TW3 – SB’s Guide to Budget Bull****

Market Wrap

Markets trended lower this week, as muted midweek gains weren’t enough to offset sharp losses on Monday. The S&P 500 suffered its worst day since early January after a slew of weak economic data stoked fears of an imminent global recession. Bonds rallied in response to the data, with Australian yields reaching record lows. Since bond yields and prices are inversely related, this means that Australian bonds are trading at all-time highs.

The development that drew the most attention was the inversion of the US yield curve, which has historically been a reliable predictor of US recession. Although this might sound scary, it does not mean we should sell our shares and go to Fiji. There is no guarantee that a recession will take place, and simplistic measures such as this don’t provide any investing insight. The fact that the Federal Reserve monitors this measure should speak to its irrelevance, as the Fed is notoriously inept at forecasting recessions. In the words of one Fed official “We spend a lot of time looking for systemic risk; in truth, however, it tends to find us.”

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Source: Charlie Bilello

In other news, the tragic comedy that is the Brexit negotiations took another twist after the House of Commons seized control of the Brexit process away from the Theresa May Government. The UK was due to leave the EU this evening, but has been granted a two week extension to agree on an exit strategy.

Finance 101 – Amateurs vs Professionals

In 1970 the famed American engineer Simon Ramo released the book “Extraordinary Tennis For The Ordinary Player”, where he posited that Tennis is in fact two games – one played by professionals and one played by amateurs. When professionals play tennis, the match is won by beating your opponent (e.g. accurate serves, superior strategy). When amateurs play tennis, the match is won by not beating yourself through novice errors (e.g. double faults, hitting the net). Based on Ramo’s studies, 80% of points in professional tennis are won, whereas 80% of points in amateur tennis are lost.

The key insight from Ramo’s research is that most people would be better off trying to avoid making major mistakes than trying to be brilliant. When it comes to tennis, that involves playing conservatively and “giving the other fellow as many opportunities as possible to make mistakes”. When it comes to investing, that may involve choosing a low cost index fund that matches the market return rather than trying to select a portfolio of stocks to beat the market. If someone wants to get rich, avoiding major mistakes such as borrowing too much, saving too little and getting divorced is much easier than trying to be an investing genius.

In the words of Charlie Munger, investing legend and right hand man to Warren Buffett “It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent”.

The Market Will Beat You!

In a previous TW3 instalment we covered the Behaviour Gap, whereby the average American investor earned significantly less than average returns (i.e. market returns) as a result of making novice mistakes. But did investors right the ship in 2018?

No.

In 2018 the S&P 500 lost 4.4%, whilst the average American investor lost 9.42%more than doubling the loss of the market! This shouldn’t be a surprising result. After two years of rosy returns and subdued volatility, 2018 saw the return of risk with two minor sell-offs in February and April and a significant sell-off from October – December. The average investor tends to underperform because they apply short-term thinking to a long-term investment, buying when shares are rising and selling when prices are falling. In other words, they buy high and sell low.

Warren Buffett once wrote that investors should never forget two things during times of heightened volatility:

  1. Widespread fear is your friend, as it serves up bargain purchases
  2. Personal fear is your enemy
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Stanford Brown’s Budget Bull**** Barometer

With the Federal Budget only four sleeps away, here’s Stanford Brown’s guide to next week’s political mumbo-jumbo:

*Insert party name* is a better manager of the Australian economy

  • Unless the party in question is Chinese Communist Party, this argument is moot. The Australian economy is heavily skewed towards mining and resources, the demand of which depends on whether China wants to build another ghost city
  • What contributed more to Australia avoiding recession after the GFC? Kevin Rudd’s $42b stimulus package or China’s $875b stimulus program?

The quality of a government service is proportionate to its budget

  • Announcing a $100m boost to education spending doesn’t mean that students will receive a better education in and of itself. We could spend $100m on more teachers, better whiteboards or new monkey bars, all of which have differing effects on the quality of education.
  • Similarly, a government cutting $100m from the health budget doesn’t necessarily mean that the public health system will be any worse, or that the government “hates nurses” or whatever other gibberish the unions babble out. All sides of politics should be in support of cutting waste when evident.

The Liberals inherited Labor’s debt and deficit

  • Federal debt was around $175b when Tony Abbott was elected to government in 2013. Despite receiving more in tax revenues than their predecessors, the Liberals have failed to meaningfully cut spending, doubling Labor’s efforts to leave the Australian government $350b in debt.

Tax Breaks vs Handouts

  • Many groups consider lower corporate tax rates as a “handout” for big business. A lower corporate tax rate doesn’t involve the government handing out money to corporations, but rather taking away less than they otherwise would.

Tax Evasion

  • On a related note, many used companies such as Qantas, who paid no corporate tax from 2013-2018, as examples of Australian corporations not paying their fair share. The first question should be whether the corporation is earning any profit from which to pay tax. Qantas made a $2.8b loss in 2013, and it took five years for Qantas to make enough profit to offset that loss and start paying tax again.

     

    Employment vs Underemployment

    Another contentious claim we’re likely to hear on Tuesday is that the Liberals have delivered on their promise of more jobs. It is highly likely that Treasurer Josh Frydenberg will pull out a statistic regarding unemployment as evidence that the economy is in good shape. Since the ABS considers someone working 1 hour a week to be employed, a more accurate figure may be the underemployment rate.

    Underemployment is where someone has a job but they want to work more hours or in a role matching their skillset. An example would be a recently graduated marketing student who is driving for Uber while they apply for jobs. Although part time jobs such as driver for Uber can help make ends meet, they are not a long-term solution for workers with mortgages and mouths to feed. This is one of the reasons why there is minimal wage growth in Australia despite low unemployment.

    Perhaps the largest indictment on the Liberal government is that the underemployment rate has significantly increased under their watch, peaking at 8.8% in 2017. Underemployed workers are likely to feel greater financial insecurity, which may lure them to Bill Shorten’s Siren Song of a living wage.

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    Source: ABS

    Who Throws The Best Debt Party?

    Who racks up more liabilities? Liberal or Labor? Keep your eyes peeled on your inboxes next week as Stanford Brown’s Monthly Top 5 ignores semantics and dives deep in the data!

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    With Taxes, Less Can Be More

    The Liberals are likely to argue that lower corporate and income tax rates will result in higher tax revenue, but how would that work?

    Income tax revenue is a function of two variables: economic gains (income, capital gains, etc) and the tax rate that is applied to those gains. A common metaphor is that economic gains are a pie, the tax rate is the % of the pie taken, and tax revenue is the size of the slice of pie taken.

    Using this metaphor, the Liberals are arguing that a lower tax rate will result in more investment and economic growth, which will result in a larger pie to take taxes from. It can be better to take a smaller slice from a larger pie than a larger slice from a smaller pie. In economics this is known as the Laffer Curve, named after American supply side economist Arthur Laffer.

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    Merrier in Mogadishu?

    There must be something in the water in the Nordic nations, with each country placing in the top 10 of the United Nations’ World Happiness Report. Australia ranked 11th in the overall rankings, with strong scores for social support and generosity. Somalia surprisingly outperformed Australia in the positive affect and negative affect categories, meaning they generally enjoy themselves more and worry less.

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    The fact that Somalia ranks higher in Australia in the two most basic measures of happiness yet is ranked 112 in the UN’s report is a reminder that the high quality of life Australians enjoy is in large part a result of living in a free and open society. For the majority of our readers, we won a lottery the day we were born in Australia rather than Afghanistan or Angola, and should regularly remind ourselves how lucky we are!

    Name That Line!

    It would appear that Alan and Robyn were ready for their close-up last week!

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    But what are these guys going to need?

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    Pic of the Week – Are You Smarter Than An 8 Year Old?

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    Video of the Week – A Dream Comes True!

 

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