Monday, 6 February 2023 — Albert Park

By Callum Newman Editor, The Daily Reckoning Australia

[6 min read]

Dear Reader,

I don’t have a new couch, but suddenly I feel like the Newman household should have one.

Apparently, Aussie consumers have been buying them up big!

Furniture retailer Nick Scali released its results this morning.

It smashed it out of the park too. Revenue is up 57% and net profit is up 70%.

Take a look at this line:

‘The Group had anticipated a slowdown compared to the Covid 19 boom yet trading remains better than pre Covid despite rising interest rates.

‘Nick Scali brand written sales orders were 12.1% below January 2022 and 22.9% above pre Covid January 2020.’

Hello! Everywhere I look, I’m supposed to see a recession, except it doesn’t show up.

ANZ Chief Shayne Elliott was cited in The Australian over the weekend saying that the percentage of ANZ mortgage loans that were 90 days past due for repayment was 0.5%. The long-term average is 1%. 

But the mortgage cliff!

What about those billions in loans about to roll over from fixed rates to variable?

The Australian reports:

‘Mr Elliot said borrowers who had already rolled off ANZ’s fixed rates to markedly higher variable mortgages were actually “better performing” on their repayments than the average home loan borrower cohort.’

Go figure!

Here’s something else I came across.

The Age says Domain data shows that four-bedroom houses only fell 4% in 2022, compared to 8% for two-bedroom houses.

The implication is that small-fry investors took a hit from rising rates, but working families were able to shrug them off.

My colleague Catherine Cashmore says four-bedroom homes are tightly held and, therefore, there’s less stock around too.

That again suggests that middle Australia is getting along just fine.

We have retailers reporting cracking results, low defaults across the banks, and a roaring share market.

The good news is there are still plenty of stocks trading at cheap valuations, even with the general market a whisker off all-time highs.

I’ve said a few times in these pages that property-related stocks are one of those sectors.

Here’s a chart I shared with my subscribers in their monthly newsletter last week. It shows Real Estate Investment Trusts surging back to life recently.

Check it out:

One reason this sector got smashed was because of rising rates last year.

REITs are often treated as bond ‘proxies’ in the short term because they pay out their earnings as dividends.

Here’s the thing, though…

REITs are NOT like bonds and should NOT be treated as such.

In 2017, an investor called Nicholas Sproats studied and reported on US REIT returns during the (then) nine rising interest rate environments over the last 50 years.

Here’s what he found:

‘It’s a myth that there’s this infallible causation and effect between interest rates and real estate returns, and real estate has historically been a fantastic hedge against inflation, as we get to capture inflation and more in our leases.’

What matters for REITs over time is the same as every other stock!

And that is growth in profits.

The price they pay for debt is only one factor behind this.

We can’t ignore movements in commercial property values, rents, development work, tax changes, labour force movements, and all the other variables that can impact any business.

For example, many commercial buildings are shifting to solar to cut energy costs.

And take a look at the chart of the REIT sector again up above. The sector is now rising again.

However, some of the discounts between REIT share prices and their tangle valuations are still very big.

There are rumours that either big super funds or private equity may take some of the public ones over completely.

The Australian Financial Review reported the other week:

‘It’s 13-months since the gods of Australia’s commercial property scene warned big super was coming for the sector - and finally the message seems to be gathering some momentum outside of the real estate scene.

‘Bankers are running around with charts showing ridiculous trading at mainstay players like Dexus, GPT Group and a bunch of Charter Hall-run listed funds, which cannot shake their hefty discounts to net tangible asset backing.’

I agree. I recommended one REIT last year and just added another one this month. These are two ‘small-cap’ property plays.

They seem more likely takeover offers because their market cap isn’t in the billions of dollars.

And if no takeover eventuates?

You’re still earning at least 6% in dividends, with a cracking outlook for capital growth considering it’s relative low risk.

If that sounds of interest, check out the latest issue of Australian Small-Cap Investigator by starting here!

Best wishes,

Callum Newman,
Editor, The Daily Reckoning Australia

By Bill Bonner Editor, The Daily Reckoning Australia

Dear Reader,

The big news last week, from CNBC: ‘Fed raises rates a quarter point, expects “ongoing” increases’:

‘Aligning with market expectations, the rate-setting Federal Open Market Committee boosted the federal funds rate by 0.25 percentage point. That takes it to a target range of 4.5%-4.75%, the highest since October 2007.

‘The move marked the eighth increase in a process that began in March 2022. By itself, the funds rate sets what banks charge each other for overnight borrowing, but it also spills through to many consumer debt products.

‘The Fed is targeting the hikes to bring down inflation that, despite recent signs of slowing, is still running near its highest level since the early 1980s.’

Baby steps

Your editor arrived at the Irish Ferries terminal in Cherbourg yesterday evening. He had a reservation, but he went ahead anyway.

His reservation was that the sea may be too rough. 17 hours is a long time to be seasick. As it turned out, the Atlantic, out beyond Land’s End in Cornwall, was a bit tempest toss’d, but the Irish Sea is relatively calm. He can work without getting sick.  

Ireland is perhaps the only country whose heroes are writers and poets — Joyce and Yeats — rather than the typical bullies and mass killers. So, our boat is named the WB Yeats, with quotes by the great poet on the walls…and features with names taken from his poems. There is the ‘Wild Swans’ bar…and the ‘Lady Gregory’ restaurant.

But there is scarcely anyone on the boat, apart from us. The restaurant is closed. A few truckers hang out at the bar. It’s not the season for travelling between Ireland and the continent. In winter, the seas can change rapidly.

Today, we pick up where we left off on Friday. Let’s begin by noting that ‘investors’ recovered from a 500-point drop on the Dow last week after the Fed announced its baby-step rate increase. But why? How would higher interest rates increase the value of stocks? Why would the Fed’s pledge to keep raising rates increase corporate profits? Why would ‘investors’ buy stocks rather than sell them?

Oh, dear reader…you ask too many questions!

But thanks, we wanted an opportunity to explain. The only real investment is one where you participate in real earnings. A business has to produce products or services and sell them at a profit. An investor gets part of the gain.

Cut in thirds

Everything else is speculation…gambling…taking a flier. Sometimes people speculate on a stock. Probably the most extreme examples happened when they bought ‘meme’ stocks…companies that couldn’t possibly be worth their market capitalisations...in the hope that other speculators would buy them too. Sometimes they made money; most often, they lost it.  

Another extreme example was the run-up in the crypto market. Cryptos — apart from some shady deals that promised ‘interest’ — were never even intended to earn money. They produced nothing. Some did provide a service (helping people make financial transactions)…but the earnings were tiny. For the most part, cryptos were pure speculation. Out of a total of nearly US$3 trillion in market capitalisation at the peak, incredibly, about one-third (~US$1 trillion) remains.

While speculators gamble on individual stocks, sometimes the whole market becomes ‘speculative’. That’s what happened to Wall Street in the 21^st century. In the ‘80s and ‘90s, analysts noticed that stocks seemed to go up reliably. They began to proclaim the virtue of ‘stocks for the long run’. The idea was that ‘the market’ always goes up…so all an investor has to do is to put his money into an ETF and he will make money.

Of course, we’ve seen that it isn’t true. In terms of real money — gold — stocks are worth no more today than they were 98 years ago. Still, speculating on stocks can be rewarding…as long as stocks are going up. In our estimation, stocks rose mostly for the right reasons — an expanding economy — from 1982 to the mid-‘90s. Then there was the dotcom speculative blow-off, followed by another huge surge in stock prices. But after 1999, stocks rose for the wrong reasons; the Fed was manipulating the market.

Sea change ahead

Many investors soon forgot about ‘investing’ all together. The Fed was pushing interest rates down and pushing stocks up. That was all they had to know. Actual business profits rose…but only in line with increases in real output. Stocks, though, soared…by 2021, prices were three times what they were in 1999. Speculating paid off. 

And now, ‘investors’ are so accustomed to a rising market…so used to the Fed goosing up prices…that they believe it must be helping them even when it raises rates. But there’s been a major sea change. The primary trend is running in the other direction — towards higher interest rates and lower asset prices. Speculating on higher prices is not likely to pay off.

‘Inflation is coming down’, the speculators say to one another. ‘The Fed is easing off. It’s clear sailing again.’

But interest rates are still going up, though, more slowly. And every increase — no matter how small — pinches households, businesses, and the government. Consumers have less money to spend. Business revenues fall as their debt service costs rise; profits drop. And the feds grow more desperate. 

Speculators may buy. Investors sell.

Regards,

Bill Bonner,
For The Daily Reckoning Australia