PING, PONG, AND PANG

No, not the Puccini Turandot version of the Three Ministers in 19^th century Beijing. This is a little more serious. The three this time are the US, German-led Europe, and China.

Have a look at the Chicago Federal Reserve National Activity Index. It measures what is happening in the real United States economy. The news is more of the same – slow growth, not recessionary, although US Federal fiscal contraction could produce that. But, no indications of that wonderful energy which historically has driven the US and led the rest of the world.

German-led Europe – more of the same. The end result will probably be what the Europeans want – more political and economic integration for long run political stability. But no huge demand drivers yet.

China: read any newspaper! “The country’s growth model has changed”; “greying population”; “Does not need to continue creating low-skilled construction jobs to ensures stability”; “That’s why more steel mills are sure to cut production or close”. (AFR 1-2 September 2012). “Iron ore rout could end up in a hard landing”; “economists are speculating about the risk next year of the R-word”. (Australian September 1-2 2012). China is changing: its economy is maturing, its population expected to peak in 2015, and ageing. In short, China is going to feel more like “Old Europe” to quote a former US politician.

These three will dance around, just like Ping, Pong, and Pang. Expect competitive devaluations or other forms of domestic advantage.

Where does Australia fit? Recession probably if the Gillard-Swan governments still try to achieve a surplus. Where do Australians fit? Use the A Dollar whilst it is at these levels. At some point, it will not be when international investors and sovereign investors realise that it is priced on an evaporating commodities boom. Today, invest offshore in USD or Euro denominated assets. Sell Australian domestic equities and property. The likelihood is deflation. You will be able to buy them cheaper later with much stronger foreign currencies v/v the AUD.

PROFITS TO BE MADE IF YOU HOLD AUSTRALIAN DOLLARS

The likelihood is that the Australian dollar will rise further against the USD, Euro, and pound sterling. This will continue to damage much of the Australian SME sector. For Australian investors, though, it will provide a generational opportunity to acquire assets in other countries. The time to buy German property was before 2010. Investment grade asset prices on ASX are relatively high, so asset allocations should be increased in non-Australian $ assets.  You will need to be careful with Swiss and German real estate: the flood of liquidity in Europe is driving prices up. The China slowdown is likely to mean easing of Chinese monetary policy which in effect means exchange rates will change making Chinese exports cheaper for consumers. That will also damage the Australian SME sector. That slowdown will also mean less demand for some commodities. Australian imports will rise, exports drop. Hope Wayne Swan doesn’t want a balanced Federal budget since he won’t be getting his revenue, especially now the States are increasing minerals royalties. The aggregate macroeconomic numbers are not going to look as great in 2013.

It’s a great time to be an investor if you have the wherewithal to invest offshore: not so great if you’re trying to run a business in Australia, or only have limited capital to invest.

IS THE GLASS HALF FULL?

(click image to enlarge)

The world press almost uniformly predicts slow or no economic growth for the next few years and devastating economic consequences for many countries and individuals. However, there have been suggestions this week that the “bottom” may have been reached, whatever that means.

If you look at the chart, this is the (US) S&P composite returns index since 1900. What it demonstrates is long cycle periodicity in investor composite returns. What it doesn’t show (without my annotations) is the source of wealth creation in periods of rising equities prices.

After WW1, equities price upswings were largely driven by consumption spending, home construction for the soldiers, and innovation based manufactures. After WW2, military R&D investment generated completely new industries in plastics, aerospace, vehicles, consumer electronics etc, financed by the advent of readily available consumer credit for the first time. In the 1980’s, US military R&D expenditure on the development of the internet, the revolution in molecular biology, and the advent of a venture capital market led directly to the iPhone and modern medical care. Fortunes were made by technical entrepreneurs in these sectors based on science, government funded R&D, commercialisation skills, and access to venture capital. The 1987 stock market crash destroyed some of what had been created, but then rising Asian demand for commodities and western lifestyles underpinned yields even if equity prices themselves remained static. That came to end, other than in resources at least, in 2008.

So where am I investing for the future? And when?

Firstly, the when. The glass is half full. Equity markets will improve. Capital will become more readily available. From 2013 onwards.

Where? Please have a look at www.millhouse.co  The demand drivers will be: the entrepreneurial United States, becoming once again an energy independent economy with the worlds’ best Universities. Supported by German- led Europe with tremendous science and engineering skills enabling manufacture of best of breed products in a high cost economy. Selling to: SE Asia, China, and other countries in those regions who can afford western-style consumption products, food, and healthcare for an ageing population. These dynamics will drive trade and investment for the next cycle and companies with these exposures will benefit from an upturn in their equity prices.

These dynamics will govern the world as we shall know it from 2013 onwards.

davidmillhouse.com.au

IS CAMPBELL RIGHT: QUEENSLAND THE NEW SPAIN?

No, he isn’t, but there are some similarities.

(For my international readers this is purely a local blog, but the next one is written for you).

One of Australia’s most eminent economists writing under the nom de plume, Henry Thornton, is a sceptic when it comes to official unemployment statistics. He thinks that the official unemployment statistics greatly understate the true position here in Australia. Since Queensland has the highest mainland official unemployment rate, that implies Queensland has a bigger real problem. Add the officially unemployed (you only have to work one hour a week) to the underemployed, those in family businesses that are employed but not taking home any cash, and those that have given up looking for work (statistically eliminated from the data), and you get a Spanish type real unemployment number, especially in people under 25 and over 50. You can see the effect of that in the streets if you care to walk, the For Lease signs, and the closed and emptying cafes and coffee shops.

Official unemployment data is always a lagging statistic. The end of the construction cycle in mining, tunnels and apartments is upon us, and, with the AUD at USD 1.05+, expect to see more business closures in all sectors and higher official and real unemployment numbers.

That doesn’t make Queensland Spain. Sorry Campbell.

The big difference is that, whilst Queensland is having a property bust in coastal and lifestyle regions, the effects on the banks is spread across the nation and internationally. If these property risks were purely restricted to Queensland banks, then, yes, we would have Spain. Some of those banks would need a bail out. Fortunately, the Bank of Queensland was able to raise nearly AUD 500 billion in new equity.

www.davidmillhouse.com.au

IMAGINE A NATION WITHOUT ENTREPRENEURS

In 1988 I hosted a major international conference “The Third Symposium on Technical Innovation and Entrepreneurship”. This was part of an international series held in the United States and the United Kingdom with the support of the Utah Innovation Foundation, IC2 Institute from Austin, Texas, and UniQuest.

A key guest speaker at the 1988 Symposium was Mr Wan Run Nan from the Peoples’ Republic of China. Mr Wan was one of the first Chinese IT entrepreneurs. He developed technology, employed lots of people, and made money.

He could not return to China without the risk of imprisonment! His crime: he was an entrepreneur. Run Nan now lives in the United States.

The Australian labour government of the time, and notably John Button and Barry Jones, were highly supportive of employing people in Australia. They recognised, as John Button made very clear when he opened the facilities of then ASX listed Laser Dynamics Ltd on the Gold Coast, that it is entrepreneurs who build businesses, employ people and make profits. They understood the role of venture capital.

Contrast that with what is now emanating from the highest levels of the Australian labour Government in Canberra. There, it seems, we as entrepreneurs are enemy number one. Henry Ergas’ comments in the Australian (6^th August) “ .…instead of celebrating entrepreneurs, Swan despises them…Swan wallows in the nostalgia of Bruce Springsteen’s rustbelt past”. He goes on to say: “It is difficult to imagine a worse way of preparing for the daunting challenges Australia faces as the era of sky high commodity prices draws to a close. And it is difficult to imagine a starker contrast to John Button…” (For my international readers, Mr Swan is the Deputy Prime Minister and Treasurer of Australia).

Like Wan Run Nan in the PRC, the present Australian government doesn’t like entrepreneurs and publicly embarrasses some of them internationally. No wonder that many Australians are going or intending to go to more friendly destinations, Singapore for example.

WHO WILL LEAD THE UPTURN?

I recently gave a short presentation in Brisbane where I told the audience of very senior business people that I thought the Australian media reporting of European political economy was “shrill” and “often ill-informed”. There are some exceptions to that including the article in todays’ Weekend Australian by Robert Gottliebsen, and a recent publication from my good friend Michael Knox of RBS Morgans. Michael reports that of the “5000 banks in the Euro area, there are 27 which were undercapitalised under the supervision of the European Banking Authority”. He concludes: “All that remains of the European banking crisis is that market participants learn that it is over”. That is exactly my conclusion.

Gottliebsen is not taking a bet and acknowledges that there are tough times in Europe. Not, however, as tough as the post-war years: it is these years that define European political economy today and for the foreseeable future. My bet is that Europe will get its act together.

In the meantime, the China story is over as we knew it. Australian resources producers in minerals and gas are getting towards the top of the costs curve in a world of declining real prices and huge energy developments in the United States and elsewhere.

Mark my words, the US will lead the world out of its present woes, and German led Europe will recover in much better financial shape as its primary partner. That defines our corporate strategy. The German experience with its postwar Wirtschaftswunder (miracle economy) will prevail and enable its European colleagues to become competitive in the world. Gain follows pain.

Where does that leave Australia? In short, a hollowed out economy which will need significant new multi-industry investment as resources investment declines and stops. There will be rising unemployment, more company failures, more house mortgages and small business loans underwater. Roger Montgomery (www.rogermontgomery.com) is worth reading: “Now that the tide is going out, we are about to find out who has been swimming naked”.

Add a bloated government sector which will need to wound back by the next Federal Government. There is pain ahead. So don’t provide your house as security to the bank for your business loan.