The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Thursday, May 19, 2011

A taste of things to come: the cries of stockbrokers feeling the pain...

Man, the RBA is about to face a stern test of its political independence and decision-making fortitude. I find it pretty galling that people that should know better are already putting heat on them. Here the banks are key culprits. They know they face few growth opportunities, and are evidently concerned that higher rates will compound the problem by further reducing credit growth and amplifying arrears. We have, thus, seen a veritable choir of bank complaints. Today, the Bank of Queensland is on the job, with its CEO warning against any further hikes for fear of the damage this will do.

But, seriously, Australia's economy can easily absorb a couple more hikes this year. Unemployment is 4.85%. Wages are growing at a very healthy 4% pa (including bonuses). Headline lending rates are only a touch above their long-term averages. Yet inflation is running way above the RBA's 2.5% pa target (based, exclusively, on the core or headline Q1 results). I mean, I have a big variable rate mortgage. I own a home. I can empathise with those feeling the pain. But the Bank needs to be free to do its job.

This is a lot like a re-run of 2007-2008, when the RBA were entirely justified in hiking rates to scorching levels on the basis of core inflation rising well above 4%. The traditional counterargument to this is that they should have seen the GFC coming (I made this point myself at the time). But, I and others were wrong. The RBA always knew it could seamlessly slash rates, which it did in September 2008, with instant transmission to the majority of borrowers with variable rate loans. They were absolutely correct in focusing on their singular price stability objective until they had incontrovertible evidence that inflation would subside.

To give you a feel for the swarm of emotive pleas the RBA is going to have to ignore, check out this remarkable email note sent out by one of Australia's leading institutional stockbrokers to his equity-investing clients. (Readers will know that we have been long-time bearish on equities, which will struggle for as long as the RBA continues raising rates). And, don't get me wrong, this guys is smart, albeit with a clear vested interest in avoiding any further damage to his beloved sharemarket (which, it should be noted, has underperformed government bonds on a compound basis over the last 30 years, even assuming dividend reinvestment):

“I really hope you know what you are doing Reserve Bank of Australia Board, because I am starting to feel you are out of touch with domestic East Coast economic reality. The last time I had this feeling you tightened rates In March 2008 right as it was obvious the GFC was taking hold globally and commodity prices had started correcting.

You were fighting inflation demons yet less than 6 months later you were fighting deflation demons and cutting rates aggressively to “emergency settings”. The February 2008 RBA Board minutes noted “ recent trends in world commodity markets, however, have further strengthened prospects for Australia’s terms of trade”. Followed by just one year later, “recent information from abroad indicates that the contraction in the global economy continues during the first few months of this year, and most assessments of the near-term outlook have been further marked down”. It is therefore fair to assume that there is no crystall [sic] ball in Martin Place.

RBA Board, there’s “ahead of the curve” and then there is “driving over the cliff”. Make sure you know exactly where you are. In March 2008 you did drive over the cliff, based on what proved an incorrect view of our terms of trade and inflationary pressures, as evidenced below in the cash rate chart below.

Don’t get me wrong, I too drove spectactularly [sic] over the cliff in terms of equity strategy in March 2008, but I don’t set monetary policy in Australia and I try to learn from my mistakes. [CJ: But the RBA's management of monetary policy both during and after the GFC was widely regarded by experts around the world as superlative.]

The RBA Minutes yesterday suggested the RBA Board are ploughing ahead with the tightening bias, despite what we believe is clear evidence of a very weak, and weakening further, East Coast economy. This surprises me because the Chairman of two of Australia’s most devastated industrial stocks, FXJ and BSL, both sit on the RBA Board. Both companies just issued further profit downgrades, yet the RBA Minutes summarise business conditions as “There had been only a limited amount of data on domestic activity released since the previous Board meeting, but this had had a slightly more positive tone than earlier in the year when natural disasters dominated the news. Business conditions, as measured by the NAB survey, recorded a significant rise in March to above-average levels, and business credit rose by 1 per cent in the month, the strongest outcome since late 2008. While there had been no new official data on retail sales since the previous meeting, the staff's liaison suggested modest growth in volumes over the past month or so”.

The RBA goes on to say “policy is set for overall economy despite divergences”. Try telling that to your average SME who is being crunched, the FXJ journalist who is being retrenched, the Pt Kembla steel worker who wonders whether they will have a job next week, or the first home buyer who now can’t afford his mortgage payments.

I truly wonder whether the RBA is becoming myopic in its monetary policy settings. They seem besotted with “terms of trade” , “real incomes” and the WA “investment boom”, but in all of strategy the key to successful strategy is adjusting it as developments occur. I just find it stunning that the RBA persists with a clear “tightening bias” when retail sales, property auction clearance rates, credit growth, advertsing [sic] sales, inbound tourism, and now even employment data is disappointing. Australian asset prices are also clearly correcting, led by residential property and followed by the equity market [CJ: I think it was the other way around].

Whether they are just “jawboning” is the question. But after reading the RBA minutes I don’t think they are. That genuinely concerns me. If the RBA raises rates twice more this year as seems to be the consensus, it will be the straw the breaks the East Coast economy’s back. The AUD will be $1.15, and domestic EVERYTHING industrial will be under real pressure. Jobs will be shed, residential property prices will fall, and retail sales will evaporate. Bad and doubtful debts for the banks will rise, and this will get VERY UGLY.

Imagine if commodity prices fall further or Chinese GDP negatively surprises. Would we suddenly see some of these massive “boom” capex intentions in WA scaled back?? It happened in the GFC and it could happen again, yet it seems our monetary policy (and fiscal policy) is set off these capex intentions ALL becoming investment reality.

Anyhow, I want to be very clear that I now think the RBA are playing with fire. There is a growing chance they could trigger a genuine East Coast recession (feels like one already) if they play the very blunt monetary policy card too hard. I think this is lose lose; if their jawboning alone will be enough to spook households, but if they actually do pull the trigger on two more rate hikes it will have a devastating effect. I call it “blunt force economic trauma”.

I have to say I was also surprised when I read a headline from Westpac CEO Gail Kelly a that said “economy can absorb another rate hike”. All I will say is that is not our view.

No doubt WBC would hope the economy can absorb another rate hike because they currently generate 93% of NPAT from Australia, the highest percentage of any major bank. They also have the equal highest percentage of home loan lending as a perctage [sic] of total loans at 66%, and another 20% lent to SME’s. They have the highest exposure to NSW/ACT at 39% post the SGB acquisition.

WBC reported the weakest revenue performance of the big 4 in the half year results, with net revenue growth -1% (vs ANZ +11%, NAB +7% and CBA +5%). It appears from the economic charts WBC released with their result that they believe the macroeconomic conditions that drove their revenue underperformance are temporary…

All 1991 WBC jokes aside, I think we are cleary [sic] have internal problems in the Australian economy. External shocks, or further self-inflicted wounds from the RBA or Canberra will exacerbate the internal problems.

We retain a very conservative Australian equity strategy (focused on genuine organic growth companies), feeling we at a crucial moment for the three speed Australian economy. I would much rather err on the side of caution (running high cash levels and concentrated stock bets), particulalry [sic] in regard to East Coast industrial cyclicals, than punt on policy makers getting the macro settings right.

By the way, how do you set appropriate monetary policy for a three speed economy using a single, all-encompassing cash rate tool??”