Early exuberance in the US was not enough to keep global markets afloat this week, as rising bond yields prompted investors to re-assess their appetite for risk. The week started off on a positive note, as the US reached a last minute trade deal with Canada and Mexico to replace NAFTA, boosting investor confidence that Trump is committed to negotiating free trade agreements. US markets continued to close at record highs as investors pulled out of Europe after the newly formed Italian government submitted a budget that could potentially violate EU membership rules regarding fiscal responsibility. The lack of fiscal discipline spooked European investors, reviving fears of Quitaly that sparked market volatility in May.
The rising political uncertainty, plus stronger than expected US manufacturing and job figures, caused a global spike in bond yields, with US 10 year bonds jumping to their highest yield in seven years. The bond selloff accelerated after US Federal Reserve chairman Jerome Powell quoted in an interview that “we’re a long way from neutral at this point, probably”. The neutral interest rate is the interest rate whereby the economy is not being stimulated nor restrained by monetary policy, implying that the Federal Reserve believes a number of rate hikes are still required. The Dow Jones had its largest one day drop in 2 months in response to yield surge.
Finance 101 – How Regulations Can Stifle Business
In light of the findings of the Royal Commission, many are calling out for banks to be more tightly regulated. But before we cry havoc and let slip the dogs of more, we should take a deeper look at the effect of regulations.
Although most regulations are created with good intentions, they often favour larger businesses by stifling competition. Most companies generally prefer to have fewer competitors, as it means they can increase prices without worrying about customers taking their business elsewhere. Regulations can reduce competition by creating an artificial barrier to entry, whereby the cost of compliance discourages the creation of new businesses. According to Liberal Senator James Paterson “In NSW, for example, it takes 48 separate forms and 72 licences just to open a restaurant. Becoming a hairdresser takes 847 hours of study, and can cost up to $9970”. Incumbents in an industry will often call for tighter regulation in the name of maintaining quality standards, which conveniently also makes it more burdensome for new competitors to enter the market.
One of the many reasons why Australia does not have a dynamic economy is due to the burden of government regulation, where the World Economic Forum ranks us 80th in the world behind the likes of Trinidad and Tobago, Vietnam and Kyrgyzstan. Unfortunately, the cost of these regulations isn’t obvious, as we don’t see the businesses and jobs that would’ve been created in absence of these regulations. According to some estimates, red tape costs the economy more than $176b each year. For comparison, the total value of the iron ore, coal and natural gas exported from Australia in 2017 was $146b.
Of course, there are instances, such as the recent Royal Commission, where it is obvious that some regulation of industry is required. However, as commissioner Kenneth Hayne details below, increasing the complexity of regulation does not make it more effective, and more often than not highly complex regulations disfavour smaller businesses who can’t afford to hire a team of lawyers to ensure compliance.
All Aboard The Hayne Train
Commissioner Kenneth Hayne released his much anticipated interim report on the findings of the Royal Commission last Friday, with the industry on edge in anticipation of Hayne’s policy recommendations. Perhaps surprisingly, Hayne did not call for further regulation on the financial services industry, writing:
“Much more often than not, the conduct now condemned was contrary to law. Passing some new law to say, again, ‘Do not do that’, would add an extra layer of legal complexity to an already complex regulatory regime. What would that gain?”
Hayne dropped the hammer on the two regulatory bodies with jurisdiction over the industry, the Australian Securities and Investments Commission (ASIC) and the Australian Prudential Regulatory Authority (APRA), and it is in his view that a lack of enforcement of regulation, rather than a lack of regulation, is to blame:
“When misconduct was revealed, it either went unpunished or the consequences did not meet the seriousness of what had been done. The conduct regulator, ASIC, rarely went to court to seek public denunciation of and punishment for misconduct. The prudential regulator, APRA, never went to court”
We’ll have to wait and see how Canberra will respond to the report, but hopefully they will enact Hayne’s refreshingly simple vision – we prevent people from breaking the law by enforcing it, not by making it more convoluted.
The Real Dangers of Marijuana!
Although 2018 has been a year of subdued returns, investors have been treated to two crash courses in bubble psychology, with speculators in marijuana stocks high on soaring prices and ignoring any lessons from the recent rise and collapse of cryptocurrencies.
The recent liberalisation of marijuana laws in Canada and many American states has created a booming market for retailers of marijuana and related derivatives such as CBD, with some believing that marijuana sales will one day rival those of alcohol and tobacco. The growth potential of marijuana has fuelled a speculative mania in marijuana stocks over the last few months, with retail investors rolling in to get a piece of the action (sound familiar?)
The bubble reached a new high a fortnight ago when the Canadian marijuana producer Tilray (with second quarter revenue and profits of $9.7m USD and $-12.8m USD respectively) was briefly more valuable than Twitter (with second quarter revenue and profits of $711m USD and $100m USD respectively). The share price of Tilray subsequently dropped 50%, although it has since recovered, up more than 800% since listing on the NASDAQ in June.
Many are comparing the rapid rise of marijuana stocks to last year’s cryptocurrency bubble, although the more appropriate comparison is to the dot.com bubble in the late 90’s. Much like the internet, investors have identified the high growth potential of marijuana and are paying astronomical prices to invest in companies loosely related to the marijuana industry, even if they have little or no revenue. The issue with this is that only a handful of companies (Amazon, Google, Adobe, etc) actually become success stories, with the vast majority of companies going up in smoke.
So unless you’d like your portfolio returns to take a drag, please speak to your adviser before investing in the devil’s lettuce!
There was no reprieve for house prices in September, with national prices falling for the 12th month in a row!
Buy The Dip?
Whilst we were perusing the interweb this week, we came across the following headline – Global Institutional Investor Confidence Slumps. This seems like a compelling development! After all, institutional investors are the ones being paid the big bucks so surely they must have some sort of insight, right?
A quick look at the index being used to gauge institutional investor sentiment shows that there is a weak relationship between the index and subsequent returns. An investor following the trends in this index would have missed out on the 2003-2007 bull run, would have got clobbered in 2008 as institutional investors grew confident before the worst of the GFC hit, and would have missed out on the quantitative easing and Trump boom from 2014-2018.
This example underlines the importance of scepticism when reading headlines. In a saturated market, media outlets are in a race to the bottom to grab the attention of readers, and are increasingly sacrificing quality journalism for sensationalism.
Unfortunately, in finance there are no silver bullets. Markets are too complex to be reflected in a single index, and investors thinking they can cut corners by making investment decisions based on the results of 1 or 2 indices are unlikely to succeed. An excerpt from Through the Looking-Glass gleans an insight into the world of investing “Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!”
Best Places to Travel 2019
Still figuring out which country to visit next year? Traveller asked 19 travel professionals where they thought most travellers will go in 2019, where they should go, and also where the professionals themselves will be going.
In true Stanford Brown fashion, we entered their answers into a spreadsheet for your easy access!
Joke of the Week
Who Am I?
A rare tie last week! Congratulations to David & Ronit and Glenn & Michelle who spotted John Cleese on the set of Monty Python and The Holy Grail!
But who is this classic couple?
Pic of the Week
Video of the Week
Congratulations to our wonderful client Karen, who co-wrote the synth-pop track below!
Have a great weekend!
Jonathan Hoyle, CEO & Nicholas Stotz, Investment Analyst