2017 Economic Review

In 2017, once again, the investment strategy of maintaining discipline and holding for the long term won out over reacting to media forecasts and predictions from speculators. In January 2017 CNBC suggested Wall Street was the most bearish they’d been in 12 years, as it turned out, the global economy continued to strengthen as share markets posted solid returns on low volatility.

In the fourth quarter, defeats in US Senate contests struck fear into Republicans about 2018 mid-term elections and they quickly agreed to the long talked about Trump tax reform bill. Markets rallied with big tax cuts ahead for corporations. US employment data remained strong, but was distorted by the effects of hurricane season.

As was widely anticipated, the US Federal Reserve lifted interest rates by 25 basis points in December. The Fed also raised its growth forecasts for 2018 to 2.5% from 2.1%.

In the Eurozone, data showed the economy continuing to recover. The unemployment rate fell to 8.8% in October, the lowest rate since January 2009. In October, the European Central Bank announced that quantitative easing would be extended to September 2018 but that the pace of purchases would be reduced from the €60 billion per month currently down to €30 billion.

Despite a sluggish economy, the Bank of England’s monetary policy committee raised interest rates for the first time since November 2007, from a record low of 0.25% back to 0.50%. Annual consumer price index inflation reached 3.1% in November, breaching the BoE’s upper target.

The Bank of Japan’s quarterly Tankan survey recorded the strongest sentiment among large manufacturing companies for more than 11 years. Despite slightly disappointing economic numbers seen in November, virtually all the data released in December exceeded expectations. The Japanese unemployment rate declined to 2.7%, a new low for this cycle, while the number of people employed extended the rising trend seen throughout 2017.

In December, the Reserve Bank of Australia (RBA) said the local economy was growing around its trend rate of 3%, with employment and investment strengthening. Activity was being supported by low interest rates and public investment in infrastructure. The RBA said one continuing source of uncertainty, however, was the outlook for household spending, with income growth slow and household debt levels remaining high.

The Bloomberg Commodities index pushed ahead +4.7% in the fourth quarter, underpinned by a rally in industrial metals and energy. Nickel (+22%) and copper (+12%) and iron ore (+12%) posted the strongest gains as Chinese demand remained firm. In the energy sector, Brent crude surged +18.2%, driven by an agreement among OPEC, and non-member countries such as Russia, to extend production cuts throughout 2018.

Christmas Trading Dates

We will be closed from Wednesday 20th December and re-open Monday 15th January 2018.

Have a great Christmas!

Great share tips for 2018 - It's a myth!

The year’s winding down, so in the financial world that can only mean one thing – forecasts for next year.

Every mainstream media outlet will be putting them together over the next month because A. people like lists; and B. they’re easy to string together. The thing to always keep in mind: they’re all worthless. There’s no value that could be gleaned from forecasters who don’t own working time machines or crystal balls.

The fun part comes from looking back because picks and forecasts are mostly made with impunity. There are so many of them that rarely does anyone ever gets held to account. So a few of the clangers should always be highlighted to remind investors not to pay them any attention.

This time last year the Australian Financial Review published a 5000+ word opus: “The Best Choices for 2017: Equities”. Surprisingly, despite suggesting it was important to pick carefully in the year ahead, for the most part the article didn’t offer up many picks.

It did allow analysts and managers to muse on the general prospects for various sectors in the year ahead: retail, infrastructure, energy, technology, healthcare, agriculture, mining, property and banks. It named companies expected to do well, but mostly stopped short of offering outright recommendations.

However, in retail, while consensus was the sector would be subdued the suggestion was there would be some winners and losers. Leading to some necks being stuck out with explicit buy and sell calls made by Citigroup and UBS. With those names collected it’s time to see how well they’ve performed in 2017.

The buys were Myer, Harvey Norman, JB HiFi and Super Retail Group. The sells were Woolworths, Metcash.

How’d they fare? As the chart shows, had you done the opposite of all their recommendations you would have enjoyed a much better return than actually doing as they said. The four companies they recommended as buys went into the red by a minimum of 16%, while the two sells gave positive returns.

From the buys, Citigroup was most positive on Myer, noting “we expect to see better operating margins and positive sales trends even with the sluggish [consumer spending] backdrop.” Yet it was the worst of the bunch, having fallen 47% year to date.

While the sell on Woolworths from UBS was reliant on the idea that price competition from food retailers may turn into a full-blown price war. In other words, a forecast on a possibility. Not exactly the most robust way to invest.

Many of the forecasting articles follow a similar formula. It’s always based on a perverted understanding of diversification. Where the investor needs to have a grab bag of shares from various industries. List each sector of the economy and pick the companies ‘most likely to succeed’ and because you’ve got a bit of everything, you’re diversifying, right?

True diversification spans asset classes and countries. It’s not reliant on whether Woolworths gets into a price war with Coles and Aldi, meaning your retail exposure should be elsewhere for that year. It allows you to remove your focus away from your portfolio and onto your life.

For the media though, they need your eyes, while the analysts and brokers need you churning for commission. So what you won’t find in the best choices for 2018 is the recommendation of a portfolio tailored to your needs with a minimum 10 year horizon.

More Transparency on Superannuation Fees

Super funds have recently had to change the way they report and disclose the fees they charge to members. Intense lobbying and demands for a delay, particularly from the industry super funds, fell on deaf ears at ASIC. This meant their Indirect Cost Ratio or ICRs had to be disclosed for the first time.

According to ASIC, there has been a significant amount of under-reporting of fees, as well as considerable inconsistency in the way fees and charges were disclosed by super funds.

“ASIC found this made it very difficult for consumers to understand how much they were paying, what they were paying for, and to compare funds.” ASIC’s statement on the changes said.

Remember the ‘compare the pair’ ads?, where industry super funds had previously made a big fuss about fees. I don’t think we will be seeing those ads anymore. After the changes to fee disclosure we can see the industry funds have been charging the same as most other funds, and more than many. One particular industry fund is charging as high as 1.6% on a $50,000 balance.

Fees are the most important factor when striving for high performance in your investments. According to Vanguard, one of the world’s largest and most respected investment managers, research on future performance points out:

Alpha is a measure of risk-adjusted outperformance. Unfortunately, as our analysis has reaffirmed, previous alpha and other measures of historical performance are of little use in identifying tomorrow’s superior performers. More than any other quantifiable attribute we have examined, lower costs are associated with higher risk-adjusted future returns—or alpha.

Across the 15 industry super funds the average fee for the default option on a $50,000 balance is now disclosed as 1.24%. The lowest is 0.89% while the highest is 1.6%.

September Quarter Market Review

Economic Overview

Despite continued political uncertainty amid rising tensions with North Korea’s ‘rocket man’ and the ongoing failure of the Trump administration to realise its policy goals, sentiment for the September quarter was largely undimmed.

In the US, both economic data and forward-looking activity indicators did slightly deteriorate towards the period end in the wake of hurricanes Harvey and Irma. However, the market and the US Federal Reserve judged any potential impact on growth as transitory and easily overcome. The Federal Open Market Committee confirmed measures to reduce its balance sheet in October, while Federal Reserve chair Janet Yellen added to expectations for higher interest rates.

The Eurozone’s economic sentiment indicator rose to 111.9, its highest level since July 2007. Unemployment in the eurozone remained at 9.1% in August -stable compared to July and the lowest rate since February 2009. Meanwhile, the European Central Bank flagged it could reduce its stimulus measures and the prospect of tighter monetary policy pushed up the euro for much of the period.

In the UK, the sterling strengthened against a weak dollar, and noticeably so in September after the Bank of England indicated it would normalise interest rates relatively soon.

Economic data continued to improve in Japan, with data released in September for industrial production better than forecast while there was also a jump in inflation. However, the principal risks came from outside Japan with sentiment capped due to the prospect of US growth-oriented policy and the escalation of tension over North Korea.

The sentiment in China was more upbeat with GDP 6.9% year-on-year, maintaining the same pace of growth from the previous quarter. A stronger yuan also helped ease any fears over capital outflows as the currency advanced +1.9% against the US dollar over the quarter.

The Bloomberg Commodities index rose in Q3. Energy generated the strongest return, with Brent crude rallying 20.1%, supported by falling US crude inventories and rising global demand. Industrial metals were also robust return as economic momentum in China remained firm. Iron ore was up 14.9% while zinc (+15.5%) and copper (+9.5%) both posted sizeable gains

Despite the shifting rhetoric in other developed markets, the Reserve Bank of Australia remained neutral during the quarter with little prospect of interest rate moves in the near term. However, their assessment of the economy has improved thanks to the gains in the labour market and progress in non-mining investment.

Market Overview

Asset Class Returns
The following outlines the returns across the various asset classes to the 30th September 2017.

Shares in global developed and emerging markets delivered another quarter of strong performances in the three months to September. Gains in Australia were more modest. Emerging markets were the star performers for the quarter, with overall returns of more than 5% in Australian dollar terms, while developed markets outside Australia delivered returns of about 2.5%.

U.S. equity markets continued their remarkably smooth journey and the last quarter was no different with the S&P 500 recording a total return of 4.5%. In the relentless climb higher, the biggest stumble so far has equated to a pullback of less than 3%.

Australian returns for the quarter were more modest by comparison at 1%, with strength in materials and energy stocks offset by weakness in the telecommunications sector, Telstra in particular.

In country terms, the top quarterly performers among developed markets were in Europe and Scandinavia, led by Norway, Italy and Portugal. The top emerging market countries included heavyweights Brazil, Russia and China.

On currency markets, the US dollar was mixed over the quarter, gaining against the NZ dollar and South African rand but down against the Euro, as well as against the Australian and Canadian dollars.

Importance of diversification to get the best investment returns

If you’re an Oasis fan you’ll know who Liam Gallagher is. If not, at one stage Liam and his brother Noel fronted one of the biggest bands on the planet – Oasis.

Due to creative differences (regular punch ups), Oasis broke up in 2009 with the brothers going their separate ways. While the pair have still been making music, things haven’t been as lucrative for various reasons.

This was recently highlighted in a video clip posted online by the BBC to promote a documentary. While making tea, Mr Gallagher mockingly explained (between swear words) that he used to employ four people to make his tea in the 90’s. One running the kettle and the other three presumably dunking the bag, putting the sugar in and stirring the spoon.

However, he noted times had changed. Today he had to make his own tea because no one buys records anymore – they download them for nothing. As he found out, business models change while consumer habits demand change. Ignoring this fact is a huge risk for investors or anyone relying on an income from one specific source.

Take the taxi industry as an example.

Five years ago, you could have had a conversation with many taxi license plate holders who’d tell you a taxi plate was the best investment you could find – and with little risk. The number of plates was controlled by government, they offered high yield (leasing fees were great) and had offered steady capital growth on a secondary market.

Then the ride sharing services Uber and Lyft took off, while some state governments issued cheap new leases which undercut the rates plate holders were leasing their plates for. All this new supply took a hammer to the values of taxi plates.

At one-point taxi plates were reaching over $500,000 in various Australian states, this year they’ve been reported to be selling in the low six figure range. With plate owners being quoted in the media saying they’d bought the plates “as investments” and their “superannuation” it’s a sad state of affairs for these plate owners.

Unfortunately for the plate owners, the uncomfortable reality was the value of their plates was always being maintained by the discretion of the government of the day – our old friend legislative risk. And the value of the plates was inflated on a secondary market away from government issuance – it was speculation by any buyer that the value of a plate would hold or increase.

With this in mind, half a million dollars is an extremely large sum of money for any one investment. And with stories suggesting some plate owners have been forced to now apply for the age pension, it seems these particular owners were woefully undiversified. Life savings should never be ploughed into any one asset, especially not on the basis of conventional wisdom like “taxi plates have always gone up and provided income”.

Business innovation doesn’t stop and it affects everyone, whether you’re a taxi driver or rock star. The lesson for investors is to remain diversified because today’s rock star can quickly become tomorrow’s tea lady.

Ethical Organisations and Individuals - You must have both!

I saw a presentation from Major General Jim Molan yesterday about ethical leadership. Amongst many other things, Jim Molan was the Chief of Operations for the multinational Forces in Iraq in 2004. As you can imagine, leading forces in Iraq posed many management and ethical issues.

One of his key statements was that for ethical conduct to be assured, an ethical view must be held by both the organisation and the individuals within it. If either fail, the outcome will be compromised.

From a financial planning point of view I take two things from this:

1.       The importance of our organisation being actively and visibly ethical to ensure the people within it can and will act in our clients’ best interests at all times, and

2.       That regardless of how dedicated and pure of heart an individual planner is, if they work for an organisation that rewards bad behaviour in order to achieve it's own goals, that is what you are going get.

As a privately owned financial planning company, we tend to go on and on about being ‘non-conflicted’. This means we are one of the 15% of financial planners in Australia (and Bathurst) that aren’t controlled by the big four banks or AMP. This means we don’t have sales targets, we don’t share ownership with any fund managers, platform providers or insurance companies. We don’t have a share price to think about and no-one exerts any pressure on us in terms of volume or revenue. We answer to no-one but our clients. This makes an enormous difference in the advice we give.

Thanks Jim!

Boom Boom Goes Bust Bust

If you are old enough, you’ll remember him winning Wimbledon as a 17-year-old. Three decades later you may have heard the news about him going bankrupt as a 49-year-old.

The man in question is Boris ‘Boom Boom’ Becker. In the wake of his bankruptcy there have been lifetime earnings figures tossed around from the tens of millions to just over 100 million. While the exact figure remains unclear, it is clear he earned a lot and a lot of that money has now departed.

Like Johnny Depp earlier in the year, it seems Becker’s financial decision making isn’t the best. Although we’ll defer on casting too much judgement on Capt. Jack Sparrow, as there’s some conjecture about missing funds. Though if that’s the case, it does prompt the reminder – get good advice!

In Becker’s case, it appears he’s prepared to accept he’s the architect of his own demise, but like all these stories there seems to be some poor investment advice.

Now there are the well reported stories about his luxury lifestyle and his wandering eye, which resulted in multiple financial settlements and large child support payments. There were also his noted problems with German tax authorities whether his residence was in Germany or Monte Carlo which also resulted in a fine in the millions – clearly something that also required some good advice.

However, something not reported in English language media, but reported in Germany, was back in 2013 Becker had apparently been investing in the Nigerian oil and gas industry.

Nigerian prince jokes aside, Becker was said to have holdings of $10 million in just one of the investments.

The oil price has taken a very negative turn in the years since 2013 and Nigeria isn’t noted as the most stable of investment destinations. It has suffered constant interruptions to its oil production and export capacity due to an ongoing conflict with the Niger Delta Avengers bombing their oil and gas facilities.

There’s no mention of how long Becker held any of these investments, but given his track record in other financial matters and the state of the oil industry in Nigeria, we could assume they also didn’t turn out well.

Becker had found himself holding this exotic and volatile investment mix thanks to advice from an associate. The associate in question had links to a Canadian investment bank with a focus on oil and mining.

We’ve noticed over the years that that celebrity associates, managers and advisers never seem to recommend basic portfolios!

But what if Boris had done something else with his money? Let’s take the hypothetical scenario of Warren Buffett’s 90/10 portfolio, with 90% in the US S&P 500 and 10% in fixed interest. It’s certainly not our ideal, but it’s easy to construct and Boris is a man of the world so maybe he wouldn’t mind a US based portfolio.

Going back to 1985, after winning Wimbledon, Boris gets his winner’s cheque of £130,000 British pound and decides to invest. Take off 50% for his taxes and other expenses (yes, we know he’s not noted for paying taxes) and Boris is left with £65,000. We’ll invest in US dollars for him and given the exchange rate at the time it would give him $91,000 to invest.

Here’s the result.

Half of that Wimbledon winner’s cheque in 1985 (a fraction of his reported career earnings) would have grown to $2.289 million by July 2017. You could only imagine his wealth had he made more choices like this over his career.

During bankruptcy proceedings held recently London, Becker’s lawyer, told the court: “He is not a sophisticated individual when it comes to finances.”

And it seems some of Becker’s advisers and associates were a little too sophisticated for his own good! Markets in developed economies have long offered decent risk/return opportunities, there’s no need to hunt exotic deals in extremely volatile provinces!

Channel Ten in administration, and what you can learn from it

In 2009 with the All Ordinaries at about 3,700 I bought a number of parcels of Australian shares. I used to be an avid ‘stock-picker’. I would read the paper and listen to the news. I would follow particular commentators and economists and even subscribed to a stock-picking service.

One of the quality stocks I purchased at that time was Channel Ten. I purchased the stock at the same time Lachlan Murdoch acquired a significant interest in the company. “If it’s good enough for Lachlan, it’s good enough for me” I thought.

I don’t own the stock any more, having cut my losses some years ago and evolved past the folly of individual stock picking, but there is still an ‘in joke’ with some of my friends that ends in “Don’t start me on Channel Ten!”. A few factors have contributed to the poor performance and eventual administration of Channel Ten over the last eight years. Some are obvious, some are not so obvious.

It’s a tough time for all media right now; at Fairfax, another round of reporters have taken redundancies as private equity circles. News Corp have been bleeding money and laying off photographers and subeditors, while remaining staff were reportedly told the company “is in a fight for its life”.

Most recently, Channel Ten went into administration when the major shareholders Lachlan Murdoch and Bruce Gordon refused to guarantee a new loan for the company. This likely won’t spell curtains for Ten as a whole but it will likely spell curtains for Ten’s smaller shareholders. And those smaller shareholders could be a little cynical given those larger shareholders have since made a bid to acquire the company themselves.

After the share price tumbled 82% this year. After they refused to guarantee Ten’s debt. After they watched Ten go into administration. To be fair, these are business decisions. My only interest in Channel Ten was to make money and it would be hypocritical for me to think others shouldn't view the company the same way. We would all rather acquire assets at a serious discount verses paying top dollar.

The lesson? The interests of large shareholders don’t always align with smaller individual shareholders. Sometimes our hard-earned capital is considered expendable because we have little else we can bring to the table – being significantly more capital to invest or political weight to influence outcomes for the business.

Ten itself hasn’t been the most stable of companies through the years, even before the recent difficulties for media companies. The internet has disrupted the flow of advertising dollars to traditional media companies and delivery methods, such as streaming, have more recently eaten away at traditional TV audience figures.

Competition and technological change have pressured companies to be better, get bigger or simply fail for hundreds of years. Investors don’t always see these changes coming and the right management may not be on hand to ensure companies respond adequately.

The lesson? Being a shareholder of any company means full exposure to the ongoing market disruptions and challenges that company faces. This means higher levels of risk and most certainly higher volatility than you would experience owning one of our diversified portfolios that contain small pieces of thousands of companies.

What does the AFL draft have in common with stock picking?

We’re now mid-way through the AFL season and football fans are enjoying the entertainment. For non-football fans it’s been 3 months of wondering why this circus takes up so much time on the news.

If you’re of the second persuasion, keep reading because the AFL still has some lessons for anyone who thinks humans are adept at turning the art of selection into future success.

At the end of every season the AFL runs its yearly draft, where teams select the best available junior (and some mature age) talent from around the country. Generally, the draft order runs from the worst to best teams in the just completed season – the team finishing last receives the first pick in the draft etc. Though picks can be traded prior to the draft for existing players.

In the year leading up to the draft prospects are watched by talent scouts, they and their families are interviewed by clubs and in the month prior to the draft there’s a draft combine where the top talent are tested for their psychical attributes. Every team has access to tests on speed, agility, endurance, kicking accuracy, jumping and ball handling. Afterwards, potential draftees are interviewed by team psychologists.

With all this time and money spent analysing and evaluating the top junior players, you would think that clubs would be nailing their selections and would have worked out who will be a great AFL player. You would be wrong.  With all this analysis, there is still no great degree of success.

And when you think about it, all this analysis is little different to all the analysis that goes into picking stocks. A bunch of experts pore over listed companies to come up with their best picks for the year ahead and frequently produce more losers than winners. There are no shortage of examples highlighting how poor stock pickers are at their jobs.

If they’re being honest, both AFL clubs and stock analysts, would have to admit there is a significant amount of luck involved in getting it right – a higher position in the draft and more picks should help with success, but often it doesn’t.

Looking at the most dominant teams of the past decade, Hawthorn (4 premierships) and Geelong (3 premierships), they have had varying success when it comes to their drafting, but interestingly fewer top picks than a less successful team like Richmond who haven’t won anything.

Since 2000 (we’re looking beyond just the last decade as drafting takes time to evaluate) Hawthorn has had eight selections within the top 10 picks at the draft, but only half of those picks became important players for the club. In the same period Geelong had five selections within the top 10, with three of those genuinely contributing to their success.

The most notable at Geelong, Joel Selwood, came at selection seven in 2006. There were no questions over Selwood’s ability, but medical reports said his bad knee would degenerate quickly. Many of the six clubs before Geelong’s selection agonised over this advice, eventually passing on Selwood. The irony? A decade later Selwood has played more games than any other player drafted in 2006, has been a crucial part of Geelong’s success and has never been hindered by his suspect knee.

Finally, there’s Richmond. Proof that more top picks aren’t a guarantee of anything. Since 2000 Richmond have had nine top ten selections. Famously, with two of those selections Richmond overlooked Buddy Franklin and Jarryd Roughead in 2004. Both were then taken by Hawthorn and played in multiple premierships for the club. We won’t continue to rub it in for Richmond fans, maybe 2017 will be their year.

It’s understandable people believe scouts and analysts who devote significant time and effort evaluating the best individual AFL prospects and individual companies could ensure success. Surely all that effort most come to something. However, the records of both are less than impressive.

The reality is the future is hard to predict and luck regularly plays a part. The difference for investors is they don’t have to depend on luck. Proper asset allocation and diversification ensures they can still enjoy growth from the year’s best performers while ensuring the worst performers won’t leave their portfolio with the wooden spoon.