Equity markets are having a good week. Indeed, most asset classes are having a good week. Equities – higher. Bond prices – higher. Crypto – higher. Meanwhile, in the ‘real’ world, Inflation -higher. ‘Official’ interest rates – higher. Economic growth – lower.

In regard to ‘real world’ data, these are lagging indicators. What has happened. Even the increase in interest rates by central banks is a reaction to information already at hand. I will ignore crypto for the same reason I ignore the roulette table at the casino; it is totally random.

Bond markets and equity markets are telling two different stories. You will recall, that bond markets were at least three months ahead of central banks in reacting to inflationary pressures. They are now signalling a peak in Inflation and, indeed, falling ‘official’ interest rates in 1 – 2 years’ time. This will only occur if Inflation is tamed. Inflation will only be tamed if supply/demand disequilibrium corrects. For their part, equity markets are seeing the economic numbers and the reaction of the bond market as a ‘light at the end of the tunnel’. A peak in the interest rates cycle and easier monetary conditions in a couple of years’ time will, in the collective wisdom of the equity market, see company profits rebound a return to ‘business as usual’. This totally overlooks the fact that the current earning cycle is yet to reflect clearly slower economic conditions.

The headline writers will be telling you that the two successive quarters of negative growth in the U S means a recession. This is one definition, but, in this case, it is unlikely the U S is already in recession. The following chart shows the quarterly GDP prints have been extremely volatile since January 2020.

Nevertheless, this does not mean one is not coming. For their part, the equity market is looking at this and thinking ‘great, that is behind us, we can move on’. This explains the rally in U S stocks over the past few days. The last time we saw more than two-quarters of negative growth was during the GFC. Before that, in the early 1980’s.

Meanwhile, those dour devotees in the U S bond market have given us an inverted yield curve. This means short-term rates are higher than long-term rates. 

Ok, that is a little busy, but it is why Alan Kohler is suddenly running around saying the RBA will start cutting rates next year. You will see from the right-hand graphic that 1-year bond rates are higher than all other timeframes out to 10 years. Out past 15 years, things normalise.

What Alan & the equity markets are missing, is that the playbook we used during the past 15 years, may not be relevant. That playbook says that as soon as the economy slows and equity markets send out a distress signal, central banks will come to the rescue. In 2009, they did so to, in the face of an existential threat to the financial system. In 2020, they did so in the face of a once-in-a-100-year pandemic. Both crises were un-prompted by central banks. A reaction was required. This downturn is being engineered by central banks. The risk of them coming to rescue markets from an event of their own making is at best irrational.

During the 1970’s Inflation persisted because Fed Chairman Arthur Burns consistently eased before inflationary expectations were sufficiently doused. We effectively had nearly 10 years of on-again, off-again inflation bursts and interest rate cycles. This was only solved when Paul Volker became chairman and squeezed Inflation out of the system ‘at all costs’. So current chairman Powell has a choice of templates to follow.

This time around, nobody needs rescuing. U S consumers have been on a binge since receiving COVID payments. Consumer debt is relatively modest. U S business profits remain high, if moderating. Employment numbers are strong.

Economies have been subjected to various stimuli since 2008. Attempts to normalise have, until now, prompted the risk of ‘deflation’ (i.e. the Euro crises of 2011 -12). These stimuli finally prompted an inflation response when Governments and central banks went ‘all in’ in 2020. The correct response is to now wind these stimuli back and let markets once again stand on their own merits.

The ‘old’ playbook is back. Unfortunately, a generation of investors haven’t read it. Thus, the temptation to bid up share prices in anticipation of the ‘inevitable’ rescue. Bear markets are somewhat schizophrenic. They swing between despair and delight at a frightening pace. This results in sharp rallies and inevitable disappointment.

The good news is, that in contrast to the past 9 months, defensive assets will once again become just that. As you can see from the left-hand chart above, U S 10-year rates have fallen significantly over the past month. Again, this is a warning from the bond market against central banks doing ‘whatever it takes’ to tame Inflation. Nevertheless, with yields across the curve between 2% – 3%, there is at least some compensation for holding defensive assets once again. Therefore, there is no need to chase the intermittent rallies in share prices.

Within markets, there will be opportunities. However, what we have seen over recent weeks is traders herding into things that ‘worked last time’. Again, on the assumption that the cycle will repeat the recent experience. The top 5 gainers on the ASX yesterday were KGN, RBL, ZIP, PBH & TYR.  All are cyber-businesses of one sort or another. All were amongst the ‘hot stocks’ through the pandemic. Some were oversold, but the worst of these were up 20% yesterday.

For anyone holding such investments, I see this more as a second chance at redemption, rather than a resumption of ‘business as usual’.

The next 6 – 9 months will be very interesting. If the past week has made you feel like you are ‘missing the boat’, rest easy. This ain’t over.

Click on the below icon to read Dr Shane Oliver’s (Head of Investment Strategy and Chief Economist, AMP) insights

I waited until today’s inflation number was printed before putting ‘pen to paper’. Consensus guestimates were that Q! inflation in Australia would rise to 4.6% (annualised). The actual outcome was 5.1%, with the January quarter alone seeing a rise of 2.2%. Underlying inflation, the data watched by the Reserve Bank, rose from 2.6% p.a. to 3.7% p.a. Clearly, this is above the 2%-3% target range. 

You will, no doubt, be assailed by breathless commentary about what this means for interest rates, how the RBA has failed, etc. However, the RBA explicitly states this target range is to be achieved ‘over time, ‘on average’. The nuance is lost in the headlines, but the following illustration provides some context (it does not include today’s number):

Nevertheless, today’s inflation figures do tell us something about the trajectory of interest rates. As I have mentioned previously, market interest rates have been anticipating rising inflation and increases in official interest rates since the beginning of 2022. We have seen an increasing number of central banks raise rates across the world. We were never going to be immune from this; it was and is always, a matter of degrees.

Clearly, the current level of official interest rates, set for the COVID emergency are no longer appropriate. The next RBA board meeting is next Tuesday. The last time they raised rates during an election campaign was in 2007. I would be surprised if they raised rates at this meeting; one month will not alter the longer game they are playing. However, it is almost guaranteed that rates will rise in June. Indeed, I will be unsurprised if they raise the official cash target rate to 0.5% (an increase of 0.4%).

What is important now is whether they can return the rate of inflation to the above range in a timely manner, and without crashing the economy. As with most things, Governments and central banks can only influence at the periphery. For the most part, the current surge in inflation is driven by supply issues. Changing interest rates will not alter the price of oil. Indeed, higher debt servicing costs can suck the air out of broader consumer spending. The consumer will cancel their Netflix subscription if it means making their mortgage payment.

In other parts of the world, mainly the U.S. there is both supply and demand pressures feeding into the inflation rate. Thus, the Federal Reserve is likely to raise rates more quickly. You will recall from previous updates, that the bond markets have been on to this for some time. Long term, market driven, interest rates have risen at the fastest pace in over 30 years.

The Australian consumer is extremely sensitive to interest rate movements. Thus, interest rates do not have to rise very far before some real damage is inflicted. The RBA knows this better than anyone. Thus, I believe they will tolerate inflation persisting above the preferred range for longer than would otherwise have been the case. In short, official interest rates are, in my opinion, likely to rise less than bond markets are currently implying. In this environment, Australian equities ought to be relatively unaffected. However, equity markets are, as we know, affected by a broader range of influences; most notably what happens on ‘Wall Street’. Moreover, the Zero COVID policy currently persisting in China could very well undermine (pun intended) those sectors that have held our markets in good stead to date.

There is also the risk of policy error in Australia. Not by the RBA, but by Government. All sorts of things are said and promised during a campaign, but whoever wins, a fiscal reckoning is nigh. Fiscal policy is a primary contributor to demand driven inflation, so this ought to be the area in which policy is concentrated by the next administration.

I don’t want to get partisan, but I do want to finish with a quick word about those yellow billboards going up. The UAP wants you to believe they will a) ensure your mortgage interest rate is capped at 3% p.a. for five years, b) will levy a 15% tax on iron ore exports to ‘pay off national debt’ c) will make super fund repatriate offshore investments.

Well, we tried capping mortgage interest rates in the early 1980’s. This led to a rationing of loans. Banks won’t lend if they can’t make a profit. The levy on iron ore sounds a bit like the MRRT ~2013. That didn’t go so well. Moreover, the ‘royalty’ proposed is a tax on revenue, not profits. Miners would leave it in the ground until it made sense to dig it up. Making super funds invest all your benefits in Australia is a recipe for lower returns and higher risk. Furthermore, they are going to make you invest more in a market that is dominated by banks and miners, who they are going to squeeze with taxes and interest rate restrictions at the same time. It is simply a recipe for disaster.

You might think the UAP is quite unhinged. However, this has nothing to do with policy. It is about attracting more votes, and with it, more Federal funding. It is a grift. Please point this out to any friends and associates who are less able to detect the manipulation being perpetrated to attract their vote.

Ok, I feel better.

The extent to which global interest rates rise, will determine the longer-term trajectory of equity markets. If they can pull off a ‘soft landing’, particularly in the U.S. earnings can remain strong and with it, valuations. This risk to the equity market is not so much in where interest rates are going, but the tipping point at which monetary policy prompts a recession.

Information current as at 27 April 2022

Disclaimer: the information and any advice provided in this email has been prepared without taking into account your objectives, financial situation or needs.  Because of that, you should, before acting on the advice, consider the appropriateness of the advice, having regard to those things.

If we thought 2022 was going to provide some respite, we have been sorely disappointed. I haven’t written a message for some time, as market conditions through 2021 were generally positive. We did see some erosion in the values of a number of Fixed Interest investments, but this was for generally positive reasons i.e. strong economic conditions across globe. Certainly, strong growth included a recovery from the pandemic induced recession, but economic momentum has been such that inflationary pressures were building. Thus, the rise in long term interest rates.

As long-term interest rates rise, the value of fixed interest investments tend to fall. However, over the longer term this tends to be compensated with higher interest income. Nevertheless, nobody has really been concerned whilst equity prices continued to rise. As interest rates are one of the key components in assessing the long-term valuation of ‘growth’ assets (shares, property etc) movements in these markets are followed closely by equity markets.

In early January, equity markets appear to have reached a tipping point. Fears arose that central banks, particularly in the U S and Europe were not acting quickly enough to curb inflationary expectations. As much as anything else inflationary expectations, rather than actual inflation tends to drive long-term interest rates. If these continue to rise it creates a headwind for those companies that have flourished in the era of cheap money. Prior to the last few weeks, the end of cheap money was already generating a significant correction in global equity markets.

What happened next changed everything. Because of the events in Europe, strong economic growth is no longer a given. However, the same events are doing nothing to assuage inflation fears. Back in the 1970’s they coined the phrase Stagflation – an environment of low economic growth and high inflation. The ultimate solution to this economic quagmire was record high interest rates to kill off inflation. Those of us that were their will also recall this policy killed off growth for some time. Nevertheless, it laid the foundations of an extended period of prosperity – a recession we had to have.

The 1970’s episode was largely a result of the oil price shocks of the same period. There are clearly a number of similarities with current conditions. However, there are some significant differences. The following is from a study conducted in 2017 that shows the change in oil consumption compared to GDP.

Put simply, the world economy uses ~60% less oil than it did in 1971. Thus, the oil price is less important (notwithstanding the pain you feel paying $2.00 a litre for petrol).

Yes, the disruptions caused by Russia’s invasion have wider implications, not least because of the range of commodities of which Russia is an important producer. Wheat is a good example

What interest me more about the above illustration, is not so much the levels reached but the volatility of prices – a 50% rise from Feb 28 to March 7, followed by a 17% fall since.

These conditions are replicated across pretty well all tradeable markets, commodities, equities, even bond prices, in a relative sense.

You may recall early in the pandemic I noted that markets were struggling to price assets because of the opaque outcome, and lack of reference points, for the pandemic. We are experiencing similar conditions. If we plot the range of outcomes arising from the war in Europe (still can’t believe we are using that term again…), it is very flat. That is, there is a base case, but the probability of an extreme outcome is higher than you would prefer.

Everyone has a theory, so I may as well give you mine – Russia will retain control of parts of Ukraine, creating a defensive parameter at the Donbass region and the South of the country to Odessa. Hostilities will become sporadic, but a quasi-north/south divide reminiscent of Korea. Vietnam etc. establishes a new status quo. This is of course, no consolation to Ukraine. Nevertheless, it lets Putin declare victory and eases the risk of adventurism by him beyond Ukraine.

Such an outcome would see market volatility ease, if not to ‘normal’ levels. Commodity prices would fall, and we could in theory return to worrying about more mundane issues, like interest rates and inflation.

However, the outcome would probably see Russia remain under heavy sanctions and in circumstances reminiscent of Cuba, Iran & North Korea. We know that in each of these instances the economies collapsed but the regimes remained. We also know that Russia is (or was) the 11th largest economy in the world. The others are of a magnitude smaller. Russia will still matter even if it remains an economic pariah. Thus, the global economy will remain, well, different to what it might have been. How different is speculation, but it can only accelerate the de-globalisation we were already starting to experience.

In the medium term, economies will adapt. As we have seen with other global economic issues, companies will also adapt. This may take some time, but there are some positives to consider. Because of the response to the pandemic, consumers are, generally in good shape. In the U S household balance sheets are in good shape. The banking system is in good shape and unemployment remains low. In Australia the savings ratio remains significantly above the long-term average and household debt has stabilised. House prices appear to have flattened out and inflation here remains relatively modest. Globally, company earnings remain strong with the biggest complaints being trying to find staff.

The global supply chain constraints arising from the pandemic continue to ease. Thus, notwithstanding the outcome in Ukraine, inflation may start to ease mid-year.

As far as investment markets are concerned, sentiment reigns. If you can avoid getting involved in the day-to-day market gyrations, you should. Traders are the only ones who make money in these conditions, and then only the lucky ones. A trader’s market is a zero-sum game, someone wins, and someone loses. Trading is a wealth transfer mechanism. Investing is a wealth creation exercise.

It is always difficult writing these pieces mid-crisis, as the content can become redundant before you hit the send button.

We are still at the point in the current environment where things can certainly get worse before they get better. However, we have every confidence in the quality of the investments you own. They are diversified, so no single investment failure can cause irreparable damage to your portfolio. They are managed by companies and individuals of the highest calibre, who in most cases have ‘skin in the game’.

To paraphrase J P Morgan, ‘in bear markets capital is returned to its rightful owners’. You are the rightful owner of your capital. Don’t give it away.

Information current as at 15 March 2022

Disclaimer: the information and any advice provided in this email has been prepared without taking into account your objectives, financial situation or needs.  Because of that, you should, before acting on the advice, consider the appropriateness of the advice, having regard to those things.

So, as 2020 draws to a close, we can agree ‘extraordinary’ probably covers it. I am not going to even try to summarise the year. Since the bushfires started about a year ago, we have all had a front row seat. This is in itself an interesting perspective. More often than not, we have the luxury of observing disasters at a distance. They tend to effect people that are either small in number or remote in location. This time around the entirety of humanity has been affected to some extent. The ubiquity of the pandemic is truly unique in our lifetime. You would think this common experience would bring us closer together. We will see.

From the perspective of the pandemic, it appears we are turning the corner. Despite the outlook for the Northern winter remaining grim, progress has been made in developing a vaccine. This ought to draw a line under the pandemic through 2021 and gives policy makers a clearer idea of the magnitude of the economic repair work to be undertaken.

Economies around the world have largely recovered from the depths of the early lockdown recession, but there remains some way to go to achieve pre-COVID levels of economic activity. The trick over the short term, is to transition from economies on ‘life-support’ to self-sustaining activities. This is always the case coming out of an economic downturn. In this event, the policy interventions helped us to avoid outright depression. Thus, the need to tread carefully is crucial. The Great Depression was exacerbated and extended by a series of policies that were too restrictive too soon. This was also the case coming out of the GFC, with the recovery proving slow and feeble.

Policy makers are making all the right noises to err on the side of maintaining fiscal and monetary stimulus. Central bank guidance is for interest rates to remain lower for longer. Budget deficits are ‘cool’ again. However, you will start to hear voices calling for fiscal & monetary restraint. These echo the voices who called for lockdown restrictions to be eased too soon. We’ve seen the result of those calls in the U.S. & Europe. It is analogous to the need to maintain policy support for as long as necessary. As the RBA Governor recently observed ‘creating asset bubbles, is a problem for another day’.

Investment markets have reacted to the policy signals accordingly. For the most part, losses on investments since March have been largely recovered. You may recall in our February update, we talked about a market ‘tipping point’ and the risk the pandemic would upset a market hitherto ‘priced for perfection’. Prescient, no? The recovery in equity markets has in many cases exceeded the lofty levels of February. Does this suggest we are again in risky territory? Maybe, but underlying conditions are clearly different. Globally, businesses are not as healthy as they were back then. While company profits are recovering, they still have a long way to recover previous levels.

Nevertheless, with interest rates locked down at virtually nothing for some years to come, the investment options are binary. You can invest safely and earn nothing in real terms, or move ‘up the risk curve’, earning at least something, but needing to endure the volatility endemic in ‘growth’ assets. We would lean to the latter. Volatility is uncomfortable but if you can be relatively certain an investment will recover value and grow over the long term, ‘risk’ takes on a different perspective.

The need to diversify to manage risk has never been more important. While companies that were able to adapt to lockdown dominated most of 2020, we are already seeing markets turn their gaze to what happens next. This is behind the recent rotation from ‘growth’ companies to ‘cyclicals’. A different perspective for a different part of the cycle.

We are relatively positive on the outlook for markets in 2021. We expect the Australian share market to out-perform global markets, as they are generally starting from more conservative valuations. There will be failures along the way. As the tide of economic support starts to recede, companies crippled by the events of the past year (known in the vernacular as zombies), will be exposed.

We expect defensive assets to provide meagre returns. They are still required in a portfolio for capital preservation purposes, but, if we are over the worst of the economic downturn, interest rate markets will be locked hard against the upper limits central banks have imposed.

We also expect to see a significant rise in the number of products offering investors yields that appear too good to be true – AKA scams.

If you take nothing else from this note, know this; returns are always and everywhere a reflection of risk. It is not always obvious where the risk lies, and indeed it is not always the case that the risk results in failure. Sometimes you bet on red and red comes up. If you are offered a ‘safe’ high yielding investment, approach with scepticism (or not at all).

Thank you to all who have provided feedback on our various communications over the year. Thank you also to all of you who have put your faith in our ability to steer you through such conditions. We take our responsibilities to you seriously and consider your success, our success.

Best wishes for the season and a peaceful 2021.

Information current as at 8 December 2020.

This article provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to your personal objectives, financial situation and needs having regard to these factors before acting on it. This article may contain material provided by third parties derived from sources believed to be accurate at its issue date.

Well, that was quite a year! We do not stand on the ‘frontline’ of public health or security, so we keep doing what we know best. If nothing else, this helps you, to get on with what is important to you, confident that we have your financial back. If this year hasn’t tested you at some level, you haven’t been paying attention.

From an investment perspective, it is like a decade of events has been crammed into a single year. Many will be surprised to see their portfolios have not done as badly as one might have expected. Some of this is due to markets, but a significant part is not by accident. Building an investment portfolio is not as simple as picking the investment you think will make the most money. It is about putting together a range of assets that complement each other, in seeking to achieve a particular objective, with the least amount of risk. In part risk is about ensuring you are able to tolerate times like these. The vast majority of you put your faith in us and ‘stayed the course’. We thank and congratulate you on this. We know of many who have not, and they are generally not in a better place.

This year, investing has been analogous to driving through mountain roads. At the start it was dry and sunny, and people in sports cars were passing us, as they tested their machines and driving skills. Then the weather turned. The roads became wet & icy. Many of those skilled in the dry, suddenly found their equipment was unsuitable to the conditions or they did not have the experience to adapt. In other cases, they were beholden to their promises to reach a destination at a pace, with inevitable outcomes.

During previous years of strong investment performance, we have warned that above average returns cannot persist. At times resembling ‘chicken little’ and the warnings appeared more ludicrous as these conditions persisted. All markets are mean reverting. They cannot perform at either above or below average indefinitely. All the same, timing of market reversals is near impossible. The best you can do is ‘lean against’ markets that are persistently performing above/below average. Counter-intuitively, the more extreme market valuations become, the safer a bet against them becomes. When we both encourage you to reduce market exposure during booms, and increase it during downturns, we are not being contrarian for the sake of it (although I have been accused as such). It is effective risk management, but it is not always comfortable.

The key, as always, is to separate the signal from the noise. This has become more difficult over the last 10 years, as various interventions by Governments and central banks, have sought to temper market dislocation. In the past few months, this has been turbo-charged. Right now, we have a situation where we know the global economy is contracting, but we know Government & central bank support is strong. The ebb & flow between the irresistible force and the immoveable object, will remain the focus of attention and source of uncertainty.

So, how do we see the world in 2020/21. In short, continued volatility. Where central bank support runs into economic reality, volatility will result. We also expect a growing dispersion of market returns. With globalisation in retreat and COVID-19 affecting different countries at different levels, the correlation between market returns is going to reduce. Moreover, this dispersion may increase within markets, with some sectors out-performing others by increasing margins. As valuations between sectors and countries becomes stretched, you can expect occasion mean reversion; more volatility. We see more long term value in Australian shares, compared to U.S. shares, but within these markets, the definition of ‘blue chip’ might change. Bonds generally yield very little, but bond prices are likely to remain anchored by central bank intervention. Thus, the fixed interest asset class is likely to provide capital stability, but meagre income.

As usual, we will review what has worked in the past, and what we think will work in the future. However, this is more likely to be articulated at the asset level, rather than the asset allocation level. This means any changes to asset allocation will generally be modest. However, underlying investments will be under scrutiny to ensure they remain fit for purpose.

What does one do? While the road remains treacherous, drive slowly & carefully. Getting there is all that matters.

Information current as at 30 June 2020

Disclaimer: the information and any advice provided in this email has been prepared without taking into account your objectives, financial situation or needs.  Because of that, you should, before acting on the advice, consider the appropriateness of the advice, having regard to those things.

Is it just me or have the past few months messed with our perceptions of time? In the words of Lenin “there are decades where nothing happens, and there are weeks where decades happen”. The past 10 weeks have proven this. The next 10 weeks may prove again.

Our last general update was written on the eve of the current crisis (Corona-tion 25 February 2020). Much has happened and much has changed since then. Reflecting back on that last update, much of what we outlined has come to pass, so far; a severe market reaction, a ‘whatever it takes’ response from Governments and Monetary authorities, increased market volatility.

I am certain you have more than enough information about the virus, and there is nothing insightful we can add. Therefore, we will stick to our area of expertise.

Markets have largely discounted the effects of the shutdown, and started to factor in the responses by Government authorities. Pricing risk remains uncertain, so volatility remains an issue. However, markets have adapted to what they perceive as the near-term risks to economies and the fortunes of businesses. Greater clarity will promote confidence and portend a return to ‘normal’ market conditions. However, normal does not mean the way things were before; at least, not in the short term. Perceptions of risk have changed. Companies, and in some cases entire nations, have realised there are risks in simply picking the cheapest supplier. If your suppliers were all situated in Hubei province, you had no ‘plan B’. If your business relied on cheap air travel, boom. Economies will be less frictionless than before as companies (and nations) adopt a ‘plan B’. More friction means lower growth. Economic reform can mitigate this drag, but it is far from clear what reforms will be appropriate. The Globalisation driving growth for the past 4 decades is in its worst state since 1930.

For us, the irony of the lessons above, is that it has always been the way we approach investment; always diversify, have multiple redundancies built in, weigh the comprise between cost and value. There is always a trade-off. We just need to decide which ones we can live with.

The outlook remains opaque. In our last message, we talked about timeframes. We remain amidst the shorter end of that timeframe. Even with the virus under control (whatever that means), the economy will take some time to recover. There is a risk that when Government support lapses, gaps will remain. Even if this is not the case, it will take some time for confidence to recover. After an initial burst of relief, we believe people will be more circumspect about what can go wrong. It has been 28 years since Australia has been through anything similar. Therefore, an entire generation will be learning the real meaning of risk management, in a truly personal sense. This too will lower economic growth expectations, but I would argue this growth can be more sustainable and robust. Then again, I would.

Those of you who I have dealt with directly will recall I have always cautioned against return expectations, particularly when they have been strong for a period. We have always been conscious of protecting against downside risk. I cannot emphasise enough that current events are still playing out and investment values may fall further. Company earnings are falling. Dividends are being cut. Things look, well, kind of crap.

However, I challenge you to raise your eyes and look beyond short term concerns. On a purely quantitative basis, and notwithstanding a less efficient economy going forward, long term investment returns, for some of the most beaten up asset classes, are as attractive as they have been in about 10 years. With the risk free rate (10 year Government bonds) below 1%, the rate of return threshold is as low as it has ever been. There is no rush. However, as perfect as the investment landscape looked as recently as January, is it not as likely that things are not as imperfect as they now seem?

I will end by mangling the preamble to the U S Declaration of Independence. In terms of investment ‘we hold these truths to be self-evident’.

• Returns are mean reverting. They overshoot long term averages as sure as they undershoot.
• Sticking to a rational and considered process produces more consistent risk adjusted returns.
• Personal investment objectives, however you articulate these, are the only benchmarks that matters.
• Humility is essential. Markets teach lessons daily. It is up to you how much these cost.
• If something is too good to be true, it probably isn’t. All investment returns are a factor of the risk you are taking. Sometimes, the risk you are taking is not obvious.

We look forward to enjoying better times with you, in the near future.

Disclaimer: the information and any advice provided in this email has been prepared without taking into account your objectives, financial situation or needs.  Because of that, you should, before acting on the advice, consider the appropriateness of the advice, having regard to those things.

A little over 7 weeks ago we said, in relation to COVID-19 “it is out”. At that point China was the focal point and there were suggestions other countries were beginning to see cases.

The focal point has steadily moved from east to west, with a range of responses from various authorities exhibiting a range of outcomes. In Australia we have had a relatively favourable outcome, thus far. It is heartening to know we can still get things done when we all pull in the same direction.

The ‘east-west’ journey of the pandemic is likely to shift to a ‘north-south’ bearing from here. That is, from richer economies to poorer. As with all disasters, natural or man-made, this is where the real human tragedy will play out.

The ‘significant’ market correction we forecast 7 weeks ago, has not disappointed. The fabric of the financial system has been tested and monetary authorities continue to do ‘whatever it takes’ to minimise the economic damage. The tools used in 2008-09 have again been deployed, with even greater vigour. New prescriptions have also been added, not least of which is various Governments subsidising employment costs for a time. So far, so good. However, the very nature of this downturn means we are all learning on the job.

Since peaking on 19 February, global share markets fell 33%, reaching a nadir on 23 March. By some measure this is the fastest fall ever. Since that date, they have risen 22% (as at 10 April). This constitutes a reclamation of about 45% of the fall. We did suggest ‘increased market volatility’ but this has been one wild ride.

Where to from here? We return to the idea of timeframes. The next 7 weeks are going to continue to test the resolve of investors. Pricing uncertainty remains high. The rebound in asset prices is every bit an articulation of this as the preceding fall.

Asset markets appear to be anticipating a quick return to ‘normal’. I have my doubts. Assuming the medical emergency is over in a matter of months (a big assumption, still), what of the economy? No doubt economic figures will indicate a sharp downturn, to be followed by a sharp upturn. But, much like the market movements above, the latter doesn’t get us back to where we were.

Despite Government assistance, there will be economic pain. Even if you are not directly affected, we all know people whose income has been cut, whether this is salary, rent, dividends etc. It will take some time before we are ready to consume, borrow, build, invest as we did until recently. This new reality will affect investment markets. Sure, safe assets like cash and bonds will not provide the return we need. But for a while it may be the case that people will be willing to forgo a return on an investment, just to feel safe.

In the short term, markets will remain messy. We will not be surprised if the market low of 23 March is again tested and exceeded. This is the nature of ‘bear’ markets. The economic history of these events is still being written and there is plenty of opportunity for disappointment in the short term.

Nonetheless, economies will recover, and markets will anticipate this in due course. It is at the point of ‘capitulation’ that markets will return to the general tendency to revert to long term trend. As we saw after 2009, this can be a long road back, and it is never a straight path. However, for the prudent investor, time is on your side.

Information current as at 14 April 2020

Disclaimer: the information and any advice provided in this email has been prepared without taking into account your objectives, financial situation or needs.  Because of that, you should, before acting on the advice, consider the appropriateness of the advice, having regard to those things.

The U S share market closes, this morning at levels past seen on Christmas eve 2018. As at the close yesterday, the Australian share market was back at levels last seen in 2016. The speed of the fall in share prices has been nothing short of epic. This has no doubt been enhanced by the ability of investors to buy or sell at the push of a button. We have no short-term idea about where this goes or how long it persists. Current conditions are not consistent with the various ‘corrections’ we have seen over the past 10 years. When we talk to you about risk profiles, this is the 1 in 20 year event to which we are alluding.

Confidence has been decimated by the inability of financial markets to price the global health emergency we are experiencing. Until some clarity arises in this regard, markets will react to the short term news-cycle. If you have never experienced this before, this is what a ‘bear market’ looks like.

It seems apparent to anyone you ask that recession, however defined, is likely. By definition a recession is a contraction in economic growth. The reduced activity you see every day (expect perhaps in the supermarket), is an obvious example. As businesses close down to manage the health risks, this is also a contraction of economic activity. The positive feedback loop the conditions create send these contractionary impulses through the economy. The figures proving a contraction are generally not published until months after the end of the quarter, but that ‘vibe’ you are feeling; that is the feeling of economic contraction.

The effects of a recession are not evenly dispersed. Some will feel it more keenly than others. Those whose job is at risk or were otherwise generally at risk will feel it the most.

Markets are trying to establish the extent of this contraction and how that looks in terms of the effect on company earnings. This is how markets price an asset – the current value of future cashflows. Current market conditions are suggesting a severe and extended effect on earnings, thus, they are discounting heavily. The real risk is where companies do not have sufficient balance sheet strength to see it through. Like in 2008/09, strong companies will be bruised, but not beaten. Weaker companies will not survive.

Our ‘average’ client has about 50% of their investments in equity type assets; risk assets, as we call them. Some have more, some have less. Thus, the effects on your portfolio will reflect this weighting. By and large the defensive assets, those that were generating modest interest income and little or no growth, are doing the primary job for which they are intended; capital stability. In normal times it is easy to dismiss this part of your portfolio as ‘lazy money’. Well, it is working hard now.

In these conditions, it is completely rational to be concerned. We are also concerned, but perhaps for different reasons. Our biggest fear, in this environment is that the pressure gets too much for you and you decide to ‘bail out’ of growth assets. It is like you just want that gnawing feeling to stop. We feel it too. However, as I look at your portfolios, and the assets you own, I start to feel better. There are investments which are losing value with markets but within these are good companies with strong balance sheets, and strong businesses. The very act of diversification means that even if a company in an investment fund fails, it is not catastrophic.

When reviewing portfolios we consider if an investment still serves the purpose it was originally intended. Even given current conditions, if we were starting from here, this would be the place to start. Clearly, we are all generally not starting from here. In the short term we see our investments have lost value. However, you still own these assets. They remain, in our opinion, quality assets. I don’t want to give them away cheaply.

If we take away the emotion (easier said than done, I know), long term return expectations are the highest they have been in many years. Assuming investment returns regress to long term averages, the expected annual return for Australian shares in in excess of 11% p.a*. Global shares are a little less than this. As always there are no guarantees these projections never travel in a straight line. However, if we are looking at the cold hard numbers, it is hard to justify selling these types of assets at this time. Indeed, it suggests adding to growth assets would be the logical outcome. In the current environment, this is a big ask. However, as the medical emergency wanes, markets will, at some point look at the lowest interest rates ever, the lowest asset prices in many years, an end to the recession and the long-term prospects of companies that have survived the recession.

We have every confidence that if you can weather current conditions, your portfolio will recover and prosper in the long run. We believe the investment assets you own are sufficiently diversified and well managed to come through these conditions in good shape.

We are hearing anecdotal evidence that super fund members without advisors are ‘cashing out’ and then phoning the call centre for affirmation they have done the right thing. They haven’t, but they won’t know it for some time. You have us. This is what we are here for. If in doubt, call us. We are with you through this in every sense.

(*assumes long term average for market dividends, growth in earnings and relative valuation – PE. I can take you through these assumptions in detail if needed).

Information current as at 17 March 2020.

This article provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to your personal objectives, financial situation and needs having regard to these factors before acting on it. This article may contain material provided by third parties derived from sources believed to be accurate at its issue date.

Last week I attended a conference, where a range of presenters from different parts of the globe provided their view on a range of topics focusing on markets and economies. Not surprisingly, a significant part was in respect of the potential impact of the COVID-19 outbreak. As you can imagine, this was a fluid discussion, but it spanned a range of opinions and prognoses. These ranged from this being the ‘Black Swan’ event for economies and markets, to a more prevalent ‘this too shall pass’ analysis.

Both are probably right; it is a matter of degrees and timing, that are the only real points of contention. However, these points of contention are what really matter.

The pessimist case argues that the world of economies and markets are severely underestimating the potential impact. Recent news is tending to support this argument. While the rate of infection at the epicentre appears to be falling, there is growing evidence that the breadth of infection is more widely dispersed than first indicated. I don’t know a lot about the biology of viruses, but I do know a bit about numbers. The fact that cases are arising in parts of the world not previously thought at risk indicates the attempts at containment by quarantine is probably a failure. If the incubation period is longer than previously anticipated, it is ‘out’. The exponential rate of growth is likely to see the virus cross multiple geographic locations (the definition of Pandemic).

From an economic perspective, the short-term damage is already being done. Clearly, anything related to tourism & travel is being affected. However, as ‘the world’s factory’ (Hubei Province) has effectively been shut down, the trickle-down impact on other industries is yet to be fully appreciated. Moreover, as the spread continues and more countries implement quarantine procedures, this can only increase. Comparisons with the SARS virus of 2003 are less useful from and economic perspective as China was a relatively modest component of world trade at that time, only ascending to WTO membership in 2001.

No matter what direction the virus takes from here, you will begin to see more and more companies downgrading earnings and economists downgrading growth. One of the less tangible aspects of this is ‘confidence’. This can be a self-fulfilling prophecy. Strength in economic growth and investment markets, has been, in the recent past, an outcome of greater confidence, as various concerns are overcome i.e. Brexit and Presidential impeachments. A ‘Black Swan’ event, by its very nature (low probability, high impact), can erode confidence quickly. In recent weeks, we have seen equity markets overcome concerns and make new record highs. This dichotomy suggests markets are either under-appreciating the significance of the virus or looking through it. This is the essence of the range of opinions presented at the conference.

In suggesting they are both right, we believe an accumulation of bad news will see equity markets reach a ‘tipping point’. Thus, the odds of s significant market correction are relatively high. We know uncertainty is anathema for equity markets. We know valuations in certain parts of the world equity markets are high. It is easy to draw a metaphor with the recent bushfires, high fuel loads, an unfortunate spark etc.

The other side of the argument is equally plausible. Economic growth will be interrupted, but once the virus has passed, there is the potential for a significant period of economic ‘catch up’. That is, demand is being delayed, rather than destroyed. It is also clear that monetary authorities are awake to the economic impact. Chinese authorities are already increasing liquidity and cutting interest rates. It is now almost certain the RBA will also cut rates further, to support short term demand. One can assume monetary authorities around the world will again do ‘whatever it takes’ (the metaphorical rain that douses the fires).

For investors, this can present a conundrum. Do you ‘take cover’ and wait out the storm or do you ‘ride it out’? in deciding to ‘take cover’ this will be the first of two decision you need to make; when to sell and when to buy back. You will almost certainly get the timing of this wrong. To ‘ride it out’ requires some measure of faith but is the rational approach.

When the virus passes, and after authorities have continued to provide economic stimulus, levels of liquidity will be higher than they have been for some years. As we have seen, this money needs to go somewhere and ‘safe’ investments such as cash & bonds generate precious little return. Therefore, a rebound in markets may be sudden & swift.

If your timeframe is measured in months, taking cover may be the right approach. If it is measured in years, it is probably a mistake.

Over the coming weeks/months, you need to prepare for increased market volatility. We understand these events will create anxiety. However, we are confident ‘this too shall pass’.

Information current as at 23 February 2020.

This article provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to your personal objectives, financial situation and needs having regard to these factors before acting on it. This article may contain material provided by third parties derived from sources believed to be accurate at its issue date.