Sub Prime

Trillion Dollar Baby?

What will it take to wake the media up to the fact that the way our government is spending it won’t be long before we are a $1 trillion net debt baby?.

Our current federal liabilities (p.121) stand at $1.002 trillion (which is pre COVID19). Have the media bothered to look at the state of the budget accounts? Or are they too busy lavishing praise on rescue packages which have a finite lifespan.

We pointed out yesterday that the “revenue” line could be decimated by the disruption – huge cuts should be anticipated in the collection of GST, income, company and excise taxes. Not to mention huge rebates to be paid to now unemployed workers. On an annualized basis the revenue line could get thumped 30-40% if this continues for 6 months.

So on the back of an envelope, it is not very hard to work out that with a current $511 billion revenue line looking to fall towards the early to mid $300 billion mark against a projected expense bill of $503 billion a deficit of $150bn will open up. Throw on c$150bn of COVID19 stimuli arriving by June 30th and we get a $300 billion budget deficit. Our net financial worth would grow from minus $518 billion to negative $818 billion.

Rolling into next year, it is ludicrous to think that hibernated businesses will have resumed as normal. This means that the following year’s tax revenue line will look as sick as the previous period. The government will be torn shredding the expense line as unemployment shoots higher so assuming minimal budget cuts, it could face another $200 billion deficit taking it north of $1 trillion net liabilities in a jiffy.

Let’s not forget what the states may face. Severely lower handouts from the federal government via GST receipts which will balloon deficits, a trend we’re already seeing.

The states currently rely on around 37-62% of their revenue from the federal government by way of grants. The balance comes through land/property taxes, motor vehicle registration, gambling and betting fees as well as insurance and environmental levies.

All of those revenues lines can dry up pretty quickly. 40% of state budgets are usually spent on staff. Take a look at these eye watering numbers.

NSW spends $34 billion on salaries across 327,000 employees.

Victoria spends $27 billion across 239,000 public servants.

Queensland uses 224,000 staff which costs $25 billion per annum.

WA’s state workforce is 143,000, costing $12.6 billion.

SA has 90,000 FT employees costing $8.5 billion.

Tasmania 27,000 setting taxpayers back $2.7 billion.

Just the states alone employ over 1.05 million people at a cost of $110 billion pa!! The territories will be relative rounding errors.

A lot of the states have healthy asset lines which are usually full of schools, hospitals, roads and land). These are highly illiquid.

Unfortunately, one of the golden rules often forgotten in accounting is that liabilities often remain immovable objects when asset values get crucified in economic downturns. When markets become illiquid, the value of government assets won’t come at prices marked in the books.

How well will flogging a few public hospitals go down politically to financially stressed constituents?? This is why gross debt is important.

The states have a combined $202 billion outstanding gross debt including leases.

Throw on another $150 billion for unfunded superannuation liabilities. Good luck hitting the “zero by 2035” targets some state have amidst imploding asset markets. It simply won’t happen. If only these liabilities were marked to market rather than suppressed by actuarial accounting. The WA budget paper (p.42) notes the 0.4% bump to the discount rate to lower the pension deficit figure. To be fair, they are far less outrageous than US state pension deficits.

How must the State Gov’t of Queensland be praying that Adani keeps plowing ahead? How Greyhound must regret terminating a contract to ferry construction workers to the mine? We doubt the incumbent government will have a climate change bent in the upcoming Oct 31 state election. See ya.

The trillion dollar federal debt ceiling seems like a formality especially as the chain reaction created by the states puts on more pressure for the federal government to inject rescue packages to prop up their reversal of fortune budgets. It is that trillion with a T headline that will get people’s attention.

In short, we ain’t seen nothing yet.

A gem on how to work our way out of the coming economic crisis

Image result for truck nitroglycerin movie

Jonathan Rochford of Narrow Road Capital has written a gem on the role of central banks in spawning this current crisis. An excerpt here:

The rapid and widespread sell-off over the last four weeks is a textbook systemic deleveraging. Whilst the culprits are many; hedge funds, risk parity strategies and investors using margin loans have all been caught out, the underlying cause is excessive leverage across the economy and particularly the financial system. The timing of the unwind and the economic damage from the Coronavirus wasn’t predictable, but such a highly leveraged system was like a truck loaded with nitroglycerin driving down a road dotted with landmines.

Frustratingly, this inevitable deleveraging was clearly predicted. Rather than act to reduce systemic risks central banks encouraged governments, businesses and investors to increase their risk tolerances and debt levels.

Naturally, it fits our own long-held view on central banks.

Jonathan adds some sensible actions which are contained in this link. The question remains whether governments will put principle ahead of expediency in the cleanup?

This can only end in tears

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As Sweden’s economy slows to the worst economic growth rate in 5 years under a negative interest rate policy, one would think the Swedish Central Bank (Riksbank) would be seeking to prudently manage its asset book on the basis of appropriate risk/reward as opposed to lecturing Australia and Canada on their respective carbon footprints. What we are witnessing is yet another discrete move by authorities to manipulate markets based on fantasy rather than fact.  The hypocrisy is extreme as we shall discover.

While the Riksbank should have complete freedom in how it wishes to deploy capital, we should view this is a pathetic sop to the cabal at the European Central Bank (ECB). Since when did central bankers become experts on climate change? The RBA is no better. Deputy Governor, Guy Debelle, gave a speech in March 2019 on the risks posed by climate change which based prophecies on the data accident-prone IPCC and Bureau of Meteorology. Why not seek balance? Easier to fold to group think so as not to be outed as a pariah. Utterly gutless. Our own APRA is also pushing this ridiculous agenda on climate change reporting. It is willful negligence.

While it is true that on a per capita basis, Australia and Canada’s emissions are higher than the global average, why doesn’t the Riksbank give us credit for lowering that amount 11.4% since 2000? Even Canada has reduced its carbon emissions by 7.3% over the last 18 years. Admittedly Sweden’s emissions per capita have fallen 21.9% according to the IEA. Greta will be happy.

Why hasn’t the Riksbank taken China or India to task for their 169.9% or 94.7% growth in CO2 emissions respectively? There are plenty of oil-producing nations – Qatar, UAE, Bahrain, Saudi Arabia and Oman that have worse per capita outcomes than Australia or Canada. Do these countries get special dispensation from the wrath of the Riksbank? Clearly.

The US has pulled out of the Paris Climate Accord. If the US has marginally lower emissions per capita (15.74t/CO2-e) than Australia (16.45t/CO2-e), isn’t a double standard to write,

The conditions for active climate consideration are slightly better in our work with the foreign exchange reserves. To ensure that the foreign exchange reserves fulfil their purpose, they need to consist of assets that can be rapidly converted to money even when the markets are not functioning properly. Our assessment is that the foreign exchange reserves best correspond to this need if they consist of 75 per cent US government bonds, 20 per cent German and 5 per cent British, Danish and Norwegian government bonds.

Essentially Riksbank commitment to climate change is conditional. The US which is responsible for 13.8% of global emissions can be 75% of holdings. Australia at 1.3% can’t. No doubt sacrificing Queensland Treasury Corp, WA Treasury Corp and Albertan bonds from a Riksbank balance sheet perspective will have little impact on the total. In short, it looks to be pure tokenism. The Riksbank has invested around 8% of its foreign exchange reserves in Australian and Canadian central and federal government bonds. So perhaps at the moment, it is nothing but substitution from state to federal. Why not punish NSW TCorp for being part of a state that has 85%+ coal-fired power generation?

At the very least the Riksbank admits its own hypocrisy.

The Riksbank needs to develop its work on how to take climate change into consideration in asset management. For instance, we need a broader and deeper analysis of the issuers’ climate footprint. At the same time, one must remember that the foreign exchange reserves are unavoidably dominated by US and German government bonds. The Riksbank’s contribution to a better development of the climate will, therefore, remain small. This is entirely natural. The important decisions on how climate change should be counteracted in Sweden are political and should be taken by the government and the Riksdag (parliament).

Still, what hope have we got when Benoît Cœuré, member of the Executive Board of the ECB, lecturing those on “Scaling up Green Finance: The Role of Central Banks.” He noted,

2018 has seen one of the hottest summers in Europe since weather records began. Increasing weather extremes, rising sea levels and the Arctic melting are now clearly visible consequences of human-induced warming. Climate change is not a theory. It is a fact.

Reading more of this report only confirms the commitment of the ECB to follow the UN’s lead and deliberately look to misallocate capital based on unfounded claims of falling crop yields and rising prices (the opposite is occurring) and rising hurricane and drought activity (claims that even the IPCC has admitted there is little or no evidence by climate change). Sweden is merely being a well-behaved schoolboy.

Cœuré made the explicit claim, “The ECB, together with other national central banks of the Eurosystem, is actively supporting the European Commission’s sustainable finance agenda.

CM thinks the biggest problem with this “agenda” is that it risks even further misallocation of capital within global markets already drowning in poorly directed investment. It isn’t hard to see what is going on here. It is nothing short of deliberate market manipulation by trying to increase the cost of funding to conventional energy using farcical concocted “climate risks” to regulate them out of existence.

Cœuré made this clear in his speech,

once markets and credit risk agencies price climate risks properly, the amount of collateralised borrowing counterparties can obtain from the ECB will be adjusted accordingly.

What do you know? On cue, Seeking Alpha notes,

Cutting €2bn of yearly investments, the European Union will stop funding oil, natural gas and coal projects at the end of 2021 as it aims to become the first climate-neutral continent.

All CM will say is best of luck with this decision. Just watch how this kneeling at the altar of the pagan god of climate change will completely ruin the EU economy. The long term ramifications are already being felt. The EU can’t escape the fact that 118mn of its citizens (up from 78m in 2007) are below the poverty line. That is 22% of the population. So why then does Cœuré mention, in spite of such alarming poverty, that taking actions (that will likely increase unemployment) will be helped by “migration [which] has contributed to dampening wage growth…in recent years, thereby further complicating our efforts to bring inflation back to levels closer to 2%.

Closer to home, the National Australia Bank (NAB) has joined in the groupthink by looking to phase out lending to thermal coal companies by 2035. The $760 million exposure will be cut in half by 2028. If climate change is such a huge issue why not look to end it ASAP? This is terrible governance.

Why not assess thermal coal companies on the merits of the industry’s future rather than have the acting-CEO Philip Chronican make a limp-wristed excuse that it is merely getting in line with the government commitment to Paris? If lending to thermal coal is good for shareholders in 2036, who cares what our emissions targets are (which continue to fall per capita)? Maybe this is industry and regulator working hand-in-hand?

The market has always been the best weighing mechanism for risk. Unfortunately, for the last two decades, global central bank policy has gone out of its way to prevent the market from clearing. Now it seems that the authorities are taking actions that look like collusion to bully the ratings agencies into marking down legitimate businesses that are being punished for heresy.

This will ironically only make them even better investments down the track when reality dawns, just as CM pointed out with anti-ESG stocks. Just expect the entry points to these stocks to be exceedingly cheap. Buy what the market hates. It looks as though the bureaucrats are set to make fossil fuel companies penny stocks.

Westpac reported a 40% increase in home repossessions

Mortgages Westpac

Don’t get CM wrong – this is still the law of small numbers.  Westpac reported this week that it repossessed another 162 properties in the latest fiscal year.  That is a 40% increase. While it is but a dribble compared to the 100,000s of total loans outstanding it is none-the-less a harbinger of things to come. Westpac made clear, “the main driver of the increase has been the softening economic conditions and low wages growth.”

The current status of 90-day+ delinquencies has been rising over time. As have 30-day +. While nothing alarming, the current economic backdrop should give absolutely no confidence that an improvement in conditions is around the corner. We are not at the beginning of the end, but at the end of the beginning.

Former President Ronald Reagan once said of the three phases of government, “if it moves, tax it. If it keeps moving regulate it. If it stops moving, subsidize it.” How is that relevant to the banks?

We have already had the government fold and attach a special bank tax on the Big 4. Phase 1 done. Now we are in the middle of phase 2 which is where knee-jerk responses to the Hayne Banking Royal Commission (HBRC) where banks will be on the hook for the loans they make. That is a recipe for disaster that could bring on phase 3 – bailouts.

Sound extreme? How is a bank supposed to make a proper risk assessment of a customer’s employability in years to come? Can they predict with any degree of accuracy on the stability of candidates who come for loans? The only outcome is to cut the loan amount to such conservative levels that the underlying purpose gets diluted in the process and prospective home buyers have to lower expectations. Not many banks will look positively at taking several loans on the same property with different institutions. That won’t work. SO loan growth will shrink, putting pressure on the property market.

What is the flip side? Given property prices in Sydney hover at 13x income (by the way, Tokyo Metro was 15x income at the peak of its property bubble), restrictions on further lending against loan books that are on average 63% stuffed with mortgages (Japan was 41.2% at the peak) won’t be helpful. A property slowdown is the last thing mortgage holders and banks need.

While equity continues to rise at Aussie banks, the equity to outstanding mortgages has gone down since 2007 i.e. leverage is up. If banks saw their average property portfolios drop by more than 20% many would be staring at a negative equity scenario. Yet, it won’t be just mortgage owners that we need to worry about. Business loans could well go pear-shaped as the onset of higher unemployment could see a sharp increase in delinquencies through a business slowdown. A concertina effect occurs. More people lose their job and a vicious circle ensues. It isn’t rocket science.

Of course, Australia possesses the ‘boy who cried wolf‘ mentality over the housing market. Yet it is exactly this type of complacency that paves a dangerous path to poor policy prescriptions.

In Japan’s property bubble aftermath, 40% of the value of loans went bang. 17% of GDP. $1.1 trillion went up in smoke. It took more than 10 years to clean up the mess and the aftershocks remain. Accounting trickery around the real value of loans on the balance sheet can hide the problems for a period but revenue tends to unravel such tales. 181 banks and building societies went bust. The rest were forced into mergers, received bailouts or were nationalised. Now the Japanese government is a perpetual debt slave, having to raise $400bn per annum in debt just to fill the portion of the $1 trillion budget that tax collections can’t fill.

The problem  Japan’s banks faced was simple.  If a neighbour’s $2m home was repossessed through mortgage stress and the bank fire sold it for $1.4m, the bank needed to mark to market the value of the loan portfolio for that area by similar amounts. In doing so, a once healthy balance sheet started to look anything but. Extrapolate that across multiple suburbs and things look nauseating quickly.

This is where Aussie banks are headed. This time there is no China to save us like in 2009. Unemployment rates in Australia never went above 6% after the GFC in 2008/9, unlike the US which went to 10%. We weathered that storm thanks to a monster surplus left by the Howard government, which we no longer have.

Sadly China has had 18 months of consecutive double-digit car sales decline. Two regional Chinese banks have folded in the last 3-4 months. China isn’t a saviour.

Nor is the US. While the S&P500 might celebrate new highs, aggregate corporate profitability hasn’t risen since 2012. The market has been fuelled by debt-driven buybacks. We now have 50% of US corporates rated BBB because of the distortions created by crazed central bank monetary policy, up from 30%. Parker Hannifin’s latest order book shows that customer activity is falling at a faster pace.

Nor is Europe. German industrial production is at 10-year lows. The prospects for any EU recovery is looking glib. Risk mispricing is insane with Greek bond spreads only 1.8% higher than German bunds.

What this means is that 28 years of unfettered economic growth in Australia is coming to an end and the excesses built in an economy that believes its own BS is going to leave a lot of people naked when the tide goes out.

The Australian government needs to focus on more deregulation, tax and structural reforms. Our record-high energy prices, ridiculous labour costs and overbearing red-tape are absolutely none of the ingredients that will help us in a downturn. We need to be competitive and we simply aren’t. Virtue signalling won’t help voters when the whole edifice crumbles.

All a low-interest rate environment has done is pull forward consumption. It seems the RBA only possesses a hammer in the tool kit which is why it treats everything as a nail. It is time to come to terms with the fact that further cuts to the official cash rate and the prospect of QE will do nothing to ward off the inevitable.

Pain is coming, but the prospects of an orderly exit are so far off the mark they are in another postcode. Roll your eyes at the stress tests. Stress tests are put together on the presumption that all of the stars align. Sadly, in times of panic, human nature causes knee-jerk responses which put even more pressure.

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The Aussie banks have passed their best period. While short term news flow, such as a China trade deal, might give a short term boost, the structural time bomb sits on the balance sheet and while we may not get a carbon copy of the Japanese crisis, our Big 4 should start to look far more like the rest of the global banks – truly sick. The HBRC will see that it becomes way worse than it ever needed to be.

Complacency kills.

Forget the return “ON” your money. Just look to the return “OF” it

CM knew a lot of passive indices existed but not to this crazy extent. Probably explains why there is so much stupid money tied up in me too commoditised investment products. 4 years ago CM wrote a piece on the dangers of ETFs (especially leveraged)  and passive products in a downturn. These products predominantly follow the market, not lead it. So if these products end up stampeding toward the exits in a market meltdown, the extent will be amplified, especially those levered funds potentially making market panic look worse than it really might otherwise be. Don’t be surprised to see the mainstream media sensationalise the size of any falls in the market.

According to Bloomberg, 770,000 benchmark indexes were scrapped globally in 2019…however  2.96 million indexes remain around the world, according to a new report from the Index Industry Association…There are an estimated 630,000 stocks that trade globally, including c.2,800 stocks on the NYSE and c. 3,330 on NASDAQ or 5x as many indices as there are securities globally.

CM wrote back in October 2015,

ETFs are hitting the market faster than the dim-sum trolley can circle the banquet hall. Charles Schwab, in the 12 months to July 2015, saw a 130-fold preference of ETF over mutual funds given their relative simplicity, cost and transparency….

…ETFs, despite increasing levels of sophistication, have brought about higher levels of market volatility. Studies have shown that a one standard deviation move of S&P500 ETF ownership as a percentage of total outstanding shares carries 21% excess intraday volatility. Regulators are also realising that limit up/down rules are exacerbating risk pricing and are seeking to revise as early as October 2015. In less liquid markets excess volatility has proved to be 54% higher with ETFs than the actual underlying indices. As more bearish market activity has arrived since August 2015 we investigate how ETFs may impact given a large part of recent existence has been under more favourable conditions…

CEO Larry Fink of Blackrock, the world’s largest ETF creator, has made it clear that
leveraged ETFs (at present 1.2% of total ETF AUM) have the potential to “blow up the whole industry one day.” The argument is that the underlying assets that provide the leverage (which tend to have less liquidity) could cause losses very quickly in volatile markets. To put this in perspective we looked at the Direxion Daily Fin Bull 3x (FAS) 3x leverage of the Russell 1000 Financial Services Index. As illustrated in the following chart FAS in volatile markets tends to overshoot aggressively

…The point Mr Fink is driving at is more obvious with the following chart which shows in volatile markets, the average daily return is closer to 10x (in both directions) than the 3x it is seeking to offer. This is post any market meltdown. On a daily basis, the minimum and maximum has ended up being -1756x to 1483x of the index return, albeit those extremes driven by the law of small numbers of the return of the underlying index. Which suggests that in a nasty downturn the ETF performance of the leveraged plays could be well outside the expectations of the holders.”

CM has said for many years, where CDOs and CDSs required the intelligence of a mystical hermit atop a mountain in the Himalayas to understand the complexities, ETFs are the complete opposite. Super easy to understand which inadvertently causes complacency. Unfortunately, as much as they might try to do as written on the tin, the reality could well turn out to be the exact opposite.

Hence CM continues to believe that stocks with low levels of corporate social responsibility (CSR) scores like tobacco companies such s Philip Morris, JT and Imperial Tobacco, as well as gold/silver bullion,  look the places to be invested. Cash won’t necessarily be king because the banks are already in a world of pain that hasn’t even truly started yet. Aussie banks look like screaming shorts at these levels. The easiest way for the plebs – without access to a prime broker – to do this is to buy put options on individual bank names. Out of the money options are dirt cheap.

Banks

Forget the return ONyour money. Just look to the returnOFit.

NB, none of this constitutes investment advice. It is a reflection of where CM is invested only. 

 

Seen this all before

What is it with the US auto market that throws up so many canaries in the coal mine? Several years back CM wrote about the growth in sub-prime auto loans. What triggered this boom? Easier access to finance? That was one reason. As it happens the largest factor was driven by the ability for finance companies to shut down a vehicle by remote and repossess the vehicle should the buyer be unable to afford the monthly payments. This lowered risk and allows these long-dated loan products to thrive. Average subprime auto loans carry 10% p.a. interest rates. More than 6 million American consumers are at least 90 days late on their car loan repayments, according to the Federal Reserve Bank of New York.

About a 1/3rd of all US auto loans issued today are stretched out to seven years and beyond, according to the WSJ. A decade ago, the seven-year loan only made up about 10% of all loans. Even 10% of 2010 model year bangers are being bought on 84-month term loans.

After the tech bubble collapsed at the turn of the century do you remember the ‘Keep America Rolling’ programme, which was all about free financing for five years? While sales were helped along nicely, the reality was it stored up pain. As new car sales became harder to achieve, new financial products offered sweeter upfront incentives and buyback guarantees (because cheap finance was everywhere and not a differentiator) helped keep the fire stoked.

However, as front end incentives kept getting juicier, the cars on guaranteed buybacks were starting to return to the market at prices well below the ‘guarantee’ leaving automotive finance arms in a whole world of hurt and huge losses. Goldberg & Hegde’s Residual Value Risk and Insurance study in 2009 suggested on average 92% of cars returned to leasing companies recorded losses on return of up to 12%. Any company can guarantee the price of its used product, in theory, the question is whether used car buyers will be willing to pay for it.

In the last decade, auto loans have ballooned from $740bn to $1.3 trillion. Auto dealers are now making a majority of their money on the finance deal as opposed to the sale of the actual car. Even worse, the US car market is experiencing a third of trade-ins in negative equity meaning the gap is being added to the price of the new car, hence the push out of the loan period to keep a lid on the size of monthly payments. This was 17% in 2008.

CM is sure there is nothing to worry about. It is consistent with nearly everything else that has occurred in finance since the GFC. Just double down, spend more, close your eyes and hope nothing bad happens. Ultimately it will be someone else’s problem.

Serious auto-loan delinquencies – 90 days or more past due – in 2Q 2019, jumped 47 basis points year-over-year to 4.64% of all outstanding auto loans and leases, according to New York Fed. This is equivalent to the delinquency rate in Q3 2009, just months after GM and Chrysler had filed for Chapter 11 bankruptcy. The 47-basis-point jump in the delinquency rate was the largest year-over-year jump since Q1 2010. Actual outstanding delinquent 90 day + delinquencies stand at $60bn in 2Q 2019, almost double the amount of 4Q 2010.

Did CM mention gold?

The Grim Repo

What a surprise to see markets show little reaction to the negative repo (repurchase agreements) market in the past week. So much nonchalance and complacency remain in financial markets. It is as if there is this false belief that the authorities can keep the ship afloat with magical modern monetary theory. Not a chance. The tipping points in the financial markets are quantum levels bigger than any that Sir David Attenborough could conjure up in his wildest pessimistic dreams. If we want to cut carbon emissions, the coming economic slump will take care of that.

On average there are $1 trillion of overnight repo transactions every day, collateralised with US Treasuries. Yet many missed that the repo market seized up late last week. Medium-term repos surged from the normal band of around 2.00~2.25% to around 5.25% on Monday. Some repo rates hit 10% on Tuesday.

Essentially what this said was that a bank must have seen that it was worth borrowing at an 8% premium overnight in return for pledging ‘risk-free’ US Treasuries at 2%. In any event, it allowed that particular bank to survive for another day. Banks use the repo market to fund the loans they issue and finance trades that are executed. It is like an institutional pawn shop.

Looking at it another way, why weren’t other banks willing to lend and take an 8% risk-free trade? A look at the global bank’s share price action would suggest that these bedrock financial institutions that grease the wheels of the economy are not in good shape. We just pretend they are. We look at the short term performance but ignore the deterioration in underlying balance sheets. The Aussie banks are future crash test dummies given the huge leverage to mortgages. As CM has been saying for years, the Big 4 risk whole or part nationalisation.

This recent repo action is reminiscent of that before the GFC. The Fed stepped in with $75bn liquidity per day to stabilise markets by bringing rates into the target range. The question is whether the repo action is a short-term aberration or the start of a longer-term quasi QE programme which turns into a full-blown QE programme.

The easiest way to look at the repo market action is to say the private markets are struggling to be self-funding, requiring central bank intervention. Bank of America believes the Fed may have to buy upwards of $400bn of securities to back the repo market this year alone.  This is another canary in the coal mine.

CM wrote a long piece back in July 2016 titled, “Dire Straits for Central Bankers.” In that report, we described how the velocity of money in the system was continuing to drift. As of now, central banks have printed the equivalent of $140 trillion since 2008 but have only managed to eke out $20 trillion in GDP growth. That is $7 of debt only generates $1 of GDP equivalent.

This is the problem. Companies are struggling to grow. US aggregate after-tax profits have gone sideways since 2012. We have been lulled into a false sense of security by virtue of aggressive share buyback programs that flatter EPS, despite the anaemic trend.

Despite the asset bubbles in stocks, bonds and property, pension funds, especially public sector retirement schemes, are at risk of insolvency given the unrealistic return assumptions and nose bleed levels of unfunded liabilities in the trillions.

Also worthy of note is the daily turnover of the gold derivatives market which has hit $280bn in recent months, or 850x daily mine production. This will put a lot more pressure on the gold physical market and also to those ETFs that have promissory notes against gold, as opposed to having it properly allocated.

We live in a world of $300 trillion of debt, $1.5 quadrillion in derivatives – until this is expunged and we start again, the global economy will struggle. That will also require the “asset” values to be similarly wiped out. Equity markets will plunge 90-95% relative to gold. That suggests a 1929 style great depression. The debt bubble is too big. Central banks have lost control.

Buy Gold.

Actually, vote on the political emergency

No surprise to see The Guardian parrot on about a climate emergency. The editorial completely misses out on the political emergency we face. The economic climate is a massive issue facing Australia. When Bill Shorten tells us that he “will change the nation forever” we shouldn’t view that positively. It is probably the honest thing he has said. Labor’s policy suite is the worst possible collection one could assemble to tackle what economic headwinds lie ahead. Our complacency is deeply disconcerting.

First let’s debunk the climate noise in The Guardian.

The math on the climate emergency is simple. Australia contributes 0.0000156% of global carbon emissions. No matter what we do our impact is zip. If we sell it as 560 million tonnes it sounds huge but the percentage term is all that is relevant. Even Dr Finkel, our climate science guru, agrees. What that number means is that Australia could emit 65,000x what it does now in order to get to a 1% global impact. So even if our emissions rise at a diminishing rate with the population, they remain minuscule.

Bill Shorten often tells us the cost of doing nothing on climate change is immeasurable. He’s right, only in that “it is too insignificant” should be the words he’s searching for.

Perhaps the saddest part of the Guardian editorial was to say that the Green New Deal proposed by Alexandria Ocasio Cortez was gaining traction in the US. It has been such a catastrophic failure that she lost an unsolicited vote on the Senate floor 57-0 because Democrats were too embarrassed to show up and support it. Nancy Pelosi dismissed it as a “green dream.” At $97 trillion to implement, no wonder AOC says feelings are more important than facts.

With the 12-year time limit to act before we reach the moving feast known as the tipping point, it gets confusing for climate sceptics. Extinction Rebellion wants things done in only 6 years. The UK House of Commons still can’t get a Brexit deal done inside 3 years but can act instantaneously to call a “climate emergency” after meeting a brainwashed teenager from Sweden. It speaks volumes of the desperation and lack of execution to have to search for political distractions like this.

The ultimate irony in the recent celebration of no coal-fired power in the UK for one week was fossil fuel power substituted all of it – 93% to be exact. Despite the energy market operator telling Brits that zero carbon emissions were possible by 2025 (40% of the current generation capacity is fossil fuel), it forgot that 85% of British homes heat with gas. Presumably, they’d need to pop on down to Dixon’s or Curry’s to buy new electric heaters which would then rely on a grid which will junk 40% of its reliable power…good luck sorting that out without sending prices sky high. Why become beholden to other countries to provide the back-up? It is irrational.

Are people aware that the German electricity regulator noted that 330,000 households (not people) were living in energy poverty? At 2 people per household, that is 1% of the population having their electricity supply cut off because they can’t afford to pay it. That’s what expensive renewables do. If the 330,000 could elect cheap electricity to warm their homes or go without for the sake of the climate, which would they choose? 100% cheap, reliable power. Yet Shorten’s plan can only push more into climate poverty which currently stands at 42,000 homes. This is before the economy has started to tank!

If one looks across Europe, it is no surprise to see the countries with the highest level of fossil fuel power generation (Hungary, Lithuania & Bulgaria) have the lowest electricity prices. Those with more renewables (Denmark, Germany & Belgium), the highest. That is Australia’s experience too. South Australia and Victoria have already revealed their awful track record with going renewable. Why did Coca-Cola and other industries move out of SA after decades? They couldn’t make money with such an unreliable

Ahh, but we must protect our children and grandchildren’s futures. So low have the left’s tactics sunk that using kids as human shields in the fight for climate change wards off conservatives calling out the truth because it is not cool to bully brainwashed kids. We should close all our universities. As the father of two teenagers, CM knows they know everything already so there is little requirement for tertiary education!

The Guardian mentioned, “But in Australia, the Coalition appears deaf to the rising clamour from the electorate [on climate change].” Really?

CM has often held that human consumption patterns dictate true feelings about climate change. Climate alarmist Independent candidate Zali Steggall drives a large SUV and has no solar panels on her roof! Her battleground in the wealthy seat of Warringah is probably 70%+ SUV so slapping a Zali bumper sticker does nothing but add to the hypocrisy.

Why do we ignore IATA forecasts that project air travel will double by 2030? Qantas has the largest carbon offset program in the world yet only 2% elect to pay the self-imposed tax. Isn’t that telling? That is the problem. So many climate alarmists expect others to do the heavy lifting.

SUVs make up 43% of all new car sales in Australia. In 2007 it was 19%. Hardly the activity of a population fretting about rising sea levels. In Warringah, waterfront property sales remain buoyant and any bank that feared waves lapping the rooves of Burran Avenue would not take such portfolio risk, much less an insurance company.

Shorten’s EV plan is such a dud that there is a reason he can’t cost it. Following Norway is great in theory but the costs of installing EV infrastructure is prohibitively expensive. It will be NBN Mark II. Will we spend millions to trench 480V connectors along the Stuart Highway?

Norway state enterprise, Enova, said it would install fast chargers every 50km of 7,500km worth of main road/highway. Australia has 234,820km of highways/main roads. Fast chargers at every 50km like the Norwegians would require a minimum of 4,700 charging stations across Australia. Norway commits to a minimum of 2 fast chargers and 2 standard chargers per station.

The problem is our plan for 570,000 cars per annum is 10x the number of EVs sold in Norway, requiring 10x the infrastructure. That would cost closer to $14bn, or the equivalent of half the education budget.

The Guardian griped that “Scott Morrison’s dismissive response to a UN report finding that the world is sleepwalking towards an extinction crisis, and his parliamentary stunt of fondling a lump of coal”

Well, he might doubt the UN which has been embroiled in more scandals related to climate change than can be counted. Most won’t be aware that an internal UN survey revealed the dismay of unqualified people being asked for input for the sake of diversity and inclusion as opposed to choosing those with proper scientific qualifications. The UN has climbed down from most of its alarmist predictions, often citing no or little confidence of the original scare.

Yet this election is truly about the cost of living, not climate or immigration. The biggest emergency is to prepare for the numbers we can properly set policy against.

We have household debt at a record 180% of GDP. We have had 27 years of untrammelled economic growth. Unfortunately, we have traded ourselves into a position of too much complacency. Our major 4 banks are headed for a lot of trouble. Forget meaningless stress tests. APRA is too busy twiddling its thumbs over climate change compliance. While the Royal Commission may reign in loose lending, a slowing global economy with multiple asset bubbles including houses will come crumbling down. These banks rely 40% on wholesale markets to fund growth. A sharp slowdown will mean a weaker dollar which will only exacerbate the problem.

We have yet to see bond markets price risk correctly. Our banks are horribly exposed. They have too little equity and a mortgage debt problem that dwarfs Japan in the late 1980s. Part/whole nationalization is a reality. The leverage is worse than US banks at the time of the Lehman collapse.

We have yet to see 10% unemployment rates. We managed to escape GFC with a peak of 6% but this time we don’t have a buoyant China to rescue us. Consumers are tapped out and any upward pressure on rates (to account for risk) will pop the housing bubble. Not to worry, Shadow Treasurer Chris Bowen assures people not to panic if their home falls into negative equity! This is the level of economic nous on the catastrophe that awaits. It is insanely out of touch.

Are our politicians aware that the US has to refinance US$8.4 trillion in US Treasuries in the next 3 years? That amount of money will crowd out a corporate bond market which has more than 50% of companies rated BBB or less. This will be compounded by the sharp rise in inventories we are witnessing on top of the sharp slowdown in trade (that isn’t just related to the trade war) which is at GFC lows. The 3.2% US economic growth last quarter was dominated by “intellectual property”, not consumption or durable goods.

China car sales have been on a steep double-digit decline trajectory for the last 9 months. China smartphone shipments dwindle at 6 year lows. In just the first four months of 2019, Chinese companies defaulted on $5.8 billion of domestic bonds, c.3.4x the total for the same period of 2018. The pace is over triple that of 2016.

Europe is in the dumps. Germany has had some of the worst industrial production numbers since 2008. German GDP is set to hit 0.5% for 2019. France 1.25% and Italy 0.25%. Note that in 2007, there were 78mn Europeans living in poverty. In the following decade, it hit 118mn or 23.5% of the population.

Global bellwether Parker Hannifin, which is one of the best lead indicators of global industrial growth, reported weaker orders and a soft outlook which suggests the outlook for global growth is not promising.

This election on Saturday is a choice between the lesser of two evils. The LNP has hardly made a strong case for reelection given the shambolic leadership changes. Take it to the bank that neither will be able to achieve surpluses with the backdrop we are headed into. Yet when it comes to economic stewardship, it is clear Labor are out of their depth in this election. Costings are wildly inaccurate but they are based on optimistic growth scenarios that simply don’t exist. We cannot tax our way to prosperity when global growth dives.

Hiking taxes, robbing self-managed super fund retirees and slamming the property market might play well with the classes of envy but they will be the biggest victims of any slowdown. Australia has run out of runway to keep economic growth on a positive footing.

We will do well to learn from our arrogance which has spurned foreign investment like Adani. We miscalculate the damage done to the national brand. Adani has been 8 years in the making. We have tied the deal up in so much onerous red tape, that we have done nothing more than treating our foreign investors with contempt. Those memories will not be forgotten.

There will come a point in years to come where we end up begging for foreigners to invest at home but we will only have ourselves to blame.

The editorial closes with,

However you choose to exercise your democratic decision-making on Saturday, please consider your candidate’s position on climate and the rapidly shrinking timeframe for action. We have endured mindless scare campaigns and half-baked policy for too many decades. We don’t have three more years to waste.

This is the only sensible quote in the entire article. The time for action is rapidly shrinking. However, that only applies to the political and economic climate. One can be absolutely sure that when the slowdown hits, saving the planet will be furthest removed from Aussie voters’ minds.

GE still $15 billion in negative equity

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While GE might have rallied back above $10 on the back of its 1Q results released overnight, the company’s goodwill shrunk $5.5bn but the company remains deeply in negative equity to the tune of $14.7bn. Why do analysts perpetually focus on the revenue and profit, rather than look at the elephant in the room? Especially as we are at the top of an industrial cycle with warning signs that global growth is already slowing faster than originally anticipated. GE is heavily indebted.

Of the $53.2bn in goodwill and $ $17.1bn in intangible assets, GE shareholder’s equity (including non-controlling interests) is at $55.6bn. The gap is c. $14.7bn.

One of the interesting notes in the 10Q regarding the goodwill Oil & Gas accounts for 42% of the total. GE noted in point 8.

While the goodwill in our Grid reporting unit, Hydro reporting unit, and Oil & Gas reporting units is not currently impaired, the power and oil and gas markets continue to be challenging and there can be no assurances that goodwill will not be impaired in future periods as a result of sustained declines in BHGE share price or any future declines in macroeconomic or business conditions affecting these reporting units.

We can celebrate the short term but when an industrial stock, one which was the largest company by market capitalisation almost 20 years ago, has such an awful balance sheet (354% debt: equity) and blew $45bn in buybacks in recent years, one has to wonder how investors can look at GE as a paragon of value? Reminiscing on the halcyon days of a stock is not a method of sensible investing when staring at reality.

Complacency kills – the ticking time bomb for Aussie banks

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In the late 1980s at the peak of the property bubble, the Imperial Palace in Tokyo was worth the equivalent to the entire state of California. Greater Tokyo was worth more than the whole United States. The Japanese used to joke that they had bought up so much of Hawaii that it had effectively become the 48th prefecture of Japan. Japanese nationwide property prices quadrupled in the space of a decade. At the height of the frenzy, Japanese real estate related lending comprised around 41.2% (A$2.5 trillion) of all loans outstanding. N.B. Australian bank mortgage loan books have swelled to 63% (A$1.7 trillion) of total loans.

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Sensing the bubble was getting out of control, the Bank of Japan went into a tightening rate cycle (from 2.5% to 6%) to contain it. Unfortunately it led to an implosion in asset markets, most notably housing. From the peak in 1991/2 prices over the next two decades fell 75-80%. Banks were decimated.

In the following two decades, 181 Japanese banks, trust banks and credit unions went bust and the rest were either injected with public funds, forced into mergers or nationalized. The unravelling of asset prices was swift and sudden but the process to deal with it took decades because banks were reluctant to repossess properties for fear of having to mark the other properties (assets) on their balance sheets to current market values. Paying mere fractions of the loan were enough to justify not calling the debt bad. If banks were forced to reflect the truth of their financial health rather than use accounting trickery to keep the loans valued at the inflated levels the loans were made against they would quickly become insolvent. By the end of the crisis, disposal of non-performing loans (NPLs) among all financial institutions exceeded 90 trillion yen (A$1.1 trillion), or 17% of Japanese GDP at the time.

The lessons are no less disturbing for Australia. Don’t be surprised to hear the authorities and local banks champion stress tests as validity that we are safe from any conceivable external shock. The November 2018 Reserve Bank of Australia minutes revealed that the next rate move is likely up but the board is happy to sit on its hands because housing is slowing even at 1.5% cash rates.

With US rates heading higher, our banks are already facing higher funding costs because of our reliance on overseas wholesale markets to fund mortgage lending. Japanese banks have 90%+ funding from domestic deposits. Australia is around 60-70%. Our banks need to go shopping in global markets to get access to capital. Conditions for that can change on a dime. External shocks can see funding costs hit nose bleed levels which are passed onto consumers. When you see the press get into a frenzy over banks passing on more than the rate rises doled out by the RBA, they aren’t just being greedy – a large part is absorbing these higher wholesale funding costs.

What about America? Who could forget former Goldman Sachs CEO and US Treasury Secretary Hank Paulson tell us how robust US financial institutions were right before plugging $700 billion to rescue the crumbling system? US banks such as Wells Fargo, Citi and Bank of America (BoA) have been reducing mortgage exposure relative to total loans outstanding. Yet each received $10s of billions in TARP (bail out funds) courtesy of the US taxpayer.

By 2009 the Global Financial Crisis (GFC) had turned over 16% of Bank of America’s residential mortgage portfolio into either NPLs, mortgage payments over 90-day in arrears or impaired (largely from the shonky lending practices of Countrywide (which BoA bought in 2008). Countrywide’s $2.5bn acquisition price turned out to cost BoA shareholders a further $50bn by the end of the clean-up. Who is counting?

Oh no, but Australia is different. Residential property prices in Australia have had a far steadier rise over a longer period – a 5-fold jump over 25 years – meaning our local banks should be less vulnerable to external shocks. There is an element of truth to that, although it breeds complacency.

Property loans in Australia as at September 2018 total A$1.653 trillion. 82% of those loans are made by the Big 4 banks. Interest only loans are around $500 billion of that. As a percentage of total loans outstanding in Australia, mortgages make up 65%. The next is daylight, followed by Norway at around 40%. US banks have cut overall property exposures and Japanese banks are now in the early teens. Post GFC, US banks have ratcheted back mortgage exposure. They have diversified their earnings through investment banking and other areas. You can see this below.

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The advent of interest only loans has helped pushed property prices higher. NAB notes in its latest filing that 29% of its mortgage loan book is in interest-only form. The RBA expects $120 billion of interest only loans resetting to principal & interest (P&I) each year to 2020 which will hike monthly mortgage repayments to jump 30-40%. If investors were up to the gills in interest only mortgage repayments, adding one third to the bill will not be helpful. This is before we have even faced a bump in wholesale finance rates due to market instability. Look at the way that GE – once the world’s largest company in 2000 – is being trashed by the credit markets as they seek to reprice the risk attached to the $111bn in debt after a credit downgrade. This is a canary in the coalmine issue.

We also need to consider what constitutes a bubble in property. Sensibly, affordability makes the strongest argument. At the height of the bubble, the average central Tokyo property value was around 18.2x income. Broadening this out to greater Tokyo metropolitan area this was around 15x. This figure today is around 5x. Making arguments that ever higher levels of migration will keep property buoyant is not a sound argument as affordability affects them too.

Back in 2007, Sydney house prices were 8x income. In 2017 Demographia stated average housing (excluding apartment) prices are in the 13-14x range. The Australian Bureau of Statistics notes that 80% of people live in houses and 20% on apartments. Only Hong Kong at 19x beats Sydney for dizzy property prices.

In 2018, Australia’s GDP is likely to be around A$1.75 trillion. Our total lending by the banks is approximately $2.64 trillion which is 150% of GDP. At the height of the Japanese bubble, total bank lending as a whole only reached 106%. Mortgages alone in Australia are near as makes no difference 100% of GDP.

Balance sheets are but snapshots in time. If we look at our current bank exposure to mortgages, it is easy for analysts to paint rosy pictures. Banks’ shareholder equity has quadrupled in the past 16 years. Prosperity and record bank profits should give us comfort. Or should it? We need to understand that the underlying tenets of the Australian economy are completely different to that of a decade ago.

At the time of Global Financial Crisis (GFC) Australia’s economy was lucky to get away broadly unscathed. We carried no national government debt and were able to use a $50 billion surplus to prime the economy through that period of turmoil. Many countries were not so lucky. Our fiscal stewardship leading up to the crisis allowed economic growth to remain in positive territory soon after. Now we have $600 billion debt and charging the national credit card with all of the promises so aggressively that we should expect $1 trillion of debt in the not too distant future.

Australian banks are highly leveraged to the mortgage market. It should come as no surprise. In Westpac’s full year 2018 balance sheet, the company claims around A$710 billion in assets as “loans”. Of that amount, according to the latest APRA data, A$411 billion of lending is ‘real estate’ related. Total equity for the bank is A$64.6 billion. So equity as a percentage of property loans is just shy of 16%. If Australia had a nationwide property collapse (we have not had one for three decades) then it is possible that the banks would face significant headwinds.

What that basically says is if Westpac suffered a 16% decline in the value of its entire property loan book then it would at least on paper appear in negative equity, or liabilities would be larger than assets. Recall in 2009 that BoA had over 16% of its residential loan portfolio which went bad. It can happen. CommBank is at a similar level. ANZ and NAB are in the 20% range before such a hypothetical situation would be triggered. See the chart below. Note how the US banks stung by the GFC have bolstered balance sheets

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Of course the scenario of a housing collapse would imply that a growing number of borrowers would have to find themselves under mortgage stress and default on payments. It also depends on the portfolio of the properties and when those loans were written. If the majority of loans were made 10 years ago at 40% lower theoretical prices than today then there is lower risk to solvency for the bank if it foreclosed and dumped the property.

Although if we look at the growth in loans since 2009, the Australian banks have been making hay while the sun shines. As it stands, the likes of Westpac and CommBank each have extended mortgage loans to Aussies to nearly as much as BoA has to Americans. That said the American banks, so stung by the GFC, have become far more prudent in managing their affairs.

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It goes without saying that keeping one’s job is helpful in paying the mortgage. If you were a two income family and one of you lost your job, it is likely that dining out, taking fancy overseas holidays, buying new cars (which have been awful this year) and so on will go on the backburner. Should those actions swell to a wider number of mortgage holders, the economic slowdown will exacerbate in a downward spiral. Even your local coffee store may be forced to close because $4 is just cash you and others might not be able to spend. Boarded up High Streets were everywhere in America and Europe post GFC.

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The following chart shows the negative correlation between housing prices and unemployment rates. US unemployment doubled to 10% when Lehman collapsed. Housing prices took heavy hits as defaults jumped. It is not rocket science.

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On the other hand, Australia’s unemployment curve remained below 6% for around two decades. Even with GFC, jobless numbers never got out of hand. Our housing prices only suffered a mild dip.

We can argue that a sub-prime style mortgage crisis is highly unlikely. But it does not rule the risk out completely. To have that, mortgage holders would need to be in arrears on monthly payments, their houses would need to be in negative equity and banks would be required to take asset devaluations.

An ME Bank survey in Australia found only 46% of households were able to save each month. Just 32 per cent could raise $3000 in an emergency and 50 per cent aren’t confident of meeting their obligations if unemployed for three months.

According to Digital Finance Analytics, “there are around 650,000 households in Australia experiencing some form of mortgage stress. If rates were to rise 150 basis points the number of Australians in mortgage stress would rise to approximately 930,000 and if rates rose 300 basis points the number would rise to 1.1 million – or more than a third of all mortgages. A 300 basis point rise would take the cash rate to 4.5 per cent, still lower than the 4.75 per cent for most of 2011.”

Do you know how many homes NAB has under repossession on its books at the latest filing? Around 277. Yes, Two hundred and seventy seven. Out of 100,000s. Recall BoA had 16% of its loan portfolio go bang in 2008?

If we think about it logically, examining the ratio of total assets to shareholder equity (i.e. leverage), the Aussie banks maintain higher levels than the US banks listed below did in 2008. Were total asset values to suddenly drop 7% or more ceteris paribus, Aussie banks would slide into a negative equity position and require injection.

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Human nature is conditioned to panic when crisis hits. Sadly many of our middle management class have never experienced recession. They are in for a rude shock. As for depositors note that you should be focused on the return “of” your money, not the return “on” it.

As Mark Twain once said, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so!