is likely to materially impact the global financial system, particuarly to reduce processing costs and times and 'cut out the middle man'.

Our concern in this article revolves around the trading of Bitcoin and other crypto currencies by those seeking to get rich quickly.  The chart below tracks the rise of some of history's great bubbles, including Bitcoin.

What prompted us to write about this is when I began seeing a friend of mine uploading a Bitcoin market report everyday on Facebook and scoffing at those who invest in "old world" sectors like fixed interest and the share market.  I can remember these type of conversations during the tech boom of early 2000's.

 

We are not professing to be experts on Bitcoin, or cryptocurrencies, we simply wish to highlight the issues that we would want to satisfy ourselves with before investing.  You can then make your own conclusion.

Cryptocurrency is a form of digital money that is designed to be secure and, in many cases, anonymous, making it ideal for money laundering, organised crime and drug/arms dealers.

It is a currency associated with the internet that uses cryptography, the process of converting legible information into an almost uncrackable code, to track purchases and transfers.  There are new cryptocurrencies being issued every week, and these are known as Initial Coin Offerings.

It is being suggested by enthusiasts that cryptocurrency will become the global currency benchmark, replacing paper money and the existing financial system.  We would caution against such a view as one of the key differences between cryptocurrency and say $USD, is that there is a Government standing behind the $USD.  So unless the Government were to default, the currency has value.  There is no Government support behind cryptocurrency.  In fact recently the Chinese Government  announced that public cryptocurrency exchanges would be shut down.

Our other questions include:

1. Why are cryptocurrencies not being embraced by larger insitutional investors, often referred to as 'smart money'?

2. What legal protections are available to investors who trade cryptocurrency in the event of fraud or other online mischief?

3. What is the intrinsic value of what investors are buying?  (ie the intrinsic value of buying a company is the future cash flow a company generates)

 

We leave this article quoting two famous investors (made famous for different reasons).  

Jordan Belfort, the original "Wolf of Wall Street" says that initial coin offerings "are the biggest scam ever" and "are far worse than anything I was ever doing".

Howard Marks, one of the worlds most famous investors, from Oaktree Capital talked about cryptocurrencies in his recent investor newsletter.  His word of caution was "They're not real".

 

 

Thursday, 12 October 2017 04:42

Business model disruption has only just begun

Written by

From a presentation by Hamish Douglass (CEO Magellan Financial Group) in October 2017

 

There’s a lot of business model disruption in the world and many companies will be left behind by the changes. There will be winners and losers in the years ahead, but sometimes business model disruption isn’t obvious. There are first-order effects when you have changes to business models, but when new technology and new businesses develop, it affects other businesses and other industries and it’s often not foreseeable. This is Part 1 of a two-part transcript.

Watch for second-order effects

If you look at a photograph of the Easter Parade in New York in the year 1900, it is full of horses and carriages. If you fast forward to 1913, the photograph is full of petrol-powered automobiles. Think about what had to happen, such as rolling out petrol stations. Transportation fundamentally changed in 13 years. In 1908, Henry Ford rolled the first Model-T Ford off the production line which enabled an automobile to be mass-produced at an affordable cost.

Many first-order effects are fairly obvious. If you manufactured buggy whips, you effectively went out of business. If you collected manure in the streets, you went out of business. There were 25 million horses in the United States in 1910 and 3 million in 1960.

The second-order effects aren’t as knowable. The second-order effects are what the automobile enabled to happen. An entirely new industry could move goods around far more efficiently. People could start the urban sprawl and move further away. We developed regional shopping centres due to the automobile.

Consider a simple change in technology, the automated checkout, such as in Woolworths and Coles in Australia. Walmart started rolling out these automated checkouts in around 2010 at scale and the other major retailers started doing the same. The first-order effects were a loss of jobs of the people working the checkouts, and retailers reduced their costs. And if one major competitor does that, other competitors follow, otherwise their cost structure is out of line.

But what of the second-order effects? Chewing gum sales have lost 15% of their volume since the introduction of automated checkouts in the US. The checkouts have disrupted the business model of impulse purchases. People do not drive to the supermarket to buy chewing gum, but when you used to stand in those checkout lines, you would pick up some chewing gum. I think mobile phones have had a bit to do with it too, because you now do other things when you’re standing there.

Our job as fund managers is to try and spot the next Wrigley. In 1999, at the peak of the technology bubble, Warren Buffett was asked by a group of students why he doesn’t invest in technology. He said he could not predict where the internet was going but investing in a business like Wrigley will not be disrupted by technology. And look what’s happened. Wrigley sales had gone up for 50 years, every year, before this change happened.

The pace of change is accelerating

Technology adoption appears to be accelerating. The chart below shows the number of years it takes to reach 50 million new users. We saw the rapid adoption with smart phones, and it only took Facebook five years to move from 1 billion to 2 billion users. These new technology-related businesses can scale at an incredibly fast rate.

I think there’s a whole series of factors explaining why this is happening, and a lot of things are starting to come together.

First, globalisation and the internet have enabled products to spread rapidly to much larger audiences around world. A second factor is the digitalising of goods and services. We have digitalised books, newspapers, music and videos. With Facebook, Google or Netflix, all their services are digital goods. Instead of spreading atoms around the world, we’re now spreading bits around the world where an identical copy of a digital good is produced at zero cost.

Third, the mobile phone today is more powerful than the world’s most powerful super-computer in 1986, in the year I left school, which is absolutely incredible. And now we’re connecting all these devices in ‘cloud computing’, where massive data farms don’t need computers to sit locally, and you can share all this information. So there’s a whole lot of infrastructure and change that’s enabling very rapid change.

The incredible power of two digital platforms

Consider the ‘GAF effect’ from Google, Amazon and Facebook. I don’t mean specifically those companies, but how they are affecting industries and important business models. First is the advertising industry. Google and Facebook know an enormous amount about their users. Anyone who uses Google has something called a Google timeline (unless you’ve opted out of it). On your Google timeline, in your user settings, you can go back five years and it will tell you exactly what you did five years ago if you carried your mobile phone, and most people do.

It tells you what time you left your house, whether you walked to the bus, which bus you boarded, if you went to work or not because it knows the address. If you take any photos on a day, it will put those photos on the timeline. It will tell you where you went for lunch, when you went home and if you went to dinner, it will tell you the restaurant. And this goes for every other day of your life for the last five years. It’s collecting enormous amounts of data about you, as are Facebook and others. That enables these platforms to start highly-targeted advertising and make it incredibly efficient.

In the last decade, traditional print advertising has lost about 24% market share, and I predict this will go to zero. It is extraordinary that outside China, two companies (Facebook and Google) have taken nearly the entire market share of a global industry that had many, many players in the world – magazine producers, newspapers producers, classifieds producers. All this revenue has ended up with two digital platforms that have this massive network effect. Television advertising, which is the largest pot of advertising money, has not yet been disrupted. We’re starting to see the rise of YouTube but it is still relatively small, as shown below. It’s probably got between US$6-8 billion of revenue at the moment, but it’s an industry with US$150-180 billion of revenue outside China.

Television is next

The television advertising business model is the next to fall due to two big factors. We’re experiencing the rise of these streaming video services. Think of Netflix, Amazon Prime, Stan, and Hulu, and Apple wants to enter this game. These businesses are spending enormous amounts of money on content creation. Amazon and Netflix this year will spend US$10 billion creating original content. They are far outspending anyone else on the planet. Facebook just bid US$600 million for the Indian cricket video streaming rights and were outbid by News Corp’s Fox. I think that’s one of the last-ditch efforts to protect sporting rights and there’s a battle going on between the television and the movie networks. Apple and Netflix are bidding for the next James Bond.

They are taking viewers away from television and pay TV which reduces advertising revenues. Then on the other side, the costs of producing the content and buying the best shows is being bid up. It is not a great business model if your revenues go down and your costs go up.

We’re also seeing the advent of new video advertising platforms. The streaming services are not advertising businesses, they are subscription businesses. But YouTube and now Facebook (and they’ve just launched Facebook Watch) are advertising business models, and I believe that a huge amount of the revenues that are currently in television and pay TV are at risk. It’s fundamentally different, because this is targeted advertising. These platforms know so much about the users that advertisements can be delivered specifically to what the users are watching on these new platforms.

The television advertising model as it currently stands gives a number of companies in the world a huge advantage because there are massive barriers to entry to promote products on television if you want to advertise at scale. It will be much easier to enter one of these new platforms. You can do very specific programmes if you are developing a new brand on Facebook, YouTube or Google compared with advertising on television.

The Amazon effect

Amazon is a business with an estimated US$260 billion in sales (including Whole Foods), the second largest retailing business in the world after Walmart. It’s a fascinating company. They run a ‘first-party’ business, where Amazon buys the goods, stores them in their warehouse and then sells them to their users via the Amazon website or mobile apps. Then they have a ‘third-party’ business called Fulfillment by Amazon, where other retailers put their own inventory into Amazon’s warehouse and then Amazon sells that inventory to their customers as well. So customers suddenly have a much greater selection, and Amazon charges other retailers rent for having their goods in the Amazon warehouse, then charges a commission for selling to the user base.

Amazon also is a massive logistics company. They are expanding warehouse space by about 30% a year and they are incredibly advanced from a technology point of view. They have developed with a robotics company something called the Kiva robot, with about 45,000 of these robots in their warehouses at the moment. Humans are good at putting goods in a package, adding a label and sending them off. But it’s inefficient for the human picker to run around the warehouse to find the shelf where that good is stored in these massive, multiple football field-sized spaces. So these robots automatically go around the warehouse and bring the shelves holding the product to the packers.

The loyalty scheme called Amazon Prime started out with two-day free shipping, then same-day and 2-hour free shipping in a number of cities around the world. Amazon Prime members receive free video, free music and free ebooks with the service.

Amazon is a also a data analytics company. They understand enormous amounts of information about what the customer wants to buy. Amazon members see web pages that look different to anybody else’s. There are 50 million goods available in Amazon so customers receive a particular look into the world.

Amazon’s Jeff Bezos wants to fulfil all of his customers’ shopping needs. He worked out that if you want to be in their everyday shopping, you need to be in the grocery shopping habit. They started with Amazon Fresh, an online grocery shopping business that’s very niche. But if you want chilled vegetables or meats or ice cream, it’s inconvenient to have them delivered on the verandah if you’re not there for two hours. A lot of people want to look at their fresh fruit and vegetables and not have anyone else choose that for them. So Bezos bought Whole Foods, the largest fresh food retailer in the US. It had a reputation for expensive produce, lots of organics, incredible displays. On the first day Bezos took control, on the key lines people are interested in, he dropped the prices 35-45%. People shop for incredibly good, fresh groceries then everything else can be put together.

He wants to connect your home by the ‘Internet of Things’. Many goods like washing detergent and milk will have computer chips on them that will connect to the internet to know when you are running out. Washing machines and fridges will automatically generate shopping lists. He’s adopting a voice platform for your house with a digital personal assistant.

What’s next?

There’s a massive number of these revolutions. You may think Amazon and Facebook and Google are big at moment, but we’re in the early stages of where this technology and these businesses are heading. Advertising and retailing is the start. Next week, I’ll discuss which large companies will suffer, and bring in the perspectives of Warren Buffett and Charlie Munger.

 

Tuesday, 26 September 2017 09:21

Rocket Man Kim - Keep calm and BUY shares

Written by

by Jack Lowenstein (Morphic Asset Management)

 

A few weeks ago, US Ambassador Nikki Haley to the UN intoned that “the North Korean can couldn't be kicked any further down the road because there was no more road”. But a few weeks seems to be a long time in rhetorical road building because the can has just had another boot applied, and is still on terra firma. 

Meanwhile after brief jitters when North Korean missiles were flying and the dust from underground nuclear tests was settling, global stock markets reached new all-time highs again last week, and several major central banks confirmed they were moving ahead with monetary policy tightening. 

Many investors ask us why we don’t tend to get more nervous about potentially catastrophic geopolitical events.

This note is a brief description of why we try to stay calm even in the face of potentially devastating instability on the Korean peninsula, and what might make that wrong. For the record, we used recent jitters to slightly top up our investment in Korea’s largest company Samsung Electronics, which makes it now the largest holding in our portfolios.

I first had to contemplate the implications of tensions on the Korean Peninsula and their potential resolution in 1990. In most regards, nothing has changed. That doesn't mean it never will - but probably not for some time. 

That year, when I was still a journalist at Euromoney magazine, I was sent to Seoul to write about the financial consequences of the Koreans copying Germany and reunifying. It must have looked like a smart idea from the distance of London, where people were still excited about the end of the Cold War and the demolition of the Berlin Wall. 

In Seoul, it quickly became apparent the proposition was laughable. 

The South, with its population of 45m or so had a per capita income generally estimated at eight times as much as that ‘enjoyed’ by the 25m in the North. Having only just escaped extreme poverty, itself, however it could little afford the cost of investing in the North to bring it up to its level quickly or cope with an influx of starving northerners moving south. So few in the leadership had any real interest in reunification, even if they had to go through the motions of aspiring for it in public. 

In North Korea, the ruling elite would lose all their privileges if not their lives if their regime collapsed, so they would never support reunification. 

The other four interested parties also had no real interest in demarche. China didn't want a western-leaning democracy on its doorstep. Russia didn't want to lose a distracting irritant to the other superpower, the US. The US didn't want to lose valuable forward bases in Korea and Japan that were nominally justified by a belligerent Pyongyang. And Japan didn't want to lose a fully engaged US military in the region. Nor did it have much appetite for a larger northeast Asian economic competitor.

Today similar factors apply. 

Pyongyang has buttressed its position through nuclearisation. “Rocket Man” Kim, as President Trump has undiplomatically dubbed him, would know his chances of preserving power, wealth or indeed his life would be negligible under a united regime.

South Korea could probably afford to integrate the North now, but the challenge from internal migration would be acute, given per capita GDP in the south is now at least 20 times higher than the north. 

Japan might worry less about Korean reunification than in the past, given the greater threat the present situation poses than in the past. The increased challenge from China now also justifies the retention of US bases in Japan to both Washington and Tokyo. A resurgent Russia, however, would probably be more opposed.

The Chinese dilemma is exquisite. Many in the Beijing leadership probably hate being held hostage by Rocket Man. But to give him up, would entail a loss of face. There would still be no interest in a country with a western orientation being directly on the border, even if it was agreed US bases would be closed.

Sadly the most likely way this impasse changes is by accident. And it is almost impossible to manage money in preparation for that kind of discontinuous event. 

Challenger superpowers like China are highly prone to start wars. Sometimes this is to distract from temporary economic setbacks, like the three wars Germany fought against Denmark, Austria and France between 1860 and 1870. Sometimes, like emerging Japan prior to WW2, wars can happen because a field commander can make a blunder and no one at the capital wants to lose face by bringing him into line. 

Pyongyang has too much to lose from deliberately attacking anyone, but what if a rocket veers off target and lands in Japan or South Korea? Or someone in the line of fire erroneously believes a rocket attack is under way?

My old friend Jonathan Allum of SMBC Nikko today drew my attention to the story of Stanislav Petrov who has died at the age of 77. On the 26th September 1983, he was the duty officer at a Soviet military facility that monitored the threat of missile attacks. The following is condensed from the BBC version of what happened that day.

In the early hours of the morning, Soviet early-warning systems detected an incoming missile strike from the United States. The protocol for the Soviet military would have been to retaliate with a nuclear attack of its own. But duty officer Stanislav Petrov decided not to report it to his superiors, and instead dismissed it as a false alarm.

"If I had sent my report up the chain of command, nobody would have said a word against it… The siren howled. All I had to do was to reach for the phone; but I couldn't move. I felt like I was sitting on a hot frying pan…Twenty-three minutes later I realisedthat nothing had happened. If there had been a real strike, then I would already know about it. It was such a relief”

A subsequent investigation concluded that Soviet satellites had mistakenly identified sunlight reflecting on clouds as the engines of intercontinental ballistic missiles… 

A salutary tale. Let’s hope the world stays this fortunate. But these really don’t seem to be risks we can hedge.

Monday, 25 September 2017 04:33

RBA likely to be on HOLD for 2017, 2018 and 2019

Written by

BillEvans small headshot WIBIQBill Evans - Chief Economist - Westpac

Markets have moved to price in three hikes for the RBA’s cash rate by end 2019. Other major banks concur broadly with that view.

Recall that in mid-August last year, these same players (markets and most other banks) were forecasting rate cuts over the course of the remainder of 2016 and 2017. Westpac’s view at that time was “rates on hold” in 2016 and 2017.

Readers of the Westpac Market Outlook publication for September will be aware that Westpac continues to forecast the cash rate to remain on hold out to mid-2019.

Indeed we are not convinced that the cash rate will need to rise any time throughout the course of 2017, 2018 or 2019.

This approach is clearly different to the thinking of the Reserve Bank Governor himself who expects to be tightening over that period (note his speech on “the next chapter” which was delivered yesterday).

However, we continue to point out that the RBA has a very different growth outlook for the Australian economy and Australia’s trading partners to our own.

The RBA expects growth in Australia to be 3.25% in 2018 and 3.5% in 2019 (above trend of 2.75%). Westpac expects a below trend pace of 2.5% in both years.

The RBA is also forecasting 2% underlying inflation in 2017 and 2018 (bottom of target band) to be followed by 2.5% in 2019.Underlying inflation is currently running at 1.8% (to June) and the upcoming revised weights are likely to reduce annual underlying inflation by 0.2-0.3%.

Going forward, the RBA’s inflation forecasts also look to be overly optimistic and are likely to be subject to downward revision. Recall that in 2016 when the RBA was forced to revise its inflation forecasts below 2% it believed it had little choice but to cut rates.

While the RBA does not provide detailed forecasts outside growth and inflation, comments from the RBA Governor and written reports point to a much more confident outlook for wages growth; incomes; employment; consumption; non-mining investment and the residential construction cycle.

The Reserve Bank expects wages growth to increase over the forecast period. A major puzzle for central banks globally has been the limited response of wages to stimulatory monetary policies since the GFC. Despite these policies in the US; Germany; the UK and Japan driving labour markets to near or full employment, wages have failed to respond. Explanations for this phenomenon have been structural: globalisation; technology; retiring higher paid baby boomers; low productivity growth; absence of pricing power for employers; low inflationary and wage expectations; high risk aversion following the GFC and job insecurity.

Consistent with that global theme, wages growth in Australia has also been weak. Australia’s wage price index has increased by 1.9% over the last year compared to average growth of 3.5%. The unemployment rate has held in the 5.5%-6.0% range compared to a generally accepted full employment rate in Australia of 5%.

Further, underemployment in Australia has been high at around 8.8% making total excess capacity around 14.5%. Given the global lessons on the structural wages outlook, it seems unlikely that wages in Australia (where spare capacity is higher than in these other developed economies) will lift significantly even in the medium term.

This weak wages performance has lowered annual real income growth to 0.6% while real consumption growth has held around 2.5%. The shortfall has been funded by a falling savings rate, particularly in the highly stressed mining states. Overall Australia’s household savings rate has fallen from 9% to 4.6% over the last three years.

Households will need to protect that fragile savings rate and pressures will emerge on consumer spending. Of course, other pressures are impacting households – rising energy prices; record high debt levels and political uncertainty. The latter effect will work through the business sector as businesses restrain employment and investment until political clarity is achieved following the 2019 election.

Markets may be underestimating the impact on the interest rate sensitive housing market of developments which are unfolding without official rate hikes.

The four majors (90% of the mortgage market) have been raising investor and interest only mortgage rates while applying tighter lending guidelines. House price inflation is slowing and regulators are unlikely to have any patience with a reversal of this trend.

To that point, six month annualised house price inflation (CoreLogic data) in Sydney has slowed from 22.4% in January to 4.8% in August. We observed a similar response to macroprudential policies in 2015/16 when six month annualised house price inflation slowed from 25% (July 2015) to -4.4% (April 2016).

Housing activity is also slowing despite a steady cash rate. Other factors, specifically relating to foreign investors, have turned the cycle. High rise building approvals have tumbled by 40% in the last year. This has been particularly due to investment restrictions in China; lending constraints by banks; and sharp increases in state government stamp duties for foreign investors. This downturn is likely to continue for at least a further two years.

While markets are currently captivated by expectations of a coordinated lift in global growth, we are more circumspect particularly around Australia’s trading partners.

With Chairman Xi likely to cement power following the National Congress in October, we expect that he will have little choice but to adopt policies to gradually deal with the excessive build up in corporate debt in China (now 166% of GDP), largely driven by the circa 30% compound growth rate of small and medium sized banks and non-banks over the last six years. These small banks now represent comparable asset bases to the heavily regulated policy banks which have only been growing at around 12% over the same period. It will be incumbent on the administration to arrest the growth rate of these small banks; off balance sheet vehicles; and non-bank institutions. Asset quality for these institutions must be suffering while reliance on overnight funding has lifted sharply.

Tighter credit conditions will slow China’s growth rate – we forecast a growth slowdown from 6.7% in 2017 to 6.2% in 2018.

Finally, the ongoing legacy of elevated risk aversion, which continues ten years after the Global Financial Crisis, is contributing to unusually steady interest rates around the world. Under our figuring, on the basis that this risk aversion persists for a few more years, a 40 month stretch of steady rates in Australia would not be out of place.

Monday, 04 September 2017 22:32

North Korea and investment markets

Written by
Written by Shane Oliver - Chief Economist AMP
 
Tensions with North Korea have been waxing and waning for decades now but in recent times the risks seem to have ramped up dramatically as its missile and nuclear weapon capabilities have increased. The current leader since 2011, Kim Jong Un, has launched more missiles than Kim Il Sung (leader 1948-1994) and Kim Jong Il (1994-2011) combined.

Source: CNN, AMP Capital
 
The tension has ramped up particularly over the last two weeks with the UN Security Council agreeing more sanctions on North Korea and reports suggesting North Korea may already have the ability to put a nuclear warhead in an intercontinental ballistic missile that is reportedly capable of reaching the US (and Darwin).

US President Trump also threatened North Korea with “fire, fury and, frankly, power” only to add a few days later that that “wasn’t tough enough” and “things will happen to them like they never thought possible” and then that “military solutions…are locked and loaded should North Korea act unwisely”. Meanwhile, North Korea talked up plans to fire missiles at Guam before backing off with Kim Jong Un warning he could change his mind “if the Yankees persist in their extremely dangerous reckless actions”. 
 
This is all reminiscent of something out of James Bond (or rather Austin Powers) except that it’s serious and naturally has led to heightened fears of military conflict. As a result, share markets dipped last week and bonds and gold benefitted from safe haven demand, although the moves have been relatively modest and markets have since bounced back.
 
At present there are no signs (in terms of military deployments, evacuation of non-essential personnel, etc) that the US is preparing for military conflict and it could all de-escalate again, but given North Korea’s growing missile and nuclear capability it does seem that the North Korean issue, after years of escalation and de-escalation, may come to a head soon. It’s also arguable that the volatile personalities of Kim Jong Un and Donald Trump and the escalating war of words have added to the risk of a miscalculation – eg where North Korea fires a missile into international waters, the US seeks to shoot it down, which leads to a cycle of escalating actions. This note looks at the implications for investors.

Shares and wars (or threatened wars)

Of course there have been numerous conflicts that don’t even register for global investors beyond a day or so at most if at all. Many have little financial market impact because they are not seen as having much economic impact (eg the war in Afghanistan in contrast to 1991 and 2003 wars with Iraq, which posed risks to the supply of oil). As such, I have only focussed on the major wars/potential wars since World War 2 and only on the US share market (S&P 500) as it sets the direction for others (including European, Asian and Australian shares).
 
  • World War 2 (September 1939-September 1945) – US shares fell 34% from the outbreak of WW2 in September 1939, with 20% of this after the attack on Pearl Harbour, and bottomed in April 1942. This was well before the end of WW2 in 1945. Six months after the low, shares were up 25% and by the time WW2 had risen by 108%.
  • Korean War (June 1950-July 1953) – US shares initially fell 8% when the war started but this was part of a bigger fall associated with recession at the time. Shares bottomed well before the war ended and trended up through most of it.
  • Vietnam War (1955-1975) – For most of this war US shares were in a secular bull market but with periodic bear markets on mostly other developments. Rising inflation and a loss of confidence associated with losing the Vietnam war may have contributed to the end of the secular bull market in the 1970s – but the war arguably played a small role in this.
  • Cuban Missile Crisis (October 1962) – Shares initially fell 7% over eight days as the crisis erupted but this was part of a much bigger bear market at the time. They bottomed five days before it was resolved and then rose sharply. This is said to be the closest the world ever came to nuclear war 
  • Iraq War I (August 1990-January 1991) – Shares fell 11% from when Iraq invaded Kuwait to their low in January 1991 but again this was part of a bigger fall associated with a recession. Shares bottomed 8 days before Operation Desert Storm began and 19 days before it ended and rose sharply.
  • Iraq War II (March-May 2003) – Shares fell 14% as war loomed in early 2003 but bottomed nine days before the first missiles landed and then rose substantially although again this was largely due to the end of a bear market at the time.

Source: AMP Capital
 
The basic messages here are that:
 
  • http://www.ampcapital.com.au/custom/reskin/images/bg-bullet-dot.png); padding-left: 11px; margin-bottom: 5px; background-position: 0px 8px; background-repeat: no-repeat no-repeat;">Shares tend to fall on the initial uncertainty but bottom out before the crisis is resolved (militarily or diplomatically) when some sort of positive outcome looks likely; 
  • http://www.ampcapital.com.au/custom/reskin/images/bg-bullet-dot.png); padding-left: 11px; margin-bottom: 5px; background-position: 0px 8px; background-repeat: no-repeat no-repeat;">Six months after the low they are up strongly; and
  • http://www.ampcapital.com.au/custom/reskin/images/bg-bullet-dot.png); padding-left: 11px; margin-bottom: 5px; background-position: 0px 8px; background-repeat: no-repeat no-repeat;">The severity of the impact of the war/threatened war on shares can also depend on whether they had already declined for other reasons. For example, prior to World War 2, the Cuban Missile Crisis and the two wars with Iraq, shares had already had bear markets. This may have limited the size of the falls around the crisis.

Possible scenarios 

In thinking about the risks around North Korea, it’s useful to think in terms of scenarios as to how it could unfold:
 
  1. Another round of de-escalation – With both sides just backing down and North Korea seemingly stopping its provocations. This is possible, it’s happened lots of times before, but may be less likely this time given the enhanced nature of North Korea’s capabilities.
  2. Diplomacy/no war – Sabre rattling intensifies further before a resolution is reached. This could still take some time and meanwhile share markets could correct maybe 5-10% ahead of a diplomatic solution being reached before rebounding once it becomes clear a peaceful solution is in sight. An historic parallel is the Cuban Missile Crisis of 1962 that saw US shares fall 7% and bottom just before the crisis was resolved, and then stage a complete recovery. 
  3. A brief and contained military conflict - Perhaps like the 1991 and 2003 Iraq wars proved to be, but without a full ground war or regime change. In both Iraq wars while share markets were adversely affected by nervousness ahead of the conflicts, they started to rebound just before the actual conflicts began. However, a contained Iraq-style military conflict is unlikely given North Korea’s ability to launch attacks against South Korea (notably Seoul) and Japan.
  4. A significant military conflict – If attacked, North Korea would most likely launch attacks against South Korea and Japan causing significant loss of life. This would entail a more significant impact on share markets with, say, 20% or so falls (more in Asia) before it likely becomes clear that the US would prevail. This assumes conventional missiles - a nuclear war would have a more significant impact.
     
Of these, diplomacy remains by far the most likely path. The US is aware of the huge risks in terms of the likely loss of life in South Korea and Japan that would follow if it acted pre-emptively against North Korea and it retaliates, and it has stated that it’s not interested in regime change there. And North Korea appears to only want nuclear power as a deterrent. In this context, Trump’s threats along with the US show of force earlier this year in Syria and Afghanistan are designed to warn North Korea of the consequences of an attack on the US or its allies, not to indicate that an armed conflict is imminent. Rather, comments from US officials it’s still working on a diplomatic solution. As such, our base case is that there is a diplomatic solution, but there could still be an increase in uncertainty and share market volatility in the interim. Key dates to watch are North Korean public holidays on August 25 and September 9, which are often excuses to test missiles, and US-South Korean military exercises starting August 21.

Correction risks

The intensification of the risks around North Korea comes at a time when there is already a risk of a global share market correction: the recent gains in the US share market have been increasingly concentrated in a few stocks; volatility has been low and short-term investor sentiment has been high indicating a degree of investor complacency; political risks in the US may intensify as we come up to the need to avoid a government shutdown and raise the debt ceiling next month, which will likely see the usual brinkmanship ahead of a solution (remember 2013); market expectations for Fed tightening look to be too low; tensions may be returning to the US-China trade relationship; and we are in the weakest months of the year seasonally for shares. While Australian shares have already had a 5% correction from their May high, they are nevertheless vulnerable to any US/global share market pull back. 
 
However, absent a significant and lengthy military conflict with North Korea (which is unlikely), we would see any pullback in the next month or so as just a correction rather than the start of a bear market. Share market valuations are okay – particularly outside of the US, global monetary conditions remain easy, there is no sign of the excesses that normally presage a recession, and profits are improving on the back of stronger global growth. As such, we would expect the broad rising trend in share markets to resume through the December quarter.

Implications for investors

Military conflicts are nothing new and share markets have lived through them with an initial sell-off if the conflict is viewed as material followed by a rebound as a resolution is reached or is seen as probable. The same is likely around conflict with North Korea. The involvement of nuclear weapons – back to weapons of mass destruction! – adds an element of risk but trying to protect a portfolio against nuclear war with North Korea would be the same as trying to protect it against a nuclear war during the Cold War, which ultimately would have cost an investor dearly in terms of lost returns. While there is a case for short-term caution, the best approach for most investors is to look through the noise and look for opportunities that North Korean risks throw up – particularly if there is a correction.
Monday, 04 September 2017 22:00

New Magellan listed trust - with a loyalty bonus

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Magellan Financial Group have announced a new listed investment vehicle, the Magellan Global Trust.

This ASX listed trust will commence trading on 18th October 2017, targetting an income yield of 4%pa and will be invested similarly to the Magellan Global Fund which has been established since 2007.

Existing investors in Magellan funds (both listed or unlisted) can apply for units in a priority offer and receive 6.25% worth of bonus units on the first $30,000 applied for.  Bonus value is up to $1,875, and to be eligible the Magellan Global Trust must be held until 11 December 2017.

The Priority Offer is open to any person who has a registered address in Australia or New Zealand and who, as at 5.00pm (Sydney time) on 1 August 2017, was a direct or indirect holder or investor in any one of the following (each an "Eligible Vehicle"):

  1. a)  Magellan Financial Group (ASX: MFG);

  2. b)  Magellan’s Active ETFs: Magellan Global Equities Fund (Managed Fund) (ASX: MGE), Magellan Global Equities Fund (Currency Hedged) (Managed Fund) (ASX: MHG) and Magellan Infrastructure Fund (Currency Hedged) (Managed Fund) (ASX: MICH);

  3. c)  Magellan’s unquoted registered managed investment schemes: Magellan Global Fund (ARSN 126 366 961); Magellan Global Fund (Hedged) (ARSN 164 285 661); Magellan Infrastructure Fund (ARSN 126 367 226); Magellan Infrastructure Fund (Unhedged) (ARSN 164 285 830); and Magellan High Conviction Fund (ARSN 164 285 947); and

  4. d)  at Magellan’s discretion, any fund or investment strategy for which Magellan is the investment manager or adviser.

 

GEM Capital will be flagging this issue to its clients directly, but in the meantime we attach a fact sheet about the offer.

 

Download Magellan Global Trust Fact Sheet

 

Download Magellan Global Trust Product Disclosure Statement

 

Thursday, 31 August 2017 00:14

Company reports can mislead investors

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We tracked how investors read company reports and here's how they're misled

File 20170828 27564 jnov8i The study used an eye-tracking device to ensure that all information included in the management report was read and considered in light of judgment formation. www.shutterstock.com Andreas Hellmann, Macquarie University

Investors would have spent a fair amount of time over the last few weeks poring over financial documents, as listed companies report their earnings and plans for the year to come. But our research shows they could have been misled just by the order of information in these reports.

We found that investors place more emphasis on the last piece of information in the management report included in company documents. Non-professional investors also ranked the performance of the company higher on more occasions, if the last piece of information is positive.

We invited 66 non-professional investors in our laboratory to read a management report of a fictitious mining company containing a short series of complex and mixed information. The positive information contained in the report told of increases in financial profitability and a strong operating cash flow. Negative information included a declining share price and increases in costs.

We randomly assigned the participants to two groups. The first group read the textual information included in the report in a sequence of positive information first and negative last. The second group read exactly the same information, but for them it was presented in the opposite way, negative before positive. We used an eye-tracking device to ensure that all information included in the management report was read and considered in light of judgement formation.

The investors we studied actually used the fictitious information in their investment decisions. Over 60% of participants were less inclined to invest in the fictitious company when negative information was presented last.

Easily mislead

Research into the behaviour of investors shows that the presentation order of financial information influences their judgements on company performance.

Because of the limited attention span and working memory capacity of the human mind, investors give more weight to information received later in a sequence.

So although financial information is often regarded as objective, neutral and value-free, the deliberate presentation ordering of information is able to influence non-professional investors. Companies could use this to try and hide negative information in the middle sections of a narrative and disclose positive information at the end of a sequence for the greatest effect.

Presentation ordering is not the only trick companies may use to influence the perceptions of annual report readers.

Graphs can attract investor’s attention and can be more easily retained in their memory than other narratives. Because of this, companies use significantly more graphs highlighting favourable rather than unfavourable performance.

One concern that arises from our findings is that readers of financial information may be mislead into believing there is more objectivity in practice than actually is the case. With regulatory efforts largely related to quantitative information, companies have much more flexibility in terms of how they present narrative information accompanying the financial statements in their reports.

Perhaps further guidance on the presentation of the management commentary is required by the global regulators to restrict the possibility that companies may influence the impressions conveyed to users of accounting information.

The ConversationMaybe next reporting season investors should take another look at what information companies include in their reports.

Andreas Hellmann, Senior Lecturer in Accounting, Macquarie University

This article was originally published on The Conversation. Read the original article.

Tuesday, 22 August 2017 04:39

Driverless vehicles are here

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The question is how quickly they become mainstream

(written by Magellan Financial Group)

 

Milton Keynes is a UK town about 75 kilometres to the northwest of London where many streets are reserved for pedestrians and bicycles. That made it a suitable place to test driverless cars, one of the great possibilities tied to the rise of artificial intelligence.

In what was declared a successful experiment, ‘pods’ with radar, lidar (that uses pulses of light to measure distance) and cameras feeding data into a central computer drove two passengers through the town during testing in 2016. The robocar travelled along the digitally pre-mapped two-kilometre route from the railway station to the town centre at a maximum speed of 15 kilometres an hour.1

The testing is part of a three-year government-funded program begun in 2015 run by the UKAutodrive consortium of businesses, governments and academics. The trials seek to overcome the technical, safety, legal, insurance and social challenges of using driverless or automated vehicles in cities.2

Such testing is happening the world over as driverless driving represents one of the most-touted aspects of artificial intelligence. Almost every developed country including Australia is hosting pilot studies on automated vehicles. The big technology companies such as Alphabet, Apple and Uber and the largest car companies including Ford, Honda, Tesla and Volvo are investing billions of dollars into driverless technology. US-based CB Insights tallies that 44 companies3 are developing autonomous technology and many of them are road-testing prototypes. The US research company estimates that global investment just in auto-tech start-ups topped US$1 billion in 20164 and reached US$1.6 billion in the first six months of 2017, more than double that of a year earlier.5 Those investing hope to profit from a leap in transportation as significant as the bound from horses to cars was a century ago. 

The promise of driverless cars, delivery bots and self-propelled buses and trucks is safer, faster, cheaper and more comfortable travel, especially for the disabled, the elderly and those who never learnt to drive. Robocars are poised to revolutionise travel within cities by promoting car sharing (what’s called transport as a service). Driverless proponents push the safety aspects the most because human error causes most of the world’s 1.25 million road deaths a year.6

The technological advances in automated driving are as impressive as any of the artificial-intelligence revolution. The breakthrough to fully autonomous cars has been made, cars are including more autonomous features, robocars that require human backup are for sale, self-driving taxis (with a safety driver) have picked up passengers and automated driving with no safety driver on public roads has occurred.7 Boston Consulting Group this year forecast that by 2030 a quarter of all miles driven in the US could be done in shared, self-driving (and electric) vehicles, and by that year more than 4.7 million autonomous vehicles will have displaced five million conventional cars.8 Research firm IHS Automotive predicts the take- up of driverless cars to accelerate from 2030, such that 21 million robo-vehicles will be sold annually by 2035.9 (In 2016, for context, about 92 million vehicles were sold worldwide.10)

But driverless cars are a while away from meeting the expectations of their biggest advocates such as Elon Musk who said this year that by 2019 the technology would allow people to sleep while being driven11 The largest obstacles to the mass uptake of driverless cars may prove to be challenges away from the technology. These issues include safety, legal and insurance liabilities, cybersecurity risks and making roads suitable. Above all this sits the unanswerable question of whether or not the public will feel safe being propelled at great speed by software. Enough people will surely be willing. Driverless vehicles are coming in some form – the technological advances so far, the amount of money being invested and the greater commercial viability of the technology will ensure a driverless world of some description. 

To download the complete article - click on the link below.

 

 

Wednesday, 02 August 2017 03:21

SA Bank Levy might be legal, but politically unviable

Written by
Joe McIntyre, University of South Australia

South Australia’s new bank levy, projected to earn A$370 million over four years, seems to be constitutionally valid but it remains hostage to political machinations.

While precise details are sparse, the Major Banks Levy will target those institutions liable for the Commonwealth bank levy (Commonwealth Bank, ANZ Bank, Westpac, National Australia Bank and Macquarie Bank). It will impose a state levy of 0.015% per quarter of South Australia’s share (about 6%) of the total value of bank liabilities subject to the federal government levy.

By making Commonwealth grant payments conditional on the removal of a levy, the federal government could force South Australia to abandon its bank levy.

It’s here that South Australia can benefit from the cover provided by the federal government’s bank levy. The federal government would be forced to tread a very tight line if they try to argue that it is fine for them to tap the banks’ honeypot but not for the states to do it too.

With new sources of state funding rare, South Australian treasurer Tom Koutsantonis has exploited this political opportunity, potentially signalling a shift of power back to the states. Unsurprisingly, the banks have reacted with fury, mounting their own attack campaign and threatening reprisals.

Taxation powers in Australia

The constitutional validity of South Australia’s bank levy rests on the distribution of taxation powers in the Australian federation. The power of the states has been eroded over time as the Commonwealth gradually came to dominate the federation.

The Constitution assigns almost equal power over taxation to the states and the federal government. Under Section 51(ii) the federal government is granted a power to enact laws with respect to taxation, but “not so as to discriminate between states or parts of states”.

However, Section 90 grants the federal government the exclusive power to impose “duties of customs and of excise”. So a state tax will generally only be constitutionally invalid if it’s characterised as a duty of custom or excise, or if it is incompatible with a Commonwealth Act.

Back in 1942, the federal government used its power under Section 96 to gain an effective monopoly on income tax. Under the scheme, the federal government levied a uniform tax on income, then gave a grant to the states equal to the income tax they had collected on the condition they cease collecting income tax.

In South Australia v Commonwealth (1942), the High Court upheld this effective takeover of income tax. While states retain the right to levy income tax, the risk of losing Commonwealth grants (together with administrative cost and competitive pressures) has made the proposition unattractive.

The federal government has consolidated more power through the expansive definition given by the High Court to the meaning of “duties of excise” in Section 90. For example, in the court case Ha v New South Wales (1997) a majority of the court held that duties of excise are taxes on the production, manufacture, sale or distribution of goods. As this is an exclusive federal government power, the states are effectively prohibited from taxing goods – such as sales tax.

The states have instead been forced to rely on a range of relatively inefficient transaction taxes (that is, stamp duties on certain written documents), on land taxes, and on payroll tax (levied on the wages paid by employers). The narrow base of these taxes has seen the federal government come to dominate taxation revenue – collecting more than 80% of tax revenue in 2015-16.

This “vertical fiscal imbalance” leaves the states dependent on federal government grants, together with any conditions attached to such grants. As Professor Alan Fenna has observed, the states are left:

…scrounging for revenue in economically inefficient or socially undesirable ways and going cap in hand to the Commonwealth.

With opportunities for the states to introduce new forms of taxation being so limited, the proposed South Australian bank levy is something of a game-changer.

The legality of South Australia’s bank levy

The levy’s structure doesn’t appear to involve the taxation of goods in a way that would go against Section 90 of the Constitution. The banks are being taxed on the basis of the value of an asset class they hold – in a way that is comparable to land tax.

Given the small percentages involved, this levy does not seem to interfere with the federal government’s levy, and would arguably not be incompatible with it. While relatively novel, the tax appears on its face to be constitutionally valid.

However, the politics of the issue is far more vexed, as the dark shadows of the federal government tied-grants scheme loom over all matters involving state tax. As Western Australia has learned, raising state taxes can have catastrophic unintended consequences. After that State raised mining royalties during the mining boom, the Commonwealth Grants Commission drastically reduced its share of GST payments - down to 34 cents in the dollar.

The fate of the state levy remains uncertain, with the politics very much in flux. What is clear is that the other states are taking notice.

The ConversationWith growing frustration over fiscal dependence on the federal government, it seems we may be entering a new phase of innovation in state taxation. Perhaps the federation is not yet dead.

Joe McIntyre, Senior Lecturer in Law, University of South Australia

This article was originally published on The Conversation. Read the original article.

Thursday, 13 July 2017 07:16

Platinum Quarterly Report - a great read

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Platinum Asset Management's quarterly report is always full of insightful information about the world economies and financial markets.

The most recent quarter considers the imbalance of investment capital around the world, comparing the economies of US, UK and Australia who all are spending above their income levels (running deficits) versus economies in Europe and Asia who are spending less than their income.  It is indeed thought provoking from the perspective of an Australian investor.

While quite a detailed read, we thoroughly recommend investors take the time to run through this excellent document that is put together by the professional investors who manage the money at Platinum rather than marketing spin doctors.

You can download your copy of the report by clicking on the image below.

 

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