Sunday, 29 November 2015 21:17

Who says men don't remember

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Sunday, 29 November 2015 21:13

Rates to remain on HOLD

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BillEvans small headshot WIBIQThe Reserve Bank Board meets next week on December 1. We are confident there will be no change in the overnight cash rate. Our reading on Reserve bank thinking at the moment is that the Governor is unconvinced that lower rates will boost activity.

In the Q&A following a dinner presentation on November 24, he noted that he was prepared to cut rates: “I am more than content to lower rates if that actually helps”. However, the governor also indicated that he expected that signalling a period of stability and pointing out the positive developments in the economy might have a more constructive impact on confidence and growth than lowering rates.

We know that the bank sees interest rates as 'bringing forward' activity, but doubts whether that effect would spread much beyond residential construction with non-mining investment decisions being unaffected by the level of short-term rates.

We have seen more evidence in the September quarter capital expenditure survey around the weakness in investment, including services (down 10 per cent/qtr) with total investment falling a staggering 9 per cent in the quarter.

Of some comfort is a modest lift in the outlook for services investment in 2016/17 with the 6 per cent fall we saw in the June survey being scaled back to 4 per cent. Non-mining investment decisions are being impacted by high hurdle rates, a perceived need to further strengthen balance sheets, political uncertainty (significantly reduced with the change in leadership), and soft current and expected demand.

The Reserve Bank appears to believe that lower short-term rates would do little to offset those headwinds. It appears to believe that lower rates would only bring forward housing construction activity, creating an 'activity gap' later in the decade.

While this psychology persists, there is little chance of a decision by the board to cut rates. Indeed the Governor encouraged market participants attending the dinner to effectively loosen up, enjoy the Christmas break and take another look at the economy next year.

That eliminated any possibility of a December move. Recall that as recently as a month ago, market pricing implied a 100 per cent chance of a cut by December, with 12 out of 28 economists also predicting a move.

However, when the governor appeared to hold similar views this time last year, the following months saw a rapid reassessment. The governor’s statement after the December 2014 Board meeting repeated the constant theme through 2014 that the "most prudent course is likely to be a period of stability in interest rates”. By February the following year, the board had cut rates by 0.25 per cent and re-formulated its forecasts on the basis of a follow up cut in May.

Westpac predicted that rate cut despite the 'stability' remark being repeated in the December statement. That was because the print on the September quarter national accounts was particularly weak at 0.3 per cent/qtr; the annual national accounts had indicated a weaker economy for the year to June 2014 with annual growth revised down from 3.1 per cent to 2.8 per cent (mainly due to a weaker trajectory for consumption); investment plans in the September quarter capital expenditure survey continued to point to a sharp (7.5 per cent) fall; and iron ore prices were falling sharply (down 26 per cent over three months).

This time around we expect the September quarter national accounts to print 0.7 per cent/qtr (due to a 1.3 percentage point contribution from net exports although we expect a comparable 0.5 percentage point drag from contracting domestic demand); the annual national accounts only showed a 0.2 per cent downgrade to annual growth being attributed to government expenditure and mining investment (rather than the structurally more important consumption); capital expenditure plans for 2016/17 have improved a little (from -24.3 per cent in June to -20.9 per cent in September) including that modest improvement in the outlook for services investment; and the fall in iron ore prices has been 'only' 20 per cent.

It is also reasonable to assume that as rates move lower, the 'hurdle' to cut rates gets more formidable. The Australian dollar was also a bigger headwind last year, holding around US0.82 in December 2014 compared to US0.72 currently, with the realistic prospect of renewed weakness once the Fed begins its tightening cycle on December 18. Of course, there has also been a marked change in attitude towards the labour market.

Last year, the RBA believed the unemployment rate would continue edging up until mid-2015 (at least) whereas the current forecast is 'stability' with some prospect of falls in the unemployment rate. In conclusion we remain comfortable with our current view that the RBA will keep rates on hold through 2016. We are not expecting a repeat of the sharp 'about face' we saw this time last year. But, undoubtedly downside risks are to the fore.

Contracting domestic demand in the September quarter; falling iron ore prices; negative investment plans; and downgrades to GDP growth are all comparable with the main motivations behind the sharp reversal in policy in February this year. Markets are currently pricing only a 32 per cent chance of a move in February (down from 120 per cent a month ago). We can be certain of one thing: expect more volatility as the rate debate extends into 2016.

Bill Evans is chief economist at Westpac. 

Tuesday, 24 November 2015 10:55

Paris Attacks bring Russia in from the cold

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Christopher Read, University of Warwick

The full international consequences of Friday 13 November in Paris will take some time to work out but already dramatic changes have occurred. Inspired by an evangelically bellicose French president, François Hollande, France has declared a full-scale war on IS.

Even more dramatically, the UN has passed a resolution sanctioning the use of all necessary means against IS. There will be no Iraq-style debate about the legality of any military action in the Syrian and Iraqi deserts.

Islamic State, then, has achieved the near-impossible. It has united Washington, Beijing, Moscow, Paris, London, Berlin, Ankara and beyond. Assuming this configuration holds, IS – through its mixture of political naivety, incompetence and sense of invulnerability – appears to have signed its own death warrant by antagonising everyone that matters at the same time. It has achieved a clear fail in Terror Tactics 101 – divide your enemies and attack them separately.

Fighting talk from Francois Hollande.

Nowhere have these developments been welcomed more than in Moscow. It is still only a matter of weeks since Russia moved into the conflict in a firm and decisive way, unleashing bombers from home soil and the newly-refurbished Latakia airbase in Syria, and batteries of cruise missiles from ships in the Caspian and Mediterranean seas.

That, in itself, caught the West flat-footed. Russia is subject to sanctions and in its usual place on the western naughty step. How could they welcome this relative pariah to the struggle in Syria, even though the coalition going up against IS was, up to that point, getting nowhere?

Indecision, leaving action to others, the reliance on poor surrogates – such as the Iraqi army – and a fear of repeating the disasters of the Iraq and Afghan invasions had let the initiative slip to IS which had established itself more securely than anyone had believed possible.

The only solid resistance on the ground was coming from the Kurdish militias and the Syrian army. The West’s insistence on a three-sided war involving IS, Assad and the Syrian Liberation Army – encompassing the campaign against IS plus a civil war in Syria – was bound to lead nowhere. Russian intervention effectively turned it into a war on IS. A reckoning with Assad and the Ba’athist regime will be postponed until the resolution of the attack on IS.

Russian realism

While such an alignment is deeply ingrained in the logic of the situation, the sticking point in this new relationship was the status of the Syrian democratic opposition. Although it had the moral sympathies of most western observers it had proven itself too weak to combat either Assad or IS and yet it was unthinkable that it would fight, directly or indirectly, alongside Assad against the brutal, black-clad jihadis from Raqqa.

In one fell swoop, which may turn out to be one of the most massive self-inflicted injuries of recent memory, IS has made this debate obsolete. The liberal qualms and resultant indecision about having dealings with Assad – while by no means swept away – have been made irrelevant after November 13. IS has made itself what Putin and the Russian foreign policy establishment said it was: the undisputed number one enemy, not only of the West but of all the great powers and many others.

New best friends? Vladimir Putin and Barack Obama in at a G20 summit Antalya, Turkey, November 16. Reuters/Kayhan Ozer/Pool

The hard-headed and clear-sighted realism emanating from Moscow, may certainly be seen as cynical and amoral but it is also ultimately correct. IS is a bigger threat than Assad – who poses a threat mainly to his own people. In international relations, for better or worse, that is not the greatest consideration. Rwanda, Sudan, Eritrea, Somalia and many other examples bear testimony to that. In fact, one might speculate that Assad’s greatest error in the eyes of the West is to have been an ally of Russia since deep into the Soviet era.

Now, however, November 13 has made that, at least temporarily, an issue of secondary importance. Hollande has declared a struggle to the end of IS and, given the will, one cannot doubt that IS could be crushed. After all, its devotees are relatively small in number and are living in an exposed and barren environment which would, in conventional terms, open them up to serious military assault.

Of course, as opposed to the organisation, the spirit of IS might be less crushable. Destroying it risks creating a spectacular and long-lasting example of martyrdom, so it would have to be achieved with a possibly unlikely subtlety and caution.

The vilification of Jeremy Corbyn and others warning against a simplistic and emotional military response suggests that the long-term risks are being discounted in a red mist of revenge.

If it comes to that, not only will Putin be proved wrong in the long run, the West will have an even more complex battle on its hands. But, for the moment, however, IS has brought Putin in from the cold.

The Conversation

Christopher Read, Professor in Twentieth-Century European History, University of Warwick

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

Tuesday, 24 November 2015 10:21

Australian Growth - State by State

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The Australian Bureau of Statistics have released the annual State Accounts.

The state accounts provide annual estimates of output growth by state, Gross State Product.  Quarterly estimates are not available.

The accounts for the 2014/2015 financial year confirm that a growth transtion is underway.  The mining states of the north west, Qld and WA are slowing, while the southern states, Victoria, SA and Tasmania are improving.

WA, despite a loss of momentum, still managed to top the growth charts in 2014/2015 at 3.5%, moderating from 5.6%.  The two largest states came in next, with Victoria at 2.5%, accelerating from 1%, and NSW at 2.4%, rounding up from 2.3%.  Next were SA at 1.6%, rebounding from a soft 0.8%, and Tasmania, also at 1.6%, extending its recovery from 1.3%.  Qld tumbled from 2nd place to 6th place, with output growth of only 0.5%, slowing from 2.8%.

The maturing of the mining investment boom, as construction work on major gas and iron ore projects are progressively completed, was central to the loss of momentum in WA and Qld.  Across the south-east conditions benefitted from the significant easing of monetary conditions - with record low interest rates and a sharply lower currency.

South Australia

SA's economy bounced back, expanding by 1.6%, following a sulggish 0.8% gain in 2013/2014.  As with NSW and Victoria, the key service sectors were the growth engine (particularly retail, hospitality and communications) adding 0.6%, up from only a 0.1% contribution in the previous year.  Health, finance and real estate added 0.9%, up from 0.6%, while conditions were mixed elsewhere.

The outcome for 2014/2015 of 1.6% was only a touch shy of the 1.75% expected by the state government, ahead of an anticiapated rise of 2% in 2015/2016.


The Victorian economy experienced a significant rebound following a couple of disappointing years.  Gross State Product grew by 2.5%, up from 1.0%, an outocme close to the state's long run average of 2.7% and  a little above the state government forecast of 2.25%.  The government expects growth of 2.5% in 2015/2016.

As in NSW, the key service industries strengthened, addinng 0.7%, up from 0.4%.  In addition, it was a good year for both construction (0.5%) and finance (0.4%), as the housing sector responded strongly to low interest rates and an expanding population.


Source:  Westpac Economics 24th November 2015

by Michael Collins, Investment Commentator at Fidelity

Novmeber 2015

In 1919, a US lieutenant colonel helped lead an 81-strong convoy of vehicles across the US as part of a campaign by the military to highlight the need for better highways across the US. Sixty-two days after leaving Washington D.C., the procession reached San Francisco, having navigated dirt roads, improvised bridges and often no roads whatsoever along the 5,200-kilometre journey.[1]

Thirty-seven years later, this US solider was in a position to fulfil the convoy’s mission. The Federal-Aid Highway Act of 1956 ushered through by President Dwight D. Eisenhower still stands as the world’s biggest infrastructure project. More than US$800 billion (A$1.1 trillion) of today’s dollars was spent in the US to build 75,000 kilometres of highway, 55,500 bridges and nearly 15,000 interchanges. Moreover, the national highway system that bears Eisenhower's name is still prized for its economic, social and even military benefits.[2] 

Politicians across the world today often talk about leaving such an infrastructure legacy. For spending on public works is touted as a cure for today’s stagnation, more pointedly as a way to overcome the lack of business investment. Most ruling parties know they need to increase spending to spur growth and many, especially on the right side of politics, reflexively back an infrastructure splash as the best means to do that. The demand for broadband and the need to build or repair bridges, railways, highways, canals and water and sewerage pipes in the world’s biggest cities add further pressure on governments to spend money on public goods.

Infrastructure spending is hyped as an economic cure because its advocates claim that, done well, it boosts productivity, stimulates the economy, aids confidence, increases the quality of life and can help government finances, even if it adds to public debt. Few would argue with these advantages in theory. It’s the “done well” qualification that always proves hard to fulfil. If infrastructure investment does increase, expect lots of dubious, vote-buying and controversial, even corruption-tinged, projects – after all, the corruption watchdog Transparency International rates public-works contracts and construction the world’s most corrupt industry.[3] Expect much bickering about how to pay for the projects and warnings that governments are overloading on debt. These issues will serve to make contentious the economic benefits of infrastructure spending. There is one optimistic thought amid any hullabaloo about white elephants that may ease the public angst if governments do spend big on capital works.

Doing anything grand always generates some opposition, especially when it creates the natural monopolies that are most infrastructure projects. The Democrat-controlled House of Representatives rejected Eisenhower’s highway bill in 1955 because enough lawmakers didn’t want the highways paid for by selling bonds. (A petrol tax was the compromise.) Policymakers these days could surely embark on enough worthwhile public projects to make up for any duds. Not all countries, especially those in the emerging world, have lacked business investment in recent years, the main economic argument for the government to step in and spend on public works. Even if governments in the developed world stay idle on infrastructure, pent-up demand would probably see business investment recover soon enough for that’s how the business cycle works. That’s not the plan. The push is on across the world for governments to invest in infrastructure. It will be part of a strategy to boost productivity while restoring medium- to long-term government finances and taking pressure of monetary policy. Record low interest rates add to the case for public spending but don’t necessarily make it watertight.

Hesitant business

To make a rationale for abnormal levels of public investment – for governments need to do a routine amount under any economic conditions so their economies can function – the lack of private investment needs to be explained. Business investment in advanced economies has only averaged 20.7% of GDP since 2010 (having sunk to 19.5% in 2009) compared with 23.6% of output during the 1990s. An even more stark analysis is that the IMF estimates that private investment in the advanced world has declined by about 20% since the crisis began in 2007 compared with pre-crisis forecasts, a result that compares unfavourably with an average decline of only 10% after previous recessions.[4]

The overarching reason for sluggish business investment is weak economic activity. The US’ so-called Great Recession, Japan’s torpor and the depression in the eurozone have, in effect, created a downward spiral because businesses sensed a lack of demand for their goods and services and have refrained from expanding production. Uncertainty has played a role, too, especially in the eurozone where a sovereign-debt crisis has deterred business from chancing big projects. Other causes are tighter access to credit in countries where banking systems wobbled and higher interest rates in recent years for companies in bailed-out eurozone countries. The Reserve Bank of Australia in June offered the interesting notion that entrenched “hurdle rates” and quick returns are to blame; that businesses look for an expected capital return that, while well above the cost of capital, ignores the cost of capital and that they look for outlays to be recouped within a couple of years, which boosts implied rates of return. “As a consequence, the capital expenditure decisions of many Australian firms are not directly sensitive to interest rates,” the RBA said.[5] Whatever the cause, the decline in business investment is costly for it robs a society of its best chance to boost productivity and, consequently, lift long-term living standards.

If one accepts that weak economic activity is behind the lack of business investment then the economic case is strong for government stimulus. The question thus narrows as to whether investment infrastructure is a worthwhile form of fiscal prodding. The query can become ideological because it can be turned into an argument about the role, size and competence of government in a capitalist system.

Stagnation buster 

Better infrastructure is a pressing need in much of the developed world for much of what exists is in need of repair. Yet government spending on public works has stagnated or even fallen in many countries in recent years because lawmakers have prioritised more politically sensitive spending on education, health and welfare over public works when formulating budgets. Investment in budget-surplus Germany, for instance, has averaged just 19.4% of GDP in the past five years compared with 23.8% of output during the 1990s. Infrastructure, like military spending and foreign aid, are easy budget items to trim in prudent times.

Many analysts contend that governments are acting contrary to everyone’s self interest when they prune allocations to public works. Lawrence Summers, the former US Treasury secretary, sees that infrastructure projects are the best antidote to the so-called secular stagnation that has gripped developed economies. He and others argue that when joblessness is high, public works financed by borrowing can stimulate the economy without adding to government debt, whereas – and this is the key to his argument – such projects wouldn’t be stimulatory if they were to be paid for by higher taxes or cutbacks in other areas.

At the same time, the extra boost to the economy from a megaproject can help reduce government debt ratios when real interest rates are low. (A project with a conservative 6% return would boost government revenue by 1.5% of the amount invested, assuming extra income is taxed at 25%, which more than covers the real cost of borrowing at, say, 1%, he figures.) On top of that, government debt ratios would benefit from the extra tax from those employed on the venture and narrow even more if government were to encourage private investment or to use equity financing, tax subsidies or loan guarantees to catalyse a dollar of infrastructure investment at less than the cost of a dollar. “In a time of economic shortfall and inadequate public investment, there is for once a free lunch – a way for governments to strengthen both the economy and their own financial positions,” Summers says.[6]

A history of flops

If now’s the time to build the next Snowy Mountains Scheme or even another Sydney Opera House luxury-style project, what should people make of the useless infrastructure governments have built or the money lost on projects that never even get started? The Ord River Irrigation Scheme at the top of Western Australian that was finished in 1971 perhaps best symbolises Australia’s hopeless public-works project, and it’s one that came with environmental damage. It was commenced without proper assessment, funded for political reasons and has never become the food bowl its proponents envisaged. The more-recent National Broadband Network famously never had a cost-benefit analysis before being proposed by the ALP during the 2007 election campaign. Even a less-flashy version being completed by the coalition government looks like costing about 15 times the initial forecast price tag of $4 billion.[7] An estimated $1 billion has been squandered on Melbourne’s East West Link 18-kilometre freeway project without a scratch being made in the ground.

Such failed or controversial publically funded projects are found all over the world, best encapsulated by the putdown, “a bridge to nowhere”. Costs, risks and damaging side effects are usually underestimated in rigged feasibility studies, while revenue forecasts and any benefits are generally exaggerated. Amid all this dubious economics, any environmental harm is minimised. Yet the public interest is often overridden by vested interests. (At least the liberal democratic capital system, by limiting the reach of government, rules out disasters such as China’s Great Leap Forward of 1955-1961, an infrastructure drive of sorts that led to an estimated 40 million deaths.[8])

Even if a project is considered worthwhile, a political fight usually brews over how to pay for it. Higher taxes, more government borrowing, the sale of state assets or public-private alliances are the usual options. In practice (but not in theory where perfect efficiency is assumed), governments can make money out of partnerships. Government can always build something cheaper than the private sector because their borrowing costs are lower and they can fetch a good price if the project is operating successfully. Alas, private-public projects are unpopular because the public has been dudded by so many.

Depressingly for the pro-infrastructure crowd, the economic benefits of public projects are clouded. An IMF study looked at 24 infrastructure blasts since 1969 in 21 emerging countries and found that, rather than inspire a speedier economic growth, such splurges mostly lead to slumps. Either over-extended governments needed to cut back on spending to fix their finances or public spending suppressed private investment. “There is no robust evidence that the investment booms exerted a long-term positive impact on the level of GDP,” the paper found. It concluded by saying that any public-sector boom in coming years will only be beneficial “if governments do not behave as in the past and instead take analytical issues seriously and safeguard their decision process against interests that distort spending decisions”.[9]

If you think developed countries would do better, remember that investment in infrastructure has never revived Japan’s economy for long. But taxpayers can take one solace if they think billions will be wasted on public works. Even projects that cost money in an accounting sense generally have vastly understated immediate economic Keynesian benefits. Useless public investment still stimulates an economy. It’s better than no spending. But perhaps against all expectations, today’s politicians will prove to have the Eisenhower touch.

Financial information comes from Bloomberg unless stated otherwise.

Monday, 09 November 2015 17:43

Banks Report Card - November 2015

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Over the last week investors have been digesting multi-billion dollar profit results for the major trading banks,
wading through voluminous investor discussion packs, whilst listening to bank CEOs and CFOs give details on their
profit results. For 2015 ANZ, CEO Mike Smith’s final results pack took the cake for the largest presentation with over
150 charts on 268 pages!

In this piece we are going to look at the common themes emerging from the results, differentiate between the banks
and hand out our reporting season awards to the companies that grease the wheels of Australian capitalism. Further
what to do with the banks is probably the biggest issue facing Australian equity investors. The banks have all raised
capital in 2015, are repricing their loan book upwards and look cheap post a correction, but bad debt charges can
only rise from current historic lows.

Reporting season scorecard November 2015

Code Share Price Revenue growth Cash earnings growth Dividend growth Netinterest margin (reported)

Impairment chargeas


Returnon Equity Forward PERatio Forward dividend yield 2015 total return Summary of 2015result
WBC $31.33 3.6% 4.6% 2.7% 2.08% 0.12% 16% 12.4 6.10% -2.0% Pros: Margingrowth,Costslow, low bad debts, good cash earnings grow th Cons: Tax benefits slightly reduced earningsquality
ANZ $25.67 4.8% -3.7% 1.6% 2.04% 0.21% 13% 10.7 6.9% -14.0% Pros: Revenuegrowth,good dividend yield Cons: Asia , higher baddebts
NAB $28.53 2.0% 2.8% 0.0% 1.87% 0.14% 14% 11.3


-8.0% Pros: New management being proactiveCons:Weakearnings, interestmargin,weakbusiness bank
CBA(Aug) $75.83







13.8 5.70% -6.0%

Pros: Solid headlinenumber,

wellcapitalisedCons:5braising w ill make it tough to maintain highROE

Source:Company reports, IRESS, AuroraFunds Management

Across the sector profit growth was mixed with Westpac leading the pack and ANZ bringing up the rear due
to softer global markets income. Whilst the cash earnings growth in the above table looks pretty solid, the
bigger issue facing all the banks is what earnings per share growth they can deliver on their expanded share
base in 2016. For example Commonwealth Bank’s $5 billion raising in August added 70 million new shares or
an additional 4.3% to the number of shares outstanding. Obviously this should reduce CBA’s return on equity.
Over the last year WBC has been the star performer ensuring that revenues are growing faster than costs,
which is referred to in banking circles as positive jaws (think the mouth of a crocodile).

Bad debt charges low: One of the key themes across the 4 major banks and indeed the biggest driver of
earnings growth over the last few years has been the significant decline in bad debts. Falling bad debts boost
bank profitability, as loans are priced assuming that a certain percentage of borrowers will be unable to
repay and that the outstanding loan amount is greater than the collateral eventually recovered. A booming
property market in NSW and Victoria has resulted in loans formerly classed as impaired returning to
performing or being repaid. Westpac had the lowest bad debt charge (BDD), with their percentage
of impaired loans over total loans now at the lowest level since the bank was founded in 1817.
Whilst bad debt charges across the sector are extremely low, investors are watching for small upward
changes in the charge. Last week we saw ANZ’s BDD increase by 0.03%, due to a lift in impaired assets primarily in Asia.
Dividend growth stalling: Across the sector the rate of growth in dividends has been declining. This is a result of increased their dividend payout ratios (dividend divided by earnings per share) to relatively high levels. Furthermore given that in 2015 the banks suspected that they would be issuing new equity to build capital, they had an incentive to limit dividend growth to retain capital. CBA delivered the strongest dividend per share growth in 2015. Dividend growth in 2016 will be a more meaningful measure, as it will be on the new larger capital base. Looking out to 2016 the large banks are expected in aggregate to deliver +1.6% dividend growth, with CBA again expected to provide the highest dividend per share growth at +3%.
Loan growth: In 2015 the banks on average achieved 7.2% growth in their loan book, whilst loan growth is improving particularly in housing; overall deleveraging continues to have an impact on the net demand for new loans especially to corporates. Further loan growth has been capped by APRA guidelines designed to keep investment housing loan growth to less than 10% per annum and requiring banks to hold more capital against their loan book. In 2015 ANZ grew their loan book the most with 11%, with good growth in Asia and market share growth in domestic home loans
Net interest margins in aggregate were steady as deposit competition has moderated and the banks have begun to re-price their loan book upwards. Over 2015 CBA and Westpac had the highest and most stable net interest margins, whereas NAB and ANZ delivered both lower margins and actually saw falls in these margins. This reflects the two Melbourne-based banks having greater relative exposures to business banking and CBA/Westpac’s greater weighting to housing.

In July the big four banks raised rates on investment housing loans and in October the four main banks raised rates for both investors and owner occupiers. One of the key things we will be looking closely at over the next year is for signs of expanding net interest margin (Interest Received - Interest Paid) divided by Average Invested Assets). We expect that the banks will reprice their loan book upward to pass some of the costs of increased capital that have been born by shareholders onto customers.
Total Returns: In 2015 every bank has underperformed S&P ASX 200 total return (capital gain plus dividends), as investors have digested the approximately $18 billion of new capital raised over the year. Westpac has been the top returner amongst the banks giving investors a total return of almost -1.5%.
Valuations: Since April the banks as a sector has been sold off and as a sector it is now back to its long term Price to Earnings ratio of 12.7x and an above average fully franked forward dividend yield of 6.3%. Looking across the sector ANZ and NAB are the cheapest, with ANZ on a PE of 10.7x and 6.9% yield. This represents a PE of 85% relative to the average of the major banks. Looking at yields the banks as a sector currently trades at a 6.3% premium to the one year term deposit rate, the largest spread over the past 30 years.


Aurora Funds Management

Stuart Gietel-Basten, University of Oxford

ChinaChina is scrapping its one-child policy and officially allowing all couples to have two children. While some may think this heralds an overnight switch, the reality is that it is far less dramatic. This is, in fact, merely the latest in an array of piecemeal national and local reforms implemented since 1984.

In fact the change is really a very pragmatic response to an unpopular policy that no longer made any sense. And much like the introduction of the policy in 1978, it will have little impact on the country’s population level.

The overwhelming narrative being presented now is that this is a step to help tackle population ageing and a declining workforce through increasing the birth rate – dealing with the “demographic time bomb”. According to Xinhua, the state news agency, “The change of policy is intended to balance population development and address the challenge of an ageing population.” The party line is that the policy played an essential part in controlling the country’s population and, hence, stimulating GDP growth per capita. It prevented “millions being born into poverty”, but is no longer needed.

Of course, many scholars have disputed this official view. When the one-child policy was introduced, fertility rates had already fallen drastically, though there was an apparent paradox that overall population growth rates were very high.

Pragmatic response

As well as being unnecessary, the policy has become unpopular because of the heavy-handed actions of some local family-planning politicians who, either through force or corruption, brought the implementation of the policy into ill repute. Indeed, the “social maintenance fees” collected for infringements of the one-child policy were often zealously enforced in order to plug local budget shortfalls. In this sense, you could go as far as seeing the policy change as an indirect result of President Xi’s anti-corruption drive.

Countless studies – as well as the experience of previous policy relaxations – have shown that the likely long-term impact of any reform would be small. Couples who are already eligible to have two children in urban areas, and also increasingly in rural areas, are choosing to have one. This means that the likely impact on overall fertility may be low. In this context, one could see the scrapping of the one-child policy as being a practical, pragmatic response to deal with an increasingly unpopular policy, safe in the knowledge that the long-term implications are likely to be minimal.

Fertility in China Data: UN Department of Economic and Social Affairs

This is not to say, however, that the policy change is unimportant. Far from it. We must not forget that for many hundreds of thousands of couples, the change in policy will allow them to fulfil their dream of having a second child.

In the short term, then, there is almost certainly going to be a mini baby boom. In some poorer provinces which have had rather stricter regulations, such as Sichuan, the baby boom may even be quite pronounced. (However, it is likely that an increase in the total fertility rate would have occurred anyway because of what demographers call the “tempo effect”, where postponement of births among one generation leads to an artificially low total fertility rate.) As with anything in China, its sheer size will mean that the numbers will be striking. This will almost certainly lead to some pressures on public services in the future.

Chinese politics

The gradual move to a two-child policy is very reflective of the way policy is designed and changed in China. Scrapping the policy completely was not an option. This would have indicated that the policy was, in some ways, “wrong”.

Plus, one must not underestimate the size of the family planning bureaucracy. In 2005, it was estimated that that over half a million staff were directed involved in family planning policy at the township level and above, added to 1.2m village administrators and 6m “group leaders”. Effectively disbanding this overnight would have led to chaos.

But the fact that a change occurred indicates that major further change might lie ahead. Although it sounds counter-intuitive, after 35 years of strict anti-natalist policies, my colleague Quanbao Jiang and I recently argued that a switch to encouraging more children was not inconceivable, with China following the example of its low fertility neighbours in South Korea, Taiwan, Singapore and so on. Indeed, examples already exist of family planning officials in some Chinese provinces encouraging eligible couples to have a second child. Under these circumstances the family planning apparatus could play a critical role after performing a seemingly unlikely ideological shift.

Finally, questions will undoubtedly be asked about the legacy of the one-child policy. While its likely role in driving down fertility has probably been overstated, its role in shaping the highly skewed ratio of boys born compared to girls is widely considered to have been significant. In 2005 there were 32m more men under the age of 20 than women in China.

In my view, we will only really tell some 10-20 years in the future when we will be able to see how fertility in China develops. It may well be that the policy could have been too successful if it transpires that fertility remains stubbornly low. What is the likely psychological impact of 35 years of constant messaging extolling the benefits of one-child families? And how is that internalised? We shall see.

Looking elsewhere in Asia, though, the Chinese government may find that it is much easier to “encourage” people to have fewer children than to have more.

The Conversation

Stuart Gietel-Basten, Associate Professor of Social Policy, University of Oxford

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

Saturday, 31 October 2015 13:37

GEM Capital Movie Night - 16th November 2015

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Everyone at GEM Capital is excited about our movie night coming up on Monday 16th November at Capri Cinema.


We not only welcome our clients along to enjoy the latest Bond 007 movie "Spectre" - but also welcome any friends that wish to come along too.  Don't forget to RSVP by 9th November 2015 to Melissa Jones Ph 8273 3222 or This email address is being protected from spambots. You need JavaScript enabled to view it.


The evening will commence at 6pm with an hour of drinks and mingling before we kick off the 007 action.


In the meantime - here is the official trailer.


We have reproduced this article from Forager Funds - originally written by Matt Ryan - it's a good lesson on the dangers from buying assets from Private Equity firms.


Want to know how to turn $10m in to $520m in less than two years? Just ask Anchorage Capital. The private equity group has pulled off one of the great heists of all time, using all the tricks in the book, to turn Dick Smith from a $10m piece of mutton into a $520m lamb.

Having spent the morning poking through the accounts, we’re going to show you how it all happened.

Firstly, Anchorage set up a holding company called Dick Smith Sub-holdings that they used to acquire the Dick Smith business from Woolworths. They say they paid $115m, but the notes to the 2014 accounts show that only $20m in cash was initially paid by the holding company.


It doesn’t look like they even paid that much, because they acquired the Dick Smith business with $12.6m in cash already in it. Dick Smith Sub-holdings was formed with only $10m of issued capital and no debt, and that is most likely Anchorage’s actual cash commitment.

So if Woolworths got paid $115m and Anchorage only forked out $10m, where did the rest of the cash come from?

The answer is the Dick Smith balance sheet, and this is always the first chapter in the private equity playbook: pull out the maximum amount of cash as quickly as you can.

In this case, first they had to mark-down the assets of the business as much as possible as part of the acquisition. This was easy enough to do with a low purchase price. You can see in the table below, that $58m was written-off from inventory, $55m from plant and equipment, and $8m in provisions were taken.


The inventory writedown is the most important step in the short term. They are about to sell a huge chunk of inventory but they don’t want to do it at a loss, because these losses would show up in the financial statements and make it hard to float the business. The adjustments never touch the new Dick Smith’s profit and loss statement and, at the stroke of the pen, they have created (or avoided) $120m in future pre-tax profit (or avoided  losses).

Now they can liquidate inventory without racking up losses. And boy did they liquidate.

At 26 November 2012, Dick Smith had inventory that cost $371m but which had been written down to $312m. Yet by 30 June 2013, inventory has dropped to just $171m.


That points to a very big clearance sale, and the prospectus confirms that sales in financial year 2013 were exaggerated by this. The reduction in inventory has produced a monstrous $140m benefit to operating cash flow, basically from selling lots of inventory and then not restocking.

The cash flow statement shows that Anchorage then used the $117m operating cash flow of the business to fund the outstanding payments to Woolworths, rather than funding it from their own pockets (note that the pro-forma profit was only $7m during this period).


And that, my friends, is a perfectly executed chapter 1: How to buy a business for $115m using only $10m of your own money.

Chapter 2 involves selling a $115m business for $520m, and it’s a little more nuanced. The good news is that, while private equity are focused on cashflow, equity market investors aren’t really focusing on how much cash has been ripped out of the business. All they seem to care about is profit.

So the focus now turns from the balance sheet to the profit and loss statement, and it’s time to make this business look as profitable as possible in the year following the float (allowing them to sell it on a seemingly attractive “forecast price earnings ratio”).

The big clearance sale in financial year 2013 leaves them with almost no old stock to start the 2014 year. That’s a huge (unsustainable) benefit in a business like consumer electronics which has rapid product obsolescence.

Remember that marked down inventory? Most of it was probably sold by 30 June 13 but there would still be some benefit flowing through to the 2014 financial year.

Remember the plant and equipment writedowns? That reduces the annual depreciation charge by $15m. Throw in a few onerous lease provisions and the like, totaling roughly $10m, and you can fairly easily turn a $7m 2013 profit into a $40m forecast 2014 profit. That allows Anchorage to confidently forecast a huge profit number and, on the back of this rosy forecast, the business is floated for a $520m market capitalisation, some 52 times the $10m they put in.

Anchorage were able to sell the last of their shares in September 2014 at prices slightly higher than the $2.20 float price and walk away with a quiet half a billion. Private equity are renowned for pulling off deals, but if there’s a better one than this I haven’t heard about it.

Chickens home to roost

Of course, all of the steps taken above have consequences. By the end of 2014, inventory had increased to $254m, with new shareholders footing the bill for repurchasing inventory. This should have resulted in poor operating cash flow, but most of this was funded by suppliers at year-end, with payables increasing by $95m.

Come the end of 2015 financial year, however, it really comes home to roost. Operating cash flow was negative $4m, as inventory increases further and suppliers demand payment, decreasing accounts payable. The business is required to take on $71m in debt to fund a more sustainable amount of working capital. As the benefit of prior accounting provisions taper-off, profit margins fall, and the company reports a toxic combination of falling same-store sales and shrinking gross margins in the recent trading update.

Following a profit downgrade yesterday, the shares are now valued by the market at $0.77, and investors in the float are sitting on a 65% loss of capital from the $2.20 float price.

This float, as we pointed out in Dick Smith Takes A Bath, Comes Out Nice and Clean, smelled funny from the very beginning. Sorry Dick Smith investors, you’ve been had.

Thursday, 29 October 2015 15:56

Busting tax myths for better reform

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An extract from Deloittes report on Tax Reform.


Australia’s tax reform debate is in desperate need of a circuit breaker, and our report Mythbusting tax reform #2 aims to achieve exactly that. It slices through the myths that clog clear thinking on super, negative gearing and capital gains, and recommends reforms that return simplicity, fairness and sustainability to the way Australia taxes superannuation contributions and capital gains.

This is the second of Deloitte’s mythbusting tax reform reports. The first focussed on issues that are central to Australian prosperity – bracket creep, GST and company tax. This second report covers matters at the heart of Australian fairness – super, negative gearing and capital gains.

Myth 1: Superannuation concessions cost more than the age pension

Super concessions do cost a lot – but nothing like the pension does.

The Treasury estimate of the dollars ‘lost’ to super tax concessions uses a particularly tough benchmark: the biggest possible tax bill that could be levied if super was treated as wage income. It also doesn’t allow for offsetting benefits via future pension savings, or any offsetting behavioural changes. Better measures of super concession costs are still huge, but rather less than the pension.

Myth 2: We can’t change super rules now, because the system needs stability to win back trust

So super concessions don’t cost more than the pension. Yet the costs are still pretty big. And that’s what puts the lie to this second myth. If our super concessions cost lots but achieve relatively little, then Australians are spending a fortune on ‘stability and trust’ in super settings while actually achieving neither. Governments can only truly promise stability if the cost to taxpayers of our superannuation system is sustainable.

Chart: Proposed reform of the tax benefit (loss) of diverting a dollar from wages to super

Deloitte Figure1 301015As the chart above shows, there’s a Heartbreak Hill at the centre of Australia’s taxation system: low income earners actually pay more tax when a dollar of their earnings shows up in superannuation rather than wages, whereas middle and high income earners get big marginal benefits. So one example of a better super tax system would be an updated and simplified version of the contributions tax changes proposed in the Henry Review – where everyone gets the same tax advantage out of a dollar going into super, with a concession of 15 cents in the dollar for both princes and paupers.

Making the tax incentives for contributing into super the same for everyone also comes with a pretty big silver lining. As current incentives are weighted towards the better off, there is a tax saving from making super better – a reform dividend of around $6 billion in 2016-17 alone.

Even better, because this is a change to the taxation of contributions – when the money goes in – it avoids the need for any additional grandfathering. Nor does it add extra taxes to either earnings or benefits.

And because the incentives are simpler and fairer, the current caps on concessional (pre-tax) contributions can also be simpler and fairer. They could be abolished completely for everyone under 50, and the cap could be raised for everyone else (subject only to a safety net of a lifetime cap). That would put super on a simpler, fairer and more sustainable basis.

And, depending on how the super savings are used (to cut taxes that really hurt our economy, or to fund social spending, or to help close the Budget deficit), the resultant package could appropriately help Australians to work, invest and save. For example, this reform alone would pay for shifting the company tax rate down to 26% from the current 30%.

Myth 3: Negative gearing is an evil tax loophole that should be closed

The blackest hat in Australia’s tax reform debate is worn by negative gearing. Yet negative gearing isn’t evil, and it isn’t a loophole in the tax system. It simply allows taxpayers to claim a cost of earning their income. That’s a feature of most tax systems around the world, and a longstanding element of ours too.

Yes, negative gearing is over-used, but that’s due to (1) record low interest rates and easy access to credit, (2) heated property markets and (3) problems in taxing Australia’s capital gains. Sure, the rich use negative gearing a lot, but that’s because they own lots of assets, and gearing is a cost related to owning assets: no smoking gun there.

Myth 4: Negative gearing drives property prices up, but ditching it would send rents soaring

And those who argue the toss on negative gearing raise conflicting arguments on its impact on housing.

Let’s start with a key perspective: interest rates have a far larger impact on house prices than taxes. The main reason why housing prices are through the roof is because mortgage rates have never been lower. And, among tax factors, it is the favourable treatment of capital gains that is the key culprit – not negative gearing.

Equally, while negative gearing isn’t evil, nor would ditching it have a big impact on rents. By lowering the effective cost of buying, negative gearing long since raised the demand for buying homes that are then rented out. Yet the impact on housing prices of negative gearing isn’t large, meaning that the impact of it (or its removal) on rents similarly wouldn’t be large.

Myth 5: The discount on capital gains is an appropriate reward to savers

The basic idea of a discount on the taxation of capital gains is very much right. There should be more generous treatment of capital gains than of ordinary income, because that helps to encourage savings (and hence the prosperity of Australia and Australians), and because the greater time elapsed between earning income and earning a capital gain means it is important to allow for inflation in the meantime.

But we overdid it. We gave really big incentives for some taxpayers (such as high income earners) to earn capital gains, versus little incentive for others (such as companies). And the discounts adopted back in 1999 assumed that inflation would be higher than it has been – meaning they’ve been too generous.

So the capital gains discount is no longer meeting its policy objectives. That not only comes at a cost to taxpayers, but to the economy as well. One possible option would be to reduce the current 50% discount for individuals to 33.33%.

Deloitte’s report ‘Mythbusting tax reform #2’ was prepared by tax and superannuation specialists from Deloitte in conjunction with economists from Deloitte Access Economics. See full report for disclaimers.