Some say that Australian's shut up shop in January and go to the beach, thereby making it an 11 working month year. From Hedge Clipping's experience that's a gross understatement. Many in the financial services sector, particularly when in Melbourne, advise that if you don't get deals in place by Cup Day on the second Tuesday in November, then getting any serious traction and attention becomes increasingly difficult. And even if that's a Melbourne issue, by the beginning of December many Australians go in to "count down mode" leading up to Christmas.

Without wishing to admit to being a member of the 10 working month a year fraternity, there's certainly truth in the facts. From December 1 onwards driving on city roads becomes progressively easier, politicians head for overseas taxpayer funded "research trips", and those left at the coal face endeavour to clear up all the outstanding administrivia we have been putting off for the past few months.

Not that it apparently affects the stock market, which according to an article  written by Wilson Asset Management's Chris Stott, argues that as the new year approaches, the market tends to perform particularly well as the Santa Claus effect, first documented in 1972, takes hold. Stott's research shows that since 1950, December has been the best performing month for the market, with the All Ordinaries index rising 74 per cent of the time. Over the period, the index has delivered average gains of 2.1 per cent over the month.

Bell Potter's Richard "Coppo" Coppleson describes the market hitting a "sweet spot" from mid-December through to early January. His research shows that during this period, Australian shares have posted gains in 31 out of the past 37 years to deliver an average return of 3 per cent. In the 31 "up" years since 1980, the market has increased an average of 4.2 per cent. Further, a remarkable 25 per cent of the time the market has surged by 6 per cent or more.

Since 1995, the All Ordinaries has fallen just twice during this trading period - once in 2007-08 (down 6.3 per cent) and again in 2010-11 (down 0.7 per cent). Analysis by Andrew McCauley of Veritas Securities finds that the market delivers inordinately high returns in the eight trading days before New Year's Eve, with the All Ordinaries rising a remarkable 83 per cent of the time from 1980 to 2015.

All this is great news for investors, but "why is it so"? Wilson Asset Management's Chris Stott goes on the explain it might be bank dividends:

"As investors make adjustments to their holdings and position their portfolios for the new calendar year they tend to be net buyers of shares as December 31 edges closer. Not to be overlooked is the fact that three of the four big banks all pay dividends in December.

This year, ANZ Banking Group, Westpac Banking Corp and National Australia Bank will pay out a combined $8.2 billion in dividends to shareholders between December 13 and 22. Assuming about 15 per cent of dividends are reinvested through dividend reinvestment plans, collectively investors will still receive almost $7 billion in cash to potentially invest in the sharemarket.

In spite of the additional buying occurring during this period, the absence of many market participants at their desks during the holidays has seen the volume of shares traded on the ASX fall markedly. For example, in recent months the sharemarket has had average daily volumes of about $5.7 billion. In comparison, over the last two weeks of December 2016 and the first week of January this year, average daily volumes dropped by 21 per cent to $4.5 billion.

In Wilson's view, the combined effect of investors' net buying and the market's constricted liquidity helps push share prices higher, creating a Santa rally at the end of the calendar year.

With the festive season upon us, investors may wonder if this year the sharemarket will bring them some cheer. With the outlook for interest rates to be lower for longer, many investors could be more inclined to reinvest their cash dividends into the sharemarket, rather than put them into term deposits with record low returns. Past experience would seem to give reason for optimism with the market outperforming on average over the holiday period."

That's enough from Hedge Clippings for now - there's a (long) Christmas lunch I'm due to go to....

Financial Services Royal Commission - double backflip with a twist.

Finally facing the inevitable, both the banking sector and the Prime Minister came to the conclusion that having at least some semblance of control over the outcome was better than none. Certainly better than seeing a couple of government MPs crossing the floor with a proposal for a banking inquiry which would have been far more extensive than both the industry and the government would have liked. You could argue, as Andrew Main did on Peter Switzer's website earlier this week, that there was little point in having a Royal Commission when most people already know what the problem is. However, the political reality was that the problem was not going away, and the banks in particular would much prefer the process now under the current government, than in the future under a potential Labour government .

Hence the reference to the "least worst option" - facing the reality that fighting the inevitable was not working, and was certainly not improving the general perception of a government on the back foot. Backflips - even double ones with a twist - are preferable to outright defeat.

Royal Commissions are dangerous, so understandably the government has announced one with a limited number (13) of terms of reference, and only allowed 12 months and $75 million for the as yet unnamed members of the commission to return their findings. In reality given that it is now December, and the Christmas break is coming up, that probably means only 10 months, or a change in holiday arrangements for those involved.

However the government has scored at least a partial win (the twist) by broadly including any "financial services entity" and by capturing the superannuation industry specifically - and we would guess the industry superannuation sector in particular, which to a degree still restricts members' entitlement to freedom of choice, and has persistently refused to accept independent directors or trustees in line with the governance requirements that apply to listed corporations. Given the importance of the superannuation system to the future financial well-being of so many Australians, this surely is long overdue.

From "Hedge Clippings" point of view it will also be interesting to see if the vertical distribution structure of financial products (managed funds) through bank owned product issuers, platforms and financial advisors, also comes under the Commission's microscope.

Of course announcing an inquiry, or a Royal Commission for that matter, does not necessarily lead to an outcome. It's worth thinking back to the Rudd/Gillard Government's "Henry Review of Australia's Future Tax System" which was not only hobbled by not allowing it to consider either the GST, imposing tax and superannuation payments to retirees over 60 years of age, or already announced personal income tax changes. Ken Henry's report made 138 specific recommendations, many of which we suspect have either been quietly buried, or remain "under consideration".

The RBA is good, but not a good forecaster!

The superannuation ideas of the super-rich were heavily featured in today's media, and we can't disagree that Australia's super pool, the fourth largest in the world, (which is significant not only in itself, but particulary against the fact that Australia only has the 13^th largest economy) creates an extraordinary pool of capital which could benefit other sections of the economy.

While we wouldn't disagree that it could be used as a source of capital for Australian businesses, this in itself would create a number of issues regarding eligibility and security of the funds. Hedge Clippings has no doubt that these issues could be resolved, but we would still argue that the allocation of a portion of superannuation funds to much-needed infrastructure projects would make an even better fit.

One such reason is that the long-term funding requirements of infrastructure projects ideally meets the investment timeline of superannuation funds. Another is that a relatively steady income stream of around 5%, or cash +3% would be attractive to both the project and the superannuation fund, particularly that portion currently held as cash or in government bonds.

Finally, if there were to be approved infrastructure bonds, any superannuation fund, including the SMSF sector which makes up over 30% of the total, could invest an appropriate portion, possibly with a taxation carrot or stick attached. Given that the allocation of SMSF's to cash is reportedly high at around 25% or more, funding for Australia's much-needed infrastructure requirements could be met with a win/win/win outcome.

Elsewhere this week a speech by Philip Lowe, Governor of the Reserve Bank at the Australian Business Economists Annual Dinner caught our attention, and gave an insight into the difficult balancing act that the RBA has been facing. Entitled "Some Evolving Questions", and referring to a previous speech he had given in 2012 entitled "What Is Normal", the Governor admitted that the RBA is still searching to understand: What is normal?

However on the economic front things are anything but normal, with low unemployment and solid employment growth, an increase in the wage price index of only 2% over 12 months, and an increase in average earnings per hour barely above 1%. As a result consumer confidence is low, particularly given that the level of household debt to income ratio is forecast to top 200% within a year or so.

The RBA is keen to raise interest rates next year but is unlikely to be able to do so. Even a small increase will put further pressure on consumers who are already struggling, although businesses are continuing improve margins on the back of low rates and productivity and technology improvements. But most of all, as a result of high household debt levels, the already cooling property market would have difficulty with any rate increase without any increase in household incomes.

Finally, the RBA is currently forecasting consumption growth of 3% over 2018 and into 2019 but what is normal is that the RBA's forecasts are overly optimistic!  For the past seven years they seem to have been fixated by a forecast in consumption growth of around 3.5%, with actual consumption growth failing to achieve it on each occasion.

And while talking of "What is Normal", 10 years ago today Kevin Rudd took over as Prime Minister, the first of five we have had since then. Maybe the new "normal" is a revolving door at The Lodge?

Ethics as an option?

Dr Simon Longstaff of The Ethics Centre (formerly the St James Ethics Centre) was quoted this week as saying he felt he'd been trying to sell umbrella's in a drought for the past 30 years, but that maybe it is now starting to drizzle.

Hedge Clippings presumes he means that organisations are starting to understand that ethics are important, and as such his wisdom and advice is now being appreciated - in some quarters - at least more than it was.

It is unfortunate of course that this has probably only come about as a result of some failures and the resulting embarrassment in the banking sector in particular, with the media having a field day with the CBA's money laundering, and various examples of market manipulation and rate rigging amongst the other banks. Suffice to say that if the rules on market manipulation in those markets were the same as insider trading in equities, there'd be some significant "holidays" being handed out by the courts, rather than hefty fines being paid by long suffering shareholders.

It is however a sad reflection on the real world of business that the good Doctor Longstaff and The Ethics Centre even exist. Most intelligent and reasonably educated business people - banker or otherwise - know the difference between right and wrong. The problem is they just don't feel the normal ethical rules apply to them, or that the reward is such that they couldn't care anyway.

We long remember the term "Commercially Naïve" being applied to anyone who put ethics ahead of profitability - and it was not meant as a compliment. That Dr Longstaff is now managing to offload a few of his stock of umbrellas is encouraging, but disconcerting that it is only to avoid the recipient getting wet, rather than not needing one in the first place.

A road to nowhere…?

A recent article on the nab asset management website entitled "The Grumpy Australian Consumer" concluded that given the rapid rise in the cost of electricity and health, coupled with subdued income growth and high household debt, Australian consumers are entitled to feel grumpy, and that these pressures can account for the recent retail spending figures as well as the modest performance of the Australian sharemarket in 2017.

The article had a series of excellent charts and tables, the most worrying of which was this one provided by the RBA, and dated March 2017. With household debt having climbed dramatically, and interest payments as a percentage of disposable income having fallen courtesy of low interest rates since 2012, it is not difficult to see the Reserve Bank's dilemma - It won't take much in the way of an increase in interest rates to dramatically increase the percentage of disposable income consumed by mortgage repayments, creating even more grumpy Australians, particularly if consumer confidence remains low.

At least investor confidence has been given a boost recently with the ASX finally touching the 6000 level, albeit still 10% below its all-time high in 2007. TheAustralian market is frequently negatively compared to the S&P500, but it is worth remembering that the ASX delivers Australian shareholders a dividend income of 4%, much of it also having the benefit of franking, whilst US companies distribute just 2.5% to shareholders as dividends.

The NAB article above referred to Leonard Cohen's song Anthem,

"You can add up the parts,

You won't have the sum"

Which is perhaps why we have economists to help us.

In Hedge Clipping's opinion a further reason for Australians to be grumpy, and thus the low levels of consumer confidence, is the lack of direction coming from Canberra, which might be equally summed up by the title of Talking Heads' 1985 hit song "A Road to Nowhere". The title is where the similarity ends, as the words to the song run:

"Well, we know where we're goin'

But we don't know where we've been

And we're not little children, and we know what we want

And the future is certain, give us time to work it out"

Unfortunately, if all the reported talk in Flemington's Birdcage on Derby Day was anything to go by, the words could be changed to:

"Hey, do you know where you're goin'

Do you know where you've been?

And you're not little children, and you should know what we want

And the future's uncertain, you've had time to work it out"

Meanwhile some managers certainly knew where they were going in October, in a strongly rising market.

A lawyer at the helm of the FED

Overnight Donald Trump announced the appointment of Jerome Powell as the next chairman of the US Federal Reserve, replacing Janet Yellen, and swapping an economist for a lawyer in the process. That's not meant to cast aspersions on either of them, or on their professions generally, it is just a point to note, as is the fact that there are four other vacancies around the Fed's board table over the coming months which will further shape future policy.

Hedge Clipping's take is that Powell is measured, experienced and unlikely to make any sudden changes, with a gradual approach to encouraging the economy to grow, and adjusting interest rates and the Fed's balance sheet over time in line with growth/inflation. In other words, steady as she goes - which is what markets like. Growth is gradually picking up, inflation is low, as is unemployment. All looks to be set for a continuation of what's now the third longest US economic and market upswing, even though there are some forecasts of three or four rates rises ahead in 2018.

As has been pointed out frequently both here and elsewhere, markets have been driven by central banks' intervention, which some considered to be a dangerous precedent. In due course it may prove to be so, but in the meantime one would have to take the view that the US Fed has successfully managed the recovery from the GFC. Everything seems to be reasonably in balance, even if those on the wrong end of low wages growth (both here and in the US) might not appreciate the benefits.

However, as noted previously economic expansion doesn't die of old age, but of sudden shocks and asset bubbles. While there are those that believe the US market is overpriced (which it may be on a historical basis) this doesn't seem to be caused by the irrational exuberance and lack of caution which preceded shock events such as the market crash of 1987 or the GFC in 2008, but more by the exceptionally low interest rate and low inflationary environment.

The danger lies in the event that in the event that either shock or bubble do occur there's little in the Fed's arsenal with which to counteract the unknown.  Steady as she goes is what's required, provided the economy, markets and politics don't upsets the apple cart.

Locally the week saw weak retail sales figures, presumably as a result of low consumer confidence. And why not? Wages growth is low, household costs from over indebtedness and increasing utility prices are increasing, resulting in reduced or limited discretionary spending.

At least we have the Melbourne Cup next week to take our minds away from the ongoing uncertainty coming out of Canberra - which also can't be helping consumer or business confidence.

Depending on one's point of view, today's news that five federal politicians are ineligible to stand in parliament will result in cheers of joy or derision, with none other than the Deputy PM facing a by-election at the beginning of December.  Whichever side of the political fence one sits on the disappointing reality is that this will further hinder the course of stable government and policy.  As such it further erodes consumer and business confidence, and thus investment.

In particular it damages the perception, reputation and attractiveness of Australia as an investment destination from a global perspective, irrespective of the final electoral outcome.

On a more positive note, although it has taken a long time since Mark Johnson released his report "Australia as a Financial Centre: Building on our strengths" in 2009 (if you're historically minded you can find and download a copy here) it seems his recommendations for making Australia's funds management and financial services sector more competitive on the global stage are finally bearing fruit. It may have taken the passage of eight years and no less than five prime ministers, but in this year's budget the current government finally started the ball rolling.

As a result yesterday ASIC released Consultation Paper 296 regarding Corporate Collective Investment Vehicles (CCIVs) and the Asian Region Funds Passport, seeking feedback on the regulatory and compliance environment which will encompass the legislation once in place.

Without going into the details of the Consultation Paper, or the proposed changes, there are two things that are blatantly obvious: Firstly Australia needs to be part of the global financial services industry. Therefore to attract offshore investors, and to be able to market to them, there must be appropriate structures and legislation in place. As a result, provided the regulatory requirements are not excessive -and the opportunities therefore only applicable to the large end of town - the changes are both welcome and long overdue.

Secondly, there will be significant changes to compliance and regulations as a result. The risk is that this will certainly make it difficult or onerous for boutique Australian managers whose main focus is on performance and attracting Australian investors.

Anniversary, yes. Celebration? No!

It is understandable that those who survived the October '87 crash would want to remember its 30^th anniversary, less understandable that many, if any, might be celebrating the event itself. Remembering the past is a useful lesson when trying to avoid making the same mistakes again, although there is no doubt that it is only a matter of time before the next major market event occurs.

October '87 was the most significant market shock since the crash of 1929, but there have been a series of market shocks since, all of which were preceded, to a greater or lesser extent, by irrational buying, thereby creating the necessary asset price bubble before the inevitable pop. While the details of each event differs, the underlying causes do not: Asset pricing ceasing to reflect reality.

Looking at current Australian equity prices it is difficult to argue that the market is in bubble territory, even if valuations in certain sectors are certainly stretched on a historical basis. While the US market has certainly steamed ahead by comparison, a market pullback of 25 to 50% would seem unlikely based purely on stretched valuations. If anything is going to upset this market, (leaving aside Trump or North Korea) one would assume it is going to be driven by excessive debt, a tightening of credit, or higher interest rates, be that in the US, Australia or China.

Having said that, while it seems certain that the next move in interest rates will be up, it is difficult to see rates moving so sharply that they would create an equity market crash. However, with rates having been so low for so long, even a small (say 2 to 3%) increase could magnify the relative effect on a number of asset classes, particularly Australian residential property, and the banking sector as a result.

This is what concerns the RBA, but the difficulty would seem to be how to resolve the dilemma.  As usual it will be those who are over-geared who will pay a price and learn the hard way.

"Same old, same old" vs. "In with the new…."

Over the past 12 months the top 20 ASX stocks - which make up 55% of the market cap of the ASX200 - have risen a paltry 3.45%. The ASX200 index itself has not surprisingly fared little better, rising 4.52%. Dominated as it is by the big four banks and BHP, and now to a lesser degree by Telstra, (the market cap of which has fallen by almost one third over the past 12 months), it is no wonder the Australian market is locked into a tight trading range.

Compared with the S&P500, which has risen 19% over the past 12 months, the local market has been a great disappointment. One of the great differences is that the US market is now dominated by new economy growth stocks, or the so called FANG's, namely Facebook, Apple, Netflix and Google, which have risen 33%, 33%, 97% and 24% respectively over the past year. Not only are these new economy companies, they're new businesses and, with the possible exception of Apple, had hardly been heard of by the average investor 10, and certainly not 20 years ago.

Australia's banks, plus Telstra, are driven and supported by dividend yield - or not in the case of Telstra - which results in the ASX200 having a total return over 12 months more than double that of its simple return based on price. Meanwhile the FANG's reinvest their profits in growing their global and industry domination.

The bottom line would seem to be that any upward driving force for the local market as a whole is limited accordingly. The banks are not only under pressure from Canberra, but their upside would seem to be constrained by a housing market that has been driven by easy credit and offshore property buying. Judging from today's Financial Stability Review published today by the RBA, the outlook for the banks at best is as good as it gets, and faces significant risks, even if the RBA did note the sector was well capitalised. And if the Treasurer is overseas spruiking that our banks are as safe as houses, you can bet your bottom dollar it is because he's not preaching to the converted.

So where do investors look for attractive returns, assuming index managers will be locked into market returns albeit with low fees - although as Hamish Douglass from Magellan points out in today's AFR, there are many active managers "dressed up in drag" charging plenty more while still hugging the index.

The answer surely lies in active management, be it a concentrated long only portfolio, probably outside the ASX100, or market neutral or long/short. Alternatively funds investing offshore, be it in Asia or Globally.  A quick scan of AFM's database of top performing funds demonstrates the benefit of either approach.

Say or think what you like about him, but it's pretty obvious Donald Trump doesn't believe in the softly, softly approach! So the bold announcement to reduce US corporate tax rates to 20% certainly fits his style. Of course what remains to be seen is his ability to deliver, and if he manages to do so, what will be the flow on effects on both the US, and then the global economy.

Given this was a Trump announcement there was of course more rhetoric than detail, and the answer to the first question lies in the ability to deliver politically. We will leave the judgement on his political ability to others and take just a quick look his ability to deliver economically:

We're assuming Trump's working on the premise that a corporate tax rate of 20% will "make America great again" by incentivising US companies to invest in America, and subsequently to hire American workers, leading to growth. As a result he's hoping the circle will be complete, and the budget will balance. However that's not a fait accompli, and the question will be how's he going to pay for it?

From a market perspective the risk lies not in the potential that the equity market doesn't like Trump's lower corporate taxes, but that the bond market doesn't. Bond markets have a nasty habit of upsetting equity markets, so it's worth keeping a close eye out for higher than expected interest rates.

Domestically in Australia Trump's move has put our antiquated, overly complicated and damaging taxation and political position into stark relief. The current government aims to reduce the corporate tax rate to 25% over 10 years, and isn't even assured of getting that past the cross benches in the Senate.

As Hedge Clippings has banged on about for as long as we can remember (which isn't that long these days) Australia's taxation system is a dud thanks to successive governments of both political persuasions which have failed to grasp the nettle, preferring to dilly dally around the edges, and adding complication onto complication.

Where's Donald when we need him - or on second thoughts, let's not go there!