We were reminded of Mark Twain’s assertion when we read that the Chinese insurance group Anbang (安邦) had bought the Waldorf-Astoria hotel in New York city (Financial Times 06 Oct 2014), making it the most expensive single hotel transaction ever. Anbang has paid USD 1.95 billion to buy the historic 1,413-room hotel, which was built in 1931 and covers an entire city block. The sale price is equivalent to USD 1.4 million per room or 33x the hotel’s historic EBITDA. The seller was the Hilton hotel group (HLT:NYQ), which will retain management rights for the next hundred years.

Why did we think of Mark Twain’s words? Because twenty-five years ago, in October 1989, the Japanese group Mitsubishi paid USD 846 million to acquire 51% of the Rockefeller Group, which owned the Rockefeller Center, Radio City Music Hall and other Manhattan landmarks. Subsequent events showed that this was not a smart buy for Mitsubishi. This outcome was not surprising in view of the fact that the Rockefeller family had been dealing in Manhattan real estate since the 1880s.

Mitsubishi’s purchase was only one among many follies committed by Japanese corporations in the 1980s when, fuelled by low interest rates and high self-esteem, they bought “landmark” assets around the world and paid landmark prices for them. Readers may remember Sony’s completely incomprehensible purchase of Columbia Pictures for USD 3.4 billion in September 1989, which signalled the start of Sony’s downfall from admired tech leader to troubled conglomerate.

For those of us who have watched the sad fates of Chinese companies who bought or developed mines in Australia, the Waldorf-Astoria sale has a familiar ring to it. The Hilton group (majority owned by Blackstone) has managed the hotel since 1949 and owned it since 1972, so it is a fair bet that Hilton knows more about the asset than Anbang does. It is possible, however, that we have completely underestimated Anbang – after all, Anbang’s founder and chairman, Wu Xiaohui, is married to the granddaughter of former Chinese leader Deng Xiaoping.

They say that no one rings a bell at the top of the market, but the Waldorf-Astoria transaction may mark the high water mark for this round of Chinese companies’ global expansion.


Disclaimer: This report is general advice only and is issued by Millinium Capital Managers Limited, ABN 32 111 283 357, AFSL No. 284336 (“Millinium”). Investors should always consider obtaining professional advice that suits their objectives, financial situation or needs. This report may be amended, withdrawn or replaced without notice. To the extent of the law, Millinium, its officers, personnel and agents do not accept any responsibility for any loss or damage arising from reliance on this report.


Recent official statements indicate China’s GDP growth rate in CY14 will be about 7.5%. This figure is way above growth rates in the rest of the world, but nonetheless it marks another step down from China’s peak rate of 14.2% in 2007. The long term factors behind slower growth include:

  • Ageing population: more retirees, less workers.
  • Rising real wages, as regional and sectoral labour shortages enhance employees’ bargaining power.
  • Over-capacity in many industries, as a long term consequence of policies that have favoured investment ahead of consumption.
  • Visible pollution of air, water, soil, food: resistance from consumers and residents increases, and pollution control will mean higher costs for many companies.
  • Too much debt: China’s debt now exceeds 200% of GDP – higher than countries like Greece, Cyprus, Portugal and Spain which suffered debt crises.

Why is slower growth in China important for Australia? Because China now buys 36% of Australia’s exports, and coal and iron ore account for three-quarters of the value of these exports. Taking a wider view, shared supply chains link China’s economy closely to Japan, South Korea, Vietnam, and neighbouring countries: East Asia in total buys 55% of Australia’s exports. China’s slowdown in the last two years has already caused 30%-plus falls in coal and iron ore prices, leading to the collapse of capital expenditure spending in Australia’s mining sector, with consequent job losses. It is clear that, even if China avoids the “crash” which some commentators have predicted, any further slowdown will be painful for Australia.

We must emphasize that, although a crash is possible in China in the next few years, it can still be avoided by prudent economic policies such as the reforms which the Chinese government is currently implementing. After all, China has a lot of room to manoeuvre thanks to its low government debt and high forex reserves: the latest official figure for China’s external financial assets is USD 6.13 trillion.

Although there are a number of problems in China’s financial system, we do not expect a re-run of the US housing crisis. Where the marginal US homebuyer in 2006 had loan-to-valuation ratios above 90%, the average Chinese residential borrower has a 30% LVR, and many have no debt at all. Where the ordinary US consumer in 2006 had maxed out his credit cards and drawn down his home equity loan, the average Chinese consumer has very little debt. Systemic risk is contained because the lending banks keep the housing loans on their balance sheets rather than packaging them up into CDOs and selling them off to investors. Most importantly, although apartment prices in China have been rising rapidly for a decade, rapid economic growth has meant that household incomes have been rising faster, with the result that affordability (apartment price divided by income) has been improving in most cities.

Nor do we expect China to repeat the US banking crisis, because its banking system is completely different from the US. There will be no “Lehman moment”, because the Chinese government never succumbed to Alan Greenspan’s fantasy that light regulation, bankers’ self-interest and the magic of the free market would prevent bubbles and frauds and insolvencies. In addition to the tight Chinese regulatory framework, the major Chinese banks are not managed by ex-traders in pursuit of multi-million dollar bonuses: they are run by senior members of the Chinese Communist Party (on modest salaries) for the benefit of the Chinese state. Banks will certainly suffer loan losses on commercial and local government debt, but the central government has recapitalized them before and will do so again.

For Australians, it is important to understand that Chinese banks are not just highly regulated, they also have much less exposure to property. The typical Australian bank has more than half its loan book in property: by comparison, in 2013 only 14% of the loans in the Chinese banking sector went to mortgages, with another 12% going to developers and construction companies.

This limited exposure means that China’s current property downturn will be painful rather than fatal. Since mid-2013 China’s property markets have been in cyclical downswing, after over-building led to an inventory overhang in residential and non-residential sectors. Non-residential markets throughout much of China enjoyed a building boom thanks to cheap money and government initiatives, but demand has slackened and vacancy rates are rising. In most residential markets, prices and new starts have been falling as developers tried to clear excess stock. The effect of the downswing will bring supply and demand back into equilibrium, but at lower prices – perhaps as much as 20% lower. A 20% price fall will bankrupt some smaller developers, but the larger developers will survive.

The current downswing may last two years, but long-term prospects for residential property remain strong, driven by improving affordability, ongoing urbanization (albeit at slower rates), and the need to replace low-quality housing stock built before 1990. But in the next two years, construction volumes must fall. As a consequence, demand for steel will fall, both for direct use in construction and in ancillary areas such as construction machinery. GDP growth in CY2015 may drop below 7%.

The impact on the Australian mining sector is obvious. Lower commodity prices mean lower export earnings (only slightly offset by some volume increases), hence lower company profits and cash flow. BHP and Rio will survive with lower profits and tightly controlled costs, but high-cost mines will be shut down, and there will be job losses in mining and in mining services. The resource states of Queensland and Western Australia will go into recession first. For Australia as a whole, higher unemployment and lower exports means falling growth and a drop in real living standards. The rising balance of payments deficit will push the AUD below USD 80c, although it will continue to be buoyed by Australia’s AAA rating and the yield differential against major currencies. Because the unemployed find it hard to keep making mortgage payments, the banks will suffer loan losses on residential property, but their commercial lending books are in good condition thanks to the tighter lending standards adopted in the wake of the GFC.

A recession starting in 2015 or 2016 is not factored into most forecasts, but we note that every Australian mining boom has been followed by a recession. Because people forecast the future on the basis of their experiences in the recent past, they never expect things to get as bad as they do. Looking at business cycles in the long term, it is easy to see that the last decade favoured resource-producing economies such as Australia, Brazil and Canada. With commodity prices continuing to fall, we expect that the next decade will favour resource-consuming economies, especially the US and Europe.

What should the Australian investor do in order to minimize the effect of the coming recession and the fall in the AUD? Domestic defensive stocks are part of the answer, but the key is to reduce exposure to AUD-denominated assets and increase exposure to the US and European economies because they will benefit from lower commodity prices. Preferred methods include US and European index ETFs or ASX listed companies with US operations. Qualified investors may wish to consider Millinium’s newly launched S&P500 Fund.

The investment strategies of Millinium’s Dividend Income Fund (soon to be re-named the Australian Equity Fund) take our macro view into account. The Fund is still weighted toward Australian companies with US exposure. We have reduced exposure to domestic cyclicals and consumer discretionary sectors, and are still watching for the early warning signals of a correction. Just lately, we have begun to consider when to sell out of the banks, on the grounds that the sector is not priced for any downturn in the economy.

Neill Colledge

Disclaimer: This report is general advice only and is issued by Millinium Capital Managers Limited, ABN 32 111 283 357, AFSL No. 284336 (“Millinium”). Investors should always consider obtaining professional advice that suits their objectives, financial situation or needs. This report may be amended, withdrawn or replaced without notice. To the extent of the law, Millinium, its officers, personnel and agents do not accept any responsibility for any loss or damage arising from reliance on this report.


In the Dreamworks movie “Madagascar 2”, there are many parent-intended lines uttered by the Lemur King Julien. One of his best is when they are leaving the African island of Madagascar on a plane, flown by the Penguins, bound for New York City. King Julien of Madagascar (self proclaimed) wants to know why people from the other end of the plane keep coming into the first class section;   “Maurice, whatever happened to the separation of the classes?”. The new Chief Economist of the IMF, Maurice Obsfeltd, answers this question in a recent report and the findings all lead back to New York City indeed; the Federal Reserve. A pending US interest rate rise is going to separate the developed and emerging economies in a way that may lead to unforeseen circumstances… [Continue Reading]


Don’t economists just love acronyms? The usual suspects incorporate GDP and CPI, which everybody recognises – or should – instantly. Moving up the economists’ food chain, we can find other delectables such as PCE, RFR & ERP. Once you enter the realm of the macro economists, the populist pinnacle (because what this class of economists talk about actually sometimes is of relevance to the man on the street), we are blessed with exposure to a whole new universe. The one that currently appears in the media with increasing frequency, for very good reason so the Fed tells us, is one of my personal favourites, “NAIRU”.


Not to be phonetically confused with the island nation Republic of “Nauru” in Micronesia, NAIRU is located very much in the realms of macro policy. NAIRU, in English, is the non-accelerating inflation rate of unemployment. The FOMC (Federal Open Market Committee – sorry, this acronym is not technically the domain of economists) periodically releases projections or estimates (CY, CY+1, CY+2 years and a “long run”) of a number of metrics pertinent to their determination of monetary policy settings. These include GDP, the unemployment rate, PCE (personal consumption expenditure) inflation and Core PCE inflation measures. Given that the inflation rate has largely remained static in recent times (even reacting only mildly to the materially significant deterioration in energy prices of ~55% in the last 12 months), the Fed is increasingly focussed on the speed of the rate of change of the unemployment rate.


NAIRU is effectively therefore often viewed as a direct representation of the FOMC’s view of its own estimates of the unemployment rate being consistent with “full employment”. The “high” band of the FOMC’s central tendency projections is approximately 5.2%. Headline unemployment is currently 5.3%. The “low” band of the FOMC’s central tendency forecasts is approximately 5.0%.


Where NAIRU sits is of importance given that we know that monetary policy often will, empirically, direct inflation and unemployment in opposing ways. Given that the overnight Fed Funds rate (monetary policy) has been at the zero bound now for years and that the Fed is internally debating whether to raise interest rates either this year or the next for the first time since 2004, the efficacy of monetary policy has never before in history been so studiously observed.


The Federal Reserve’s dual mandate causes them to pay incredible heed to where levels of inflation and unemployment are. The economic theory attempts to draw a link between the short term effects of monetary policy being that inflation and unemployment are pushed in opposite directions. Other schools of economics believe that NAIRU is also affected by changes in productivity, not just inflation and unemployment. As far back as 1752 in economic literature, linkages were formed between the supply of money upon inflation & unemployment. The Fed is today, in 2015, attempting to ascertain where NAIRU should sit, given the impact that their abnormal policy settings since the GFC have had on the two variables that they say determines, more than anything else, whether or not they raise rates.


The Fed has been understandably surprised that keeping rates at an effective overnight rate of approximately 0.14% since the GFC and then additionally increasing the circulation of non-gold-backed currency has not contributed more to inflation. Indeed, QE was introduced to attempt to revive some semblance of inflationary expectations into the economy by attempting to influence the long end of the yield curve. That is to say, to attempt to increase 10 year bond yields. Core Personal Consumption Expenditure Inflation in the US for 2015 remains in the 1.3 – 1.4% range. This only “improves” towards where the Fed would like it to sit, by 2016, in the 1.6 – 1.9% range. Only by 2017 do the FOMC members believe that core inflation (which does not take into account the volatility that energy and food price fluctuations introduce to the inflation basket) will begin to approach the desired 2.0% level.


The employment data in some regard contributes an even murkier sense of how to dictate monetary policy than the inflation rate, which has not reacted as many market participants initially suspected – remember gold at USD$1800 just a mere few years ago? The vacuum of demand for physical gold now that inflation doesn’t appear to have panned out to be a global problem, is these days filled almost solely by Indian jewellers and former Chinese equities market investors. Employment has been steadily increasing since the nadir of the GFC, however it has only been in the past 12 months that the nominal number of people employed in the US workforce has returned to the previous high of employment levels pre-GFC. Additionally worrying is that the participation rate in the US labor market is now on par with levels last seen in the 1970s. However, even from 2016, the FOMC members expect that headline unemployment will range from 4.9% to 5.1%.


The notion that the Fed presents to us is that by next year (2016) unemployment (headline, and not taking into account participation rates) will have recovered to be in fact below the NAIRU rate, whilst inflation will still not have returned to the Fed’s targeted long run rate of 2.0%. The expected trajectory of inflationary expectations gives weight to the doves at the Fed who do not favour an early rate rise. However, the Fed’s own central tendency forecasts (taken from all 17 Governors of the Federal Reserve system) indicate that by the end of calendar 2016, US interest rates will be approximately 1.5%.


15 out of those 17 Governors believe that the appropriate time for monetary policy to be “firmed” (as the Fed words it) is calendar 2015. Only 2 of the 17 dissent, and believe that said “firming” should not take place until 2016.


How does this affect the outlook of the US economy and US capital markets given that the Fed demonstrably expects and estimates that NAIRU will be between 4.9% and 5.1% next year? The Fed patently thinks that if they raise interest rates this year, 2015, then that will contribute ever-so-slightly to improving inflationary expectations, yet will actually drive the unemployment rate lower? Our view from NAIRU is that the 2 dissenting Governors may well be correct in their wish to allow further productivity gains associated with current extraordinarily low base rates persist for a few more quarters yet.


Given the amount of global dislocation evidenced by the taper tantrum event in 2013 when Bernanke’s words were misinterpreted by the market that QE was going to be concluded earlier than the market had previously expected, we shudder to think what one short sharp rate rise will do to US debt markets, emerging market economies with material USD bonds outstanding and then of course the US equities market. As we know, the US has one of the most liquid labor markets in the world. When distress affects the real economy (transmitted in most cases via the financial markets, notably the GFC in recent times) the US is able to shed jobs at a rapid pace to offset “business risk”. The converse of this is that US companies (as evidenced by the upturn out of the GFC) can also re-hire those previously fired employees, very quickly.


We would like to see the headline unemployment rate go some distance between the mid point and the low range of NAIRU before Dr Janet Yellen at the Federal Reserve raises rates. This may occur naturally some time in early to mid 2016, but is unlikely to occur by September 2015. So, delay a little longer, dear Chairman. If the Fed does raise rates, then the outcome to debt markets, equity markets and the real economy is not quantifiable. It is not quantifiable because the US has never had to raise rates from zero to “something” ever before in history. When it inevitably does this (hopefully once unemployment is 5.0% or lower) then it would be comforting to know that investors’ funds are held within hedge funds that are capable of providing downside protection. The Fed will not raise rates until it thinks the real economy can sustain a rate rise, but the manner in which the Fed removes the band-aid will still cause the 7-years-now suffering US patient some degree of discomfort.


Ball, Laurence. Professor of Economics, John Hopkins University

The Financial Times

Mankiw, N. Gregory. Professor of Economics, Harvard University

FRED Database from the Federal Reserve Bank of St Louis

The US Federal Reserve


Marcel von Pfyffer


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