The cold, lifeless body of a machine…

  • We shudder at the thought
  • BlackRock fears inflation
  • In the mailbag

From Metro.co.uk, something that may or may not be of interest:

Would you want to make love to the cold, lifeless body of a machine?

It might happen sooner than you expect.

Experts are predicting that sex with robots will become widespread within the next decades — and robots could be better in bed than any fleshy partner, an expert has revealed.

Blah to experts! [Reader’s voice: Shouldn’t that be sexperts?]

We’re always fascinated by new technology, but this is something else. At this year’s ‘The Great Repression’ conference in Port Douglas, our in-house tech boffin, Sam Volkering, will take the stage.

As with our last conference, we expect Sam to tell us all about the latest technology and new developments that will likely shape the future.

We’ll ask him about this development. He may even mention it at the conference. Although, if he does, being a family show, we’ll encourage him not to request any audience participation…

Markets

Overnight, the Dow Jones Industrial Average gained 46.16 points, or 0.25%.

The S&P 500 index added 6.5 points, or 0.3%.

In Europe, the Euro Stoxx 50 index fell 7.5 points, for a 0.24% loss. Meanwhile, the FTSE 100 fell 0.78%, and Germany’s DAX index rose 0.14%.

In Asian markets, Japan’s Nikkei 225 index is down 92.07 points, or 0.54%. China’s CSI 300 index is up 0.36%.

In Australia, the S&P/ASX 200 index is up 4.67 points, or 0.09%.

On the commodities markets, West Texas Intermediate crude oil is trading for US$44.75 per barrel. Brent crude is US$47.26 per barrel.

Gold is US$1,350 (AU$1,757) per troy ounce. Silver is US$20.04 (AU$26.06) per troy ounce.

The Aussie dollar is worth 76.87 US cents.

We shudder at the thought

Every time we write the words ‘central banks’ and ‘debt’, a small shudder travels up our spine.

We think to ourselves, ‘We’ve written about this stuff almost every day for eight years; aren’t the readers bored of it yet?’

It’s possible.

It’s possible that the merest mention of those words drives the majority of our readers to close the email…or drives them to despair. Or maybe, drives them to the bottle.

In which case, we apologise. Unless you have a masochistic nature, so that you enjoy being driven to despair…or you’re a drunk who’s looking for any excuse for a snifter.

In which case, we accept your thanks.

However, each time we experience this shudder, we find it easy to rationalise.

After all, if it weren’t for the constant meddling and manipulation of interest rates, and the determination to achieve growth by debt, we wouldn’t have to discuss these issues each day.

And yes, it is important to remind you about what’s really happening with the world’s economy. Sure, you could argue that the only time worth knowing about it is just before the whole thing collapses.

That’s a fair point. The trouble is, as much as we try to predict when the markets will crumble, there’s absolutely no way of knowing for sure when that will be.

So we just try to keep you on your toes. Remind you of the problems and, hopefully, provide you with solutions to grow and protect your wealth in the face of these problems.

Getting back to the point of central bankers and debt… Boy, are they doing a good job of crunching down rates and ramping up debt.

You’ll recall that one of the big themes after the 2008 meltdown was that the world was deleveraging. From the start, we said that was nonsense. You didn’t need a PhD in economics to know that debt was increasing, not decreasing.

You only had to look at the huge increases in government debt. Australia is a good example. Prior to the 2008 meltdown, the Australian federal government was in debt to the tune of $60 billion.

Right now, according to the Australian Office of Financial Management, government debt stands at $433.1 billion. This time next year, it will likely be half a trillion dollars.

Good, huh?

But the rampaging appetite for debt doesn’t begin and end with the government. The private sector is doing its darnedest to match the public sector.

The chart below shows you how the issuance of US corporate debt has skyrocketed since 1995:



chart image

Source: Financial Times
Click to enlarge


Now, this isn’t total outstanding debt. This is the issuance of debt. In other words, many of these debt issues are in order to replace existing debt.

A company paying 7% on debt due to mature in three years may choose to buy back that debt today, and issue new debt at, say, 3% for five years.

In instances such as that, the debt pool has remained the same, but the interest rate has fallen, and the maturity has lengthened.

Of course, it would be a disciplined company that would only replace debt like-for-like. The reality is that lower interest rates will induce, and have induced, companies to increase borrowing.

If a company can halve its interest payments, theoretically, it can borrow twice as much for the same cost.

It’s a no-brainer move, right? It seems that way, except for one problem. When the debt matures in three, five or seven years, the company has to repay that debt, or roll it over into new debt.

Any seasoned investor will tell you that twice the debt doesn’t necessarily result in twice the return on investment. Failing to increase profits and cash flow, while not affecting the regular interest payments, could make it hard for the company to repay the debt in the future.

Ah, the reader replies, surely the company can just refinance the debt, rolling the maturing further into the future.

Of course. Providing the company can service the interest payments, and providing the market trusts the credit worthiness of the company.

What should happen if interest rates increase between now and then?

Without labouring the point, we think you get the idea.

But while debt is growing for corporate America, the debt growth of ‘Government America’ should be the biggest concern for savers and investors.

Check out this chart. Note that I’ve adjusted the ‘Y’ axis to reflect the relative size of the bars:



chart image

Source: Bloomberg
Click to enlarge


The chart represents the maturity profile for US government debt. The top chart shows you where the US government stands today. The bottom chart shows you the forward-looking picture from the fourth quarter of 2009.

In the bottom chart, look at the third blue bar from the left. That represented debt maturing in 2011 — two years after 2009. The value of the maturing debt was US$823.7 billion.

Now look at the third bar from the left in the top chart. You can see already that the bar is much taller. That’s because debt maturing in 2018 (two years from now) will be US$1.5 trillion.

That’s as it stands now. In all probability, the debt will be larger. Why? Well, look at the second bar from the right. Debt maturing in 2017 stands at US$1.6 trillion.

It’s hard to imagine the US government paying off that debt, not when it continues to run a budget deficit. That means the government will need to issue more new debt to pay off the old debt. The US Treasury will then issue bonds, spreading maturities out over several years.

Considering the lowest interest rates are at the shorter end of the yield curve, a big chunk will fall into near-term maturities. So, US$1.5 trillion of maturing debt in 2018 isn’t likely to stay low for long.

This is why we keep going on about central banks and debt. Things aren’t getting any better. If they were, we’d turn our attention elsewhere.

As we mentioned before, we’re convinced this will all end badly. The only uncertainty for us is that we don’t know when it will happen; nor do we know the catalyst that will cause it to happen.

BlackRock fears inflation

On the subject of bonds, investors have swarmed to government bonds, even those with negative yields. Why? Because of their supposed risk-free nature.

Big institutions would rather have the certainty of getting something back, in the form of devalued money, than the uncertainty of perhaps getting nothing back by parking cash in the bank.

However, if safety is the name of the game, government bonds may not be the best option for big investors. As Bloomberg reports:

BlackRock Inc. is shunning long-term Treasuries following a surge in 2016 in a bet the Federal Reserve will allow a pickup in inflation.

“We think the Fed is likely to allow inflation to run hotter than its target for a while,” Rick Rieder, the chief investment officer of global fixed income in New York, wrote in a report Sept. 2. “While we have believed that there was more value in longer-end interest rates over the past year or so, we are more comfortable holding shorter, or belly, interest rate exposure.” BlackRock is the world’s biggest money manager with $4.6 trillion in assets.

Two things. ‘Belly interest rate exposure’ means medium-term maturity bonds.

Second, the fact that BlackRock has US$4.6 trillion in assets under management tells you that asset price inflation, and inflation in general, is already completely out of control.

To put that in perspective, that almost matches the combined market capitalisation of the Aussie and UK stock exchanges.

But that’s by the by. BlackRock is basically saying that it’s too risky to hold long-term bonds. At the moment, a 30-year US bond yields 2.226%. In order to achieve a positive outcome, an investor needs inflation to be below that level.

An inflation rate above 2.226% means an investor receives a negative yield on their investment.

For a long term bond investor, that creates a problem. If inflation spikes, the investor has a choice. They can ride it out, hoping for lower inflation, knowing they will at least get their principle investment back on maturity.

Or they can sell out of the bond now, likely at a loss if inflation and interest rates have risen, hoping they can reinvest in higher-yielding assets.

That brings us full circle. If inflation increases further, then interest rates will rise, whatever the US Federal Reserve does with short-term rates.

With higher inflation, investors would likely demand higher returns.

Interesting, eh? We can only imagine what that will mean for the US government, other governments, and corporate America. Especially as the debt binge and lack of deleveraging has resulted in debt levels reaching a record breaking high.

In the mailbag

Subscriber, Guy, writes in about setting up a self-managed superannuation fund (SMSF):

I am in the process of establishing a SMSF after a rather wrong advice from my former financial adviser. I have been in touch with a finance company facilitating the establishment of this structure. Along with the establishment costs the audit and accounting costs we will be charged with ongoing costs of 7% a year for financial advice I do not need plus the 15% tax on money earned by the government. I thought that SMSF was created to streamline and reduce costs. In this case it seems that I will be worse off. Also the financial planner I am using is establishing in November a portal where I can manage my investments and reject the financial adviser option thus saving money. This seems to be a better option than the SMSF as it is proposed to me. I am trying to save money as I will be losing my government pension in January 2017.

Thank you for your view. Looking at your letters every days and enjoying them.

We can’t offer personal financial advice on this situation, but we can offer some general comments.

First things first — 7% on financial advice!? Your editor is tempted to hang up his boots as a lowly newsletter publisher and get back into the mainstream financial advisory business.

We haven’t seen 7%…well, ever. Not outside of the hedge fund industry, where they usually follow the ‘2 and 20’ formula. That is, 2% charged on funds under management, and 20% charged on profits.

So 7% as a management fee, to your editor, is outrageously high. The only justification we can think of for such a fee is if the financial advisor provides his statements of advice on gilt-edged paper. Or if the comprehensive financial plan has a gold leaf cover.

As for the question of setting up an SMSF, folks should be aware that it’s not for everyone. Having an SMSF does require maintaining good records, and understanding the rules about what you can invest in, and how. Failure to follow the rules can lead to trouble.

In fact, an egregious failure to follow the rules can result in the Australian Tax Office (ATO) declaring the SMSF non-compliant, which would result in the fund facing income tax rates at the members’ marginal tax rate, and penalties for non-compliance.

That said, if you understand all that, an SMSF can be a great option. When we first set up an SMSF, we went with Esuperfund (www.esuperfund.com.au). They offer a cheap service, with annual fees at around $699 per year.

There are a few restrictions on what you can do, but not many. For instance, your main cash management account has to be an ANZ V2 account. If you want to buy and sell shares, it has to be through a CommSec or CMC Markets Stockbroking account.

And if you wanted to set up a term deposit, it would have to be with certain providers.

But that shouldn’t be a problem for most folks. Now, in exchange for the low annual fee, you do pay a higher brokerage rate with CommSec. That’s not necessarily a bad thing. I was aware of this, and it therefore made me think twice before buying and selling shares.

I also believe they take a small clip on the ANZ V2 interest rate. Again, it’s not a big deal, depending on your account balance. I could be wrong on that, so I will happily stand corrected if that’s the case.

But whatever it is (if anything), it’s not going to be anywhere near a 7% management fee.

Now, in the interests of full disclosure, I’ve recently moved my family super fund to a different firm. But it wasn’t because I was unhappy with the service. It’s simply because my SMSF is at a level where I need more proactive advice from a specialist.

Even so, the fees I’m set to pay are nowhere near 7%. In fact, doing a rough back-of-the-envelope calculation, the annual fees will amount to less than 1%…and that’s with an element of advice.

I’ve spoken about Esuperfund before. Their service won’t be for everyone, because they don’t offer personalised advice. But before ‘jumping into bed’ with anyone else, perhaps get in touch with them to see if they suit your needs.

(Note: Port Phillip Publishing does not have any kind of referral or ‘kick back’ arrangement with Esuperfund. We simply mention them because you may find their service of use…or not.)

Cheers,
Kris