Chris Joye delivered the goods again over the weekend in an interview with Matthew McLennan who runs $US80 billion of (primarily) global equities, cash and gold at First Eagle Investment Management, which is a privately owned fund manager based in New York. As such he manages more money than any other Australian on earth.
The following is a brief excerpt from 6,500 word interview that was available in Q&A form at the site over the weekend. A shorter version was also available for dummies.
Q: What is your outlook for the Australian economy?
I have a few question marks over the Australian economy and think the outlook could be potentially quite challenging.
The first issue is regional stability. Recent generations have benefited from China’s huge urbanisation process and the mining boom that has gone alongside it in Australia.
But China is now experiencing a transition that is gradually moving away from an urbanisation and export-based model to one that is more consumption driven – and that’s unlikely to be a linear development.
This is happening at a time when you are seeing material weakness in the Indonesian, Japanese and Indian currencies. So competitive pressures for China are ramping up.
I think currency instability in some of Australia’s largest neighbours, like Indonesia, Japan and India, combined with our own exchange rate volatility, could portend a more difficult period ahead for both us and Asia.
A second challenge is Australia’s internal shift from structural tailwinds to structural headwinds. Notwithstanding the mining boom, several decades of pretty large current account deficits in Australia have produced a very highly leveraged private sector.
While the new government is clearly pro-business, if we have the private sector in balance-sheet repair mode at a time when the government goes into a period of fiscal restraint, this could give us a fairly soft underlying pulse, especially if China is chugging along more slowly than she has in recent years.
Although the sovereign debt ratios in Australia are currently pretty good, that’s mainly because there is a lot of excess debt in the private sector. If you had a crisis in the private sector in Australia the sovereign finances would deteriorate quickly.
Q: Australia’s banking sector accounts for about 30 per cent of the sharemarket index and the majors rank among some of the most profitable institutions in the world. Are you investors?
We haven’t been investors in the Aussie major banks because the raw equity-to-asset ratios, as opposed to the ratios calculated using risk-weighted assets, are lower than our comfort zone. We also haven’t been there because there is an element of dependence on wholesale funding in the business model.
We’ve felt that it’s been a pretty good time for Australia – there has been a fair amount of cumulative credit growth over the last generation – and if you look at the reserves-to-loan losses inside the banks it’s pretty low in the scheme of things.
A lot of people would argue it’s been a successful, oligopolistic, and well-regulated market. But the risk-reward for us investing in an environment where the private sector has built fairly high levels of debt and the structural tailwinds for the economy are becoming structural headwinds, has made it non-compelling for us to spend a lot of time there. There are better non-brainer opportunities for us around the world.
Q: You are clearly very knowledgeable on the Australian economy – what are your views on the resurgent Aussie housing market?
It is interesting to me when you hear a politician [recently Joe Hockey] saying this is not a housing bubble – that is just a supply-constrained market.
At the end of the day, I think the Australian housing market is instinctively on the full side of fair value in a situation where the natural constituency, the marginal buyer, is already quite levered.
I don’t understand why people feel the need to say a market is not in a bubble. I don’t think that’s a prudent approach when you see large levels of leverage and fairly low rental yields. While I get it that you want to support confidence, I don’t know what the upside is in talking down legitimate risks.
We’ve always made money by not losing money. Ultimately you feel far more confident when a management team tells you what it is worried about than when it displays complacency.
Luci Ellis needs to read that last sentence and the RBA to chisel it into the stone in the foyer of its building. The rest of the article is also spectacular; covering financial repression here and abroad, QE and nominal growth targeting, inflation and deflation and the worrisome future of the global monetary system. It’s great stuff.
McClennan agreed to the interview to improve awareness around Advance, which is a leading not-for-profit organisation representing the Australian professional diaspora. Advance was founded by Elena Douglas, a good friend of mine and also now an AFR commentator and philanthropy guru based in Perth.
