Rudi’s View: Banks, Central Banks, Inflation & Debt

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

Dear time-poor reader: Part Two contains an interesting piece of research on Australian banks, and further zooms in on the threats and risks from super-accommodative central banks' policies and the ever rising mountain of global debt; and why there still is no inflation danger.

In this week's Weekly Insights (published in two parts):

-Corporate Earnings Still Matter In 2019
-Dividends, Quality And Australian Banks
-Central Banks' Policies Not Without Risks
-Charts: Mind The Output Gap, And Global Debt
–Rudi Talks
-Rudi On Tour
-Rudi Talks

By Rudi Filapek-Vandyck, Editor FNArena

Dividends, Quality And Australian Banks

With the August reporting season approaching fast, I thought it worthwhile to reference one particular piece of research released last year by banking analysts Brian Johnson, Christopher Kightley and Ed Henning at CLSA.

The three conducted detailed historical share price performance data and found there is quite the difference as to how long it takes for the Major Banks in Australia to see their share prices recover after having paid out dividends to shareholders.

For some among you, no doubt, this will be useful information when setting up specific, timing-based dividend stripping strategies. For others, it is yet another piece of evidence that corporate quality does show up, as long as investors are looking into the right direction.

As it turns out, CommBank ((CBA)) shares tend to require significantly less time to recoup the loss in dividend. CLSA's research stretched back 53 dividend payments up until August last year and their calculation is that CommBank shares require about 44 days on average to fully compensate for going ex-dividend following the release of interim and full year corporate profit results.

The difference? Westpac ((WBC)) shares require an average of 87 days. For ANZ Bank ((ANZ)) shares the average duration is 91 days and National Australia Bank ((NAB)) needs 92 days. The research did not include any of the regionals, but my gut feel tells me they won't do this quicker than CommBank or even Westpac.

Also, the gap between CommBank shares and the first runner up -Westpac- is nearly double in time. This makes one wonder: why such a big difference?

One explanation could be that CommBank shares virtually always trade at a premium versus the rest of the pack, and this means less needs to be compensated for, in terms of percentage loss from going ex-dividend. This would also explain why Westpac comes second, and why NAB sits at its familiar sector-last position.

But the gap between CommBank and the others is way too large to simply blame the market leader's valuation premium. CLSA saw a correlation with the tighter-than-peer share register for CommBank. Shareholders consist mostly of retail investors, and they don't necessarily sell upon receiving dividends, suggest the analysts.

In other words: it's the institutional investors that are to blame. They are structurally underweight the sector leader. I would wager this might also be the case because analysts tend to feel attracted to the "cheaper" alternatives, which, as my own data research taught me over the many years past, does not translate into the better investment returns.

The irony of the local banking sector is that, over time, CommBank shares significantly outperform the three other Majors, and this runs contrary to the general belief that "valuation" and a "cheaper entry point" are sacrosanct for achieving superior long term returns.

National Australia Bank shares have looked the "cheapest" ever since the in-house currency scandal from around 18 years ago. The shares pay out the highest yield. NAB shares are most often recommended as a Buy/Outperform for these reasons.

But apart from a temporary catch-up rally here and there, NAB shares have proved the perennial underperformer in the sector and CLSA's research into the duration of loss of dividend compensation in banking share prices again confirmed the NAB as the least desirable exposure to the sector.

Viewed from another angle: CommBank is, simply put, the best in the sector locally. Apart from carrying a permanent valuation premium vis-a-vis its peers, the CLSA research provided yet another piece of evidence that quality does matter for long term, buy-and-hold investors.

Below is more evidence from my own personal research, which has been part of my PowerPoint presentation slides for a number of years now. Simply observe the differences in share price returns.

Central Banks' Policies Not Without Risks

Thus far, the story about ultra-accommodative central bank policies post-GFC is coloured with right wing political populism, sharply increased inequality and asset price inflation. Most retirees and investors would consider this a positive outcome, on balance, as do governments who are notably absent, and have been for quite a while now.

But nothing is without consequences and the fact that flooding the globe with excess liquidity hasn't yet shown up in a tangible negative outcome might just be a matter of time and/or timing.

Mohamed El-Erian, chief economic advisor at Allianz and author, most recently, of The Only Game In Town: Central Banks, Instability and Avoiding the Next Collapse, suggests investors should not let themselves being lulled into some kind of complacency, simply because thus far the outcome appears to be without too much of negative consequences.

In a recent Op-Ed, El-Erian writes that, "In recent years, central banks have made a large policy wager. They bet that the protracted use of unconventional and experimental measures would provide an effective bridge to more comprehensive measures that would generate high inclusive growth and minimise the risk of financial instability.

"But central banks have repeatedly had to double down, in the process becoming increasingly aware of the growing risks to their credibility, effectiveness and political autonomy."

That Op-Ed, by the way, concludes with the following sentence: "Like seasoned gamblers, central bankers may soon discover that not all bets pay off over the longer term."

According to some market analysts, central bank policies have transformed the global economic and financial system into a rather binary matter of liquidity: is there enough/plenty liquidity sloshing around inside the system, or not?

Investors looking for a thorough understanding of what this type of financial conundrum implies for equities and other assets, and for central banks' options and considerations moving forward, need not look any further than the interview of Michael Howell below. Howell was once upon a time head of research at Barings in the UK and one of the first to incorporate the concept of liquidity in his market research.

The interview below is both revealing and frightening, and a must see for every investor who likes to stay on top of how exactly today's world is morphing into something different than the world we all know from decades past:

https://youtu.be/Loj0z43VZ7I

Another market expert whose views have generated quite the attention recently is Ray Dalio, founder of Bridgewater Associates, one of the world's largest hedge funds. His updates require reading:

https://www.linkedin.com/pulse/paradigm-shifts-ray-dalio/

Charts: Mind The Output Gap, And Global Debt

One does hear the mantra still, every so now and then, what if the world is confronted with inflation breaking out to the upside?

While it is true that nothing ever lasts forever, it is but an accurate observation that inflation has largely gone missing in years past and most experts that had been advising their clientele to hedge and/or prepare for the return of inflation have gone eerily silent, having been proven awfully wrong by the facts.

Central banks' policies are seen as co-responsible by some. Others seek an explanation in demographic changes and the advent of new technologies as well as the significant broadening of the available labour pool for jobs and tasks in developed economies through the inclusion of citizens in Emerging Markets.

Does the largest mountain of debt in human history by default keep a lid on price inflation, or is it merely a case of too much debt weighing upon household budgets?

My personal interest was piqued last week when David Rosenberg, chief economist and strategist at Canada's Glushkin Sheff, published the graphic below, revealing the output gap for OECD countries has simply never fully closed post-GFC, and it doesn't appear this gap is about to close soon either.

Economics 101 suggests that unless this gap is closed, implying the world's largest economies are starting to operate at full capacity, and then moves further away from the zero line on the upside, the global economy is likely to remain captured by deflationary forces, which is the exact opposite of runaway inflation.

Looking at the chart above, and considering economies are weakening which means the gap is widening again, this strongly suggests -all else remaining equal- it remains far, far, far too early to worry about inflation.

At the same time, and this is quickly turning into one of the dominant characteristics of the modern era, global debt is growing at much quicker pace than global growth, see Rosenberg's second chart below. This, for obvious reasons, raises a few questions about longevity and sustainability or do Modern Monetary Theorists have a point?

For those readers who'd like to get acquainted with what this is all about, FNArena published an introductory explanation on Modern Monetary Theory, or MMT as it is colloquially referred to nowadays, in May.

https://www.fnarena.com/index.php/2019/05/15/modern-monetary-theory-global-saviour-or-highway-to-hell/

Rudi Talks

Audio interview from Wednesday last week:

https://www.youtube.com/watch?v=BTmBz-IC8JA

Rudi On Tour In 2019

-AIA National Conference, Gold Coast, Qld, 28-31 July
-AIA and ASA, Perth, WA, October 1

In 2020:

-ASA Hunter Region, near Newcastle, May 25

(This story was written on Monday and Tuesday 22nd & 23rd July 2019. It was published on the day in the form of an email to paying subscribers, and again on Thursday as a story on the website. Part two follows on Friday).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via the direct messaging system on the website).

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