Good afternoon loyal readers,

ASX200 hit lows of 6031 this morning before recovering to 6048 at the time of writing (around 11.30am).  I wouldn’t be surprised to see this market recover further in the afternoon.  Market down -0.61% for the week, with most of the damage in the smaller, more expensive end of the market.


I’ve got a small allocation for the new hybrid offer from Westpac.  It’s a rollover from the WBCPC which is expiring and investors are being offered 3.20%-3.40% over the 90 day bank bill swap rate.  That means, at current prices, Australian tax payers will be getting about 4.99% gross return (including franking) or 3.5% net.

If you’re interested, I’ll need to know and need to know quickly.  Email bids through by midday tomorrow (6 Feb).  Expect to be scaled back. Notes to be issued 13 March, trading by 21 March.

I’ll provide prospectus and further details on request.

ZIP CO $1.20

Zip got to all time highs of $1.34 last week and has since slipped back to the $1.20-mark, up 71% since the start of the year.  As I said last week, great quarterly and I think things are still just getting started for the company with profitability a focus.  They have still yet to really leverage their relationship with Westpac or do any major enterprise-scale deal and I’d expect these are items on management’s to do list in the next few months.

I get really frustrated with the quality (or lack thereof) of financial journalism in this country.  This morning this is what I wake up to from the AFR:
The same paper who will pump up passive, index investing for the masses, lean on the wisdom of guru’s like Warren Buffett on a regular basis and argue a perspective on the basis valuation metrics all of sudden is concerned with rising bond yields because the markets went down for a day?

Let’s just get one thing straight (and I’m not picking on the AFR, The Age, The Australian, they are all the same) are not interested in informing you or providing you, the reader with insight.  They are interested in your attention, even for a short fleeting moment.

Yet, the average person reads these papers like they are the going to glean some investment edge or insight, they see the people presented as ‘thought leaders’ and take their biased opinion as fact.

What’s worse, is it’s scary to think how much money is sloshing around in our market with really no idea why things happen or what’s going on.  I recently joined a whole bunch of ASX private investor forums/groups on Facebook to take a look at how people think, for me it’s a case of knowing who my counter party might be.

Private investors seem to forget that for every buyer there is a seller who thinks you’re paying too much and for every seller, there is a buyer who thinks you’re selling too cheaply.

Anyway, suffice to say the level of sophistication in these forums is low.  There’s the odd decent poster, who might get a 5/10 on knowledge but lacks the systems, access to information and sheer processing power that someone who’s doing this for living possesses.   These rookies are like casual players at the pool hall.  A savvy hustler can spot them a mile away, and though over the course of an evening you might get one or two games off him, if you play long enough, the hustler’s going to win a lot of money from you. Probably more than you intended to spend walking into the room.

I’m rambling on a bit.  But two takeaways:

  1. Newspapers are good for wrapping fish and chips, packing glassware and starting camp fires.  Reading them is their lowest utility application.
  2. Don’t bet your money on your skill as a snooker player if you aren’t practicing 8 hrs a day, with the best coach and a $10,000 cue stick.

I honestly reckon that many of my readers wouldn’t even be able to define what a bond is and why it matters for shares?

What is a bond?
A bond is just an IOU.  An individual/company/government writes “I’ll pay you $100 in 10 years time” on a piece of paper and gives it to you.  How much money would you give that person to receive that $100 in the future/take the risk of them not being able to pay you the $100 they promised?  That my friends, is a bond.

Governments need to borrow money for a number of reasons and they raise money by writing out a stack of these IOU’s.  Because governments can effectively print money (or have a truckload of it stored away) they are good people to lend money and very likely to pay you your $100 when they say they will.

So lets say for 10 years we are willing to accept a 2.5% return from the Australian Government, we do $100 divided by 1.025 and get $97.56.  We swap cash of $97.56 for 1 of these IOU slips, put it in our sock drawer and wait 10 years.  This is the risk free rate of return.  There is almost no chance we do not get paid our promised $100 in 10 years time.

Why it matters for stocks?
If we are now thinking of investing in a company, called AAA Pty Ltd, how do we know how much to offer the current owners for the business?  Well, one way would be to forecast all the future cash flows for the company.  So let’s say company AAA is going to earn $10 a year for $10 years and at that point, we could sell the business for $30.  How much do we pay for it today?

The sum of these cash flows is $130.  So assuming we aren’t silly, we would pay less than $130 for this business.  How much would you pay?  I’d pay no more than $110.96.   Why?  If I took $110.96, gave it too the Australian Government at 2.5% return, I’d get $130 in 10 years time, guaranteed. So I’d definitely want to pay less than $110.

Now think, what if the risk free rate was 3.5%?  (I’ll do the math for you) the number is $104.43.  See how the same company is worth less now that interest/risk free rates have moved higher?  Below I’ve showed you the same company/cash flows at a few different interest rates, just to demonstrate the effect.

Late last week the value of US Bonds went from 2.6997% to close Friday at 2.8405%, an almost 5% increase. They have now increased 17.9% since 31 December 2017.

Remember however, that this is easy first order thinking.  All I’m doing is explaining to you what the main stream media refuses to explain, what most brokers you know probably can’t explain and what most people can’t be bothered learning.  All I’ve said is future cash flows are worth less when your opportunity cost is higher.  Very very rudimentary.  It’s overly simplistic to say “interest rates up, stocks down”.  If only it was that easy…..

I’ve said nothing about the size of those future cash flows, the rates of change or historical correlations of these two moving facts (valuation & risk free rate) or how they interrelate with other balancing factors like currency.   I’ll try and get to this next week.

Sirtex (SRX) got a takeover bid from private equity.  Not sure if it’ll go through, wouldn’t count on it.  NextDC (NXT) getting upgraded like it’s an Instagram influencer on a Qantas flight, which bodes very well for our upcoming IPO.
Having a hard time of it this week was the lithium/graphite/nickel/cobalt/battery stocks and just about anything on a high PE.

Try not to worry too much and have a good week.

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