The Experts

Barrie Dunstan
Barrie Dunstan
+ About Barrie Dunstan

Barrie Dunstan is one of Australia's most experienced business and investment journalists. He has been an associate editor and columnist with The Australian Financial review AFR since 1987 and specialises in superannuation and funds management. He also writes on personal investment and has published three books for investors.

Will we see a Trump recession?

Thursday, January 18, 2018

Back in 2017, everyone talked about the Trump boom. But times change and already some anxious investors are talking about the Trump bust or, at least, the Trump recession.

While stock markets are at record levels, it’s natural to anticipate an eventual sell-off or correction. Unlike late 2017, when President Trump and his policies were mostly regarded as supportive to a bull market, now investors aren’t so sure.

In today’s hothouse climate, exotic manias like Bitcoin flourish, sections of the local property market still bubble and many share market speculators won’t hear of corrections.

But each boom is different. Within the last week, investors were getting conflicting views. A World Bank economist, along with executives at big investors like Legal and General Asset Management and big US bank, Citi, warned markets were complacent about the possibility of surprises (like rising interest rates) popping the bubble. In contrast, perennial bear Jeremy Grantham of GMO thought the boom could still have some nine to 18 months to run.

Market pundits like to count off the months a boom has run, but the duration of a boom, in the end, depends on valuation levels rather than how long it has run. And many investors know the real risks of selling too soon; most booms tend to over-shoot – sometimes for painfully longer periods of time.

So these are dangerous times, with investors forced to ignore valuation warning signs to get any sort of yield. In the US, the Wiltshire 5000 index is now around 130 per cent of US GDP. This uncomfortably close to the level of 140 per cent, reached just before the late 1990s dotcom bubble burst.

These are the sorts of factors which anxious investors should be considering, rather than simply looking at economic numbers and relating them to the stock market. Unfortunately there doesn’t seem to be any firm correlation, long-term, between the performance of the economy and the stock market, much to the chagrin of economists who love to deal with known numbers.

Instead, it’s often an unexpected event which trips off a share market reaction and the uncomfortable reality is that there are plenty of potential international mines which could be triggered like  North Korea, China, the middle East.  And all this is happening in a world where, as the Australian Financial Review remarked Donald Trump is “less a leader than a liability.” (AFR editorial January 9).

In addition to queries on the world economy looks, there also are local worries in the property market. There are fears of an over-zealous crackdown by regulators, signs of weakening in some sections of the market, concern over so-called “liar loans” - and all the while the high-rise building boom is still powering along in markets like the Gold Coast and suburban Melbourne. So, while no one wants to contemplate a nasty pause in both the speculative share and property markets, there are a few worrying signs.

Frankly, Donald Trump is probably the biggest cloud on the horizon. The big danger is that optimistic share buyers may put too much faith in the Donald Trump factor. As I noted I November when I unkindly called him the Flim Flam man, Trump defies conventional analysis.  He’s the fast-talking snake oil salesman who comes into town and proceeds to fleece people by telling them one thing while doing another

While Trump’s program doesn’t have a lot to boast about, the big picture is that Trump wants to increase spending on infrastructure, cut taxes and increase the budget. The Flim Flam man certainly doesn’t look like a financial conservative.

Overlay that on the renewed signs that long-term bond interest rates have bottomed plus the chance of slowly rising inflation in the US. Will this continued to be bullish for shares or might it prove the wrong time to give a buoyant US economy even more stimulus?

These are hard questions at any time. The presence of the Flim Flam man tweeting the shots definitely adds a degree of difficulty to investors’ concerns.

Long term investors may be able to ignore the ructions but, in the short-term, the Trump era has inroduced a new element of concern.


Buffett's next play in Australia

Monday, July 06, 2015

By Barrie Dunstan

Warren Buffett’s deal with IAG seemed to excite the stock market only temporarily, before dropping off the radar of short-term focussed dealers.

The fact is that Buffett’s Berkshire Hathaway is a quintessential long-term investor, and is loath to tip off markets about its strategies – and probably will be looking for other direct deals rather than on-market share buying.

The Australian market is never likely to be deep enough to absorb the sort of share buying which could be unleashed by Berkshire Hathaway, now the fifth largest listed company in the world. And, in any case, Berkshire’s whopping size has now forced Buffett to concentrate on buying parts of, or the whole of, companies.

The IAG deal follows this pattern. It is in an industry which Buffett knows intimately. As a major re-insurer, its General Re group has long been dealing with IAG. Berkshire appears to have done a good deal by getting 20% of its business while only buying an initial 3.7% of IAG – one of two major players in the Australian insurance market.

This is classic Buffett deal-making, using a partnership approach to gain a strategic interest in an industry he knows well. The Sage of Omaha has long followed his rule of not investing beyond his circle of competence. Instead, Berkshire recently established a branch operation in Australia as part of what it describes as a global insurance operation. Despite its recent major diversification into major energy companies and American railways, its other major activity has long been its insurance business.

Buffett did, however, teasingly drop a hint that he liked Australian banks, though any of our big four still might seem overvalued compared with his most-admired US bank - Wells Fargo - in which he has almost 10%.

When it comes to share market purchases, Buffett runs a very keen, value investor’s eye over direct investments, and he has already noted that current world share prices are heavily dependent on interest rates staying at record low levels.

Still assuming Buffett and his investment staff do take a fresh look at the Australian market, what is the likely viewpoint from Omaha?

First, they will see a share market heavily dependent on China, an economy struggling to re-adjust to less growth in demand for minerals from China, and a deteriorating budget position.
Second, the Australian share market is already heavily shaped by overseas investors. Recent data showed that foreign investors held almost $A774 billion of Australian listed shares, or nearly 45% of the total on issue.

At the same big time, local investors, like superannuation funds that now have more than $A2 trillion of assets to invest, are increasingly finding limited opportunities and are moving into overseas markets.

Buffett likes to buy in down markets and this may not be the best time for a very large investor to attempt to amass a portfolio. It’s far more likely that Buffett may adopt his more recent strategy of buying whole companies instead of listed shares, as in the IAG case.

Of course he may still surprise locals, although picking through our limited stock market list for bargains might seem penny ante stuff to the men from Omaha.

But, if they do, where might they look? Well, Buffett has long signalled he likes companies with uncomplicated businesses with some protection (or a “moat”) from competition and good brand names.  Berkshire has been strong on consumer brands – Proctor & Gamble, Coca Cola, Heinz and Duracell – and has dabbled in media (mainly old-fashioned newspapers), specialist retailers and, more recently has pushed aggressively into energy and railways.

It’s hard to see any local brands, media companies or retailers exciting Berkshire. In Australia the really big names apart from the banks are the two major retailers, Wesfarmers (Coles) and Woolworths, Telstra and mining and energy groups like BHP, Rio Tinto and Woodside.

Buffett’s “circle of competence” rule would seem to rule out resources and he might not relish the potential technological changes faced by Telstra. And even the big two retailers have found that the “moat” around Australia isn’t complete protection from big overseas retailers – as Buffett himself painfully found out with UK retailer Tesco.

In conclusion, rather than try and “front run” Buffett’s possible picks, investors would probably be better off concentrating on their own choices – leaving the chance of a surprise boost from the Sage from Omaha as an added bonus.


Warren Buffett's biggest investment secret

Monday, March 23, 2015

Warren Buffett’s Berkshire Hathaway has long been worshipped by many and its chairman lauded for his investment wisdom, laced with homespun humour.

But, for all those devotees who adore him as a disciple of the father of value investing, Ben Graham, or those who use his name to sell investment schemes and advice, this year’s version of his annual letter to shareholders was something of a revelation.

Sure, there were the usual zingers: ”You see a cockroach in your kitchen; as the days go by, you meet his relatives,” and “if horses had controlled investment decisions, there would have been no auto industry.” But, marking its 50th year, Buffett and vice chairman Charlie Munger have reflected on Berkshire Hathaway’s growth into a completely new beast.

The new order

They provide a clear view of the group’s success – and how much it has changed. Previously, it was invested in listed securities; today it emphasises owning and operating large businesses. It is now probably the world’s most successful conglomerate, with 340,500 employees and capex spending of $US15 billion. It is, in Buffett’s words, “a sprawling conglomerate – trying to sprawl further.”

Berkshire now has four main arms, headed by what Buffett calls the Powerhouse Five – the railways and utilities mainly bought in the last decade – which in 2014 contributed $12.4 billion in profits (all figures $US and pre-tax).

Then there are its smaller industrials with $5.1 billion profits, and the insurance group with $2.7 billion of profits (but more importantly generating $84 billion in its “float”).

To that add the group’s listed investments, notably IBM, Coca Cola, Amex and Wells Fargo bank, which alone had $4.7 billion of equity accounted profits, though Berkshire only recognises $1.6 billion of dividends. The top 15 listed investments had a market value of $117.5 billion (they cost only $55 billion).

As a reminder of Buffett’s investment smarts, it also has a “call” option over 700 million Bank of America shares with a market value of $12.5 billion, a deal done in the GFC when only Berkshire had capital to invest. It paid $5 billion for the option.

The 2iC

Before he met Munger, Buffett says he had Berkshire investing like someone picking up cigar butts. Then in 1959 the two were introduced (Buffett was 28 and Munger 35) and the partnership blossomed. In over 50 years they may have disagreed but never argued.

Usually, says Buffett, Charlie ends by saying: “Warren, think it over and you’ll agree with me because you’re smart and I’m right.” Munger’s philosophy produced the blue print, which has seen Berkshire develop into a major US industrial powerhouse.

Previously, it was about “buying fair businesses at wonderful prices” – Ben Graham’s recipe of buying shares well below their intrinsic value. Under Munger’s guidance that switched to ”buying wonderful businesses at fair prices.”

Berkshire’s cash-generating insurance arm and canny husbanding of cash (now around $60 billion in cash or Treasuries) has led the group into partnering other groups in acquisitions. While this continues, Buffett suggests shareholders can forget about dividends for perhaps 10 to 20 more years before cash becomes too large.

First it joined the 3G Capital group to acquire Heinz, and it expects to participate in other activities, usually as an equity partner. It also has similar partnerships with Mars and Leucadia (often called baby Berkshire Hathaway).

Now it has moved into the unfashionable field of car distribution, buying the fifth largest group in the US – and looking to expand in this area.

Buffett wants to make more “bolt on” acquisitions, both large and small, and hints that acquiring an occasional Fortune 500-size company isn’t out of the question – obviously to make a major impact to earnings.

Succession planning

And when Buffett goes? Munger says potential replacements Ajit Jain and Greg Abel are “world-leading” performers who in some important ways may be better than Buffett.

The group has been carefully grooming the executives who will take over. Of Jain who runs the reinsurance business, Buffett says his underwriting skills are unmatched and “his mind is an idea factory that is always looking for new lines of business.”

He also has given the two investment managers, Todd Combs and Ted Weschler, oversight on at least one operating business as chairman, to add business management to their investment management skills.

And just in case shareholders need an example of the advantages of buying a great business, Buffet reminds them of See’s Candy bought in 1972. Berkshire paid $25 million, invested another $65 million –and has reaped cumulative profits of $1.9 billiion. Overall, Buffett says, “listening to Charlie has paid off”.


Why you'll need more than $1 million

Wednesday, March 18, 2015


By Barrie Dunstan

Potential knee jerk reactions to allegations of SMSF retirees taking advantage of tax concessions, which favour the rich, ignore the new realities of Australia’s $1.9 trillion superannuation system. Even as low interest rates drive share prices higher and boost funds’ assets, the same factor depresses the likely retirement income those assets can earn.

And, as David Murray’s FSI report argued and the Inter Generational Report emphasises, the key element in super is the expected retirement income for members – and possible offsets to burgeoning age pension costs.

With interest rates at lifetime lows – and likely to go even lower in the short term – suddenly a $1 million super portfolio no longer represents riches for the fund’s members. A risk-averse SMSF investing $1 million in guaranteed one-year bank term deposits will struggle to earn $30,000.

That’s only about 15% above the poverty line (as calculated by the Melbourne Institute) and about the same as the minimum age pension for each member of a couple. It’s about 13% below what couples need for a “modest” retirement, according to the Association of Superannuation Funds of Australia.

Even if SMSF members look to an assured income via an annuity, Challenger is currently quoting annual payouts for a 65-year-old male, which represent between 3.2% (fully indexed for inflation) to 4.3% (without inflation protection) on their capital. Longer-living women receive slightly less.

In other words, when interest rates are so low, there are no free lunches when it comes to retirement incomes.

Of course, as every second adviser is spruiking, SMSFs can boost income with dividends from higher-risk shares but relentless arithmetic is making this harder for SMSFs. This is because of the combination of low interest rates and the ATO’s minimum pension amounts.

To earn enough to pay the minimums (see ATO table of minimum pensions below) without running down their capital, SMSFs need to run retirement income portfolios with growth-type asset mixes of perhaps 70%-plus in equities.

With a share market, and the domestic property market, showing signs of altitude sickness, investors chasing higher yields risk investing near the top and losing part of their irreplaceable capital. So, while it might seem difficult to convince those howling for tougher rules for millionaire super funds, these are tough times for retirees who aim to be self-funded.

They also are changing times. The latest APRA figures show pensions paid out by super funds in 2014 rose from $24.5 billion to $27.7 billion and, at current growth rates, this year will exceed lump sum payouts of $28.7 billion in 2014. The system has crossed the line and is now paying out more in pensions than lump sums – at just the time you don’t want low interest rates.

Those peddling the line about millionaire SMSFs should recall that when fund returns were threatened by falling share prices during the GFC, the government halved the minimum payments to avoid pressuring fund balances. But, then, when the GFC was ending in 2008, bank term deposit rates were around 8%, showing how changed economic circumstances can play havoc with the best-planned retirement income plans.

This emphasises the policy danger of jumping to short-term solutions to solve long-term budgetary problems. The dangers only increase when critics assume, wrongly, that the figure of $32 billion of tax concessions on super is potential budgetary savings. To put it simply, that figure is theoretical and simply can’t be assumed to be available to add to Budget revenue.

Remember, superannuation is a very long-term program, which has only been going for a quarter of a century. It is already straining to meet the retirement needs of the baby boomer bulge. Into the future the government needs to recognise the long-term commitment of fund members, who lock away part of their earnings for retirement, under rules that offer enough incentive to forsake current spending.

The fact that many SMSF members receiving a pension from their fund face the unenviable choice between very low payments, or the risk of losing capital in an increasingly expensive share market, only underlines the looming investment problems for most funds.

In the meantime, for SMSF members who don’t want to take too much risk in the share market, the arithmetic suggests they probably need assets of more like $2 million than $1 million – or a Warren Buffett type investment record, which shoots the lights out.