Contradictory messaging coming from Fed committee members speaking independently in the media has the market constantly guessing at present. While Trump appears to be running out of steam and his bag of tricks nearing empty, has he really got much more to add? John makes a controversial prediction and discusses the impact of US, China and European activity (including the unwinding of QE) on Aussie investors.
DW: Hello again everyone, David Walker from StocksInValue, and we have another video version of The View this week. Thank you for watching. With me as usually is John Abernethy set to answer your questions and mine about the macro side of investing. Now John, can we start by scanning America? We’ve got conflicting views on the future direction of fair monetary policy coming from Fed committee members speaking independently in the media and often saying different things. This contrasts with Australia’s Reserve Bank and whatever its flaws, at least there’s only one voice and the committee members don’t talk independently and confuse the market, which improves our Reserve Banks’ credibility. Can you chart a course for us for fair monetary policy, also touching on the Fed’s balance sheet steering us through the conflicting views coming out of the committee?
JA: I think the Fed doesn’t want to lead the market astray, but it also wants to keep it guessing a little bit because otherwise you get front running and trading through the cycle. I listen more to Yellen than say, Dudley. Although I think Dudley had a purpose when he talked about another interest rate rise more than the forward yield curve was suggesting. First, let’s talk about what Yellen said. After putting up interest rates she talked about the Federal Reserve balance sheet, which is full of government bonds and mortgages and she’s talking about an unwinding of that balance sheet. But these suggestions are going to be very mildly done in those tens to twenty billion dollars a month – on a $4tr. Balance sheet that would take 3-4 years to unwind. Clearly she wanted to flag the fact that the Federal Reserve at some point will be out of the bond market. That may have lead the market to believe that if the Fed is going to be so mild on that, then it will be mild on interest rate movements. Maybe what Dudley was required to do the next week was to say ‘Well, look if you think that there’s only going to one interest rate increase before Christmas, maybe don’t be so keen on that, there may be two’. The fact is that the employment numbers and the growth of the economy would suggest that there might be 2. Overlying all that is the international problem with Europe and Japan – that they are not moving interest rates and they have no intention of moving interest rates, so America’s going it alone. The consequences of that are quite profound for the American economy because the US dollar couldn’t revalue against the Euro and Yen and that’s not in the American industrial-based interest. Then that gets you back to Trump, because he’s very much pro-business and he would have something to say if interest rates went up quickly in America independent of the rest of the world.
DW: Can I just jump in there and say it’s a view of the market that this political risk priced into the US dollar for Trump. That’s one reason the US dollar is weaker that it would have been.
JA: I think that’s becoming more obvious as days go on and there is a range of inquiries. You can have a view on that – they seem to be like TV shows to me. But it is exposing Trump in that he probably jumped out of the gates very aggressively in the first hundred days, making a lot of noise. Some activity in terms of the attack on Syria, the health insurance bill, the promotion of interest tax cuts. Now we’ve gotten over that and we’re into managing the economy, managing America, and I think just right now it looks like he’s out of beans. I think that the momentum is going out of him. My personal view is he won’t last the distance of four years. I think he’ll pass the baton over at some stage.
DW: Sorry, do you actually think he’ll resign? That’s a very strong view.
JA: Yes because I don’t think he’s a normal US President and I don’t think he’s a politician. He’s a business guy and I think at some point he’ll say ‘look I stirred up the system, I did what I had to do and we’ll put the politicians back in place because a business guy can’t run this place’. There are too many restrictions in terms of law and the Parliament that he can’t do what he wants to do and I think a guy like that will be frustrated. He will stir it up, which he’s doing. There might be a bit more stirring to go, but eventually he runs out of energy and he says that it’s all too hard. He got the Republicans elected and he’s got a Vice President that can take over, giving him a year before he runs for reelection. Quite clearly Trump’s not re-electable, he certainly wouldn’t run for reelection. I don’t even think he’s a one-term president, I think he’s less than that.
DW: If you look at what the S&P US equity market is telling you, I think they’re already looking through Trump to the Fed, the economy and earnings. That’s what’s driving it now. Hopes of a Trump stimulus are no longer driving the US equity market.
JA: Yeah, I’d suggest you’re right. I’d say there is earnings growth in America, a lot of it stimulated by those IT multinational companies exporting to the world. That’s been a feature of our International Fund – buying those sorts of stocks. Mainstream America is in upheaval. The support Trump suggested for mainstream manufacturing is still to come. There’s been a lot of talk. He certainly hasn’t taken on the Chinese, so that still sits there unresolved. He hasn’t got a wall up against Mexico. He has upset NAFTA but we still haven’t seen how that’s going to settle. I think there will be some American manufacturing companies that are hoping he doesn’t do it, it’s not a very sensible strategy to increase their cost base by putting up tariffs with Mexico, for example. It’s interesting, his talk has caught everyone’s attention but now reality is that it’s going to be too hard and that’s my view. The American stock market, I’d have to say, is partly justified by earnings. I do think we’ve had a massive PE expansion, which fuels the view of a lot of high profile, large active fund managers that we are dealing with a very inflated equity market in the US. It has to have some steam taken out of it to bring it back to reality and hopefully that happens slowly not in one night. That’s probably the risk we’re watching at present.
DW: Ok, could we talk about China? I know in last week’s conversation we talked about the down-trend in commodity prices from China trying to thread the needle between keeping growth and employment strong enough to keep the population happy but trying to take some of the heat out of their over-geared property market. Where are we going with China and the policy of their authorities and what that means for commodity prices?
JA: I always look at the stock market and the stock market is certainly telling you that China is not booming. Now they may get a blip out of the being put into the World Index. Having put that aside, the Chinese stock market has not performed anywhere near the stated growth of the economy so that tells you there is a disconnect. I think the disconnect is in leverage. The financial system of China has obviously got problems as a shadow banking system, which no one can understand. That leverage issue will have to be addressed. If you put up interest rates too tightly you could blow it up, so that’s not going to happen. They’re going to try and manage it a bit like what the central bank of Australia is doing – dictating to banks to change lending policies and lending rates on specific areas of the economy. So, I think they’ll do that. Again, qualitative controls will come in and take the steam out of it. Recently the Chinese government has clearly been weakening the Yuan aggressively, which supported employment. I think they’ve got the message from America not to do it again, so they have tightened up outflows. They can turn that on again, but right now we’re seeing foreign reserves begin to grow again so the currency looks to be stable and there’s no release valve there. Actually I’d continue to say that the Chinese currency is undervalued on any logical basis. So the free kick there is not coming and China is probably going to enter into a slower growth period. Now the consequences for Australia in terms of commodity prices are already being reflected and most of the respected commodity owners I look at are not suggesting any boom in commodity prices, only recovery. So we’re stuck at current levels in that $50-60 for iron ore, holding current coal prices and oil and gas prices are probably going to remain quite weak. That’s an issue for Australia with LNG coming on board – about 1/3 of our natural exports are floating rate pricing. The Chinese economy is looking at a tough period and Australia; unfortunately we are caught in that.
DW: How and when should investors and/or traders think about buying resources stocks? Is there further to go yet?
JA: I’d like to see really deep value from an investment perspective. BHP has got diversity issues – it’s actually diversified into quite weak commodities at present. You’ve got iron ore, coal, oil and copper all not really going their way. A lot of prices are weak in that sector. Iron ore focused RIO – why they’re doing a buyback is beyond belief, but they want to do that so they’re holding up their price but it’s breaking down a bit now. Fortescue is just very leveraged by iron ore. Woodside has commented about the risk now with government controlling gas exports.
DW: Plus they can’t get the staff given the changes to the 457 Visas.
JA: Correct, and on top of that they’ve got a massive overhang of stock from their major shareholder who wants to sell. The commodities area of the stock market doesn’t look particularly pretty at present. Now contrarian investing says you’ve got to have a look at that. I’m just saying…
DW: Probably what we should do is record a video for our listeners just on the large-cap resource stocks at some point because it is getting more interesting without being a buyer just yet. Just to finish up, did you have any quick final comments on Europe and China?
JA: In Europe the signs are reasonable now. The financial system has been recapitalising consistently. I did comment in The View a few weeks ago about a take out in Spain, where we saw one of the major banks, Santander Bank, buy one of the weaker banks in a controlled takeover and there was a wipeout of bondholders but deposit-holders were protected. That is part of the continuing process of getting a stronger financial system in Europe, which is what you need before any sustainable recovery can take place. That’s why I think the ECB is so cautious. You’re not seeing them put up interest rates, you’re not seeing them pull out of QE because they know the belly of the financial system in Europe is still not one hundred percent where it should be. That’s unfortunate because that means interest rates stay low putting pressure on the Federal Reserve not to increase the way they should and that means that Australian interest rates relatively ok so the Australian dollar is over priced. It’s all connected, that’s the problem for investors. It’s a drawn out process and I think we’ve got another year of this nonsense where the Australian dollar just drifts before reality sets in.
DW: Thank you very much John that was a good conversation. Thanks everyone for watching. Any questions about the macro, the big picture side of investing please post in the fields below this video. Also, please let us know your views on resource stocks and commodity prices; we would be interested to hear what you think. Thanks for watching and we’ll see you next time, all the best.