Earnings and THIS Are Holding Aussie Blue Chips Back

Good weekend? Great! Me too.

Let’s pick up from where we left off on Friday…

If you remember, we touched on ASX earnings season.

The thrills and spills are great for headlines. But how does knowing company XYZ missed sales expectations by a few percent add value to you?

The simple answer — it doesn’t. And yet, the show goes on.

How does the field look now?

Well, it depends who you ask the question. How are things looking for the heavy hitters like Suncorp and Telstra?

Not great.

Even the best public relations writer can’t help the latter.

Telstra saw earnings fall 27% this half. It’s also come to light that their NBN reselling business might make no money at all.

The ‘NBN reselling business is a zero margin [business],’ CEO Andy Penn told reporters.

As the [NBN] roll-out completes and as the number of [NBN] services that we provide increases and becomes close to 100 per cent, our margins effectively on that business line will be zeroAnd the closer we get to that, I think we will have to think about increasing prices for customers.’

But ask how things are going for the small-caps, and it doesn’t look so bad…

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If you had better than 20/20 vision to see into the near future, you’d have put your money in Aussie small-caps at the start of 2019.

The Small Ordinaries (white line), a proxy index for Aussie small-caps, is up more than 11% this year. More than 2% of that has come since earnings season kicked off.

Aussie large-caps (green line) have stood still in comparison over the same week.

Money Morning

Source: Bloomberg
[Click to open new window]

With such general data all we can make is general conclusions.

Small-caps have fared better than their larger brethren so far during earnings season.

But it’s probably not just earnings pushing the largest stocks down on the ASX.

Talk of lower Aussie interest rates is implying slower economic growth. Across the water, people are even using the word ‘recession’ to describe what could come next.

Fears are swelling for the global economy at large. And it’s putting pressure on Aussie blue chips.

One of the American doomsayers is Peter Schiff.

He’s CEO of Euro Pacific Capital. He was also one of the few to predict the 2008 financial meltdown.

But unless you made money during that time, you don’t get a medal in my book.

Schiff thinks we’re heading into ‘the beginning of the end’.

He believes the US central bank, the US Federal Reserve, set Americans down this path in 2015. In December that year, the Fed rose interest rates for the first time since the 2007–09 meltdown. Schiff stated:

The reason that I originally said that I did not expect the Fed to raise rates again was because I knew that raising rates was the first step in a journey that they could not finish, that in their attempt to normalize rates, the stock market bubble would burst and the economy would reenter recession.

Normalizing interest rates when you’ve created an abnormal amount of debt is impossible.

I knew all along that at some point, that would be it, you know, the straw that breaks the camel’s back. I didn’t know how many rate hikes the bubble economy could take, but I knew there was a limit. And I still knew that there’s no way they were ever going to get back up to normal or neutral. Whatever that number is, it ain’t 2%.

If debt is the problem, I’ve got a simple solution.

Get the Fed to buy up all the non-performing loans on banking balance sheets. They can do this at no cost. They have the power to create money for free.

Then encourage banks, through incentives, to create money for productive activities. These are activities that create new goods and services.

Not only do you get a healthier banking system, you also get economic growth.

This is the good side of money creation.

It’s not always good in practice, of course. There is more than one drawback to my back-of-the-envelope plan.

First, this creates a terrible precedent. If the Fed buys up all the non-performing loans from banks, why then shouldn’t banks take on as much business as possible, risky or not?

Second, the Fed is magically fixing the poor decisions made by banks but not the middle class. Why is it fair to absolve banks of their sins but not the average joe?

I guess what I’m trying to say is that interest rates aren’t all that important. What’s more important is money creation and what that money is created for. We touched on this in a recent video, all about why it’s better to have a decentralised banking system and smaller banks.

You can watch that video here.

Now, let’s bring things back down under…

What happens next?

Ok, so the large-caps are not only getting a beating on earnings — investors at large are worried what might come next.

But that’s always been the case!

Whether it’s trade tensions, growth concerns, interest rates or something else, investors always find something to worry about, sooner or later.

In the long run, all this worry turned out to be noise.

What’s far more important than macro events are the businesses you buy and why you bought them.

On Friday, I told you to stick to small-caps. You have far more advantages down in the smaller end of the market than you do competition with the million- and billion-dollar funds up the top.

So, why make things harder for yourself?

Forget about what happens next. Forget about looking at the heavily followed blue chips.

Put the odds in your favour. Bet on the small-caps you understand and the ones you’re confident are cheap.

Time takes care of the rest.

Your friend,

Harje Ronngard,
Editor, Money Morning

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Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Fat Tail Investment Research, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.

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