Guess what they’re giving away now!

Monday, 29 July 2019
Adelaide, Australia
By Bernd Struben

  • Drip feeding the markets
  • In the mailbag

We open today with a joke. One that ties into the big investment event of the week.

Namely, the US Federal Open Market Committee’s Wednesday meeting.

This particular joke dates back to my early school days…some 40 years ago. It resurfaced in my conscious mind when I was skimming the financial news over the weekend, bombarded with the importance investors are placing on ever lower interest rates.

Anyhow, here’s a slightly amended version of that grade school joke:

A naive passenger — we’ll call him Mr Sheeple — is on a plane to Bali. He’s the sort who innately trusts in the powers of the authorities to ensure everything is…and will remain…hunky-dory.

Halfway through the flight, one of the engines quit. The flight attendants rush to reassure the passengers that the plane still has three working engines. Everything will be fine. In fact, they’ll all be getting complimentary bottles of champagne when they land. Mr Sheeple loves champagne and cheers to good news.

10 minutes later a second engine quits. Again, the flight attendants do the rounds. This time they promise free air travel vouchers and calmly point out that the plane still has two working jets. No worries. Mr Sheeple begins to daydream about where he will fly on his free vouchers.

Soon a third engine sputters and dies. The flight attendants are looking flustered now, but again they dutifully make the rounds to placate the passengers. Now they’re offering a full refund on the ticket price and a week’s free hotel stay in Bali. Mr Sheeple is over the moon.

When the fourth engine quits, he grins over at the passenger beside him and says, ‘I can’t wait to hear what they’re going to give us now!’

More, after a look at the markets…

Markets

Over the weekend, the Dow Jones Industrial Average closed up 51.47 points, or 0.19%.

The S&P 500 closed up 22.19 points, or 0.74%.

In Europe the Euro Stoxx 50 index finished up 14.32 points, or 0.41%. Meanwhile, the FTSE 100 gained 0.80%, and Germany’s DAX closed up 57.80 points, or 0.47%.

In Asian markets Japan’s Nikkei 225 is down 80.62 points, or 0.37%. China’s CSI 300 is down 0.11%.

In Australia, the S&P/ASX 200 is up 33.51 points, or 0.49%. Going by my numbers that’s .0003% away from finally breaching the previous closing record set on 1 November 2007. It could still make it!

West Texas Intermediate crude oil is US$56.06 per barrel. Brent crude is US$63.15 per barrel. That’s almost unchanged since I wrote to you last Thursday.

Fears over an escalation in hostilities with Iran (disrupting supply) appear balanced with fears that the global economy is grinding lower (diminishing demand). The latter fears were fanned by Trump over the weekend. Trump said he believes China will delay any meaningful new trade agreement until after the 2020 US presidential election.

Traders may well be right in betting on drawn out trade negotiations and slowing global growth dragging on crude demand. But I think they’re underestimating the powder keg building in the Strait of Hormuz. More on that tomorrow.

Turning to gold, the yellow metal is trading for US$1,420.21 (AU$2,056.19) per troy ounce. Silver is US$16.38 (AU$23.72) per troy ounce.

One bitcoin is worth US$9,540.28.

The Aussie dollar is worth 69.07 US cents.

Drip feeding the markets

Leaving the jokes behind…

On Wednesday the US Fed meets to decide how much to cut interest rates. This will mark its first cut since December 2015.

You’ll notice I didn’t say ‘whether’ to cut rates.

That’s because the market has already locked in a 0.25% cut. If the Federal Open Market Committee opted to keep rates on hold — it won’t — the fallout would be swift and ugly.

Markets would take a steep tumble. Not just in the US, but across the globe. And Fed Chairman Jerome Powell would once more find himself the focus of Trump’s wrath.

Powell may put on a brave face when defending his independence. But you need look no further than his nimble backflip on planned rate increases for 2019 — following heavy pressure from Trump — to get a good measure of his backbone.

You’ll recall it was only back on 19 December that the Fed last raised rates.

As recently as last month, many pundits thought the bank would stand its ground and keep rates on hold. In fact, the Fed had signalled as much. This snippet comes from The Balance (25 June):

The current federal funds rate remained at 2.5 percent when the Federal Open Market Committee met on June 19, 2019. This benchmark rate is an indicator of the economy’s health.

The Federal Reserve signaled it would keep rates at 2.5 percent through 2021.

So much for that signal.

With a 0.25% rate cut ‘all but’ guaranteed, investors are hoping the Fed will go all in and slash rates by 0.50%. That could happen. But I don’t think so.

With the official rate only at 2.5%, Powell will want to drip feed future cuts into the system. That will ensure he remains relevant for longer.

As rates edge closer to zero, the power of central banks’ interest rate levers to buoy markets and the economy also approaches zero.

So long as we have good hard cash to fall back on, negative rates on the consumer level just won’t wash. With that in mind, keep an eye open for a revived media blitz linking cash (and cryptocurrencies) to all kinds of nasty crime, terrorism and tax evasion.

Here in Australia, RBA governor Philip Lowe is even closer to the edge of the abyss. Following two rate cuts this year, the Aussie cash rate is at an unprecedented low 1.0%. And Lowe has indicated he expects another cut — if not two — this year.

The RBA meets next Tuesday 6 August to run through the numbers. The Australian Bureau of Statistics’ inflation report, due out this Wednesday, is one to watch. If inflation comes in lower than forecast, the odds of a cut next month rise.

That ‘good news’ should see investors bid stock prices higher. Even after the stellar run stocks have enjoyed so far in 2019.

While a ‘healthy correction’ is almost certainly in the cards sooner than later, the big crash could be years away yet.

But don’t let your guard down.

The world’s central banks are getting down to their last engine. And when it finally sputters out, the Mr Sheeples of this world are going to be fleeced.

To learn how you can take valuable steps to protect your wealth today, go here.

In the mailbag

Last week we looked at Australia’s sky-high home prices. And I suggested that a 50% price fall, however painful, would prove to be a huge boon for most Aussies once the dust settled.

We received a lot of feedback on that subject. Including one from reader Ian last Thursday suggesting a Capital Gains Tax on all properties…including your primary residence…could be the answer.

Today a reader, also named Ian, responds to that.

Hi Bernd,

From another Ian.

I agree with Ian (mailbag 25/7/19) that the house price bubble and the concomitant national reduction in investment in productive assets, is in part due to the obviously skewed incentive that inevitably arises when a broadly based tax, such as the capital gains tax, includes a major populist exemption such as in this case, the principle private home.

It simply diverts scarce investment away from wealth creating (but comparatively risky) industry into a tax free, generally price rising and relatively risk-free and therefore significantly more attractive (at least in the short-term), alternative.

This in time results in a sub-optimal economy where the great majority of people end-up being worse off.

The housing bubble (and Equities market) then need to be ‘defended by the Reserve Bank and government, by such things as manipulating Interest Rates and otherwise attempting to ‘stimulate’ the economy, which further distorts the market, encourages increased debt and poor investment decisions, leading at some time in the future to a major, probably long-term, financial crisis and economic collapse.

As much as I do not like capital gains tax, if you are going to introduce one, it must apply right across the board or the distortions it creates will more than offset any perceived benefits from its introduction.

We are setting ourselves up in a no-win situation unavoidably heading for disaster. Keynes and his naive followers have a lot to answer for. I agree with Vern Gowdie.’

Thanks Ian.

Indeed, when central authorities pull a lever to fix one problem, they tend to create two more problems in the process. This then requires two more levers to be pulled. And so forth…

So a capital gains tax on your residence would need to be applied across a much broader spectrum with more new policies to avoid new distortions.

But rather than jump on a pro-tax bandwagon, why not do away with the raft of distorting incentives luring people into overpaying for property. Things like interest-only loans, record low interest rates, and the latest brainchild from our pollies…the 5% mortgage deposit.

If you need to borrow 95% of the capital to buy your house you’ve either not spent enough time and effort saving…or you’re overpaying for your piece of the Australian dream.

Or both…

As for the unavoidable disaster we’re barrelling towards, Vern Gowdie wrote the book on why it’s coming, along with some crucial steps you should be taking now to protect yourself.

You can find that book here.

Remember to send your replies or feedback to letters@portphillipinsider.com.au. When we get some good responses, I’ll publish them here.

Cheers,
Bernd