Comment

Quarter 3 Economic and Market Update

This Quarterly update is written by Matt Vickers, principal adviser of Snowgum Financial Services. It provides a high level overview of economic and market conditions before taking at detailed look at the demise of inflation. We finish off with our thinking on the changing fates of passive investing.

Please feel free to forward this update to clients, colleagues and friends who can in turn subscribe to it.

Key Stats

  • GDP growth is at 1.8% for the year, as at October 4 (RBA)
  • Cash rate finished up at 1.5% (RBA)
  • Inflation dropped from 2.1% to 1.9%. Any chance of cash rate rises in Australia just became even less likely (RBA)
  • Coincidently, wage growth currently matches inflation at 1.9% (RBA)
  • Unemployment bounced back up to 5.6% from its unexpected low of 5.5% last quarter (RBA)

Inflation is an endangered species

Money is still what it used to be...

Endangered Species

Aussie inflation dropped from 2.1% to 1.9% this quarter, keeping firmly in its medium term holding pattern at the bottom end of the RBA’s target range (graph 1). The developed world also struggled to stoke their own inflation fires (graph 2) and even developing countries are falling victim to the new normal of lower inflation (graphs 3 & 4).

Can inflation mount a Robert Downey Jr style comeback?... we think not.


In Australia, the recent drop in inflation (although just a blip in the long-term) is particularly interesting in the context of rising energy costs and a housing price boom. Both on the surface have been inflationary without even moving the needle. We believe each of these recent spikes has the potential to become heavily deflationary in the long-term.

Australia’s Housing sector boom stems from a combination of a low interest debt binge, foreign investment and low housing supply in key markets. Macro-prudential intervention has been successful in tightening lending standards and increasing debt servicing costs. Australia is dealing with a huge debt hangover hampering future consumer spending and any further substantial asset price appreciation in the medium term. Property owners might be wealthier on paper, but with limited wage growth and higher expected debt servicing costs, they don’t feel wealthier and aren’t loosening the purse strings.

Higher energy prices are squeezing businesses and households further still. This current energy market turbulence is part of the very rocky long-term transition to cheaper and democratised renewable energy. The marginal cost of producing renewable energy is virtually zero. The significant obstacle in fully making this shift is energy storage and transmission. 58% of recent energy price hikes stem from increased transmission costs (maintaining the poles and wires network).

Not even politicians, emboldened by their best budgie smugglers, can stop the steady rising tide of scientific discovery, innovation and the disruptive effect of market forces driving commercial outcomes. More competitive storage options will come online decentralising renewable energy, resulting in the proliferation of solar cells on roofs, community wind, solar and storage stations, providing cheap energy to the masses. Battery technology is in a continuous evolution with Lithium Ion batteries still improving and more commercially viable sodium ion batteries attaining key milestones. More here

The long-term impact will be far cheaper access to energy than at any time in history. This will have massive global deflationary effects and be particularly destabilising for old world energy rich countries like Russia and much of those in the Middle East.

3-D printing may seem like an odd inclusion in the demise of inflation, but the fledgling industry has the long term potential to digitise physical goods in the same way we have music and video. A physical good when coded, can be purchased online for pennies and dimes. The code is the sent to your families 3-D printer. Once you cut out distribution, retailing, inventory, packaging, centralised production and labour costs – the future looks very deflationary.

Finally, in the short to medium term, policy makers are making more noise about attempts to normalise cash rates. There just isn’t scope to do this in Australia, but the clear global intent coupled with record low cash rates means even the slightest up-tick in inflation will see the shackles lifted on policy makers to lift underlying cash rates. This means even slight inflationary pressures will quickly be met with a tightening monetary policy response. 


Passive investing on the nose

What is passive investing

Passive investing is an investment style that aims to replicate a benchmark investment return. I.e. Should the S&P 500 index go up 10%, your passively invested portfolio tracking this index also goes up 10%.

One of the great peculiarities of the investment management industry is that active investing, where one is paid to outperform a benchmark, is a zero-sum game. That is, for every investment professional outperforming the benchmark index, there must by an equal amount of under-performance given that the benchmark index return is an average, and over 95% of trading volumes are professional active managers.

Once professional investment fees are accounted for, active management overwhelmingly underperforms.

Nine and half years ago Warren Buffet made a ten-year bet with hedge fund managers that the S&P 500 index would outperform their funds (after fees) over this time frame. The wager was one million dollars. Only one brave manager stepped up to the plate. They have been overwhelmingly beaten by the index, with the wager already settled such is the margin of loss of the active manager. More info here.
 

The changing winds of passive investing

Lemmings running off a cliff

Having heard us chastise the zero-sum game of active investing; What could we possibly say that undermines passive investing efficacy?

We believe only a structural change in how markets are functioning would impact the status quo of passive investor success. We think such a change is underway, in some markets. Consider:

  • An index contains many companies. A passive investor is exposed to every company in the index. Between the years 1900-2000, the average lifespan of a company listed on the S&P500 was 64 years. A passive investor had very little exposure to failing businesses. Since the year 2000, the average lifespan of a listed business is now only 15 years. Industries and business are being disrupted faster than ever and the passive investor is invested in every single failing business.
  • What about the good businesses? Fortunately, the passive investor gets exposure to all these terrific disruptive businesses. Unfortunately, the passive investor buys in late and high. Like the dot.com boom before it, some businesses trade at astronomic valuations. A passive investor chases high after high as they need to hold the market weighted cap of the listed business not its intrinsic value.

We still think there is a place for passive management and are grateful that it has forced the hand of active managers to become more price competitive. However, we think passive investing in mature markets, those full of businesses ripe to be disrupted, gears up and investors downside risk. It is often easier to avoid a losing company than pick the winners. 


Disclaimer
Any advice contained in this update is of a general nature only and does not take into account your circumstances or needs. You must decide if this information is suitable to your personal situation or seek advice. Prior to investing in any particular product, you should read the Product Disclosure Statement.

Snowgum Financial Services Pty Ltd (ACN 603 703 859 is a Corporate Authorised Representative (Corporate ASIC AR number 001001581 ) of Peter Vickers Insurance Brokers Pty Ltd (Australian Financial Services Licensee (AFSL) No 229302 & Credit Licensee (ACL) No 229302 ǀ ABN 68 074 294 081).

Comment

Quarter 2

Quarter 2

This update provides you with high level economic stats before exploring the fast changing retail landscape in Australia. We talk all things Amazon and disruption before providing our investment positions. We finish off with an update of the latest from Snowgum.

Quarter 1 Market Update

Quarter 1 Market Update

Quarter one economic and market update provides economic statistics before exploring the renewable energy sector and the future this looks to shape.

Quarterly economic and investment update

Quarterly economic and investment update

Our quarter one economic and investment update does the silliest thing in finance... makes predictions about the future of certain industry. A light read touching on a variety of topics and hopefully making you excited to be an investor.

Cashflow (not Smashed Avo) for Gen Y's

Cashflow (not Smashed Avo) for Gen Y's

When young, how well you save is more important than how well you invest. Only once you accumulate scale in assets, that investment decisions become progressively more important. We run the numbers in a tongue in cheek case study.

US election update

US election update

This US election update is written by Matt Vickers, principal adviser of Snowgum Financial Services. We provide commentary on how we expect markets to behave in a president elect Trump world and explore why the polls got it wrong again.

Quarter three economic and investment update

Quarter three economic and investment update

This quarterly update is written by Matt Vickers, principal adviser at Snowgum Financial Services. It provides a high level overview of economic and market conditions before taking at detailed look at the power of exponential's and the industries they apply too.

Please feel free to forward this update to clients, colleagues and friends who can in turn subscribe to it.

Key stats

  • Pop the champagne*, Australia hit 25 years without a recession
  • Australian unemployment holds below 6% (5.7%) in a tough global environment. or another way of looking at it, we have 12 million employed people.
  • Inflation remains low at 1.0%.
  • Interest rates will remain lower for longer (current cash rate is 1.5%)
  • Services account for 58% of all industry output
  • Manufacturing accounts for 7%
  • Average dwelling price in Australia is $614,000
  • Economic growth is surprisingly resilient at 3.3%
  • Average weekly earnings in Australia are $1,161 with a savings ratio of 8%

*Note - we mean sparkling wine


Investment Focus

This quarter we are taking a deep dive into the world of exponential growth, the industries displaying these characteristics, why we are uncomfortable accepting future exponential projections and finally, investment ideas worth considering.

An introduction to exponential's

Exponential growth is the compounding effect of rates of change growing continuously over time.

Two million years of evolution have hard wired our brains to process information linearly not exponentially.
 
Calculating how long it takes to cross paths with a distant migrating herd or, figuring out when to plant and harvest crops are important brain functions that have allowed humanity to advance. Our evolution has ingrained in us a linear intuition, which has poorly prepared us to reason exponential's trends, especially beyond a short term time frame. Our bias to think linearly makes longer term exponential outcomes often seem 'counter-intuitive'.
 
Markets are not rationale, especially when market participants allow intuition to trump reason. This is certainly the case in some industries, which presents tremendous opportunities for investors. Industries currently in the grips of an exponential revolution are;

  1. Information technology
  2. Bio-technology
  3. Renewable energy technology

To appreciate why some industries and not others are undergoing exponential growth, the best place to start is Moore's law.

Moore’s law

Moore’s law, named in 1965 after Gordon Moore, co-founder of Intel, was the prediction that the number of transistors within an integrated circuit would double every year and that this trend would continue for the foreseeable future. A doubling of transistors essentially doubles computing power. The trend has prevailed for forty years and there is no reason to suspect it will not continue.

Moore's Law

Computational power doubling every year has unlocked a new world of opportunity in data and technology driven industries.

Energy

We are seeing vast improvement in both energy production and efficiency of energy consumption.

Solar

Solar power is growing exponentially. Consider this;

  • At present, 1% of global energy is produced by solar power. The cost of producing solar power is reducing at an exponential rate. Solar power’s contribution to global energy production has been doubling every two years. This has been occurring somewhat consistently for 30 years… Solar power is now more affordable, even when unsubsidised, than most fossil fuels (in sunny areas). 
  • 1% does not sound like much, but 1% is seven doublings from 100%. This means that on current trends, in 14 years’ time, the global supply of energy could be solar!!!

Coal makes up to 14% of Australia’s exports. This solar revolution will have a particularly profound effect on Australia’s production of thermal coal.

Energy innovation

The university of Washington has developed passive Wi-Fi. This a variation on back-scattering (used in things like pay-pass). Passive Wi-Fi allows devices to feed off other signals to then power their own. It uses 1/10,000 the energy of typical Wi-Fi and Bluetooth sets, with greater range. In tomorrow’s smart home; security cameras, temperature sensors and smoke alarms should never need to have their batteries changed.

Snowgum Financial Services Pty Ltd view – We limit our investment portfolio exposures to oil/gas/coal producers. This is a long term imperative. It is easy to see who will lose from this trend and harder to predict which company will be the solar/efficient energy providing “winner”. Renewable energy Investment opportunities are more abundant overseas, making International investment an imperative.

Bio-technology

Bio-tech has recently joined the exponential industry growth trend. The catalyst for change has been an exponential reduction in the cost of genetic and cellular sequencing. 

Genome Sequencing

The first sequencing of the human genome cost $100 million in 2001, today a genome can be coded for a $100. To see just how far we have come, read this article in the MIT Tech review about the future of health care apps. Additionally, further reductions are expected.

Practical applications

Genetic sequencing of the human genes and cancer/viral/bacteria cell construction has unlocked a whole new area of study in 'Immune Engineering'.

Consider this;

  • A young girl in a UK hospital was fighting Leukemia last year. In June 2015 she was out of T-cells and ahe had no options left. In desperation, a doctor sought permission to use genetically engineered white blood cells (T Cells). The cells, produced by Celletics, a bio-tech company based in New York, had four genetic changes, two of which were only recently possible via a new technique of genome editing. The doctor wanted the young girl to be a ‘special’ - to allow her to receive the enhanced white blood cells, without a clinical trial. The last recipients of the enhanced cells were mice. The choice was either take a risk or die. The young girl was administered the cells and made a full recovery. More info here
  • In the course of writing this quarterly report, the first baby was born to three parents via a series of procedures to overcome genetic defects. This child now has DNA from three people overcoming known genetic defects in the would be mother’s mitochondria. Not only are we solving genetic based defects, we are preventing them occurring in the first place.

The bio-tech revolution is really a data revolution. Once ‘decoded’, humans are essentially giant computers full of discrete, but interconnected applications, all of which have a data based source code (DNA). Once we know and understand this code, we can pinpoint exact areas of degradation or irregularity causing health issues and either replace these broken segments or inject targeted engineered immune responses to address anomalies.

As our capacity to manipulate data improves at an exponential rate, the world in 20 years’ time might be one that has cured most, if not all, the ‘mundane’ illnesses and ailments, leaving the ‘problem’ of aging as a final frontier.
 
Snowgum Financial Services Pty Ltd view – We look to explore portfolio exposures to a diverse range of biotech producers. As it is hard to predict which company will emerge as “winners”, diversification is key. Pharmaceutical companies not supporting R&D in genetic based treatment solutions may be left behind by more effective and targeted treatments. This is a highly volatile sector and piggy backing expertise from biotech specialist managers is a prudent approach. Investing in this industry requires a strong risk appetite.

Information technology

Data is big business. We categorise technology companies into two broad categories.

  1. Providers of Digital Ecosystems (DE); and
  2. Users of Digital Ecosystems via Information Innovation (II).

Information Innovation businesses use cleverly coded applications that provide a unique insight, service, network or productivity advantage. A Digital Ecosystem business provides the technology tools and infrastructure that support the army of coders building tomorrow.
 
Key Digital Ecosystem providers are IBM (makers of computers, AI and much more), Intel (makers of processors), Samsung and Apple (makers of hardware and software), Amazon (cloud services and various other tech-based logistics), Microsoft and Google (Software, cloud based services, App engines, data storage, AI and more…).

Providing a Digital Ecosystem is capital intensive. As such, barriers to entry are high. Modern Digital Ecosystem providers all began their journey first as an Information Innovator’s piggy backing existing Digital Ecosystems. Once an innovator becomes very successful that enough capital is generated to make the transition to being a provider of a digital ecosystem.
 
Information Innovation business, like Twitter, Facebook, UBER, AirBnB, Stripe etc. have much lower barriers to entry and are nowhere near as capital intensive. Because of this, they might have higher profit margins but are also at greater risk of becoming obsolete by the next great innovation.
 
Snowgum Financial Services Pty Ltd view – We incorporate portfolio exposures to a mixture of both II and DE providers. It is harder to predict which company will emerge as “winners” in the II space, but we can be more confident in DE providers like Alphabet, Amazon, Microsoft, IBM and Apple.

Exponential summary - where to next

A convergence between information technology and bio-technology is underway.

In the quest to build smarter computers, programmers are modelling advanced elements of human brain function to guide their research. Similarly, health care research is evolving to see the human body as a series of discrete applications (lungs/pancreas/brain etc.) all of which can be decoded and then treated like a computer application needing an update.
 
Although this parallel may seem nuanced at best, we strongly believe that a convergence is occurring and we are at the beginning of another exponentially growing industry (the crossover of bio/info tech). The profitable companies of tomorrow will be the ones that drive this trend.

Our biggest ‘shot in the dark’ predictions in the future is the lateral movement of key technology companies into the bio-tech space. The likes of technology players like IBM, Microsoft and particularly Alphabet (Google) could soon be key bio-tech players as the human body becomes the next computing frontier. Another expectation we have in the more immediate future is for Apple to disrupt the car industry, more info here.
 
As an Australian investor, there is cause to be worried. The cliché Australian portfolio, underpinned by banks and mining stocks, are companies within industries that may become relics of a fast moving digital evolution.
 
Should the industries discussed continue to match the rapid growth we have seen in the last thirty years, it may be that we are fast approaching a new era, marked by vastly expanded life expediencies and artificial intelligence which looks very different to today’s life. If this continues we may soon be drawing a line in the sand from which we say goodbye to the 'industrial age' (a rapid and turbulent era which fueled innovations) and enter a new age of technologically evolved humanity. The likelihood of there been a profound change in 'era’s' will be dependent on the development of artificial intelligence and the eventual occurrence of profoundly smarter computers than human’s. I.e. Computers a billion times smarter than us or an event called singularity.
 
Regarding your investment decisions, simply ignoring changes on our doorstep will likely well see your investment portfolio also become a relic of a different era!


Superannuation update

Bring-forward NCCs – transitional arrangements

Where an individual has triggered the bring forward in 2015/16 or 2016/17 but has not used it fully by 30 June 2017, transitional rules will apply.
 
Where an individual triggers the bring forward in 2016/17, the transitional cap is $380,000 (the current annual cap of $180,000 plus $100,000 annual cap in 2017/18 and 2018/19). See examples 1 and 2 in the table.

If an individual triggers the bring forward in 2015/16, the transitional cap is $460,000 (the current annual cap of $180,000 in 2015/16 and 2016/17 plus $100,000 annual cap in 2017/18). See example 3 in the table
 

$1.6 million eligibility threshold

Individuals are unable to make further NCCs where their total superannuation balance is $1.6 million or more (tested at 30 June of previous financial year).
Where an individual’s balance is close to $1.6 million, they can only make a contribution or use the bring forward to take their balance to $1.6 million but not beyond.

Note: Information above has been provided by Asteron. These measures are not yet legislated. Draft legislation is expected in the next few weeks.

To reward those that made it to the bottom of this update, here is our favourite video from the last quarter. The pathway to becoming an interplanetary species, by Elon Musk. It is an hour long masterpiece, best to put some time aside before you get sucked in


Disclaimer

Any advice contained in this update is of a general nature only and does not take into account your circumstances or needs. You must decide if this information is suitable to your personal situation or seek advice. Prior to investing in any particular product, you should read the Product Disclosure Statement.

Snowgum Financial Services Pty Ltd (ACN 603 703 859 is a Corporate Authorised Representative (Corporate ASIC AR number 001001581 ) of Peter Vickers Insurance Brokers Pty Ltd (Australian Financial Services Licensee (AFSL) No 229302 & Credit Licensee (ACL) No 229302 ǀ ABN 68 074 294 081).

Copyright © 2016 Snowgum Financial Services, All rights reserved.
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