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Interest rates are going up, er, no, now rates to remain unchanged, er, no it is up. Inflation has peaked, er, but no, latest data seems to show inflation still festering, so now more upside on rates! This has been the continuous yo-yo effect of quickly digested information we have heard happening around the globe for the past few months now, maybe longer!  It all somewhat resembles the Donna Summers hit song which goes “ Upside  Down…and round and round!” Showing my age!

The bottom line to this market choppiness and recent weakness is speculation that there may be a further official rate rise in the US and Europe, as well as one in Australia next month. Even though global supply constraints have been steadily improving, we are seeing spending remaining at the high levels for the past year, even still at the very visible higher prices for most goods and services we purchase. I guess that is how business works, put up prices until demand and spending show signs of detracting.

We must be close to that peak point, one would think. Price rises and higher interest rates just do not appear to weary the consumer…yet! In reality though, it must impact soon, one would have to believe, but the concern is that inflation will linger more persistently and longer than the central bank officials and economists anticipated. It seems there has been a constant wave of further price increases in recent months, especially with employment remaining very robust, and spending cash flow flowing. The rising price of oil and gas now is also more in the volatility mix, which unfortunately has been heightened by the latest Middle East flare up.

Global economies still seem to be moving along at fair speed and elevation, albeit within a sub-trend growth trajectory expected for the next few months.

We are in an adjustment period, and things should settle down soon. For this happen, there will probably need to be more stable and normalised inflation and interest rate levels, a sort of self-correcting really. Again, this is in the process of settling, possibly by early 2024, which should see bond and equity markets return to more positive outcomes again for investors. In the meantime, there are long- term bargains for investors to be had in such prevailing market volatility.

We must not forget the core reason why we actually do invest. It is to best secure our financial futures, and deliver consistent and solid income streams of  cash flow from our accumulated and diversified investment portfolios, mainly for use in our post-working lives. As investors, we must retain a long-term focus, and realise that with volatility comes many good opportunities to add more investments at decent value prices. We must again remember that we should control what we can control, and we should manage what we cannot control. And to keep the commitment to our goals, and having patience, in the harder more volatile times, are the necessary rudders to future financial success and security.

On this investor characterisation theme, and with the current state of play in the markets, I believe that the article below written by Dr Shane Oliver, Head of Investment Strategy and Chief Economist with AMP Capital, is both very relevant and very accurate in its messages for the true investors, of which we all are and should be. I would recommend you read through this article for its quality of information and the reassurance for investors of the points which the paper details. It is also factual, interesting reading and written with salient quotes too.

Key points in this Dr Oliver’s article,  “Three reasons to err on the side of optimism as an investor” , include:

– The natural human tendency to focus on bad news, the increased availability of information and the rise of social media are magnifying perceptions around worries and making it easier to be pessimistic.

– However, to succeed as an investor it makes sense to err on the side of cautious optimism: otherwise, there is no point in investing; growth assets like shares have trended up over the long term; and trying to get the timing right of the 2 or 3 years out of 10 when they fall can be very hard.

Three reasons to err on the side of optimism as an investor.     

 – Introduction

The “news” as presented to us has always had a negative bent, but one could be forgiven for thinking that it’s become even more negative with constant stories of disasters, conflict, wrongdoing, grievance, and loss. Consistent with this it seems that the worry list for investors is more threatening and confusing. This was an issue prior to coronavirus – with trade wars, social polarisation, tensions with China, worries about job loss from automation and ever-present predictions of a new financial crisis. Since the pandemic higher public debt, inflation, geopolitical tensions, and rising alarm about climate change have added to the worries. These risks cannot be ignored, but it is very easy to slip into a pessimistic perspective regarding the outlook. However, when it comes to investing the historical track record shows that succumbing too much to pessimism does not pay.

Three reasons why worries might seem more worrying.

Some might argue that since the GFC the world has become a more negative place and so gloominess or pessimism is justifiable. But given the events of the last century – ranging from far more deadly pandemics, the Great Depression, several major wars and revolutions, numerous recessions with high unemployment and financial panics – it is doubtful that this is really the case, when viewed in the long- term sweep of history.

There is no denying there are things to worry about at present – notably inflation, political polarisation, less rational policy making and geopolitical tensions – and that these may result in more constrained investment returns. But there is a psychological aspect to this combining with greater access to information and the rise of social media to magnify perceptions around worries. All of which may be adding to a sense of pessimism.

Firstly, our brains are wired in a way that makes us natural receptors of bad news. Humans tend to suffer from a behavioural trait known as “loss aversion” in that a loss in financial wealth is felt much more negatively than the positive impact of the same sized gain. This probably reflects the evolution of the human brain in the Pleistocene age when the key was to avoid being eaten by a sabre-toothed tiger or squashed by a wholly mammoth. This left the human brain hard wired to be on guard against threats and naturally risk averse. So, we are more predisposed to bad news stories as opposed to good. Consequently, bad news and doom and gloom find a more ready market than good news or balanced commentary as it appeals to our instinct to look for risks. Hence the old saying “bad news and pessimism sells”. This is particularly true as bad news shows up as more dramatic whereas good news tends to be incremental. Reports of a plane (or a share market) crash will be far more newsworthy (generating more clicks) than reports of less plane crashes this decade (or a gradual rise in the share market) ever will. As a result, prognosticators of gloom are more likely to be revered as deep thinkers than optimists. As English philosopher and economist John Stuart Mill noted “I have observed that not the man who hopes when others despair, but the man who despairs when others hope, is admired by a large class of persons as a sage.”

Secondly, we are now exposed to more information on everything, including our investments. We can now check facts, analyse things, sound informed easier than ever. But for the most part we have no way of weighing such information and no time to do so. So, it’s often noise. As Frank Zappa noted “Information is not knowledge, knowledge is not wisdom.” This comes with a cost for investors. If we do not have a process to filter it and focus on what matters, we can suffer from information overload. This can be bad for investors as when faced with more (and often bad) news we can freeze up and make the wrong decisions with our investments. Our natural “loss aversion” can combine with what is called the “recency bias” – that sees people give more weight to recent events in assessing the future – to see investors project recent bad news into the future and so sell after a fall. As famed investor Peter Lynch observed “Stock market news has gone from hard to find (in the 1970s and early 1980s), then easy to find (in the late 1980s), then hard to get away from.”

Thirdly, there has been an explosion in media competing for attention. We are now bombarded with economic and financial news and opinions with 24/7 coverage by multiple web sites, subscription services, finance updates, dedicated TV and online channels, chat rooms and social media. This has been magnified as everything is now measured with clicks – stories (and reporters) that generate less clicks do not get a good look in. To get our attention news needs to be entertaining and, following from our aversion to loss, in competing for our attention dramatic bad news trumps incremental good news and balanced commentary. So naturally it seems the bad news is “badder” and the worries more worrying than ever which adds to a sense of gloom. The political environment has added to this with politicians more polarised and more willing to scare voters.
Google the words “the coming financial crisis” and it’s teeming with references – 270 million search results at present – and as you might expect many of the titles are alarming:

• “A recession worse than 2008? How to survive and thrive.”
• “Could working from home cause the next financial crisis?”
• “Economic crash is inevitable.”
• “Three men predicted the last financial crisis – what they’re warning of now is terrifying.”
• “How China’s debt problem could trigger a financial crisis.

People have always been making gloomy predictions of “inevitable” and “imminent” economic and/or financial disaster but prior to the information explosion and social media it was much harder to be regularly exposed to such disaster stories. The danger is that the combination of the ramp up in information and opinion, combined with our natural inclination to zoom in on negative news, is making us worse investors: more distracted, pessimistic, jittery, and focused on the short-term.

Three reasons to be optimistic as an investor.

There are 3 good reasons to err on the side of optimism as an investor.

Firstly, without a degree of optimism there is not much point in investing. As the famed value investor Benjamin Graham pointed out: “To be an investor you must be a believer in a better tomorrow.” If you do not believe the bank will look after your deposits, that most borrowers will pay back their debts, that most companies will see rising profits over time supporting a return to investors, that properties will earn rents, etc, then there is no point investing. To be a successful investor you need to have a reasonably favourable view about the future.

Secondly, the history of share markets (and other growth assets like property) in developed well managed countries with a firm commitment to the rule of law has been one of the triumph of optimists. Sure, share markets go through bear markets and often lengthy periods of weakness – where pessimists get their time in the sun – but the long-term trend has been up, underpinned by the desire of humans to find better ways of doing things resulting in a real growth in living standards. This is indicated in the next chart which tracks the value of $1 invested in Australian shares, bonds, and cash since 1900 with dividends and interest reinvested along the way. Cash is safe and so fine if you are pessimistic but has low returns and that $1 will have only grown to $250 today. Bonds are better and that $1 will have grown to $903. Shares are volatile (and so have rough periods – see the arrows) but if you can look through that they will grow your wealth and that $1 will have grown to $811,079.

Source: ASX, Bloomberg, RBA, AMP

This does not mean blind optimism where you get sucked in with the crowd when it becomes euphoric or into every new whiz bang investment obsession that comes along (like bitcoin or the dot com stocks of the 1990s). If an investment looks too good to be true and the crowd is piling in, then it probably is – particularly if the main reason you are buying in is because of huge recent gains. So, the key is cautious, not blind, optimism.

Finally, even when it might pay to be pessimistic and hence out of the market in corrections and bear markets, trying to get the timing right can be very hard. In hindsight many downswings in markets like the GFC look inevitable and hence forecastable and so it’s natural to think you can anticipate downswings going forward. But trying to time the market – in terms of both getting out ahead of the fall and back in for the recovery – is difficult. A good way to demonstrate this is with a comparison of returns if an investor is fully invested in shares versus missing out on the best (or worst) days. The next chart shows that if you were fully invested in Australian shares from January 1995, you would have returned 9.3%pa (with dividends but not allowing for franking credits, tax, and fees).

Covers Jan 1995 to March 2023. Source: Bloomberg, AMP

If you were pessimistic about the outlook and managed to avoid the 10 worst days (yellow bars), you would have boosted your return to 12.2%pa. And if you avoided the 40 worst days, it would have been boosted to 17.1%pa! But this is very hard, and many investors only get really pessimistic and get out after the bad returns have occurred, just in time to miss some of the best days. For example, if by trying to time the market you miss the 10 best days (blue bars), the return falls to 7.2%pa. If you miss the 40 best days, it drops to just 3%pa.

As Peter Lynch has pointed out “More money has been lost trying to anticipate and protect from corrections than actually in them.”

On a day-to-day basis it’s around 50/50 as to whether shares will be up or down, but since 1900 shares in the US have had positive returns around seven years out of ten and in Australia it’s around eight years out of ten.

Daily & monthly data from 1995, data for years & decades from 1900. Source: ASX, Bloomberg, AMP

So, getting too hung up in pessimism on the next crisis that will, on the basis of history, drive the market down in two or three years out of ten may mean that you end up missing out on the seven or eight years out of ten when the share market rises. Here is one final quote to end on.

“No pessimist ever discovered the secrets of the stars, or sailed to an uncharted land, or opened a new heaven to the human spirit.” – Helen Keller.

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As always, should you have any queries please do not hesitate to contact us.

Disclaimer for information provided in this Commentary: This document, and the contents contained within, is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, or plan feature. The views expressed in this are subject to change at any time. No forecasts are or can be guaranteed.

I hope you all had a well-earned and very Happy Easter break!

Money is no longer ‘free’ or at least as near to free as it has been in the past few years. Money is now more expensive, primarily because of the significant burst of inflation and the quickly rising interest rates response by central banks to combatting this burst. The world is still realigning, readjusting, and rebalancing from those strange few years since early 2020.

Families, businesses, and governments have felt the challenges of these years with each of these sections, i.e., all of us, absorbing a lot of pain in the process and for much of this duration. However, life continues onwards, and it is really just another part of history to try and understand, and to learn from it all, including certain mistakes but with the benefit of hindsight. It reinforces that you take nothing for granted in life. By historical measures, it also emphasises the need of keeping with ‘the plan’ and not being diverted by short term events and hurdles.

With the Reserve Bank of Australia (RBA) pausing its run-on official interest rate increases this month, there is a strong sign that the rising discomfort of the rate rises in the system is dousing the prevailing inflationary pressures that we all have felt with shortages of goods and services, and with the persistent expensive prices we are all paying for those we can get!

I think it was an intelligent move by the RBA to take this ‘rate rise pause’. As Philip Lowe, the Governor of the RBA, stated last week, “The Board recognises that monetary policy operates with a lag and that the full effect of this substantial increase in interest rates is yet to be felt. The Board took the decision to hold interest rates steady this month (April) to provide additional time to assess the impact of the increase in interest rates to date and the economic outlook”. Of course, savers have loved the higher interest returns again on their cash and term deposits, as well as making bonds more attractive too.

Nevertheless, it is likely that a future rate increase or two may still be needed in the RBA’s calculations. Lowe was clear in saying that if inflation does not return to the RBA’s target range of 2-3 per cent annualised (currently running at 6.8 per cent), then further rate increase(s) will be needed. However, a positive outlook on all this is that the RBA has positioned this target to be reached by 2025; as such, realising that it will take time for inflation to retreat. The US and European central banks have a shorter timeframe for their similar decline in inflation targets to be reached which is why their interest rates will likely move up a bit further from here, but unlikely by much though as the ‘financial stretch’ is certainly happening by now to most people and businesses alike.

With my clients, over the past few months, I am certainly noticing them wanting more drawings or even small redemptions from their investments, typically this is the case with the super/pension clients. This is the direct impact of maintaining lifestyle in these more expensive times. The longer inflation persists, the more awareness people have of their increased cash outgoings. These high prices have been absorbed for many months now, but there is a growing dent in people’s disposable incomes, whether that income is being sourced from work earnings or from retirement investment returns. People are aware, especially those with mortgages, those renters paying higher rents with the housing shortage, and other debts that people and companies have in place. Ahead, there will be/simply must be a pullback on discretionary spending. The buffer of cash reserves, and of monies in people’s offset accounts is being steadily drained to preserve their lifestyles. Economists believe this eventual spending pullback will likely be more pronounced in the travel, entertainment, and service sectors or, conversely, but with the same effect, prices will retreat to more normalised and more familiar levels.

This also implies that businesses will feel their margins squeezed and, certainty so, unless our labour market shortage eases. This labour shortage is seeing wages rise in many places; so, finding an equilibrium point in all this is confronting many businesses, particularly in the discretionary space. Although, what should help improve the tight labour situation over the next few months, is the fact that immigration is happening again, and it is in high numbers (record numbers, I believe). A very different picture to the near zero immigration of the Covid-19 of the past few years.

This should see the heat, that has been caused by these unusual last few years, taken out of the economy, and an overall slowdown result. Generally though, this really is just all part of economic cycles. Using sailing parlance, you could say that Economies jibe in and out with the tailwinds and the headwinds of life’s events on their passage through time!

Keeping with the long-term view theme for investing, I came across this informative and visual version of charts supporting the benefits of long-term investing. This information below may be of interest to you. The source and the content is adapted from a recent article by Katana Asset Management, where they quote at the start that, “The short term is unknowable, but the long term is inevitable”.

It is a bullish article for investing, and is based on historical data. Katana Asset Management describe the below as the four best charts from the past 30 years of investing.

Chart 1. The long term is inevitable

Calendar year 2022 marked the 147^th year of trading on Australian exchanges (under various guises). That enormous amount of data provides the clearest guide for anyone willing to learn. During this period, the market (dividends plus share prices) has risen 117 years and declined 30 years. So, 79.6% of the time, the market rises. One in five years on average, the market declines.

Source: Katana Asset Management

When the market rises, it does so by an average of 16.1%, and when it declines the average is minus 10.1%. When combined, we see that over the past 147 years, the market has averaged a return of 10.8% per annum.

Since we have become more sophisticated and introduced the Accumulation Index in 1979, the data points to an even stronger outcome. Over the 43 years since 1979, the market has risen by an average of 13.0% per annum. And this is despite some seriously scary episodes, including the 1987 stockmarket crash, the 1997 Asian Financial Crisis, the GFC, and the fastest fall on record, the recent Covid-19 pandemic.

Chart 2. Volatility is the price you pay for a seat at the table

But, of course, in the short term – from year to year – markets are volatile.

The distribution curve is shown below but many investors have failed to grasp the most important aspect.

Source: Katana Asset Management

The main point is that crashes are inevitable: be ready and don’t panic at the bottom (the only time to panic is at the top).

There has only been one (calendar) year in the 147-year history where the market fell by 30% or more, in 2008. But if you panicked and sold during that crash, you would have missed an extraordinary recovery. In 2009 the market was up by 39.6% and rose in 11 of the 14 years following the crash, including by 18.8% in 2012, 19.7% in 2013 and 24% in 2019.

Chart 3. Rolling period returns

To better understand how the market behaves over different timeframes, we can break the data into rolling periods. For example, a rolling five-year period is the average return over every five-year period since 1875.

What this table demonstrates is extraordinary.

Source: Katana Asset Management

If you had invested your money in the index, turned off your screen, went away and came back five years later, then on average you would have a 65% return. There would have been only seven occasions out of the 143 rolling five-year periods you would have a negative return.

If you had invested your money in the index, turned off your screen, went away and came back in seven years later, then on average you would have a 100.6% return, and there would have been only two occasions where you would have a negative return.

But even more remarkably, if you had invested your money in the index, turned off your screen, went away and came back eight years later, then on average you would have a 120.2% return, and there would have been NO occasions on record where the dividends and capital growth would have been negative. There is only one long-term trend, and it is up.

Chart 4. Wait … here’s a better table!

Source: Katana Asset Management

At Katana Asset Management, we have literally compiled hundreds of tables over the past three decades, and this is our best. We see even more dramatically, the true power of compounding. Compounding for 10 years, produces the equivalent of 17 one-year returns. Impressive. But, compounding for 20 years produces the equivalent of an extraordinary 63 one-year returns!

Timeframe, timeframe, timeframe

If the short term is unknowable and the long-term inevitable, an investor really does need to focus on the long term. If through age or financial circumstance an investor does not have the luxury of a long-term horizon, then they should understand the extra risk that they are taking on.

Remember in the stock market, volatility is the price you pay for a seat at the table. There will be another crash. Guaranteed. If your time horizon is not beyond the next crash, or you panic and do the wrong thing at the wrong time, then discretion may be the better part of valour.

(This Katana Asset Management  article is general information and does not consider the circumstances of any individual. Any person considering acting on information in this article should take financial advice. Past performance is not a guarantee of future performance. Stock market returns are volatile, especially over the short term).

It is all certainly good food for thought, and is reinforcing information for us true investors!!

As always, should you have any queries please do not hesitate to contact us.

Disclaimer for information provided in this Commentary: This document, and the contents contained within, is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, or plan feature. The views expressed in this are subject to change at any time. No forecasts are or can be guaranteed.

With the summer holiday season now completed, and as the new year is getting underway, we may well ask so, where are we at now?

Without doubt, the past year of 2022, was a continuously volatile year with ‘many fears of this and fears of that’ being exploited by traders and expounded by media hype. Yet life goes on and we move forward, sometimes facing headwinds and other times with breezy tailwinds. It was not just a year of challenges for investors, it was also a year of good opportunities for investors with adjusting portfolios and for adding cheaper but still good quality assets to their investment portfolios.

As Ausbil Investment Management notes in their monthly outlook report; inflation and monetary policy continued to occupy the market, however, the US and Australian inflationary reads (of late) supported the view that inflation may have peaked, and the markets responded with vigour over the past few weeks’. By the end of 2022, sentiment was far more positive that rate rises would soon reach a terminal level and remain on hold, offering some respite for consumers and businesses alike. This more positive outlook for the capping of interest rates is coupled with positive news from China on Covid restrictions easing, and its potential reopening of travel and doing more exports. All this underpinned the strong positive return generated in markets in last month.

The past few months have favourably seen a moderation in consumer demand and an increase in global supply. These twin scenarios should see a dampening of the high prices which we all see and feel! Without doubt, we are all noticing and commenting on the rising cost of living. Everything has gone up in price. Probably this is plateauing now but, still, it is making an impact on cash flow needs, especially for retirees. You know my views on having good business and personal cash flow management, and in the current higher costs environment it is even more important for all of us.

In saying all that, there will likely be one more rate rise from the RBA here next week based on very recent strong retail sales data and the prevailing, but anticipated, annualised inflation rate now of 7.8%; its highest level in over 30 years. Nevertheless, I agree with Shane Oliver of the AMP when he said this week that “There is still a strong case for the RBA to pause on rate hikes (after February) given the rapid rate hikes to date, to allow for the lagged impact of the (already implemented) rate hikes to work, and given the risk of unnecessarily knocking the economy into recession”. The prospect of a recession this year in Australia does remain low, while the US and Europe may delve into one or, more likely, be on a trend of sub-trend growth.

The Australian equity market is now well back in positive territory from a year ago (very few other markets are) when the unnecessary Russian/Ukrainian conflict started to unfold. Furthermore, our market is higher than its pre-Covid time of nearly three years ago.  There was a lot of dislocation in all markets, particularly in 2022, but certainly there is a gradually growing feeling of better stability and a greater return to ‘normalisation’.

As we discussed in our last commentary, Australia appears to be somewhat of a leading light around this turbulent world and compared against many other economies. Our long-term outlook is quite encouraging. Yes, we are part of the global flowing world so we indeed can be and are impacted by world events, markets, and prices, but we appear to have an array of aligned ‘positives’ in our favour such as the abundance of sought after commodities, energy, agriculture, education, and professional services. We have stable political, financial, and legislative systems, and we have growing immigration supporting a steady population expansion over the decades ahead. Population growth is an important economic driver, particularly if immigration is targeted at adding to the areas where skills shortages are prevalent. We always seem to need tradies!

We regularly speak about the keys to successful investing, such as, smart diversification and allocation of quality assets; having a long-term view and commitment; and resilience and patience in times of volatility. The fund manager company, Allan Gray, describes patience as one of the most valuable advantages that investors can arm themselves with – precisely because it is also one of the most difficult to apply in real time, especially in times of hype, greed, and fear. These are the common and regular challenges posed to investors. However, I think that a true investor has seen and received the rewards over the years with the benefits of being well invested over the years. Investing is a means to successfully achieving your financial goals, especially in one’s non-working years where it is intended to deliver effective lifestyle cash flow for an enjoyable retirement.

This leads me into a timely article I read by the financial author, Peter Thornhill, who also advocates a multi-decade investment strategy which especially articulates the merits of dividend income. Remembering that investing does not have to be complex, I am noting here some simple but important points which he reinforces.

Peter refers to investing as being the use of money productively, so that a regular income is obtained. He does not focus on the so-called volatility of share prices as he sensibly maintains that over his fifty decades plus of investing, he sees a rising stock market producing ever-increasing dividends, which he sees as his ‘income’ for life. Indeed, so true.

Moreover, only with Australian equites, there is the added benefit of franking credits, which is icing on the cake for many retirees. (The same could generally be said with investment property prices in that prices rise over time as will their rental income).

Peter wisely and correctly states that “The ‘Covid crash of 2020’ is like all previous market setbacks. They are relatively short-lived. If one is in tune with history, then this pandemic is no different to those (and similar ‘black swan’ events) we have been exposed to for the last 2,000 or so years!” There will always be bouts of volatility, but the markets move on.

One thing I have noticed in recent years, is the forecasting of where markets are going for the ‘new year’ is now rarer to see as economists seemed to have worked out that trying to do short-term forecasting is often futile and inaccurate because, unfortunately, the short-term future is far less predictable than the longer term. As investors, we invest for the longer term, and I believe that is far more ‘in tune’ with the ‘prediction’ that investing over time sees growing capital gains and increased income! Traders and hedge funds really just live (and die) for the moment and, as such, get caught up in short-termism; simply failing to understand the mindset of the true investor, and the long-term income and growth gains that result for true investors.

I look forward to continuing working with you in in pursuit of your goals and, of course, as always, should you have any queries please do not hesitate to contact us.

Disclaimer for information provided in this Commentary: This document, and the contents contained within, is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, or plan feature. The views expressed in this are subject to change at any time. No forecasts are or can be guaranteed.

Benjamin Franklin famously stated that, “In life, nothing is certain except death and taxes”. Playing on this undisputable piece of wisdom, to quote the American university professor, John A Paulos, when he said, “Uncertainty is the only certainty there is, and knowing how to live with insecurity is the only security.” Again, unquestionable realism!

As the past three years have shown us all, we do live in a world that simply has many uncertainties and many insecurities. These appear to be more enhanced with the age of extreme globalisation that we live in these days. The world is a big place, yet it can seem so small sometimes. So much appears intertwined. We see and hear much of what goes on; and this often results in too much information, and certainly too much misinformation and misguided information!

When we invest, we are buying assets for the future that will, typically, be there to produce income and, also, to grow over time. The future has its uncertainties and insecurities, we know, however, history can help us to understand far better these and to explain why; how you say, “c’est la vie”! And with investing, the more we examine history, the less of a concern it becomes for when we determine its reliability over time for the future. Sensible investing in good quality assets pays dividends, especially over time.

As we know, the topics of inflation and monetary policy have dominated the financial markets for much of this year. Global inflation has risen with the ‘double-whammy’ of built-up demand for goods, services, entertainment, and travel, and by the disrupted supply chain on the other side.  As we have anticipated in the past few months, we are now seeing the peaking and likely eventual declining in inflation both here in Australia and around the globe. The desired impact of steadily increasing interest rates to take the heat out of the abnormally high inflation, and the forewarning of this by the central banks, is happening. Increasing interest rates does gradually reduce demand driven inflation. People have less cash to spend, and those with interest bearing debt have even less still.

On the constrained supply part of the equation, this too is improving as more supply lines are getting back in place and, also, with the positive news finally that China, the world’s biggest exporter, is relaxing its inhibitive zero-Covid tolerance rules, and it is re-opening of late more of its many trade avenues. More of the world’s much needed shipping containers and supply ships have been stuck in Chinese ports for many months. World trade needs a substantial number of containers and shipping vessels. Hopefully, this staggering availability problem should dissipate further in the new year.

I certainly believe that consumers are now becoming more price sensitive to the high prices for many goods and services, especially those consumed of a discretionary nature. People like value and not to pay full freight.  Sentiment does now appear to be showing that consumers are not chasing ‘items’ at too high prices, which we have all been frustrated by this year. Some much-needed price stability and more normalised price equilibrium is happening.

Disciplined management by households of their cash flow is paramount now that interest rates have risen, and with the very evident increased prices on many goods and services over the past year. The same control diligence applies for businesses in managing their costs, particularly with wages rises. Life is always a balancing act!

It is a very realistic scenario that with global inflation now subsiding, the central banks will reduce or even pause further interest rate increases in 2023. Economists’ consensus is that for next year, the US and Europe will probably touch into recession (again, a normal part of economic cycles!), while Australia, although not be able to avoid the impact of a global slowdown, should be able to remain recession-free, and even maintain its relatively strong  economic standing it is having. Again, Australia’s tag of being the ‘Lucky Country’ with all its abundances seems to be on the money in these more challenging of times around the world.

With that global scenario, it is hard seeing further rate rises if central banks believe that there is going to be a material global slowdown to a technical global recession. Most technical recessions are mild ones, and ones which happen in the economic cycle. Once more, steady judgement is needed to smooth out, but not crash, the wave of inflation via the implementation of interest rate rises.  Having some inflation is healthy to have, but too much is not so.

It must be remembered that economies do emerge from brushes with recession, so having a long-term view on economic cycles is recommended, especially with our investor hats on.

As we discussed in our previous commentary, even though this year has been challenging for investors with the market gyrations, it has also presented good opportunities to build on more investment assets to portfolios. Buying and holding quality assets is the core of a long-term successful investment strategy. With interest rates rising it has also widened the pool of investment asset choices. Of course, buying them when cheaper, as has certainly been the case this year, enhances that success!

Keeping to the broad investment strategy and adapting the plan to changes in your circumstances when required as you progress through life, leads to a far greater chance of goals being achieved. Good management and solid commitment to a plan makes the journey far smoother. Tending to your investments can be like growing a garden. “Plant a garden in which you can sit when digging days are done ”, adapting Sir Winston Churchill’s advice to good investment philosophy!

As the year of 2022 draws to a close, I would like to sincerely wish you and your families a very Merry Christmas and a Prosperous 2023. Thank you for your trust and continued support. The past three years have been challenging yet insightful for all of us. The new year ahead will have its joys and its challenges, no doubt, but what is life without these! Yet with its ups and downs, life moves on, as do markets! Season Greetings!!

As always, should you have any queries please do not hesitate to contact us.

With the noticeable lessening of market volatility over the past of couple of months, we have seen some substantial recovery gains in the markets. There has certainly been stabilisation and, also, an apparent regained awareness of how things may look post the inflationary driven fears that had dragged the markets downwards for much of the year. People, businesses, governments, and central banks have all had to adapt from the years of very low interest rates to the more normalised rates we are now seeing. Solid corporate earnings have also supported the positive market moves in recent weeks.

Presently, we appear to be in a holding pattern to find if an easing of interest rate tightening will happen. Earlier this year, central banks probably started to pull back the joystick on raising rates a bit late but then went full throttle with rate rises, albeit these were anticipated in the main. As mentioned in last month’s newsletter, we are very  likely to see the key central banks do one more rate rise in the US, Europe and here next month, and then really assess the impact of the sequence of rate rises made in stemming or possibly reversing inflation. The markets recent rallies seem to underpin this view. Markets tend to front run actuality, but they can get it wrong on occasion too!

So, maybe, to hold interest rates steady for a while in 2023? I really think the undertaken rate rises need to be given time to be gauged for their impact rather than continue with further rate rises next year, which would certainly increase the chances of undesired recessionary economic consequences. It is hard to envisage that the rate rises to date are not having effect on certainly the dampening demand side of inflation. I also think that with the passage of time, we are also seeing the supply line constraints and shortages improving. The improvement of supply chains will help stifle consequential inflation pressures. Alas, all just seems to be taking time!

This lessening of or maybe even ceasing of further rate tightening next year is being factored into the markets as we have seen. If the inflation ‘worm’ begins to turn downwards then this anticipation should see reality. If not, and inflation remains stubbornly high, additional rate rises could be implemented by central banks. Steady judgement is needed.

Reading a recent article from the fund manager, Investors Mutual, in it makes a couple of interesting observations as to why it considers rate rises will have a faster inflation dampening impact in Australia than that in the US. It notes that Australian household debt sits at a (gulp!) 202% of net disposable household income, which is one of the highest in the developed world. By contrast US household debt sits at 101% of disposable income which is exactly half that of Australia’s. This means that any increase in consumer interest rates through an increase in mortgage, personal loans or credit card rates hits Australian households twice as hard as those in the US.

Investors Mutual also interestingly note that in the US around 95% of existing residential mortgages are on 30-year fixed rate loans which means that repayments for the vast majority of existing mortgage holders in the US, do not change at all in the current environment. However, in Australia, it is a very different situation with over 60% of Australian residential mortgages being at variable rates. And, as we have seen over the seven-interest rate rises in Australia this year to date, whenever the RBA raises official interest rates this increase is passed on in full by lenders to mortgage holders. This has meant loan repayments have gone up seven times already this year, and very likely at least one more to go next month!

Servicing a mortgage and other personal debt is costing more and more both in dollars and in cash flow outlay. With reducing property prices but high debt levels, many people will feel less comfortable and less able in spending on other things all round. Bottom line is that with these aspects combined, it appears that inflation should show signs of tapering off, and even reverse faster here in Australia than in the US.

So, you would have to think, and hope, that inflation here is peaking, and should then start declining to more normalised levels. Amusingly, compared to only a couple of years ago, you have to ponder how the reverse fear held by economists was that there was virtually no inflation and what that meant to lack of global growth of note! Having annual inflation somewhere between the target zone of 2% and 3% seems to be the ‘fearless zone’!

As Fidelity International state in their Outlook for 2023, “…If central banks remain excessively hawkish and negative, and over tighten monetary conditions through a mix of interest rate hikes and quantitative tightening, there is a risk of an inflationary bust this year, with economies struggling to mitigate the damage. This could hurt both the real economy and asset prices”.

Fidelity International also note that, over a longer time horizon, “…we see no reason for undue pessimism. Economies will survive particular bout of challenges and doubtless emerge stronger when they do. As long-term investors, it is important not to lose sight of the big picture, but to be alert to opportunities along the way”.

Even though this year has been challenging for investors with the market gyrations, it has also presented good opportunities to build on more investment assets to portfolios. Buying and holding quality assets is the core of a long-term successful investment strategy. With interest rates rising it has also widened the pool of investment asset choices. Of course, buying them when cheaper, as has certainly been the case this year, enhances that success!

As always, should you have any queries please do not hesitate to contact us.

As I ‘put pen to paper’ (the former expression for what is known now as ‘tapping the computer keyboard’), the old Tears for Fears song, ‘Mad World’ came on the radio in the background. What a very appropriate song to describe what seems to be going on in the world, er, the mad, mad world at present! And the persistent rains outside my office, propelled by the strong southerly winds, do their own mass tapping on the windows in front of my desk, creating its own added madness!

Ten months ago, as the world was well winning the battle against Covid-19, things were looking much brighter ahead. However, some of the consequences and now realities of the previous two years of Covid troubles that were simmering, were evidently coming to the fore.

The world was immersed in very cheap cash, record low interest rates, and aggressive government spending and handouts to combat Covid-19 induced global lockdowns and life adjustments. No one seemed to complain about these actions and remedies! At the start of this calendar year, the world was ready to emerge from its long moth cocooned Covid-19 stage to its anticipated bright butterfly future.  

Yet, as the curtain came up and this year unfolded, it may better be described as a false dawn! Sluggish global supply lines and logistical constraints became more obvious and inflicting. Increased demand caused by people and businesses wanting to spend but needing to pay up higher and higher prices for goods, services, and staff. The massive boom in online shopping and deliveries to our homes has also very notably spurred on this habitual spending.

To the problem: inflation had two ignitions at the same time sending it well higher than anticipated: shortage of supply and excessive demand. Not a good mix, but it is seen as being more temporary than entrenched.

Rising global inflation rates were further added to by the China zero-Covid lockdown policies and thereby creating the underutilised but much needed seaports for trade; and, also, by Putin and his posse of failed generals trying their maniacal bullying approach and threats to world peace and European energy supplies. I can’t believe psychopathic Putin running an empire of fear and death is still here.

The severity of weather conditions both in Australia and in many other countries has also caused delays and supply issues. All these variables have had an extraordinary accumulation effect on inflation. Seemingly, what could go wrong in this regard has done so. As we have seen, for all, and for the markets of all asset classes it has been a challenging 2022.

The cavalry of the central banks of the globe came with their fire hydrant technique of swiftly raising interest rates to cool the inflationary heat. And these rate rises, along with the uncertainty of possibly future rises, furthered with the somewhat confusing rhetoric on rates from the US Fed has been causing much of the market volatility in the more recent months. But rate rises are starting to take effect, but it will take time to work through.

Keeping all in perspective though, the overall level of rate increases is merely putting them nearer to historical normality but still, to date, below long-term averages. It was interesting to see the RBA pull back on the size of the rises with its one done last week being only 25bps not the markets expected 50bps. After six straight rate rises, it is prudent to somewhat pause to allow the rate rise medicine to do its job!

Dr Shane Oliver, Chief Economist at AMP, points out in his latest ‘Economics and Markets’ report that “The RBA sensibly dropped back to a 0.25% hike this month taking the cash rate to 2.60%. It is still signalling more hikes ahead though…. Slowing the pace of rate hikes makes sense: the RBA needs to allow time to assess the impact of rate hikes so far given that they impact with a lag; many households will see a sharp rise in mortgage payments which will depress spending through next year; global inflationary pressures are easing; (and importantly) inflation pressures are less in Australia than elsewhere; and there is now a higher risk of global recession which will impact Australia… We see another 0.25% rate hike next month taking the cash rate to 2.85% which we still expect will be the peak in the cash rate, albeit the risk is on the upside to 3.10%. (However) we still see rates falling late next year.”

The Senior Portfolio Manager for the Fidelity Australian Equities Fund, Paul Taylor, outlined in his October post that,” The August reporting season saw some strong results. Going forward, the market will be more focused on interest rates, the prospect of an economic slowdown and maybe even a recession in 2023 (because of the degree of rate rises). With interest rates expected to keep rising, the likelihood that the US and Europe will enter a recession in early 2023 is increasing, but it is less certain if Australia will follow suit. High energy costs coupled with better conditions for commodities will help cushion the blow to the Australian economy, but future rate rises could do some damage. An official interest rate of 4% has the potential to push mortgage rates to the 6% range, putting considerable pressure on a highly leveraged Australian consumer”.

I think this scenario of 4% interest rates here is very unlikely given we are now seeing the impact of rate hikes already doing their job to slowdown inflationary, as well as seeing the supply links improving and consumer demand reducing. The global economy is slowing down, so to have continued rate rises into next year would be very questionable economics. The markets are certainly starting to factor and price in a mild recession next year in the US and Europe, but I am not sure why so in Australia? Australia is better placed in many regards, but it is still part of the world. Nevertheless, is it a case of sell the rumour, and buy the fact, I do think so.

Taylor concludes his article by saying, “More importantly, I believe, when we talk five years from now, we’ll look back at this period of volatility and recognise it as a very attractive time (now) to have invested in markets for the long term”. And we know that investing should be and is for the long-term. We must maintain the vision for being invested in good assets.

Similarly, to both Oliver’s and Taylor’s points, Lonsec Research states in its latest News & Insights report that it “still believes that inflation will eventually peak, and we may see central banks seek to reduce rates at some point in the coming 12 months as the economy shows further signs of slowing. The global economy is already showing signs of slowing with consumer sentiment falling, certain parts of the market such as construction under increased pressure, and indicators such as PMIs, while still broadly positive, showing signs of weakening. If central banks overshoot in their rate hikes the economic slowdown will be more pronounced plunging world economies into a recession”. The RBA appears to be very aware of this by taking a very measured approach to rate rises from here.

In short, it appears that the next couple of months or so to year end, we will likely need to absorb some more market volatility, but this would appear to be lessening, and the possibility of a rate rise or possibly two more by the RBA this year, should be pretty much what we can and should expect.

With that, the rain outside has stopped, and I can see the sun is creeping through the dissipating clouds. My mind turns to a more appropriate song, which I have now just downloaded from YouTube, being ‘Walking on Sunshine’ by the boppy band, Katrina And The Waves. And it goes: ”Walking on sunshine,…..and wooah, don’t it feel good…”. 😊

Keep the faith!

As always, should you have any queries please do not hesitate to contact us.

Disclaimer for information provided in this Commentary: This document, and the contents contained within, is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, or plan feature. The views expressed in this are subject to change at any time. No forecasts are or can be guaranteed.

After a seemingly long and very wet winter, Spring has arrived! Not an obvious change in the weather yet, but let’s hope the warmer weather is just around the corner! Let the sun shine!

Funny how a drop in petrol prices feels so good in these times of rising prices. I filled up the car yesterday at a fuel price of $1.81 per litre. About two weeks’ earlier,  I paid $2.30 per litre, being the normal price at that time.  We have had many months of notable rising prices in almost all goods and services, so it just felt nice that this necessary item, and now more items as well, are reversing the rising price trend which we all have experienced. Is this a sign that prices are retreating more back to the norm; and that the grumble of global inflation is stabilising from these  unusually and concerning high levels of the year to date. Maybe it is.

Albeit slowly happening, the supply side is improving, and the opening up of some spare capacity is helping douse the unusual level of inflation which is believed to be more transitionary in nature rather than being entrenched. In the main, businesses, both large and small, are getting closer to operating as ‘business as usual’. Of course, the reality is now the adapted business as usual in our post-Covid impacted world of how we are all doing business.

It cannot be doubted that the Covid-19 pandemic has been one of the biggest and longest impacting happenings that the world has ever experienced. The world was turned upside down in a very short period of time in early 2020. However, with much concerted effort and the strong human spirit, we are moving on, maybe though a bit jaded from its duration!

So just where are we in this rising interest rate cycle?

For several months now, we are seeing central banks around the globe raise interest rates in response to growing inflation which is well beyond the ‘acceptable 2% to 3% range’. You do want economic growth but not at extreme levels of inflated prices. As we have discussed previously, the demand for goods and services is high, supply is tight, and that also is the case with finding staff, in these times. In a global nutshell, with shortages in supply, and with heightened demand especially backlog of demand, it means extreme levels of inflation are resulting.

If central banks want inflation down, they typically respond by increasing official interest rates (as well as issuing/selling bonds to soak up cash – reverse QE!). This is what is happening now, as we know. Rates will still go higher with the aim to find the right point where inflation is curbed, and then heads back towards the ‘acceptable’ levels. The challenge is to find the correct amount of rate rises, and the right timing of these, to ideally have a ‘soft landing’ that achieves the desired outcome. If it is too much, then it could dampen economic activity to a point where it may trigger a period of too low economic growth or even recession, albeit only likely to be only temporary.

In JP Morgan’s latest Insights, it notes that “Central bankers are not backing down from the inflation challenge. In the past week, the message from both the U.S. Federal Reserve (Fed) and the European Central Bank (ECB) is that rates will have to go higher and remain there longer to curb price pressures.

A key takeaway from the very recent annual symposium of central bankers at Jackson Hole is that inflation in the U.S. is still a problem and more needs to be done to tame price increases, even if this leads to a period of weaker growth. The recent drop in bond yields, and subsequent easing in financial conditions could also have prompted the Fed to reiterate its hawkishness. Fed chair Jerome Powell said that the Fed ‘must keep at it until the job is done and to push inflation down could result in a lower economic growth for a sustained period’ ”.

Our own RBA meets tomorrow, with this very likely to result in Australia’s cash rate to go up 50 bps to 2.35%. Interestingly and positively, rising inflation in Australia is lower than in the US and Europe.

Nevertheless, seeing interest rates rise now is both understandable and acceptable. We are approaching more normalised levels for rates. The consensus appears to be, and is hoped to be, that by the end of this year, central banks should have taken rates to sufficient levels to bring down inflation and therefore stopping further rate rises. It appears that this expectation is being factored into the markets.

Business and consumer confidence are also contributing factors in which direction and at what speed economies move. These factors were very favourable at the start of the year, but they have lagged with the surprising high inflation, the level of interest rate rise uncertainty, and general but niggling global geo-political events occurring. This all has brought about significant market instability, with most investment assets caught in the volatility.

There is media hype that having higher rates is unfair on households with mortgage debt. But it must be remembered that it is only a third of households in Australia which actually have mortgage debt. In 2020 and 2021, we had the pandemic induced ‘emergency’ record low interest rates, and this clearly spurred on property prices to record levels. We are simply returning to a normal interest rate environment, which is now definitely seeing lower but more normalised property prices.

For investors and savers in the ‘rate’ space, interest rate rises are now offering up better and more viable returns for cash holdings and term deposits, etc. These rates were near zero percent for most of 2020 and 2021! You can now get near 2% for cash, over 3% for TDs, 3-yr government bonds at near 3.5%, and listed bank capital notes grossing at over 5%. These yields are likely to go higher by the end of this year, but what it shows is not all people will be adversely affected by rate rises! Higher rates are pleasing for certain investors.

So, we are in a period of adjustment. The challenging environment in these current times has been having business activity and consumer demand high, and supply chains still chunky. This is what primarily underlines the market volatility in the past six months with there being various forces adding to the sensitivity of rate rises. In saying all this, there is much ridiculousness in watching the day-to-day market volatility that envelops markets and through dramatic media reporting. Traders, not investors, live on the news wires for anything said or rumoured to cause them to immediate jump in and out of markets on a whim or a mere comment! There is little investment conviction with that approach. They live and die by the sword approach!

We may have higher rates for longer than hoped at the start of the rate rises this year. However, as time goes on for the remainder of this year, expectations are that interest rate and inflation uncertainty should diminish to create more market stability.

A long-term outlook is always the best approach to successful investing, which is achieved by acquiring good quality investment assets capable of delivering a combination of returns for investors via cash flow income and price growth returns.

In the short-term, however, we await in anticipation for Labor’s first Federal Budget to be handed down by the new Treasurer, Jim Chalmers, on the 25^th October. Let’s hope it contains more good news than bad so that ‘Grim Jim’ can repel his anointed nickname by the media!

As always, should you have any queries please do not hesitate to contact us.

Other than cash, it must be remembered that investment financial assets are typically two-dimensional, that is, having returns and valuation movements. The part of income returns is often forgotten , especially by the media bad news spruikers who simply report market price to market price. They forget (or do not really understand) income and its importance. Whether that income be derived from bonds, equities, property, or infrastructure, they all produce tangible forms of cash income, and whether that be from bond coupons, interest, dividends, or rent.  Income is a critical thing to remember always, especially during the more volatile periods in the markets such as we are experiencing in these current times.

What the media do is pretty much always neglect when reporting about the markets is that there also is this vitally important income equation, and not just about the market prices going up and down!

It is nice and reassuring when we see our investment portfolios going up in price, but that is not how markets operate over time. Markets do go down, to varying degrees, on occasions, as we well know. In saying that, and in principle, as investors, we should not be phased by this occurrence as much of it is simply day to day noise; traders jumping at minute-by-minute news; and economic broadcasters simply trying to over-predict outcomes, and often changing (or as they call it, updating) their views in a short timeframe.

So, just why do we invest? Essentially, it is so that we can earn income and growth in our portfolios over time. The income may appear less important in our working lives but, when we are retired, whether fully or partially, the investment income returns become more relevant and essential, as this is what we will live on, and ideally allowing us a comfortable lifestyle in the future. This point is where Passive Income from an investment portfolio replaces Exertion income from our work, as we plan for or as we know already if retired!

In the month of July, we investors receive our main annual dividends and distributions from managed funds and ETFs. This cash fills the ‘well’ which can hold these monies, and other future investment income, that we can and will draw on. And this deliverance of income streams happens year in, year out, with a quality and diversified portfolio, which will, also, have opportunity to grow further over time.

In his book, about quality and value investing, ‘20 Lessons from 20 years’, the well-respected equities fund manager, Anton Tagliaferro of Investors Mutual, illuminates this very point of producing income via dividends.  Tagliaferro is absolutely right on the mark when he says that “I have learnt over the many years of investing that there are three reasons why dividends are key to investing in the sharemarket.

1. Dividends are an important part of the return of an equity portfolio.  

2. The levels of dividends is not impacted by the level of the sharemarket; and  

3. The dividend yield on stocks can act as a ‘safety net’ in times of volatility”.

Tagliaferro further points out that “The level of dividends and the dividend payout ratio of any company is set by their board of directors, and is generally a reflection of a company’s overall profitability, independent of its share price. This is important to remember as it means that during negative periods in the sharemarket (such as exists at present), an investor’s level of dividends from a diversified portfolio, if made up of quality companies with the right attributes, should not vary greatly from year to year, and is largely irrelevant of what is happening in the sharemarket”. So, importantly, dividend volatility is far less than that of the sharemarket volatility, which is quite reassuring to us, being investors, when taking regard of the importance of continual income from our investing over time.

Dividend rates are particularly high in Australia compared with the rest of the world. Historically, they represent over 40% of the total returns in the Australian sharemarket, which also has the additional benefit of having tax effective franking credits added on top of many of the Australian companies returns. Franking credits are even more attractive to investments made through super and pension accounts.

All of the above points hold if you do not have to sell shares. In the main, people do not borrow to invest in shares, and many of us use super for the bulk of our accumulation of investment assets. This helps support the strong case to stay invested in income earning and quality companies despite share price moves.

In the past few newsletters, we have discussed in detail the ongoing topical theme of rising interest rate and inflation conditions throughout the world, including here in Australia. I think we all know where both these variables are at. Taking out a mortgage now, filling up the car, or doing some shopping, will very much be evidence of these rises!

Global inflation rates have sped out to an early, and substantial lead to that of interest rates. The global markets, most notably in the past few weeks’, are expressing the concerns with the rising interest rates on cash and bonds, and weaker equity and property markets. Little is spared from the volatility in any of the asset classes at present! However, this is the adjustment back more to the norm really, which must be remembered. It is also a result of imbalances in demand and supply factors as we have well discussed. Why it appears more dramatic now is that the official responses, that is central bank interest rate rises, are measured in implementation but in a quantum that is slower than maybe it should be.

This divergence between the higher rates of inflation and the lower, but rising, interest rate increases is frustratingly still there. The consequential fear of the impact of interest rate rises includes that global economic growth will retreat and global corporate earnings will slow down despite both continuing to still be well positive. The primary concern seems to be the considerable gap between the rising inflation rates and the responsive interest rate rises. Normality is really to be having official cash rates in line with inflation rates, but this gap shows the current disparity. It will take time to close the gap.

It is early days in this quelling of inflation, but it seems that the fear of the interest rate rises in response to the inflation could be overdone with the aggressive predicted interest rates in the forwards markets. For example, the official cash rate in Australia (and in the US) is predicted to get to above 3.50% in 2023. An economic slowdown and growth rate decline caused through fear before fact may very well see that higher level not reached then. Inflation is artificially high today with the various issues economies face, but it could easily retreat back to acceptable levels quite quickly, particularly if supply constraint issues are alleviated. If so, central banks may well cease the quantum of the rate rises earlier than anticipated by the forward markets.

Until more of an equilibrium point between interest rates and inflation rates is reached, then economic uncertainty and market volatility will most probably continue. Investors must remain focussed and patient in such times, albeit unusual and challenging times, essentially all caused by the Covid-19 pandemic and its ongoing consequences started over two years ago. I had my fourth vaccination today so this shows how it all still lingers, but it will be overcome! Sadly, the one constant in place is this persistent rain! A tough few months for all!

As investors, we must see this market pullback as understandable (i.e. we know why it is happening), but also, to see it favourably, as a good opportunity to add cheaper income and growth producing investment assets to long term diversified and goal focussed portfolios.

As always, should you have any queries please do not hesitate to contact us.

Disclaimer for information provided in this Commentary: This document, and the contents contained within, is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, or plan feature. The views expressed in this are subject to change at any time. No forecasts are or can be guaranteed.

FMA Wealth Commentary – June 2022

This economic battle to tame global inflation is the fire underneath the continued market volatility. Inflation’s revival has always been expected after the dramatic and large Covid-19 impact (and resultant consequences) to the whole world; a near unprecedented event in the past hundred years. Yes, and since late last year, the recovery from all this is happening indeed, but just not happening smoothly.  Especially, inflation’s happening with a vengeance!

Having some inflation is regarded as being both positive and a normal feature within an economy. It implies there is growth and stimulus of activity in motion. However, with this present global recovery underway, it is becoming evident that inflation is at higher levels than central banks around the world anticipated, both in its size of increase and its speed of increase. Although it is commonly agreed that this current inflationary problem was seen to be more of a transitory symptom as the world adjusts back to more normality, the concern has now become when will the rising inflation halt, and will it fester longer and be more rigid to repel.  We all are seeing, feeling, and hearing about rising inflation for months now.

A major function of central banks is to manage inflation and, typically, to do this they adjust the monetary and bond levers. The Reserve Bank of Australia habitually likes to have annualised inflation in the 2% to 3% band. Not too little and not too much. If an economic slowdown beyond the RBA’s desired level for economic growth, it would likely ease official interest rates and pump more cash and liquidity into the system through bond buying coordinated programs, etc. During the critical Covid-19 period of 2020 and 2021, the RBA, and other central banks around the world, just applied ‘emergency measures’ and put the release on the handbrake down completely. Cash rates, bond rates near to zero percent. Unprecedented Government fiscal measures and cash ‘hand-outs’ also happened, as we know. All this combined, flooded the economy with cash and liquidity, and thereby avoided what could have been disastrous economic and social outcomes otherwise. All in all. it seemingly worked for its purpose.

However, with cash at its cheapest level ever, and large amounts of household savings and many businesses with healthy cash holdings in their balance sheets, this all was inevitably going to spark inflation as the recovery and more economic and social normalisation re-emerged. However, other factors too, as will be noted below, have turned ‘up the heat’.

Many central banks around the world are now being criticised for acting too slowly in not raising interest rates earlier (which they began to do a few months ago), and also for not been quicker to cease quantitative easing measures (pushing cheap money into the economies). It probably is a fair criticism of central banks, and of governments too, as inflation has now burgeoned.

But, gee, the past two or so years have been a battle for successful economic management amidst the closures, lockdowns, shortages, deaths and illness, travel bans, etc. triggered by the Covid-19 pandemic. And we must remember that it is easy to be critical of events and the actions taken because of them, when reading about them through the eyes of history!

When asked by a commentator after not winning a close PGA tournament whether he should have used a different approach to an important shot that fell short of the green; the Irish golfer, Shane Lowry, responded with his big smile and simply said “Er, sure, hindsight is genius, isn’t it!”.  So true, so true.

Okay, so now, the converse situation is in play now. Central banks are front-loading interest rate rises to ensure that inflation has peaked or at least close to peaking. Possibly another criticism is that they should have gone in with larger quantum of rate rises initially but there are also other variables and headwinds in play (life is never simple!). The central banks know they must hike up rates at a quicker pace, as they most certainly will do, to create a more normalised financial environment from its current pressures. We are in interest rate rise mode, as we know, and bond yields continue to rise across the yield curve.

Equally, central banks and governments must manage the quantum and timings accurately enough so they can respond quickly by having capacity to reduce rates, etc. to avert stalling the economies. Flexibility management is important as they desire to achieve the old ideal ‘soft landing’ approach to avoid unintended recessionary outcomes.

So just why is inflation so rampant at present?  I have outlined below the fundamental reasons for this rapid spike in inflation around the globe being a combination of numerous factors occurring together, and which is, in culmination, causing the prolonged market volatility around the globe:

• Consumers and businesses are broadly flush with cash/savings creating excess demand for goods and services. Such heightened demand is causing price rises. Disposable incomes are still at high levels and, therefore, spending by consumers remains at a rapid clip, as the world has, to the great part, ‘re-opened for business’!
• Economic growth on a broad global basis remains strong so there is also ‘normal’ growing demand taking place.
• Slowness in central banks active responses to curtailing the obvious outbreak of inflation. Anyway, this is now being tackled by actual aggressive global rate tightening.
• Most economists did not foresee the degree of inflationary rise. In saying that, several factors involved were not known or had not been on the radar as they have emerged in recent months e.g. the Russian/Ukrainian conflict.
• Covid induced trade, transport and travel restrictions causing supply side constraints, this ‘less supply availability’, with increased demand pressures, creates price rises.
• Near full employment (also because of virtually no new immigration here for two years) induces capacity constraints, thereby causing wage increase pressures.
• Businesses which suffered downturns in trade and activity over the past couple of years simply charge more now as part of their ‘catch-up’ strategy and ‘we should’ philosophy.
• The Russian invasion and despicable war on Ukraine causing massive oil and gas price rises, and now also food delay shortages and resultant price rises.
• China is the biggest exporter of goods in the world, however, its extreme zero-Covid lockdown policy which it forced upon its citizens because of its ineffective homegrown vaccine, has caused massive supply shortages, and has meant supply ships and containers sitting idle for many weeks’ which is adding to bottlenecks in the global supply chain.
• High demands for Commodities and Resources being very strong, and now seeing some record prices in key ones. Fortunately, Australia is blessed with being the ‘lucky country’ with its abundance of natural resources, including energy, and its high food production output. So, economically this is good for Australia and its exports. Australia’s GDP outlook remains strong.

Looking through the above list it is no wonder that inflation has risen, and particularly so most notably in the past few months. Australia’s own official annualised inflation rate is over 5%, however, most things that we buy or services we use appear to have risen in price more than that, I am sure we all agree! The US inflation rate is now at over 8% annualised.

It certainly seems that persistent inflation will remain for a while more, and the markets will likely continue their volatile actions until inflation is capped and reduced, and to what extent further interest rates rises will be taken.

It is a rough ride for investors at present, and there likely will be further frustration, but we do know what is happening and why it is occurring. We also know that many of the above issues will be solved with time, and with directed central bank, Government, and corporate policy measures. We also know that global economic growth remains positive, and the evidently good corporate earnings now and forecasted ahead, also support this brighter picture.

Yes, this stemming of inflationary pressures must be, and is, at the forefront of action being taken. Yet, the markets do overreact, especially when frenzied traders and media meddlers are involved, as they always are in such times. Uncertainty in the short-term can be challenging, as it is what is impacting current weakness in the markets. However, with a long-term outlook by investors, and a reminder that with long-term solid economic fundamentals being relevant, the current volatility can and is presenting very good opportunities to add quality growth and income assets to investment and superannuation portfolios.

As I see it, and practice it myself, by having belief, implementation and commitment as a defined strategy when owning and building a quality investment portfolio puts true investors on the path to achieving their financial goals over the long-term.

Speaking of superannuation, do remember that any superannuation ‘top-up’ contributions for this financial year must be completed within the next couple of weeks’.

As always, should you have any queries please do not hesitate to contact us.

Disclaimer for information provided in this Commentary: This document, and the contents contained within, is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, or plan feature. The views expressed in this are subject to change at any time. No forecasts are or can be guaranteed.

For many people, both here and abroad, it has been a particularly tough few months for a variety of reasons. We have had Covid-19’s impact lingering on (but working through); Rains and floods galore; Shortages and delays of goods, staff; services, skills and tradies; Commodity, oil and energy prices soaring; The continuing and tragic impact of the elevated Russian/Ukraine conflict in Europe; and the Chinese ‘expansion operations’ and tighter economic reforms.

And now, the RBA raises the official cash rate 25pbs, its first rise in over 11 years!

So, we face two more twists, albeit they have been brimming for a while, and which we have discussed in our previous commentaries. The inflation rate in Australia is running higher and higher and, similarly, inflation is doing so around the world, causing the central banks of many nations to increase official interest rates. Furthermore, we have a ‘here we go again’ Australian Federal Election occurring in three weeks’ time. The very topical matters of interest rates and the Federal Election are discussed further on below.

These are turbulent and unusual times for all of us, including for most central banks and governments. It is also a time of adjustment and, as such, current events are weighing on the markets too, even though several of the ‘reasons’ noted earlier are slowly changing favourably for the long-term benefit.

Primarily instigated by the onset of Covid-19 in early 2020, much as it can be said that the global economic management of the past two or, so years has been considered successful management on the run, it was so because of the authorities mainly using the channels of the flooding of cash and credit liquidity to stave off a major probable global calamity. The earlier than anticipated and effective arrival of the vaccine to the virus was also a huge game-changer.  The pendulum of the Covid-19 situation has turned, as we know, yet this shift has, in the process, also caused abnormalities to economic current outcomes, especially those noted above. And our daily lives and even lifestyles have changed too since early 2020. Flexible working location (home and office combination) and hours an obvious change.

Nevertheless, we must keep things in perspective and understand that we are in a correction phase or, maybe better seen as more a return to more normality, particularly regarding the onset of higher inflation and interest rate rises. These will balance out more to the historic norms, but we do have inflation back, wage growth coming back, and we will have higher interest rates. Providing these all settle around a few percent, as is anticipated, say by early 2023, then it is back to normality, which is a good thing. The monetary policymakers aim to reach neutral relatively quickly to essentially get interest rates back to the right levels, which are higher than present.

Having interest rates virtually at zero for two years was good to have for most of the period noted, but it is not needed now, and is not sustainable in a cash rich world pushing up asset prices, etc. The economic changes that we are now seeing and feeling, are the shorter-term consequence of what should be closer to getting us arriving again to the right status quo!

The RBA should have raised rates earlier but at least it has now moved before 2024!

The Governor of the RBA, Philip Lowe, must cringe at what he stated publicly as late as last year in that “…the central scenario remains that the conditions for a lift in cash rate will not be met until 2024…”. Obviously, Lowe got that one very wrong. Once again, predicting macro future events and timings can be thwarted with danger, even for the supposedly very well-informed RBA Governor who is on a salary north of $1mm!  

A rise in official interest rates in Australia circa mid-2022 has actually been on the cards for a while because, as inflation has been rising quickly most notably since the start of this year, not just in Australia, but also across much of the world. The annualised 5.1% inflation rate in Australia last week forced the RBA’s hand based on its monetary policy targets. So, no real surprise, and more rate rises on the way, also no real surprise.  High demand not being met (yet) by limited supply. This anomaly is being addressed within the adjustment and sometimes pain of the ‘return to normality’. I think the new normality will be a little different though in how we feel and act because the past couple of years has also changed us and changed how the world operates more permanently now.

In saying all this, the May Monetary Policy Statement, released yesterday by the RBA, provides a very good update on the economic state of play in Australia (and, also, with broader world) on the machinations behind it.  I have given some edited notes below from the quoted Statement on what I consider are the key points that the RBA outlines with its action now and likely continued action in the next year or so. Overall, the RBA’s Statement appears clear, and quite positive and realistic for the picture of Australia economically ahead.

In the Statement, it states that…”The RBA Board judged that now was the right time to begin withdrawing some of the extraordinary monetary support that was put in place to help the Australian economy during the pandemic. The economy has proven to be resilient, and inflation has picked up more quickly, and to a higher level, than was expected. There is also evidence that wages growth is picking up. Given this, and the very low level of interest rates, it is appropriate to start the process of normalising monetary conditions (FMA comment: this is done by increasing interest rates, and by tapering-to-stopping quantitative easing bond buying programs).

The resilience of the Australian economy is particularly evident in the labour market, with the unemployment rate declining over recent months to 4 per cent and labour force participation increasing to a record high. Both job vacancies and job ads are also at high levels. The central forecast is for the unemployment rate to decline to around 3½ per cent by early 2023 and remain around this level thereafter. This would be the lowest rate of unemployment in almost 50 years.

The outlook for economic growth in Australia also remains positive, although there are ongoing uncertainties about the global economy arising from: the ongoing disruptions from COVID-19, especially in China; the war in Ukraine; and declining consumer purchasing power from higher inflation. The central forecast is for Australian GDP to grow by 4¼ per cent over 2022, and 2 per cent over 2023. Household and business balance sheets are generally in good shape, an upswing in business investment is underway and there is a large pipeline of construction work to be completed. Macroeconomic policy settings remain supportive of growth and national income is being boosted by higher commodity prices.

Inflation has picked up significantly and by more than expected, although it remains lower than in most other advanced economies. Over the year to the March quarter, headline inflation was 5.1 per cent and in underlying terms inflation was 3.7 per cent. This rise in inflation largely reflects global factors. But domestic capacity constraints are increasingly playing a role and inflation pressures have broadened, with firms more prepared to pass through cost increases to consumer prices. A further rise in inflation is expected in the near term, but as supply-side disruptions are resolved, inflation is expected to decline back towards the target range of 2 to 3 per cent.

In a tight labour market, an increasing number of firms are paying higher wages to attract and retain staff, especially in an environment where the cost of living is rising. While aggregate wages growth was subdued during 2021 and no higher than it was prior to the pandemic, the more-timely evidence from liaison and business surveys is that larger wage increases are now occurring in many private-sector firms.

Given both the progress towards full employment and the evidence on prices and wages, some withdrawal of the extraordinary monetary support provided through the pandemic period is appropriate.

The RBA Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time. This will require a further lift in interest rates over the period ahead. The Board will continue to closely monitor the incoming information and evolving balance of risks as it determines the timing and extent of future interest rate increases…”.

Fairly clearly stated and net positive is the outlook by the RBA. Australia is positioned well to other economies for strong continued above trend growth. On this, the fund manager, Ausbil, has just written that “Relative to the rest of the world, (looking ahead), Australia’s starting position is quite favourable, with solid growth, lower headline and core inflation levels, lower cash interest rates, an unemployment rate falling to 3.5% from 4%, and wages growth still lagging for some time at 2.5%. A negotiated settlement in Ukraine would present (further) upside to the economic outlook”.

As said, the markets are in the process of adapting to this changing environment. Volatility in the markets will be around so we should understand this and be remembering that volatility brings opportunity too. However, property prices thrived on the ultra-low interest rates of the past couple of years, so to expect a correcting downward in prices because of these rising interest rates will happen. Corrections can be very positive sometimes too. So, very probably, frustrated property buyers can finally flap their wings! My eldest son certainly hopes so!

In the race for this month’s Federal Election, we are seeing jostling, sledging, promise making and more attacks and counter attacks between those wishing to lead our country for at least the next three years. The voters are fed up and quite disinterested by the same old, same old.

However, placing political cynicism aside, it must be difficult and bordering on stupid for our political leaders to keep stepping up making promises of what they will do and what their opposition will not do!

I do think that there is genuine desire for each side of politics to want to make ‘promises’ and actually know that they can execute and deliver them when they are ‘in power’. Unless a government can run a country for its elected term, be able to implement its policies during that term, and for them and us, the voters, to properly assess the results of their policies, much of the electioneering is simply false. Yet, with the political leaders’ repeated line of ‘when we get in power, we will do this and we will do that’, just does not appear to hold these days in what seems to be near an ever-hung lower and/or upper houses. Alas, at this stage, this upcoming election result appears no different. Politicians’ credibility is very poor because of this very point of lack of execution often caused by politics itself! Politicians are limited or even unable from delivering many ‘promises’ as they just cannot get them through the political dogfight that our political system seems to be, sadly.

Politicians must be honest and sincerely announce during the electioneering exactly what is their platform on why they should be elected; and to say where they will genuinely find it hard to deliver in certain areas unless they have bipartisan support. Politicians must be honest about how it will be, not making many promises which they will be unable to deliver. If they cannot control it, how can they say they will deliver it. Not easy, but let’s have some reality and truthfulness by them all, in these somewhat unsettling short-term times.

Politicians really need to have a straightforward approach and solution process to the issues which people feel are relevant to them. People want to hear about matters such as Health; Wages; National Security; and, of course, Cost of Living. The last item is what is on everyone’s mind,  and connected to their pockets given the notable rise in, let’s, just say everything we all pay for these days!

In a nutshell, people, including investors, know you cannot predict the future, but they do want better surety in our leaders’ approach about the future. Plan wisely and plan realistically and execute the plan!

As investors, we should remain invested, focused, and diversified. Even though the winds of change are in play, we should always favourably use the tailwinds, and manage the headwinds, as we keep sailing to our goals over time. A good destination at the end is well worth it!

Disclaimer for information provided in this Commentary: This document, and the contents contained within, is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, or plan feature. The views expressed in this are subject to change at any time. No forecasts are or can be guaranteed.