Thursday, 25 February 2016 12:00

Contagion is unlikely for the banks

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The banks have taken a beating lately, with the financials ex-property subindex falling 27% for the year to date. One of the big fears for investors has been the banks exposure to commodities, oil and gas lending. However, Uday Cheruvu thinks that their exposure is ‘very manageable’ as the banks only have around 3-6% exposure to these sectors on average. The exposure that the banks do have is mostly to well-established players, with very limited exposure to high-yield lending. “Maybe there is a risk, but the size of the risk is significantly smaller than what people are worried about,” he said. Indeed, leading into the GFC, banks had up to 30% exposure to sub-prime loans, whereas total exposure to oil & gas high-yield lending is closer to 2%. Given the limited exposure, he says contagion in the financial system is unlikely.

This video courtesy of PM Capital is well worth watching.


Wednesday, 10 February 2016 19:23

Magellan Global Update - 1st Quarter 2016

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Hamish Douglass (CEO Magellan Financial Group) talks about his current views on Global Financial markets.

He talks about the next steps in the US with the Quantative Easing program, China and how he has his fund positioned.


As one of Australia's leading investors - Hamish is very much worth paying attention to.



Tuesday, 09 February 2016 20:07

The plunging oil price - why and what it means?

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Investment research glassesIntroduction

Our view on the financial market turmoil has been covered in the last two Oliver’s Insights - except to add that central banks are now sounding more dovish. This started with the ECB which is now expected to ease at its March meeting and is also evident from the Fed which last night was less positive on the growth outlook and indicated it was monitoring recent economic and financial developments. The probability of a March Fed hike is now just 20% and rather than four Fed rate hikes this year I see only one or none. The Reserve Bank of NZ has also turned more dovish and I expect the RBA to do the same.

The one big surprise in the ongoing turmoil in financial markets is the role played by oil. Past experience tells us surging oil prices are bad and plunging oil prices are good. But that has not been the experience lately. It seems there is a positive correlation been oil prices and share markets (“shares down on global growth worries as oil plunges” with occasional “shares up as oil rallies as growth fears ease”). So what’s going on?

Why the oil price plunge?

The oil price has collapsed because the global supply of oil has surged relative to demand. Last decade saw the price of oil go from $US10/barrel in 1998 to $US145 in 2008. After a brief plunge during the GFC it average around $US100 into 2014.

Black lines show long term bull & bear phases. Source: Bloomberg, AMP Capital

This sharp rise in the oil price last decade encouraged fuel efficiencies (use of ethanol, electric cars, etc) and more importantly encouraged the development of new sources of oil (offshore, US shale oil, etc) that were previously uneconomic.

Source: Bloomberg, AMP Capital

This is similar to what occurred in response to sharp rises in oil prices in the 1970s. But other factors are playing a role too:

  • Slowing emerging world growth. Chinese economic growth has slowed to around 7% compared to 10% or so last decade and more of this is now being accounted for by services and consumption so it’s less energy intensive.
  • Middle East politics – Iran coming back on stream this year and OPEC no longer functioning as a cartel but rather driven by Saudi Arabia’s desires to put pressure on Iran and assure its long term oil market share (by squeezing alternative suppliers and slowing the switch to alternative/more efficient energy sources).
  • Technological innovation has enabled some producers to maintain production despite the sharp fall in oil prices.
  • A rise in the $US, which has weighed on most commodities as they are priced in US dollars. However, the oil price has also plunged in euros, Yen and the $A.

Last year the world produced a near record 96.3 million barrels of oil a day, which was 1.8m more than was used. More broadly oil is just part of the commodity complex with all major industrial commodities seeing sharp price falls over the last few years.

Are we near the bottom for the oil price?

How much further the oil price falls is really anyone’s guess. Oddly enough having fallen 77% from its 2011 high the plunge is similar to past falls after which supply started to be cut back (see the next chart). I suspect we have now reached or are close to the point where, baring a global recession, it will start to become self-limiting but the oil price could still push down to $US20/barrel which in today’s prices marked the lows in 1986 and 1998.

Source: Bloomberg, AMP Capital

At current levels, even oil futures prices are likely below the level necessary – thought to be around $US50/barrel – to justify new shale oil drilling in the US. And prices at these levels are seeing consumer demand in the US shift back to more gas guzzling vehicles. So I suspect we are near the bottom. By the same token the ease with which shale oil production can be brought back on stream and rapid technological innovation in alternatives suggests a cap is likely to be in place on oil prices during the next secular upswing (maybe around $US60).

Why has the oil prices plunge been a big negative?

There are several reasons why the negatives may have predominated this time around. First, Middle East oil producers consume more of their oil revenues now than in the past and so a collapse in the latter may have forced a cutback in their spending compared to oil price plunges of the 1980s & 1990s.

Second, consumers in developed countries are more cautious than in the past & so respond less to lower energy costs.

Third, the plunge in oil prices at the same time the US dollar has increased has added to the stress in many emerging countries, causing funding problems in such countries and raising fears of a default event in the emerging world.

Finally, much recent corporate borrowing in the US and growth in investment has come from energy companies developing shale oil. They are now under pressure leading to worries of a default event and causing a fall back in investment.

But will the negative impact continue to predominate?

Many of these worries will persist but at some point the positive impact flowing from reduced business and consumer costs will become evident. The historical relationship indicates that the positive impact of lower oil prices and developed country growth takes a while to flow through, with the next chart suggesting the bulk of it is likely to show up this year.

Source: Deutsche Bank, Thomson Reuters, AMP Capital

Lower oil and energy prices also mean a usually one-off hit to inflation as the oil price level falls. This largely impacts headline inflation and is generally thought to be temporary. But the longer it persists the greater the chance that it will flow through to underlying inflation and inflation expectations. This is something that central banks are now grappling with as it makes it harder for them to get inflation back to their target levels, which in turn will mean low interest rates for longer.

What are the implications for Australia?

While Australia is a net oil importer, it is a net energy exporter which means that to the extent that lower oil prices flow through to oil and gas prices it means a loss of national income and tax revenue. For Australian households though lower oil prices mean big savings. The plunge in the global oil price adjusted for moves in the Australian dollar indicates average petrol prices should be around $0.90/litre (see next chart). While prices haven’t dropped this far – apparently due to high refinery margins based on Singapore petroleum prices – the price at the bowser is still well down on 2014 levels.

Source: Bloomberg, AMP Capital

Current levels for the average petrol price of around $1.10/litre represent a saving for the average family petrol budget of around $14 a week compared to two years ago, which is a saving of $750 a year. Some of this saving will likely be spent.

Source: AMP Capital

What happened to “peak oil”?

Last decade there was much talk of an imminent “peak” in global oil production based on the work of Dr M. King Hubbert and that when it occurs it will cause all sorts of calamities ranging from economic chaos to “war, starvation, economic recession and possibly even the extinction of homo sapiens”. The film “A Crude Awakening” helped popularise such fears. Such claims have in fact been common since the 1970s, but they have been wide of the mark with global oil production continuing to trend higher. With the real oil price once again plumbing the lows of the 1980s and 1990s it’s clear that such claims remain way off. While the world’s oil supply is limited, “peak oil” claims ignore basic economics which, via higher prices combined with new technologies, will make alternatives viable long before we run out of oil.

Implications for investors

As long as the oil price remains in steep decline the negative impact on producers is likely to predominate the positive impact on consumers at least as far as share markets are concerned. However at some point in the year ahead, it’s likely the boost to consumers and to economic growth in developed countries and in energy importing countries in Asia will predominate. In the meantime weak oil prices mean that deflationary risks remain and interest rates will remain low for longer.

About the Author

Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

The turbulence in financial markets would appear to suggest that the world is heading toward recession.  Leading investment bank have produced a table showing the probability for major countries of recession over the next 8 quarters (2 years).  The table suggests that Australia's chances of recession in the next two years is 21%, which is below the long term average.

Tuesday, 24 November 2015 10:55

Paris Attacks bring Russia in from the cold

Written by
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.

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

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.


There is little doubt that Australia's property market, particularly in the eastern states is at an extreme point.  Whether this corrects sharply, or over an extended period of time remains to be seen.

What is clear though is the elevated level of Australian property prices.  The table below featured in a recent edition of the Economist and shows the level of over-valuation relative to both rents and also relative to income.  On either methodology, Australia's property market appears expensive and investors exposed to the property cycle either directly or by owning shares in building companies or property developers would be wise to exercise caution.

Wednesday, 30 September 2015 10:49

A Tale of Two Chinas

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Nike surprised the market last week with a 30% increase in Chinese sales. The resulting 8.6% weekly share price rise took the gain for 2015 so far to 30.0%. The Nike market performance (shown in yellow in chart below) has been the mirror image of the Caterpillar outcome (shown in blue). Last week, the Caterpillar share price fell another 9.6% to bring to 29.0% the fall during 2015.

The performance differential signals that the long-awaited pay-off for companies positioned to take advantage of the growth of Chinese consumption is becoming meaningful. The maturation of the Chinese economy will increasingly undermine macro-themed generalisations about Chinese exposure.

Forecasting GDP movements, which may have contributed to investment success in the past, will have lost some potency as strategic business positioning becomes a more important determinant of investment outcomes.

(Sourced from EIM Capital Managers)

Monday, 31 August 2015 08:05

Why have the banks corrected recently?

Written by

Banks have been top performers before correcting

The banks represent a large portion of Australia’s share market. The ’big four’ banks have been top global performers (in local currency terms) and a very large driver of our stock market rally particularly since the Euro-crisis days of 2012. All four major banks have outperformed the index. For the past three years rates have been falling and are now at all-time lows, so the banks were able to grow their mortgage books at the same time as problem loans dissipated due in part to these lower rates. As a result, the profits of the ’big four’ have doubled from 2008 levels. This has led to a sustained, steady rise in stock prices, bank profits and a growing stream of dividends.

Since their recent reporting season, all our major banks have run into a volatile patch with the sector giving back much of its year-to-date gains. The market has been underwhelmed by the financial results delivered by the banks in May and now in August. With all of the banks increasing their capital by issuing shares the dilution could signal the end of their record profits and dividends.

Why have they given back gains?

Many of the drivers of that growth in profitability and earnings are now slowing and this will lead to some contraction in valuations.

One driver has been cost reduction. Banks have kept a keen eye on costs over this period by capping the growth in employees and implementing productivity and cost-out initiatives. This has led to what the banks call ’positive jaws’, which basically means an increase in profit margins. But cost pressures are re-asserting themselves, meaning this area of margin expansion may be more difficult to achieve going forward.

Another big driver of profits has been the release of balance sheet provisions for bad and doubtful debts. These are reserves the banks hold against loans that are in arrears or at risk of impairment. As interest rates plummeted to all-time lows, these problem loans started to improve to such an extent that the banks are obliged by accounting standards to release those reserves to profits. But with the provisioning for these loans now below pre-GFC levels, they represent a one-off profit driver which may reverse if the cycle weakens. So while profits should still grow this year, some of the factors that were driving these profits are starting to run their course. In the recent reports and updates in August we have seen some slight tick up in provisions, which implies that this trend is unlikely to contribute to profits going forward and may impair growth if the economy softens.

Bank shares have given back some of their large gains

Source: AMP Capital and Bloomberg

Final thoughts

While profits are at all-time highs, earnings growth is slowing and with high starting valuations the banks have come under pressure. Together with industry regulation to increase capital and reduce lending within the investment mortgage market, a more subdued outlook for bank profits is expected along with more challenging times ahead for shareholders as returns on equity moderate.

As banks make up a large part of the Australian share index, most investors will hold these stocks. While banks have recently given back some of their gains made over the past year, they still provide attractive dividends which are an important feature in a yield-starved world.