Mark Draper

Mark Draper

Thursday, 18 April 2019 14:28

Roadsigns to Recession

Mark Draper (GEM Capital) wrote this article for the Australian Financial Review and was published during the month of April 2019.

 

With the graphs of leading Australian economic indicators taking on the shape of a waterfall, investors would be wise to dust off the play book about how to invest in a recession.  While not in recession yet, we are likely to know in the next few months whether Australia will enter recession, and it depends on whether some indicators, that we examine here, can change direction.

Many investors have not seen an Australian recession during their investing life, with the last one taking place in 1990/1991.  During that recession the economy shrank by almost 2%, employment reduced by just over 3% and the unemployment rate moved into double digits.  Business failure rates increased along with bank bad debts, and two of Australia’s major banks were in financial stress with share price falls of at least 30%.

At the epicentre of the current downturn is the residential property market.  Property values have been heading south, rapidly, particularly in the eastern states.  The further and faster property prices fall, the greater the probability of recession.  The IMF believes the downturn is worse than previously thought.  This is one of the few times that property prices have fallen without the RBA raising rates or from rising unemployment.

The second key indicator is housing credit growth.  Housing credit growth is currently below the level seen during GFC and below the level witnessed during the 1991 recession.  Credit approvals are falling, particularly in the second half of 2018.  This reflects tightening of lending standards by banks, but also that Australian consumers may have reached their capacity to take on new debt.  Investors need to ask what will alter this environment.  Previous episodes of weak demand for credit have been met with cuts to official interest rates, but with rates currently at 1.5%, the RBA does not have much ammunition to fire.

Building approvals are collapsing.  While there is currently enough work from buildings currently in progress to keep tradesman busy, building approvals point to a more troubling future.

Falling property values can create a wealth effect where consumers feel less wealthy and as a result defer purchasing decisions.  This can be seen in new car sales figures and 2018 saw its worst annual result since 2014.  This is against a backdrop of strong population growth during that time.

The weakening economic outlook is unfolding during an election campaign that the ALP are favoured to win.  The ALP is proposing to significantly increase the overall tax levied, (ie franking credit changes, CGT and negative gearing changes) which is likely to suck further money out of the economy and act as an additional handbrake.

If Australia were to enter recession, there are several investment sectors where investors should tread carefully.

Given that 60% of the Australian economy revolves around consumer spending, discretionary retailers are most at risk to a consumer under pressure.  Caution should also be taken with the price paid for food retailers who may also come under pressure as consumers seek to lower their expenses during a downturn.  The recent Woolworths profit result shows the food retailers are already operating in a very difficult retail environment.

Travel is another sector at risk as consumers in a downturn could turn their focus away from discretionary leisure spending.  Businesses too could replace interstate travel with more teleconferences in tighter economic times.

Banks are obvious investments to suffer in an economic downturn as demand for credit weakens and bad debts rise.

Property investments with a focus on property development profits should also be scrutinised.

The currency could be one of the few safe havens as the Australian dollar most likely depreciates during recession.  Beneficiaries of a weaker currency are those Australian companies who earn income from overseas or unhedged International investments.  Australian exporters who have not hedged currency can also benefit from a lower Australian dollar.

Investors should pay attention to the next few months of leading economic indicators to determine whether Australia is likely to break the 27 year recession drought, and position their investments accordingly.  

Montgomery Investments have recently produced their 'Best of the Best Report' for April 2019.

 

In this edition, they cover:

1. The recent company reporting season - opportunities for investors

2. Sydney Airport - is the runway for growth likely to continue?

3. Their view on Challenger

 

To download the report - please click on the image below.

 

April 2019 Best of Best image

Thursday, 18 April 2019 14:15

Major Parties' Tax and Super policies

thinking aboutThe federal election has been called for May 18 and both major parties have outlined their superannuation and tax policies. With the federal election only weeks away many of our clients have been asking what the major political parties’ policies are that may impact their SMSF, individual taxation circumstances or personal investments. 

 
LIBERAL-NATIONAL COALITION

Superannuation

  • Australians aged 65 and 66 will be able to make voluntary superannuation contributions without needing to work a minimum amount. Previously, this was only available to individuals below 65.

  • Extending access to the bring-forward arrangements (the ability to make three years of post-tax contributions in a single year) to individuals aged 65 and 66.

  • Increasing the age limit for individuals to receive spouse contributions from 69 to 74.

  • Reducing red-tape for how SMSFs claim tax deductions for earnings on assets supporting superannuation pensions.

  • Delaying the implementation of SuperStream (electronic rollovers for SMSFs and superannuation funds) until March 2021 to allow for greater usability.

Taxation

  • From 2018-19 taxpayers earning between $48,000 and $90,000 will receive $1,080 as a low and middle income tax offset. Individuals earning below $37,000 will receive a base amount of $255 with the offset increasing at a rate of 7.5 cents per dollar for those earning $37,000-$48,000 to a maximum offset of $1,080.

  • Stage 1 tax cuts: From July 1 2018, increasing the top threshold of the 32.5% tax bracket from $87,000 to $90,000.

  • Stage 2 tax cuts: From 1 July 2022, increasing the top threshold of the 19% personal income tax bracket from $41,000, to $45,000.

  • Stage 3 tax cuts: From 1 July 2024, reducing the 32.5% marginal tax rate to 30% which applies from $120,000 to $200,000. The 37% tax bracket will be abolished.

AUSTRALIAN LABOR PARTY

Superannuation

  • Disallowing refunds of excess franking credits from 1 July 2019 – this would mean SMSF members in pension phase no longer receive refunds for the franking credits they receive for their Australian share investments.

  • Banning new limited recourse borrowing arrangements.

  • Reducing the post-tax contributions cap to $75,000 per year down from $100,000.

  • Ending the ability to make catch-up concessional contributions for unused cap amounts in the previous five years.

  • Ending the ability for individuals to make personal superannuation tax deductible contributions unless less than 10% of their income is from salaries.

  • Lowering the higher income 30% super contribution tax threshold from $250,000 to $200,000.

Taxation

  • Labor supports the stage 1 tax cuts and will match the $1,080 low and middle income tax offset. From 1 July 2018, individuals earning below $37,000, will get a $350 a year tax offset, with this amount increasing for those earning between $37,000- $48,000 to the maximum $1,080 offset.

  • Introduce a 30% tax rate for discretionary trust distributions to people over the age of 18.

  • Will limit negative gearing to newly built housing from January 1 2020. (Existing investments are grandfathered under the current law).

  • Reduce the capital gains tax discount for assets that are held longer than 12 months from the current 50% to 25%. (Existing investments are grandfathered under the current law).

  • Limit the deductions for the cost of managing tax affairs to $3,000.

Clay Smolinski - Platinum

Sunday, 31 March 2019 07:58

Investors Guide to the Federal Election

The next Federal election will be held during May 2019.

It is difficult to remember an election that potentially has so many impacts on investors.  Mark Draper wrote this article for the Australian Financial Review which was published during the month of March 2019.

As if worrying about potential changes to franking credits and capital gains tax discounts weren’t enough, there are a myriad of other potential changes that investors need to think about should Australia have a change of Government at the next Federal election, as is widely anticipated.

Normally politics doesn’t usually need to feature prominently with investment decisions, but we suspect that this Federal election will bring politics to the top of mind for investors.

Here we examine some of the sectors that are likely to be impacted by the election.

Nathan Bell, (senior portfolio manager Intelligent Investor) says “If Labor reduce the CGT discount to 25%, that could drastically reduce demand for investment properties, which has already collapsed due to falling property prices and tighter lending.

This would be very bad news for the banks (and mortgage brokers and other lenders), which need to increase the size of their loan books to grow earnings.”  The banks could also face a higher bank levy from either side of politics as a politically acceptable way of funding election promises, particularly following the Royal Commission.

The ALP has proposed a cap of 2% on private health insurance premium increases. Matt Williams (portfolio manager Airlie Funds Management) is of the view that the insurers are already preparing for the introduction of this policy and that the question investors must ask is whether the health insurers, or the hospitals will have the upper hand in negotiating prices.  Who has the upper hand will determine whether the insurers can operate under this policy without a hit to their bottom line.  He points out that insurers are already looking to reduce claims and keep people out of hospitals with a focus on greater recovery at home and other alternatives. The recent profit result from Medibank Private showed very tight cost control.

Williams is also surprised that neither party as yet has committed to policy to write down the value of the NBN, thereby potentially reducing the price that NBN wholesalers, and by extension consumers, pay for their internet access.  He believes it is likely that the next term of Government write down the value of the NBN.  Such a write down would be broadly positive for the Telco sector as it could lead to higher margins for Telcos, which have struggled to generate a reasonable return from re-selling NBN.  This is unless the price reductions were ‘competed away’ in a highly competitive environment.

Nathan Bell is also concerned about the effects of policy changes to consumer behaviour.  He says “Labor's main policies all act as a tax on consumers. We've already got a recession on a per capita basis, so these policy changes will reduce spending. Non-discretionary retailers, including Woolworths and Coles, recently reported weak earnings growth. These policies could see growth evaporate altogether. People will find ways to cut their spending by buying more discounted groceries; shopping less often; buying more generic brands; and avoiding small treats.  Imagine what that then means for discretionary retailers, such as Harvey Norman and JB HiFi.” 

The Coalitions’ energy policy has ensured that the share prices of Australia’s energy retailers have been heavily discounted on the concerns of electricity prices being capped or companies broken up.  

Bill Shorten late last year also contributed to the uncertainty in energy policy suggesting the ALP will redirect east coast gas, earmarked for export, to the domestic market, if certain price levels (which weren’t disclosed) were reached.  Australia’s gas producers have export contracts to deliver gas that usually spans decades.  Investors are right to be concerned if a Government considered mandating that export contracts be put at risk in order to fulfil domestic demand.  Williams believes that this uncertainty is creating opportunities to buy energy companies that are cheap as a result.

It’s hard to be definitive about how to position investments for the Federal election at this stage, given that both major parties haven’t really put many cards on the table.  What ends up being legislated is often not necessarily what is promised during an election campaign, so investors need to ensure they don’t over react too..  

One thing however is certain, populist politics and business bashing is with us for the moment, and is likely to have material ramifications for investors.  Investors must respond by paying more attention than usual to this years’ Federal election.

Roger Montgomery (Montgomery Investments) talks with Mark Draper (GEM Capital) about the Australian property market which is now firmly in decline.

They discuss whether the market has bottomed and what indicators investors should be watching out for as well as some investments to be cautious about.

 

 

Friday, 22 March 2019 17:14

Australian Property Update

Roger Montgomery

Friday, 01 March 2019 17:47

Knowing when to sell

Mark Draper (GEM Capital) writes a monthly column for the Australian Financial Review.  In his January 2019 article he outlines some of the triggers investors should look for that provide clues for when to sell.

 

7 flags to tell you ‘it’s time to sell’

The days of the ‘buy and hold’ strategy has long been a ‘dinosaur’ and probably always was. Regular changes to technology, regulation, consumer tastes not to mention competitors can turn today’s hero investments into tomorrows dogs. 

Successful investing involves not only buying assets for a reasonable price, but also knowing when to sell.

The term ‘red flag’ is referred to by professional investors as events that take place that act as an early warning signal to sell.

Here are 7 red flags to help investors sell before ‘it hits the fan’:

  1. When directors sell shares in their own company, particularly when more than one director sells in a short period of time, investors should be nervous.  History is littered with examples of director selling followed by dramatic falls in share prices.  In August 2016 the CEO and Chairman of Bellamys both sold a combined total of 365,000 shares at around $14.50 per share.  In June 2018 two directors of Kogan sold 6,000,000 shares at $7 per share. The share price charts below tell the rest of the story.  INSERT Bellamy’s and Kogan charts (attached PDF’s)
  2. Crowded trades takes place when consensus opinion on an investment is universally positive which usually coincides with excessive valuation.  The ‘investment that can not lose’, verbalised by cab drivers and instant experts at barbecues  is usually a place to avoid.  Crowded trades could also be referred to as fads.

Who can forget the mantra in 2007/2008 about peak oil theory, when the oil price was around $150 per barrel.  Investing in energy was a one way bet according to common beliefs of the day, providing an excellent example of the crowded trade.  Oil today of course trades today at around $60 per barrel.  

  1. Poor behaviour from management which include directors/management using company assets for private use, related party transactions such as the company renting premises from directors and excessive management remuneration.
  2. A google search of Nepotism reveals “the practice among those with power or influence of favouring relatives or friends, especially by giving them jobs”.  Whether employing a relative or friend of management, or the company expanding into an unrelated business, so that a relative can run it, rarely results in getting the best person for the job.
  3. Most investors appreciate that a company’s share price follows the earnings.  Earnings should follow cash flow, so when earnings rise without a corresponding rise in cash flow, investors should beware.
  4. My father always said to me ‘everything comes from the top’, and how true this is with respect to investing.  Changes to management can play a big role in share holder returns.  A Financial Services executive employed to run a healthcare company?  A Milkman running a Childcare company?  True situations that didn’t end well for shareholders.  Investors should consider the background and experience of new management that is appointed to satisfy themselves that they are fit for the role.
  5. Valuation is the ultimate red flag. Buy low and sell high sounds simple but the only way an investor can do this is to first hold a view of what an asset is worth.  While this seems elementary, I continue to be surprised by investor behaviour which clearly demonstrates no regard for valuation.

Let us pay tribute to the poor souls who invested in Cisco Systems at the height of the dot.com bubble paying well in excess of 100 times earnings.    Almost 20 years later, the share price is still not back to its level at the peak of the dot.com boom.

And there were many examples of this behaviour in Australian technology stocks in the dot.com boom that didn’t even have a price earnings ratio due to the fact that the company’s didn’t have any earnings to show.  Crypto currency is possibly the most recent example of investors chasing returns from an asset without regard for intrinsic value.

7 flags to help investors keep from trouble.  As the great Kenny Rogers song said, “you gotta know when to hold ‘em, know when to fold em’, know when to walk away and know when to run.  Happy investing!

Livewire recently interviewed arguably two of Australia's best Global Investors.  They are Andrew Clifford (CEO Platinum Asset Management) and Hamish Douglass (CEO Magellan Financial Group).

The interview discusses their current views on the financial landscape and is a must see for investors.

 

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