31 January 2022

Interest Rates Rising, Share Prices Falling, House Prices To Fall, Superannuation Funds Headed For A Poor Year

The weakening share market is signaling an expectation of rising interest rates. Westpac is the first Australian bank to raise fixed term rates in 2022 and the others will follow. Several rate increases are anticipated by markets during 2022. The housing market is expected to weaken during the coming year. Holding a proportion of cash or bank hybrids appeals as a prudent strategy with better buying opportunities after interest rates have increased. Recently share prices have turned downwards. We have about 45 percent of our Super fund in bank hybrid securities, shares subject to imminent settlement of takeovers and cash. It will be timely to increase our holding of shares after several small interest rate increases have occurred. I expect the fund to be holding a substantial proportion of its value in cash for the next 6 months or longer.

There is a rush to get houses listed for sale before expected interest rate increases drive the market lower. The expectation will itself lower the market. 

ARB Corporation 

An isolated broker’s report suggesting that profit margins were falling was blown out of the water by ARB’s market update of 31 January indicating that sales were up by 26.5 percent in the 6 months ended 31 December 2021 compared to the equivalent 6 months one year earlier and that profit before tax is up by a similar percentage. The audited half year results are due in a few weeks. ARB’ announcements are traditionally conservative. The reluctance to travel internationally has caused a major boost to ARB sales of quality 4WD accessories in which it is recognized as the market leader with growing international sales. ARB is one of our long-term investments.

Taking Up CSL’s Share Purchase Plan 

CSL had a massive institutional capital raising of $6.3 Billion to assist in its purchase of Vifor Pharma and the institutions dragged the price down through a bidding process with the capital raising price $273 per share. Since that date the market correction has dragged it back to around $260. Retail shareholders will get the advantage of the lower of two prices being:

·      Either the price paid by the institutions of $273, or

·      A 2 percent discount to the volume weighted average price over the 5 days preceding the offers close.

CSL is a good company in an industry with great growth. It has likely been oversold under the pressure of large institutions funding a huge capital raising, which is normal, and may be expected to trend toward the previous weighted average price of CSL and Vifor shares prior to the acquisition. It’s array of pharmaceutical products including the Vifor Pharma products and their joint pipeline of product development supplies an aging international clientele with a myriad of medical needs. It remains a growth stock in my view. People have a lot of medical conditions besides Covid.

We have applied to take up our entitlement in the share purchase plan for our superannuation fund and our portfolio accounts. Readers should do additional research including accessing CSL’s web page including announcements via the ASX 200 website.

What does overweight mean? 

If you are advised that you are overweight particular stocks pause and add up all your assets including home, business or practice, business premises, superannuation and cash minus any debt. Then calculate the percentage of overall assets represented by the particular stocks.

Lessons Demonstrated by Successful Dentists and Vets

Overwhelmingly those who have concentrated their assets on the quad of:

1.     Their long-term home

2.     Their practice

3.     Their practice premises and 

4.     Their family superannuation fund

usually enter retirement in a much heathier financial situation than do those who experimented with a variety of other strategies.

Say no to health fund preferred provider arrangements. While there are sound reasons to have hospital insurance, the gross profit margin achieved by health funds on ancillary cover is so great as to leave both consumers and ancillary health providers out of pocket. In the long term it is cheaper to pay for our own dental care and buy our own spectacles than to have a health fund recycle some of our money.

As for dentists, 33 years of examining the actual financials of dentists demonstrated that the most successful dentists with big patient lists enduring over long periods were not preferred providers for health funds. 

For most ancillary health (extras) cover is a rip off.

Is China’s Economy in Deep Trouble?

Almost nobody believes the official economic growth figures announced by the Chinese Government. Officials at all levels are reluctant to report bad news or negative numbers and are practiced in massaging numbers to meet the expectations of their superiors, hence all the economic measurement components are suspect and the recently announced annual growth rate lacks credibility. President Xi’s plea in the Davos forum to western economies not to raise interest rates which flow on globally at a time when China is trying to reflate its economy by reducing interest rates indicates that economic conditions in China are much worse than is officially admitted and is inconsistent with the announced annual growth rate. US bond markets are already pricing in Federal Reserve increases in interest rates by selling down bonds at lower prices and hence higher yields. The Fed is beginning its run-off of its stock of bonds by letting them mature and be paid out rather than rolling them over. To replace them as a financing source, the US Government has to offer increased yields on new bond issues and hence in this way the Fed forces up interest rates—meaning that stocks of existing bonds are worth less in the market. As Warren Buffett said last year this is not a time to be holding bonds. There will be successive US interest rate increases forcing rates across the globe to rise and dampening demand for Chinese exports.

This comes as China is in the midst of a property crisis with huge developers—including Evergrande—in deep trouble, housing unit prices plummeting leaving a horde of investors with huge interest bills and negative equity in their properties. This segment of the Chinese economy is reportedly much higher as a percentage of the economy than is the case in major western economies. As many Chinese cities get much of their finance by selling land to developers this is creating flow on problems through local government. The crisis is too big to paper over and is causing China to slash interest rates at the precise time at which the US is leading Western economies in raising interest rates.

The Chinese birth rate continues to fall and based on official figures China’s population is no longer increasing and is aging. Efforts to encourage families to have up to three children, a reversal of the one child policy, are clearly not working, with women choosing careers over larger families, delaying marriage and many choosing not to have children. The one child policy led to a significantly more male children than female and hence this places a further restraint on future birth rates. However, even the child birth statistics are being questioned with global investor George Soros last year indicating that the birth rate was lower than reported indicating that the population is already falling and is certainly aging.  

Is China’s Strategy Failing?

The Chinese leader seems to have miscalculated the response to Chinese repression of Hong Kong, Tibet, other minorities, threats to Taiwan and the 14 demands on Australia. Thus far the US, UK, Canada and Australia the four main members of the Five Eyes together with Japan, South Korea and India appear to have strengthened their strategic relationships. Australia has not caved in to Chinese trade coercion while China is unable to replace its imports of high-grade iron ore from Australia for the foreseeable future. Australia has been able to further strengthen long standing defense relationships with the US and UK through the AUKUS agreement and moved to strengthen our defense relationships with Japan.  The US is increasing the number of US troops rotating through our military training facilities in Northern Australia. We have long participated in a regular sequence of Navy, Army and Air Force training activities with the US. Australia has increased defense expenditure with substantial Navy, Army and Air Force equipment modernization occurring.

Much has been written about China building artificial islands in the South China Sea and these are a major concern. To an extent they are a reflection of China’s insecurity, since substantial countries bordering the area including Japan and South Korea are allied with the US while Vietnam is China’s historical enemy. Building a huge navy poses a threat to the US and all its allies but a look at the map suggests that acting in concert US, UK, Japanese and Australia’s (few) submarines pose a substantial threat to the Chinese fleet possibly restricting movement of a large fleet beyond the South China Sea. Nor do we know how effective the Chinese defense forces are since, unlike the west, they do not participate in the regular major international exercises which hone defense preparedness, identifying and rectifying weaknesses.

In its current economic state, as evidenced by Xi’s plea to Western countries to restrict interest rate increases, can China risk the major disruption which would occur if it attempts an invasion of Taiwan? Rather Xi’s Davos speech suggests a realization that he has overplayed China’s hand, has underestimated the strength of opposition generated and is belatedly realizing the probability of causing massive economic losses. It is suggestive of a backing off.

Does Dixon Advisory Collapse into Administration Indicate Further Trouble For E&P Financial Group Ltd? There Are Huge Lessons for Advisers

On 19 January 2022 E&P the parent company of Dixon Advisory Superannuation Services (DASS) placed DASS into voluntary administration. DASS was facing multiple legal claims as a result of the failure of the 36 years old companies highly conflicted business model. The decision came after the directors of the subsidiary determined that current and future penalties, compensation claims and three legal actions launched in late 2021 would be likely to leave DASS insolvent.

It has become apparent that in merging with DASS, E&P’s due diligence process was seriously deficient despite a report by KPMG which referred to the risks in its vertically integrated model and the acquisition/ merger turned out to be a strategic mistake. In announcing the voluntary administration of DASS E & P is moving to protect itself but it remains to be seen whether this action will be sufficient to isolate E & P from legal claims if the assets and insurance cover of DASS are insufficient to cover claims. The devil will be in the detail as to what E & P knew of the conflicted business activities of DASS, when it knew and whether its actions at the time were sufficient to create safe harbor conditions for E & P and E&P directors. Professional indemnity insurers will be closely involved. It is unclear as to whether KPMG truly understood the huge risk of Dixon Advisory advisers becoming progressively compromised in order to support deteriorating inhouse investments. There can be little doubt that a variety of lawyers and investigating accountants will comb through all evidence of the relationship between E&P and DASS to determine whether E&P and its directors can be connected to the DASS disaster. The action of putting DASS into voluntary administration is clearly intended to distance the remainder of the E & P group from substantial damages claims.  It seems probable that at the time of the acquisition of DASS E&P were unaware of the unfolding financial time bombs within but the question which follows is when did the parent group become aware of troubles within E&P and did it take timely and appropriate actions to deal with the situation including making appropriate disclosures and appointing investigating accountants?  This may determine whether E & P and its directors can claim safe harbor or can be found to be liable. While it may be argued that it had nothing to do with the disastrous business strategy of DASS that caused the disaster any delays in disclosure might be argued as making the situation of the clients of DASS who had been wrongly advised into an array of related in house assets worse.

One aspect is that it is apparent that in acquiring Dixon Advisory E & P’s parent group’s due diligence was myopic despite KPMG’s involvement.

Dixon Advisory was started up in 1986 by former federal Treasury public servant Daryl Dixon a specialist in government superannuation policy, and his wife Kate. It is likely that Daryl Dixon himself is not responsible for the later troubles of the business. In 2001 their son Alan Dixon assumed the Managing Director’s role. Many of its clients initially came from retiring public servants, but in due course it embarked on heavy advertising and cast its net widely. Dixon Advisory grew into the fourth largest superannuation advice firm in Australia and in late 2016 it merged with Evans & Partners, the brokerage firm founded in 2007 by AFL football identity David Evans. That merger proceeded despite concerns raised in a report to directors of Evans & Partners by KPMG that highlighted the risks of Dixon Advisory’s vertically integrated business model heavily reliant on fees raised from its US Residential Masters Fund (URF) which was intended to take advantage of a distressed US property market following the Global Financial Crisis by buying apartments in New York and New Jersey renovating and reselling them. The renovations were carried out by another Dixon fund and it also raised debt from Dixon Advisory clients to fund the renovations. A huge number of its clients had substantial parts of their superannuation funds invested in intertwined securities, URF, the renovations business and the debt funding meant and that all three investments were reliant on a far away US property market in which Dixon Advisory lacked sufficient relevant expertise. The strategy was extremely high risk and it is apparent that Dixon Advisory clients did not understand the risk to which they were subjected. Whether KPMG were able to identify the extent to which Dixon’s financial advisers were compromised by the structure would be of significant interest.

The Weakness of Inhouse Investments

Way back in 1994 I personally left the SAI Group with Bill Dewez, an accountant, and established the Synstrat Group consisting of two companies we owned in parallel, Synstrat Management Pty Ltd, the advisory arm and Synstrat Accounting Pty Ltd. The recession referred to by treasurer Paul Keating as the “Recession we had to have” had exposed the pitfalls of vertical advice models with inhouse investments and in establishing Synstrat we stated to our clients that we would not be engaging in inhouse investment strategies such as internal property or agricultural trust syndication. It was already clear that these had serious economic flaws and in due course many were to fail.

Pressures on Advisers to Cover Up the Weakness of Inhouse Investments

Where an organization such as Dixon Advisory embarks on a strategy of selling inhouse investments to its client base, it is mainly reliant on its advisory staff to sell these investments to clients. This immediately creates a conflicted situation which may be properly declared and indeed clients may readily accept the advice if it appears sound. The real problem occurs when the inhouse investment trusts perform poorly and there is huge pressure on employed advisers to downplay the problems, perhaps indicating to clients that the problems are temporary or are being resolved. From this point the inhouse advisers become increasingly compromised. In a situation of several closely intertwined investments such as was the case at Dixon Advisory the inhouse advisers are likely to be under huge pressure to get clients to tip more money into the financing or maintenance investments to prop up the failing property fund. Worse still, if some advisers have stretched personal finances and are so heavily dependent on the income that they receive tied to the client investments of those clients whom they advise they are under extreme pressure to prop up the edifice as their only alternative is to resign thereby giving up their income. Such a situation ultimately results in the dam bursting when the entire situation can no longer be papered over and a large client population come to question the succession of advice that they have received.

I doubt that administration will see the last of the legal problems and claims arising from the failure of Dixon Advisory without claims extending further into the E & P group.

The Defense of Australia

From my military days (long passed), I have maintained a lifetime interest in defense matters. The rise of China and some of its actions have caused a rethink of Australian Defense spending and a huge amount of new equipment has been purchased by the current government with substantial weapon systems on order and projected. Australia’s Defense budget has increased substantially in both dollar terms and as a percentage of Australia’s GDP compared to the reduced spending during the Rudd/Gillard government. Whether this is sufficient only time will tell. I expect that it will have to increase further and the ANZUS alliance with the USA is vital to Australia’s security regardless of valid criticism of aspects of US politics. Our defense spending is necessary to contribute toward the ANZUS alliance but the simple facts are that there are a range of capabilities which are so costly that they can only be owned and operated by a super power with a huge economy. The US spends a much greater proportion of its GDP from a vastly larger economy than does Australia. History demonstrates that alliances only last if both parties contribute substantially and build up mutual trust over an extended period. Ultimately Australia’s security rests on the ANZUS Alliance. Both Coalition and Labor parties are committed to maintaining the alliance.

Financial Success for Dentists

Financial Success for Dentists: Rules for How to Approach Your Dental Career sets out the key strategies which make dentists successful. It is specifically written for those dentists and dental specialists owning their own practices and for those aspiring to own practices. Among the topics included:

·      Understand key practice valuation criteria.

·      Learn how some dentists inadvertently reduce the value of their practice by $500,000

·      Avoid long term errors when purchasing your practice.

There are many accountants, financial advisers, marketing consultants, web site designers and practice advisers who give advice from their particular disciplinary experience, but very few have the wider breadth of experience to define for their clients the key rules to follow to optimize their practice and their long-term financial outcomes. An otherwise competent financial adviser may have little understanding of what makes one practice much more successful than another. Many accountants have detailed knowledge of the taxation rules but cannot identify if a dental client has broached invisible barriers to practice growth or a threat to practice goodwill value. 

I spent 33 years examining dental practice financial outcomes and reviewing the key strategies and decisions which separated successful Australian dental practices and practice owners from the less successful and this led to relevant conclusions and advice to dental practice owners. 

A complete and comprehensive career guide for mature and aspiring dentists.

Based on real life situations and a lifetime of dealing with dental practice ownership outcomes this book is worthy of Text Book status for every dental teaching school.

—Merv Saultry, Founder Dental Innovations Network

To Obtain a Copy:

·      Go to the Delany Foundation website at http://www.delanyfoundation.org.au

·      Click on the Donations tab and make a donation of minimum $60. This is easiest by Mastercard or Visa.

·      Email financialsuccessfordentists@gmail.com confirming that your donation has been made, as well as your name and mail address

·      A copy of the book will be mailed directly to you

All production costs and mail costs are met by me personally, so all money donated goes to the Delany Foundation which contributes toward the running of schools in Ghana, Kenya and Papua New Guinea. Naturally donations above $60 are welcome.

The donation to obtain this publication will be the most cost-effective practice advice most dentists will ever receive.

General Advice

I sold my interest in a financial services and accounting group on 30 June 2020 and have no intention of starting another financial services business. I own, via my family superannuation fund and investment portfolio, some of the stocks mentioned in this newsletter. My website is now available at grahammiddleton.com.

Those who find my newsletters of value to them are asked to consider making a donation to the Delany Foundation, a registered charity which assists schools in Papua New Guinea, Ghana and Kenya. Delany Foundation c/- Holy Cross College, 517 Victoria Road Ryde NSW 2112.

Best wishes to all 

Graham Middleton