This Quarterly edition from Snowgum Financial Services provides you with a 7 minute summary of matters to do with the economy, investing and markets.

Please feel free to forward this summary to clients, colleagues and friends who can in turn subscribe if they wish.

Key Stats

  • Australian economic growth remains strong at 3.4%

  • Inflation languishes at 2.1%, the bottom end of RBA’s target range

  • The Aussie dollar drifts between 0.71-0.73 USD. Pushed lower by US interest rates rising faster than those in Australia

  • Shanghai Composite Index is down over 20% from its January highs on fears of a trade war acceleration.

Jobs boom, wages doom.

  • Aus unemployment remains low at 5.3%,

  • jobs growth at 2.4% but

  • wage growth remains stubbornly low at 2.1%.

  • Productivity growth is appearing to be concentrated in high technology adoption businesses. These businesses are not sharing productivity gains with employees. We are seeing a productivity-to-wage growth gap emerging. More here

Economic Update

Spring is in the air and signs of new growth are fleeting in the Australian economy. A closer look at our otherwise drought stricken regional areas sees green shoots in the resource sector, on the back of more buoyant commodity prices.

On the 20th of September each year the Reserve Bank of Australia (RBA) releases their annual report (available here). This 206 page turner is unsurprisingly a dry read given the report spends much of its time discussing the RBA’s function as the banker of the government. The RBA governor’s forward however provides a fantastic snapshot of where the economy is at, both globally and domestically. Our highlights:

The Positives

  • Unemployment rates in many countries have declined further and, in some cases, are at ‘multi-decade lows’.

  • Financial conditions are still expansionary, although they are gradually becoming less so

  • This improvement in the global environment is helping the Australian economy. Higher commodity prices and stronger employment growth have provided a welcome boost.

  • Higher levels of public and private investment are also supporting the economy.

The negatives

  • Rising risk to the global economy from a move towards protectionism.

  • Subdued growth in wages in Australia.

  • High level of household debt in Australia.

Australia is a beneficiary of the open international marketplace because of the bounty of commodities we export. Any risk of increasing impediments to trade, undermines our export capacity.

The credit hangover from our household debt binge is starting to bite. Beroccas are being handed out willy-nilly by lenders whose heads are throbbing from the last few years of extraordinary credit growth.

The RBA might not be tightening monetary policy, however credit markets have already taken the initiative. The following graphs demonstrate the decline in credit growth and the more rapid decline of the major banks lending practices.

Finally, the lack of wage growth will continue to dominate domestic economic commentary in Australia. Forecasts have got it consistently wrong since 2011 with surprises always on the downside. Given current wage growth is at 2.1%, 2018 may be looked upon as the wage growth turning point.

Lending 3

Domestic concerns aside, the global economic outlook remains positive, rewarding Australian investors who have diversified internationally.

Investment commentary

Building wealth takes time. A good investment is one you believe will produce good earnings for the next ten years and beyond, acquired at a fair price.

Regardless of the economic conditions, we are always optimistic about quality income earning assets… an eye-roll worthy statement, but one worth repeating.

We regularly go through the following exercise to test our investment strategies:

When considering a business to invest in, we ask ourselves if we can readily conceive a realistic and believable hypothesis of why that business may not exist, or might have substantially reduced earnings, in ten years’ time. If the hypothesis is reasonably conceived and there is a realistic possibility of that bad outcome, it is best to avoid investing in that business.

There are ample Australian businesses that don’t hold up well in this thought exercise. Obvious examples are Myer, Harvey Norman (however some analysts argue this is now a property business) or CabCharge. Less obvious examples might be businesses like AMP or even Telstra which you can reasonably conceive a narrative that sees a significant portion of earnings structurally challenged within ten years.

If, like us, you don’t always invest directly in businesses and offload some responsibility to professional fund managers, you are still faced with another decision. How to pick the right fund manager.

Many fund managers sing from the same hymn sheet, where the tune is something along the lines of – We do bottom up fundamental analysis and only invest in a business where the intrinsic value has a margin of safety above the market value. Often this tune will have some percussive overlays with a macro, technical or geographical analysis used to filter stock selection.

Picking between different fund managers is sometimes nearly as hard as picking the right business to invest in! When we scrutinise fund managers among other things, we look to see if the decision makers in the management team are themselves invested in the fund, a high tracking error (i.e. deviation from an index), low turnover (i.e. stability of underlying investments), stable management and a preference for in-house research.

If you are curious or have questions about our investment philosophy, feel free to get in contact with us or explore our website for more information.

Royal Commission

The Royal Commission is battling our national broadcaster (the ABC) for best homemade drama. The Commission has released an interim report on Friday September 28th. This report has been the first signal of the direction the commission may pursue in outlining recommendations. The banking and financial services industry might have been taken to the cleaners, but the interim report also had some good news for the industry. It would appear unlikely that further laws or regulations will be recommended as a path for remedying the industry’s malaise. This was highlighted by the following comments:

“Much more often than not, the conduct now condemned was contrary to law. Passing some new law to say, again, ‘Do not do that’, would add an extra layer of legal complexity to an already complex regulatory regime. What would that gain?”

The commission even asked the question as to whether the current regulatory environment was too complex, given the “basic ideas are very simple” that is “obeying the law; not misleading or deceiving; acting fairly; providing services that are fit for purpose; delivering services with reasonable care and skill; and, when acting for another, acting in the best interests of that other

Certainly, one aspect that looks likely to be pursued is continued enforcement and punishment of regulatory breaches and breaking of the law. It may be that penalties for regulatory misconduct will be given more bite and the regulators themselves may get empowered with bigger teeth.

Whatever the outcome, the Commission has already proven an effective catalyst for cultural change in the financial services industry. The matter of fact approach, speed of proceedings and breadth of content already covered are an incredible triumph for all those working on the Commission.

By Matt Vickers