Australia – on the precipice? (part one)
Part one of a two part series on the demise of Australia
Last week’s year-six father and son breakfast was never expected to throw up any investment ideas. Indeed, I was so focused on the kids that I wasn’t even listening out for investment insights when one hit me, or, to be more accurate, brushed gently before me.
It was a friend of mine, a semi-retired fund manager who now spends all his time managing his own portfolio and cattle farm. He made the observation that everyone is sanguine – if not optimistic – about equities.
“Who are you talking about?” – I asked.
“Everyone,” he answered.
Holed up in our converted warehouse in Pyrmont, far from the distracting natter of daily broker lunches and street corner stock tips, we don’t get much of a handle on sentiment. Fortunately we don’t need to. Other than observing which stock presentations at the Macquarie conference only had one or two attendees (gold) and those which only had standing room (commercial leasing), our ‘reading’ of the level of optimism and pessimism is deliberately restricted to our observation of how many stocks are trading well above our estimate of intrinsic value each day.
Either way, my experience is that the market always does what it needs to do to ensure the majority is proven wrong. And based on the sentiment observed by my very experienced and successful friend as well as the number of stocks trading at discount to intrinsic value (none of those that we believe have bright prospects or that we don’t already own), it looks like the majority appear to be very long indeed. But is the enthusiasm misplaced?
The number of collapsing retailers and fashion houses, as well as the increasing struggle for local tourism operators and food producers to stay profitable under the weight of the high Australian dollar, suggest that there are few reasons to be overly enthusiastic about local economic conditions.
Long term, the issue for our country can be exemplified thus: Australian supermarkets are committed to delivering lower prices to consumers (beating the competition to it) – no matter what the cost. They will import cheaper products from offshore if it means consumers can pay less, and with weaker international currencies making foreign exports more competitive than our own, it seems like a straightforward plan. The problem with this strategy, however, is that local manufacturers go bust and lay off staff, who then in turn have to call for lower prices because they have lost their jobs.
We simply can’t insist that local businesses deliver products and services at lower and lower prices while also demanding that we get paid time-and-a-half, double time and triple time on weekends. Something has to give. Lower prices will only deliver unemployment and serfdom – while we fuel the improvement of overseas businesses and investment conditions.
Elsewhere, take a look at the balance of payments’ current account deficit and last week’s budget deficit. Not only do these suggest that the business of Australia is in poor financial shape but that it also has poor managers at the helm. So why the investor enthusiasm?
China. With an increasing influence on Australia from the Chinese stock indices, it is not just the high level of iron ore and coal we export to China that ties us to that country’s fortunes.
But what is going on in China now should serve as a warning to Australian stock market and property speculators. The next five to ten years in China will be nothing like the last decade. That country’s positive influence on Australia’s prospects may become proportionally negative and prove just as cyclical as the commodities we export to them.
China is moving from investment-led growth to consumption, but the transition may not be nearly as easy as that statement is to write. Meanwhile debt growth – the product of China’s own quantitative easing to fund increasingly unsustainable rates of economic growth – may be reaching its own limits, and economic growth must slow if household income is not built up fast enough to replace the contraction in government spending.
I personally think, as do an increasing number of others, that even seven per cent economic growth in China will not be achievable beyond this year, and that the motivation for reaching it this year is merely the pride and reputation of the new leadership. More importantly for Australia, even if seven per cent is achieved, it will not be as capital intensive as previous growth – so we might have to expect slower increases in demand for our iron ore at best.
On the supply side, RIO, BHP, FMG and Roy Hill are all expected to add to iron ore production in the near term. The result? It would be falling prices. No wonder George Soros is rumoured to be shorting the Australian dollar. The rumours of me having done the same might also be correct.
If you are trying to pick the bottom in iron ore stocks, or worse, justify their purchase on yield, just remember – you are speculating, not investing. Finally, given we cannot find many, if any, bargains in the stock market currently (“bargains” are those stocks that we don’t already own that we also believe have bright prospects), buying at today’s prices may also be more speculative than rational.
(…click here to read part two)
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Barry Dredge
:
Re your 4th para that there are (none) stocks trading at discount to intrinsic value, I must be misunderstanding something. Skaffold has many such companies,(not that I am buying them). I very much agree with the broad thrust of your comments, but cannot reconcile this paragraph; why am I misguided?
Roger Montgomery
:
Hi Barry, it is referring to companies that we believe also have bright prospects and/ore we don’t already own.
James Ho
:
I think the worst part is that the damage has already been done.
If the Australian Dollar doesn’t fall, Australia basically just went all-in on mining.
If the Australian Dollar falls, speculative flows (which are substantial for Australia) will shift away from the economy. And if there is no government intervention to create a range of maybe $0.80-$0.90 AUD/USD.
Any fall greater than that, coupled with deleveraging will drive a heavy consumption economy into a mixture of falling property prices, but increasing consumer goods inflation.
Australia for the better word to describe, is S.T.U.C.K
Chris B
:
Manufacturing in Australia is too expensive. We are smart workers but far too expensive. We get time and a half and double time, we get our superannuation, we’ve got carbon tax and add to that all the red tape, you can’t do this, can’t do that. It makes Australia really expensive.
On top of that, I know that many manufacturing companies have not controlled costs well. They were protected before by a lower currency and when the currency got stronger, the manufacturers are expensive. Manufacturers have no one to blame but themselves. Sure things could be better but now they have been forced to be more efficient. And many have cut costs and are doing much better now.
xiao fang xu
:
Chris B. nice but do not forget our dear beloved Jony GST or VAT.
“The great individualist Frank Chodorov, once an editor of Human Events, explained clearly the hankering of government for hidden taxation:
It is not the size of the yield, nor the certainty of collection, which gives indirect taxation [read: VAT] preeminence in the state’s scheme of appropriation. Its most commendable quality is that of being surreptitious. It is taking, so to speak, while the victim is not looking.
Those who strain themselves to give taxation a moral character are under obligation to explain the state’s preoccupation with hiding taxes in the price of goods. (Frank Chodorov, Out of Step, Devin-Adair, 1962, p. 216–239)”
interesting thanks Ned
Tim S
:
Roger – having spent the last 5 years investing in Asian real estate and financials, I have had great concern for Australia for a number of years. On one of my first trips to China in 2008, I offered a bottle of wine to anyone on the tour who spotted a resident at one of the 10 (predominantly sold out) developments we visited in Guangzhou – I never had to pay up on that one. In 2009 the Chinese government pumped 4 trillion remimbi (US$0.5 tr) into the economy to build infrastructure – no wonder 2009 was the Great Recession We Never Had. China cant continue to grow in the same manner – the local governments will struggle to pay the interest on the bonds issued for the 2009 stimulus, as their main source of income is land sales to property developers. Liberalisation of the Chinese financial system will ultimately lead to the deflation of their property bubble as domestic real estate ceases to be the safest store of wealth.
For us I believe that we have spent too little time understanding our biggest customer. Iron ore will serve as a great case study for Australian economics students of the future as the learn about inelastic supply curves.
There are no rumours regarding me shorting the A$, but I have! Having more than 100% of your gross assets exposed to the Australian economy in this environment is not a risk that I wish to take.
Roger Montgomery
:
Great stuff Tim
Chris B
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Hi Tim,
I’ve been seeing on the TV some huge new buildings next to each other with no-one living in them in China. Like a ghost town that is new. Would you say this has been going on a lot in China or just a little bit?
Roger Montgomery
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A Lot. Investors don’t rent out their apartments. They like to keep them new.
Tim S
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I don’t think cities like Ordos are common.
My experience has been that there are limited residential rental markets outside the (5) large Tier 1 cities. Real estate has been held as a store of wealth, as the other options have been limited: negative real interest rates for cash deposits; stock market is very volatile. Real estate on the other hand has risen almost every year since it first became privately owned around 1990. So, even without a yield, it looks like the stand-out investment choice.
Given this, many apartments, that are sold as bare/ concrete shells, are never fitted out. There was a number of 68.5m apartments that had never had the power connected that was being quoted last year.
Like many aspects of China, there is a large mis-allocation of resources. There are the wealthy who may own tens, hundreds or even thousands of apartments, and the large under-class who will never be able to afford to live in these empty apartments.
Rob Langley
:
Roger, the most poignant statement in your article is the reference to our potential to move into unemployment and serfdom brought on by the ridiculous demands for penalty rates and lower prices. The result of this is very apparent with the massive shakeup and bankruptcies going on in the Restaurant trade.
The current government has exacerbated this situation by encouraging unions to go back to harassing employers. A much better result can be achieved by in-house negotiations between employer and employees, with some controls to prevent sweatshop situations.
Roger Carrigan
:
Spot on Roger. Did you notice how many times the word “rural” or “regional” was mentioned in the budget speech?
greg meredith
:
Great article. The Australian GDP growth numbers are giving a distorted view of the underlying economic performance. Outside of the areas benefiting from the LNG and mining investment spending the rest of the economy seems to suffering from low confidence and uncompetitive cost structures. It speaks volumes when it is more profitable for cafe’s and restaurants to close on Sunday’s and public holidays due to the requirement to pay staff penalty rates. Some vision and big reforms are necessary to turn things around and restore competitiveness.
Robert Summers
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These penalty rates also result in absurd coffee prices – $9.80 for two plain coffees yesterday in Canberra, and they didn’t even come out the back of a Civet!
Roger Montgomery
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Indeed.