Economic Hoons

Well finally the RBA have raised rates. Just how far behind the curve they are would be funny if it wasn’t so serious. It’s been apparent for several months there has been a problem with inflation and that rates needed to be raised. At the very least, it made no sense to hold them at basically zero. You need to be proactive with inflation and knock it on the head early. If you raise rates too soon, you can drop them back down, but it’s when you react too slowly that the inflation genie gets out of the bottle. Then, the only way to reign it in is to raise rates higher, for even longer than expected, and that likely leads to a recession.

Managing an economy is not that different to driving a car. Dropping interest rates is the economic accelerator. Raising them the brake. For the last 15 years, central banks across the world have been driving economies like a 17-year-old P-plater, accelerating as fast as they can only to jam on the brakes on at the last minute. Ironically, all these boring old guys in suits are basically the hoons of the global economy. They appear to be prudent and considered but the reality is that they pose as much danger to the economy as the P-plater does on the road.

We are at the jamming on the brakes phase, so strap in. 

But be mindful that inflation is quite nuanced and interest rates are just one part of the inflationary puzzle we face. A lot of the inflationary pressure is on the supply side, specifically, lack of supply. That’s what is forcing the price of many foods and commodities higher. Rising interest rates are necessary, but they won’t automatically bring the cost of goods down when it’s supply related. So, supply constraints need to be lifted before this part of the inflationary equation eases. That relates to supply chains and the flow on effects of the war in Ukraine and both of those issues are far more difficult to control.

Another critical aspect of the inflation equation locally is the potential for wages growth to skyrocket and compound inflationary pressures. With unemployment at 4% in Australia, politicians chasing an even lower unemployment rate of 3.5% are making a big mistake. While it seems a noble goal, and both the government and the opposition have spoken about wanting to achieve it, they will make the economy worse not better. Super low unemployment is creating a really tight labour market. Employers in many industries simply cannot find enough people.

Both sides of politics only need to talk to business to find out what they need most. They will tell you they need workers. From the mining industry in WA to the hospitality industry in Victoria. They need workers. Throw the doors open and bring in as many overseas workers as needed as soon as possible. If they don’t, wages will explode higher, forcing inflation higher and damaging business. It’s easy for politicians to sell voters on an ever-lower unemployment figure to tout their economic credentials. It is far more difficult to explain why a higher unemployment rate might be better for the economy.

To be clear, for investors right now, it’s not so much high interest rates that are the problem, it’s the transition to high interest rates that’s the problem. That’s why there’s so much volatility right now and likely in the months ahead. Once we actually have higher interest rates then companies and financial markets will have adjusted significantly and settle. It’s getting to that point that will be the most painful for financial markets. There will be opportunities emerge as markets overreact along the way. They are already starting to appear in some sectors, but broadly speaking it’s way too early to start buying.

Yet while I remain bearish in the short term, I am always mindful that there are really great companies that we want to add to our portfolio and the reality is the lower price we can buy them for the better.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Feels a Lot Like a Bear Market

In a bull market, momentum relentlessly drives stocks higher. You’ll get occasional pull backs and profit-taking but then it just goes again. We’ve seen that for much of the past decade. Bear markets are basically the opposite and are typically defined as the market falling by 20% from its highs. So far this year, the S&P500 in the US is down about 13%, so we are not there yet, but I think that’s where we are heading soon enough.

One of the problems as you progress through a bear market is that no one wants it to be the case. They want the good times of the bull market to keep going. So, when markets bounce as they did in mid-March everyone likes to think everything is back to normal. Denial kicks in, but the inevitable drop after the bounce comes soon enough. This is called a ‘dead cat bounce’ for exactly the reason the imagery of the phrase conveys.

The S&P500 in the US fell steadily from Jan-March. But then surprisingly (to me at least) it rose 11% in the 2 weeks to the end of March for no good reason, only to fall by the same amount in April. Dead cat bounce. There were a whole range of factors contributing but the most surprising part was just how much it went up. I raise it only to point out the vagaries of the stock market and why you need to be more cautious in bad markets and difficult times. In a bull market, you can buy the dip. In a bear market that is generally a mistake. In a bear market you are best served by waiting. You buy when there is blood in the water.

Perhaps being so cautious will mean you miss out on some upside if the global situation suddenly changes. If that happens, then so be it. The aim of the game in this environment is the preservation of capital in the first instance. Genuine bear markets are not all that common, but they do happen from time to time. As they unfold investors will find every way to talk themselves out of it until it’s impossible to deny. We are getting closer to that point now. Frankly, it’s kind of obvious.

In a bull market, investment and business conditions converge to provide stocks with all they need to rise ever higher. Everything about the economic and geopolitical conditions are favourable and trending up. Currently, the opposite is true, everything looks ugly and is trending the wrong way. Inflation is high and will force central banks across the world to hike interest rates far more dramatically than many expect. The war in Ukraine is causing all sorts of significant flow on effects. Many won’t be felt for months, some years. China’s economy is forecast to slow dramatically especially on the back of their massive lockdowns with covid. The list goes on.

The likelihood of recession globally is increasing. Markets won’t wait for the recession to be here to retreat. They are already retreating in anticipation and as it becomes more apparent in the weeks and months ahead, they will retreat further. So, make no mistake, markets are forward looking. By the time the consumers and businesses across the world are dealing with the reality of a hard economic landing at some point in 2023, markets will already be looking ahead to the recovery. So do not confuse the current economic conditions with what the share market will do. They are operating on different timelines. One (the economy) is the actual conditions and the second (the share market) is anticipating the future conditions.

The earnings numbers for last quarter and guidance for the following one coming from the mega tech this week will be critical to just how quickly markets adjust. Normally, I don’t put that much weight on the quarterly reporting and prefer to focus on the long term. But in this market the quarterly numbers are going to have an outsized impact on the market from here. We’ve seen it recently with Netflix being smashed after failing to deliver. If the mega tech companies report revenue and profit in line with expectations or better, markets probably hold up ok for now. But a miss will be a completely different story.

I expect the next couple of months to be tough. Markets need only a couple of bad news events to really drop their bundle from here. A reality hit confirming what most are concerned about, a consumer lead recession, will sharply turn sentiment negative and potentially push markets into bear market territory. Right now, there are several risk factors that can easily flare up in the next month or two and become the catalyst for the market to react negatively and take a further leg down. There will be great opportunities once markets settle but for now, I remain cautious.

We remain defensively positioned expecting further downside risk. We are overweight cash, floating rate notes, and commodities, especially energy.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Blockchain Is a Game Changing Technology

Blockchain might be the most boring exciting technology since data storage and data centre based computing services went online and changed the world. What we now know and refer to as ‘the cloud’ was probably accelerated in many ways by the reframing and marketing of that simple phrase.

Blockchain faces a similar challenge to the cloud of 10 or 15 years ago. While it is a transformative technology it is still waiting for its mainstream marketing message breakthrough that catapults it into the everyday understanding of business and consumers.

So, what is the blockchain?

To say it is “a distributed database that is shared among the nodes of a computer network” tells most of us nothing. In simple terms, I think of blockchain as ‘the cloud’ for records and transactions. It doesn’t sound particularly significant but like many aspects of revolutionary technology, once it becomes mainstream it will change the world in previously unimaginable ways.

The technology is basically blocks of data that form a secure chain of records detailing transactions as they occur. The ledger that contains these transaction details is public, allowing complete transparency as anyone can view it at any time. The technology is also decentralised as no one entity has authority over the blockchain and its decision making it great for trustworthy digitally record keeping.

So, what are the practical use cases?

Imagine lodging your insurance claim and having it paid within the hour. No more claims departments for insurance companies. No more hassle or waiting for customers.

Or making an offer on a house and not only is it accepted within the hour it is also settled within the hour too. No more settlement agents. Move in the next day.

Even simple transactions such as registration of births, marriages, and deaths. Instantaneously recorded to the blockchain. Passports and travel records automated. No more unnecessary bureaucracy.

Today, cryptocurrencies allow for transactions between anyone without the need for a third party or bank. Effectively it cuts out the bank completely. We have previously seen the appearance of that evolving in finance, but, in many cases, it’s really just been lower cost crowd sourced third parties or tech platforms cutting out the banks. Eventually, there won’t be any third parties needed and the transactions will all be directly between the two parties via blockchain.

This is a really big deal because so many transactions and businesses are built on being a third party or intermediary. Many of these, if not all of them, will be eliminated.

Smart contracts, which are essentially code-based rules for defining a transaction, will allow every type of transaction that is currently recorded manually to be digitised. Think about all the different transactions in life that are completed and recorded in quite manual ways. Even those that are digital, it involves intermediaries and brings with it a whole range of extra costs and issues around trust and counter party.

Smart contracts will end up recording ownership of everything. Homes. Shares. All products bought and sold. All agreements made.

The emergence of the virtual world and metaverse will see increasing amounts of commerce go online. With that, we are already seeing the evolution of digital assets and NFTs. These digital assets while in the virtual world are still valuable assets and ownership of those assets is no less important than ownership of any real asset. In the years ahead, expect this to be an increasing mainstream aspect of life as people spend more and more time online.

There are the obvious emerging companies that will grow on the back of developing this technology and customising it for specific areas. But more importantly for all investors, just as with the emergence of the internet years ago, there are going to be efficiencies created for a range of existing businesses too.

It wasn’t that long ago we all lined up at the teller in the bank to deposit pay cheques or make withdrawals. Banks are a great example of how the internet revolutionised a traditional powerhouse industry. Now we bank on our phones. A lot has happened over the years.

Blockchain technology will have a similar impact as it becomes ubiquitous for financial records, medical records, supply chain and inventory, insurance, property sector, legal sector and obviously finance. There is an entirely new wave of technological disruption coming based on this technology alone.

There are some very interesting stocks with direct exposure to this technology, while many large blue-chip companies will benefit from incorporating it into their business operations, other will be disintermediated out of business. While the technology is still some time away from being mainstream, now is the time to become familiar with the implications of how it will start to playout.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Are You Ready for What's Coming?

To quote the well-known pugilist and lesser-known philosopher Michael G. Tyson “Everyone has a plan until they get punched in the face”.

Right now, we are on the cusp of a once in a generation adjustment as the world moves from low inflation and low interest rates to high inflation and high interest rates. So, are you ready for what comes after you’ve been hit? Because inflation and interest rates are about to punch everyone in the face, consumers, businesses, governments and yes, investors.

Central banks around the world had their chance to deal with inflation proactively and they missed it. Inflation in the US is now at 8.5% and its 7.5% in Europe. There is an inflationary wildfire raging across the world and so far, central banks have turned up to fight it in clown suits with water pistols.

Yet, most are sleep walking into the situation unfolding. They have their heads in the sand, are in denial or simply not thinking objectively enough to assess what is happening. Individuals and institutions with vested interests talk in theory and forecasts on spreadsheets. They make the numbers fit their narrative.

This is a problem. They don’t understand how this really impacts the economy and society.

When I first started in the investment industry as a 21-year-old in 1997, it had been 10 years since the 1987 crash. Over the next several years as markets rose, the more seasoned investors would lament the fact that the younger generation had never seen a crash. They’d argue that it caused them to be overly optimistic in the face of rising risks as they had not experienced a genuine bear market.

The old heads were right. Nothing prior could prepare you for living and breathing in the moment of an actual crash. Not just a fall but a market that completely capitulates into free fall. The GFC provided everyone with that experience, and you become a better investor because of it.

Just as when I was a young adviser, as part of a generation of advisers and investors who had not experienced a crash, there is now a similar dynamic at play. Today, there is an entire generation of advisers and investors and for that matter businesspeople, bankers and executives who have never experienced high inflation and high interest rates.

This is a problem. They don’t know what they don’t know.

I continue to see people wheel out advice, commentary and strategies that may have worked for the last 15 years but are no longer appropriate for the way the world has changed going forward.

I’ve said this before, but I cannot emphasise it enough – high inflation and high interest rates are a game changer for investment portfolios. Most asset classes will need to adjust values lower, bonds, shares, and property. You’ll want to be positioned more defensively during that transition until the one-off adjustment occurs for asset values.

The level of complacency on this topic and impending adjustment astounds me. Most are completely underprepared for what’s coming and seem to prefer passive reassurance that all will be ok than preparing proactively for the inevitable. It is difficult but necessary to be proactive with the preparation of the transition from low interest rates to high interest rates.

This is a generational adjustment.

To a large degree, a big part of the problem is the misconception about what low rates and high rates actually are these days. The fatal flaw of those new to markets in the last 15 years is that they frame those questions within the context of their own universe of relative experience. However, we are breaking out of that cycle.

Ask anyone if interest rates can potentially go to 5% and I will be able to tell you how long they have been investing or advising for based on their answer.

Most with under 15 years of experience will dismiss such a suggestion out of hand as ridiculous. They say this not because it is ridiculous but because they’ve never seen it and the ramifications of that move are so significant that they refuse to consider it.

Conversely, anyone who remembers the 1990’s will say something like ‘It wouldn’t surprise me’. That’s because they remember what historically high interest rates look like at 15% plus and that historically normal interest rates are more likely between 5%-10%.

The last 15 years were the anomaly, not just the last 2 years.

Until everyone understands that the new interest rate cycle will see interest rates move towards more normal levels in the historical sense then they will continue to be underprepared for the problems that continue to evolve before us.

There will always be opportunities for long term growth, but it is critical to ensure you understand when pivotal moments of economic change require a more patient and defensive approach to portfolio management.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Building a Great Nation

As a nation with a rich indigenous history, but still a relatively young, developed nation, only 200 odd years on from English settlement and a population of around 25 million, it’s sometimes difficult to imagine the potential for future greatness. Yet, on one side of the country to the west, you’ve got states with massive amounts of natural resources. While on the East, which was settled earlier, you have a financial centre and the heart of the nation’s industry. Is it possible for that same nation to emerge over the next 100-200 years as the world’s leading superpower?

Well, it did.

I just described the USA in 1850. Fast forward to 2022 and obviously the USA with a population of some 330 million is one of the wealthiest and most technologically advanced nations in the history of the world. So, what then could the future look like for Australia? How much potential does this nation have to not only be successful on the world stage; but to be a truly great economic power in the future?

This thought crossed my mind as I was on one of my early morning walks through The Rocks in the heart of Sydney. This area is where our early settlers and convicts worked some 200 plus years ago on the wharves. I imagine what their lives were like back then. Very tough. Even more, I wonder what they would think if they could see what has been created here in Sydney today. The Bridge. The Opera House. Circular Quay and the incredible beauty and lifestyle we get to experience here every day. I think they would be stunned.

We are so preoccupied with the very short term we don’t think about the very long term. Long term these days is considered around 3 years. You can’t build nations like that. Great nations are built on a vision of not only what is possible but on ambitions of what seems impossible and is pursued anyway. Truly great nations aspire to be more than anyone can imagine it to be right now. They are built on the back of people free to dream of creating greatness and a nation with the vision to help them do it.

In a world in as much turmoil as we currently have, it is easy to only see the negatives and decline. But that is not really our future. I see an Australia that will emerge in the decades, and century, ahead that outgrows its current status as a small but influential bit player on the global stage. This is merely a phase in our emerging growth, it is not our destiny. We need to think much bigger and realise we can create a truly great nation that one day grows up to become the world’s leading economic superpower. It will take more than a century. But the vision and actions required to do it can only start with the right mindset today.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

What the Bond Market Is Telling Investors

I had ‘bond market concerns’ listed as #10 in my ‘10 Themes for 2022’ article earlier this year. In my opinion, sustained low interest rates had created one of the biggest bubbles in the world and it was due to unravel. It’s an issue markets are not well prepared for because bonds are seen as very defensive. Usually that is true. But we do not live in usual times and as interest rates rise there were always going to be adverse consequences for bond values.

The beauty of bonds is that they are far better at pricing risk than share markets. In fact, that’s really all they do. Bond holders assess the yield return they need to justify the money they lend you for the risk you present to their capital. It applies to corporations as much as countries. In that sense, it is comparatively simple and carries far fewer of the multitude of emotions and variables of share markets and individual stocks.

Since the US Federal reserve increased interest rates by 0.25% earlier this month, share markets have rallied strongly. In a market where interest rates are starting to increase sharply, you’d expect share markets to fall, not rise. Meanwhile, in just the month of March, the 2-year US bond yield increased significantly from 1.31% to 2.30%. It’s a big deal. Rising bond yields lead to falling bond values, and that is reflected in the Bloomberg Aggregate Bond Index being down around 10% from its highs last year.

So, one of these markets has got it wrong, and it’s not bonds. 

The S&P500 is up 9% from its recent lows and in no way is any of the news better. If anything, the prognosis for global economy and equity markets is worse. Bond markets are working this out but share markets still haven’t caught on. The low interest rate party is over. Yet for some reason, presumably a combination of optimism, naivety and greed, equity markets are still in denial. 

But it’s not just the fact that interest rates are going much higher. Usually, interest rates need to go up to slow a booming economy. The real problem now is that interest rates need to go up and the global economy doesn’t look good. There are signs that the Europe and even the US are headed for recession, possibly early next year. As the yield curve starts to invert, the bond market is telling us recession is increasingly likely in the US.

While many institutions and analysts are going to become fixated on the debate of whether we will or won’t see a recession, they are kind of missing the point. Whether or not its officially a recession it’s pretty obvious that those economies will slow considerably. Company profits will suffer, and jobs will be lost. None of that is good for the economy or share markets.

There is a theory that share markets are efficient. That they are correctly priced at any given moment as they adjust instantly to new information, as all information is known by the market and is assumed to be correctly weighed and priced. It is a great theory. The problem is it’s not how markets actually work in practice. You see just how inefficient markets are in times of geopolitical and economic crisis. All sorts of distortions occur. That is what we are seeing that now.

While I think much of the recent surge is money flowing out of higher risk areas across the world and into comparatively safe markets, it does seem that equity markets will continue to be in denial until they are faced with actual interest rate increases of 0.5% multiple times. Until then, markets appear willing to believe the worlds current economic problems will simply improve from here by themselves.

Unfortunately, that isn’t going to happen.

The good news for the Australia economy amongst all of this is that we produce, in abundance, most of the commodities that the world needs more of, from wheat to iron ore to energy. We are a safe and stable country with low sovereign risk. As countries and corporations around the world look for where to safely invest for the future, we are fortunate to be at the top of the list.

So far, the Australian economy has been broadly insulated from the same inflationary levels as other nations. That won’t last much longer as prices across the board jump to even more extreme levels. From a stock perspective we have held core positions in Woodside Petroleum, Santos and BHP for some time and we have increased our holdings significantly over the course of this year too.

Overriding everything else in the short term is the outlook for higher inflation and rising interest rates and ensuring that our portfolios are prepared for that eventuality. We continue to hold an overweight cash position and I expect the stock market to pull back as the economic reality sets in. That reality may be closer than many investors realise if bond yields continue their dramatic rise.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Seeing the Forest for the Trees

Amongst the sheer volume of urgent daily events, detail, and information to digest at the moment, the most important attribute for investors is to ensure that it doesn’t distract them from what matters most. Think long term. At a time like this, when everything seems to be on a knife edge, it is critical for investors to understand they need to zoom back out and not allow themselves to be engulfed by the all-consuming urgency of the 24-hour news cycle. It will overwhelm your thinking if you let it.

That said, the current short-term events from war in Ukraine, to supply chain disruptions, and inflation, do have significant long-term implications too. So, it’s important to understand that the macroeconomic and geopolitical events occurring now are changing the world. Understand also that unless there is a serious escalation in the war, investment markets will adjust and move on. But it is important to look through all the data and news and work out what actually matters from an investment perspective.

The main short-term trends are:

• Inflation was already heading higher across the world due to supply chain issues

• The war in Ukraine makes this worse as it’s forced almost every commodity price to increase

• The food commodity shortage has the potential to be an economic & humanitarian disaster

• Europe heading for recession with a low growth and high inflation environment which is bad

• USA is similar to Europe, but they have a better economic backdrop and prospects

• Australia is in a better position. Yes, high inflation is coming but likely higher growth too

Short term trends do matter for long term investors. They bring opportunities to take profit on an overpriced stock or buy an undervalued company. The short-term volatility will impact your entry and exit points for assets, the timing of when you might invest. This is especially an issue for new portfolios being established. However, it’s more important to understand the impact of the current situation on long-term global trends and adjust accordingly.

The main long-term trends are:

• Significant increase in defense spending globally

• Globalisation unwinding in preference for national interests

• Long term economic decoupling from China and the West

• Energy independence and growth in national renewable energy sources

• Sustainability refocuses to start with national security strategy

• Technological advancements continue regardless

Long term trends influence where you will invest. The increase in defense budgets globally will create huge demand and growth for a range of businesses across industries, not only defense. After decades of underinvestment in defence and short-sighted strategic thinking, the current crisis has awakened most countries to the need to become increasingly self-sufficient with more turbulent times ahead.

Chinese stocks and US listed Chinese companies, regardless of their returns and potential, remain uninvestable as far as I am concerned. Even when they are attractively priced, these companies (eg Alibaba, Baidu, Tencent) risk being torpedoed by their government on a whim, without notice. It makes the allocation of portfolio capital to this area too high a risk.

Beyond the obvious though, unless China categorically distances itself from Russia, the likely result is the West doing to China what they did to Russia, but over a 10-to-15-year time frame. So significant realignment is coming for all businesses doing business with China over the next decade. The flip side is more opportunities for businesses in Europe, the USA and Australia.

Energy across the board will be a huge focus. In the short term, it’s great for almost all energy companies as there simply needs to be more energy supply secured by Western nations. Long term, I expect a rapid rise in renewable energy as the climate issue merges with the strategic national security issue. Governments will push hard here for many years ahead, climate and sustainability will be the sell to the community, but the end game here is securing energy independence and national security.

The flow on effect of these huge new capital allocations are important.

But the #1 most important long term mega trend remains the continuous disruption of technology. Don’t lose sight of that. Even in a market where most tech stocks are out of favour, that remains the most important trend. It influences almost every investment decision I make. It influences the types of companies we buy shares in and those we avoid, which is just as important.

The short-term issues may impact the prices we pay and the timing of investments but behind the scenes, all sorts of incredible companies are continuing to work relentlessly to change the future. So, understand what’s going on in the short term, because it is important, but keep focused on the long term because that’s what really matters for long term investment returns.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

The Next Phase in the War

Geopolitical conflict is unpredictable. One of the major problems for financial markets given the situation in the Ukraine is that it could escalate or deescalate in any number of ways. It’s impossible to know what comes next.

Yet, as uncertain, and unpredictable as the entire situation is in Europe, I think the most probable outcome is very simple. Russia takes Ukraine while the USA, Europe and their allies allow it to happen. It seems the most realistic way it plays out without a major escalation. The alternatives are not great.

The US and Europe have been clear so far in stating they will not put troops on the ground in Ukraine and they will not put in place a no-fly zone over Ukraine. Both of those acts would spark a massive retaliation from Russia and probably lead to World War III. US President Biden said as much in a tweet over the weekend.

So, Putin likely gets Ukraine, for now at least, and probably in name only. In due course the Ukrainian people are sure to take it back. Putin needs to accomplish his objective though, declare victory, and save face, otherwise the stakes are raised higher. But Putin will go no further. The western world has collectively combined to collapse the Russian economy.

The counter measures from NATO countries means Russia have been crippled financially and economically. Not only from heavy sanctions, compounding their downfall is that almost every multinational company in the world is withdrawing and refusing to do business with them.

The most important next phase of the war is how China responds.

China has deep ties with Russia, but Putin’s strategic blunders and the fact that China is still an emerging power, and not the power it will one day be, puts them in a precarious position. Tolerance for a pro-Russian stance is almost nonexistent in Western Society now so it is a rare opportunity for the US to aggressively pursue its agenda without looking like the bad guy.

I would expect the US and Europe to apply maximum pressure on China to definitively choose sides. The current mood globally is very much one of “you are either with us, or you are against us”. The strategic rationale from the US seems obvious; if you are our enemy now and you will be in the future, we would prefer that battle now, before you are any bigger.

While the Chinese economy is significantly larger and more difficult to extricate from the global system than Russia it is now clear to China that a strategic misstep could see their emerging nation face similar devastating sanctions. This would be an economic catastrophe for not only China but indeed for the global economy. But if China continues to support Russia explicitly or implicitly it is very possible that it will come to that.

China though, are masters of passive aggressive business and political negotiations. There is no country better at using capitalist system against the West by punishing a company or an industry. It would not surprise me if the sudden ‘covid lock downs’ of entire Chinese cities, critical to the global supply chain, such as Shenzhen, was a warning from China to show they can do economic damage too.

To nullify a future adversary early in their ascent I expect the US and its allies to fully leverage the current situation to force China to make a call and not sit on the fence. Either way, how China proceeds from here will have a significant and lasting consequences for the entire world and its economy.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions. 

Everyone Is Printing New Menus

I took my 20-year-old daughter to dinner Thursday last week. I ordered the same $45 T-bone steak I’d ordered just the week before at a lunch, and again at a client lunch in December. It was amazing.

When the bill came it was $65. I queried the figure as I recalled seeing $45 on the menu as I ordered (I don’t forget numbers). They told me it was the correct price. Much to my daughter’s embarrassment, I asked to see the menu with that price on it. Sure enough, a nice shiny new menu said $65. It didn’t match the image I had in my head.

My daughter was starting to hide under the table at this point, but it was a matter of principal now. I asked them to check if I’d been given a different menu as I recalled specifically seeing $45 as the price. The restaurant manager came over shortly after and explained they have recently printed new menus and I had been given an old one.

There was no mention of price increases of 10%-50% across the board. Simply that they had printed new menus. I realised the menu was the same though. The only difference was the prices.

My 18-year-old son works part time at a fine dining Italian restaurant. I asked him if his work has put their prices up recently. He said he didn’t think so. I told him the story of the new menus. He said yes, his restaurant is printing new menus too.

I see. Restaurants and cafes don’t put their prices up, they just print new menus. Clever.

It’s a simple story that adds to the growing list of anecdotal evidence we are starting to see all around us. The canary in the coal mine for what’s to come for inflation and everyday consumers.

Prices are going up significantly.

Every business is seeing it. Talk to any builder and you’ll find they have had to move to ‘cost plus’ building contracts because fixed price contracts are killing their business as the price of building materials and contractors has skyrocketed.

Inflation is everywhere at the moment and while it was previously a supply chain issue, brought on by covid, that is starting to change fast. Wages growth is accelerating hard and fast. Talk to any recruitment firm and they will tell you salaries for a $70,000 role are now $100,000. Companies just need workers.

This was all before the Russian invasion of Ukraine.

Now, in addition to all the inflationary pressure mounting globally, we have a huge spike in the price of oil and gas as well as all types of commodities from iron ore to wheat. This is a serious problem for inflation and the global economy.

Later this week, we have CPI data from the US which is likely to show sustained high inflation. This will be followed shortly after by the European Central Bank announcement on rates. The ECB are in the impossible situation of trying to navigate their economy through what appears to be emerging stagflation situation of high inflation and low growth. Interest rates across the world are rising.

Meanwhile, here in Australia, the signs of inflation are all around us and the RBA continues to ignore the reality and fails to act. RBA boss Philip Lowe is doing his best impersonation of the dog with the coffee in the burning house ‘Its fine’ meme. If you’re not familiar with it just google ‘Its fine meme’. This is where we are at.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions. 

The Economic Response to War

The crisis in the Ukraine is a timely reminder of the genuine existential threats that we are faced with. A reminder that power, left unchecked, will corrupt, and seek more power. In Vladimir Putin, we have the world’s most dire threat since Hitler. It has been remarkable to see how quickly the world’s most powerful nations have mobilised to confront and nullify this threat. For all the political missteps that got us to this point, the world is now fully focused on the threat at hand. I am increasingly confident that the leaders of the western world are acting in the most rationale and pragmatic way possible to address this situation long term.

The invasion of Ukraine will have a far-reaching impact on the global economy. The economic and financial sanctions will have significant consequences, both intended and unintended. As necessary as these sanctions are, it makes for an even more dangerous time for the global economy. You cannot cut off a country the size of Russia and not have significant flow on effects. Obviously, it is essential to manage the crisis and the world will need to adjust, but that doesn’t make it any less risky in the financial sense. There is a risk that the Rouble collapses and potentially the entire Russian economy. The subsequent flow on effects will not be insignificant for the global economy.

Another concern is the potential for contagion in relation to the collapse of Russian companies or non-Russian companies with large exposure to Russia. There will be nations and banks with large exposure to assets and liabilities in Russia. Removing Russian banks from the SWIFT system is a powerful move but relatively untested at that scale. There are always two sides of the transaction to consider. There will be defaults and it will require intervention by international governments to manage this issue.

Energy prices and food commodities are going to go up, probably a lot. Russia controls about 40% of the natural gas supply in Europe. It is the 3rd largest oil producer in the world. Prices may spike creating an energy crisis that cripples the global economy and sparks inflationary pressures to levels even greater than they are currently. I have been surprised by Germany’s willingness to lead the way with sanctions and support given they source over 50% of their natural gas from Russia. It’s possible that Russia retaliates by turning off their supply to European nations dependent on them for energy. Sharp increase in energy prices will not only spur higher inflation, but it will also slow global growth.

There are significant long-term impacts too. Between the previous supply chain shocks from covid, and new ones from the current conflict, many weaknesses and vulnerabilities have been exposed. Countries will be far more strategic in pursuing a more robust and independent supply chain going forward. Increased prices sourcing goods that may not be as cost-effective is a small price to pay to ensure national security going forward.

You’ll see massive increases in military spending, especially from those nations threatened by Russia or China. The recent announcement by Germany to massively increase their defence budget marks a turning point. Since WWII, Germany has been neutral and reticent to be active in military conflict due to its past. But the threat that Putin now presents has been deemed large enough that Chancellor Olaf Scholz has made this adjustment with the full support of the national and international communities.

Importantly, for world peace in the years ahead, Putin has awakened the rest of the world from its slumber. The change in the geopolitical landscape in the past week has been greater than would ordinarily happen over the course of years. We have Sweden and Finland aligning more closely with the west and potentially resulting in their NATO membership and Switzerland breaking from its neutral stance to applying sanctions. While organisations such as the EU and NATO have been revitalised and empowered in the face of the crisis.

Initially, I felt the condemnations and sanctions were the worthless equivalent of ‘thoughts and prayers’ and did nothing to provide genuine assistance to the Ukrainian people. However, as these sanctions and support have been rapidly increased it is clear that the USA, Europe, and their allies are carefully and strategically navigating this situation. Their decisions are co-ordinated and considered. They are mindful that Russia is a nuclear power run by a power-hungry lunatic. They are clearly aware that perhaps the only thing more dangerous than a powerful and aggressive Putin is a weakened and cornered Putin. So far, they appear completely aligned and I believe they are prepared to do whatever needs to be done in response to any escalating threat Putin presents. While Ukraine may soon fall, Putin’s time is now limited.

Overall, the current situation with Russia overlays a significant new layer of risk across financial markets globally. This is over and above the significant existing concerns for inflationary and interest rates. Stock markets appear to be treading water as the situation evolves. It is possible that the current situation will result in a delay in the interest rate increases that were pending. This may be so, but if anything, it will be even more problematic later if inflation escalates and rate increases were delayed.

From a portfolio perspective, Australian stocks remains relatively insulated, while our international exposure is heavily weighted to US stocks and US dollars. We remain very underweight Europe and we avoid China. We retain an overweight cash position and will add to stocks on weakness as long-term buying opportunities emerge. 

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions. 

My thoughts on Russia and Ukraine

The prospect of Russia invading the Ukraine is causing concerns across the world. It would likely lead to a military response from the US, Europe, and their allies. These situations can escalate quickly and for obvious reasons no one wants a conflict between nuclear powers. The West does not want a war and will negotiate to avoid a conflict with Russia. However, if Putin has decided to invade and take control of Ukraine, then no amount of diplomacy or negotiation will change his mind or nullify the threat.

While it is possible Putin is using the threat of war as a negotiation tactic to leverage a particular outcome, I do not think this is the case. If there is a diplomatic solution reached, I believe it is more likely a tactic from Putin to gain concessions and buy time as he continues to advance. Putin is approaching 70 and, in my view, is more concerned with solidifying his power, restoring Russia to its former glory, and cementing his place in history.

I think it is possible Russia escalate then de-escalate several times in the weeks ahead. It will provide Putin with intelligence around the response they can expect and applies maximum pressure and sustained anxiety in both the military sense and on the general public. One of Putin’s key weapons in that sense is certainly the Western media, both mainstream and social media. Perhaps though it will galvanise the USA against a common enemy and alleviate the polarised political environment at home.

No doubt Putin sees an opportunity. The US opened the door following their shambolic exit from Afghanistan last year. He knows the US are preoccupied with matters at home and with China. But it would be a mistake if the US were to prioritise their disputes with China over the risk of an aggressive Russia. While China may present more of a threat to the US as the worlds undisputed economic power, I believe Putin and Russia present a far greater threat to world peace.

There are parallels with China and their stance on Taiwan, but I think there is a significant difference between the two nations and their leaders. Putin is a megalomanic and will take Ukraine and then work his way across Europe. He is a genuine threat to world peace. China is more insular and though there are disputed territories that are strategically and historically important I don’t believe they are the same type of global threat. Putin will continue to forge an alliance with China to pressure the US and its allies to deal with two potential conflicts at the same time.

If Russia does invade the Ukraine, share markets will fall, at least initially. Given the uncertainty and fear, there will be a flight away from risk assets to defensive assets. Commodities and energy prices will spike much higher. But thereafter I’d expect stock markets generally to settle and business and consumers to carry on as normal. The biggest economic risk would likely be the inflationary impact of commodities and higher energy prices given the level of control Russia has over Europe’s energy market.

War is obviously horrific, but from a consumer’s perspective, how will it change your spending habits? What will you change in your daily life? It won’t change my daily routine. I will still go to the gym, work out and buy my coffee each morning. At work, I will still subscribe to Microsoft office and use my iPhone and all the other services we use in business. In the afternoon the shopping my family orders from Amazon will arrive too. There is a fear factor attached to the current situation. If Russia do invade the Ukraine, we can expect a significant response from the US, Europe, and their allies. But, after an initial shock, the majority of consumers and companies will quickly return to business as usual. I expect share markets will likely do the same. 

What History Teaches Us About Finding the Next Giant Tech Companies

If history has taught us anything it is that there are patterns that tend to repeat. I find these patterns often flag the warning signs that are useful reminders of the negative consequences of past cycles and events. Over the course of history these apply to all sorts of situations including overheated markets & stock market crashes, geopolitical tensions & war, and government spending & debt crises.

Investors though are not typically very good at studying history (or at least remembering it). It is one of the reasons why there will always be booms and busts. Partially, its due to human behavior driven by fear and greed and by the time those investors gain the necessary experience to take advantage of similar events as they repeat there is a new batch of people seeing a situation unfold for the first time. But failing to learn from history does not only apply to dramatic catastrophes.

We often overlook the patterns of success too.

The great companies of the last 10-20 years, Amazon, Apple, Google, and Microsoft are all trillion-dollar plus companies today. In the past 10 years, the share prices of these companies have increased in value by 10x or more. They have seen extraordinary growth and they are all still rapidly growing companies despite their size.

Perhaps the most interesting thing to me is that 10 years ago they were already huge companies. They were market leaders that many thought were overpriced and didn’t buy. Back then they were $100b and $200b companies. For many, it was difficult to see the upside. They were viewed as expensive. My point here is that to find the next tech giants that deliver exceptional long term returns we don’t need to scour the earth looking at small companies. High growth large companies have that potential too.

People generally aren’t great at conceptualizing or comprehending exponential growth over the long term, especially when that growth rate is very high. A company share price worth $1 increasing by 10% per annum would be at $4.18 after 15 years. Compare that to a $1 company share price that increases by 20% per annum and after 15 years it would be at $15.41. From there it starts to get ridiculous but for the sake of the exercise I’ll continue. At 30% per annum a company with a $1 share price would reach $51.19 a share after 15 years.

What history tells me is that the next giant tech companies are already well-known companies we (or our kids or grandkids) use every day. They are emerging global leaders and even though they may worth $50b to $200b they are still growing at 15%-20% plus per annum. It is possible that some of these companies become the trillion-dollar companies of the next 10 years. In the next few weeks, I’ll write more on this topic and outline the attributes I look for in these types of businesses and provide a few examples of stocks I think have this potential.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Eye of the Storm

We are living in unique times. There are a range of issues that make investing in this environment very challenging. This market is the most uncertain I have seen since the start of Covid. For good reason too. With inflation at 7% in the US, the Federal Reserve will likely start increasing interest rates from next month. Some institutions are now forecasting up to 7 interest rate increases this year. We also have geopolitical tensions as the prospect of conflict between Russia and the Ukraine intensifies. Not to mention the significant ongoing effects globally of the covid pandemic. After a big drop in January, markets have settled somewhat, but I would be extremely surprised if this is the end of the volatility.

In the very short term, there are real headwinds for markets, and I believe the change in monetary policy after 15 years of low rates is still being digested by markets. Wages growth due to labour shortages is now resulting in big jumps in salaries and will continue to put even more pressure on inflation and in turn interest rates in the short term. Even if inflation is transitory, interest rates will settle higher than they are currently. So, if the data from the US doesn’t show easing inflation soon then the volatility of January will likely be revisited at some point in the next couple of months.

Usually, when a market falls sharply you are rewarded by buying the dip. But the current situation the world faces isn’t a normal dip simply occurring because of a lack of confidence and over selling. We are seeing a fundamental shift in the rules of the game. Inflation is going higher at the moment and interest rates are poised to do the same. We are at an inflection point. It makes markets volatile as investors adjust rapidly to new information that either confirms or changes their view on inflation and interest rates. This is a market that will reward those who are patient over those who are bold and rush in.

However, from a long-term perspective, I am not concerned. If any of the current headwinds eventuate, there is very little I would do differently with regards to the specific stocks we invest in. We buy shares in great companies. So, regardless of short-term concerns, we will still hold stocks like Microsoft and Amazon in our client portfolios for the long term. The types of companies you want to own at the core of your portfolio are those that are great businesses, market leaders with great products and services and reliable earnings. Businesses that can easily scale but cannot be easily replicated and importantly have pricing power.

When a business has a unique product or service it can increase its prices and customers will stay. A good example is McDonalds who late last year passed on price increases of 6% in the US without missing a beat. Think of a company that could increase its prices by 10% and you’d still buy its product or service. That’s the hallmark of a great company, and it allows them to sustain their growth. This is especially important in times of rising inflation because the company can increase its prices to pass on costs and customers will pay the higher prices. So regardless of short-term trials and tribulations, companies with these attributes will do well over the long term in any economic environment.

It is said that time in the market, not timing the market is what matters most for long term investors. While that is broadly true the one situation that I have seen timing matter more than any other is investing a lump sum of cash in a volatile or sharply falling market. For existing portfolios, we hold more cash than usual, sure. It does make it more difficult for investors investing an overweight cash position into stocks. This is especially the case for those setting up a new portfolio or who have sold a business and have new cash to invest. But patience is key and over time opportunities to buy into core positions progressively will emerge.

I am as optimistic about the future as anyone. I am very bullish on the prospects of the share market over the long term and there are some fantastic companies out there that will do very well over time. That said I am cautious in the very short term. I don’t believe that the net result of 15 years of low interest rates coming to an end is a 3 week drop in January that recovers in February. That doesn’t make sense to me. The higher interest rates coming change the mathematics that underpins asset valuations, and the higher costs will impact everyone’s bottom line. I think cash is king for now and I am investing it slowly, progressively, and selectively adding to our high conviction stocks. Sometimes the most important part of managing money is protecting the downside risk at the expense of potentially higher returns. 

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

What Happens Next as Interest Rates Rise?

Interest rates are going up across the world and it will impact all asset classes. While we are currently seeing stock markets reacting negatively, higher rates are going to flow through to the real economy and impact everyone from businesses to consumers, as well as asset values for bonds and property. This isn’t simply market movement that comes and goes. We are witnessing the end of a 15-year period of historically low interest rates, never seen before and unlikely to be seen again. With that comes an entire generation of investors, advisers and fund managers who have not experienced a rising inflation and rising interest rate environment and certainly not a high inflation, high interest rate environment.

Looking back over the long term, the RBA reduced rates over the last 15 years from 5% to virtually 0%. But in the 15 years prior to that (1992-2007) rates were consistently between 5%-7%. Go further back to the 70’s and 80’s and the RBA rate ranged between 6% and 17% for the entire period. Since the GFC, the absence of inflation allowed rates to continue at ridiculously low levels. That changes if inflation starts to dig in for the long term. If inflation gets away from governments, interest rate rises become the primary weapon to fight it and rates will rise to whatever level is needed to curb it. From such a low base a return to ‘normal’ rates in historical terms would be a major problem. I don’t expect that but the move to higher interest rates is a permanent change.

While stocks have fallen significantly over the last month or so there is probably still further to fall before markets settle. But the asset bubbles that emerged globally over the last several years are not limited to stock markets, they include property and bonds too. My view is that the value of fixed rate bonds and property will fall significantly over the next couple of years as interest rates increase. A fall in the price of property seems fairly straight forward. Higher interest rates are going to put pressure on property owners. Banks started lifting their rates last year and tightening their lending criteria.

Residential property is especially vulnerable to a serious downturn. Sky high prices and many property owners are already overextended even with record low interest rates. Borrowers tend to ask the bank ‘how much can we borrow?’ as the starting point for their property purchase and upsell themselves from there as they progress through the process. I expect that residential property will see a similar re-rating to that of the share market, and I wouldn’t be surprised by a fall of 10%-20% or more over the next year or 2. This has significant implications for the entire economy.

I am also cautious of REITs and property trusts across the board, but especially those that use high leverage to generate higher yields. These all look great on the spread sheets and in the prospectus forecasts but that great yield starts to look quite different in an environment that combines soft rents and rising interest rates. Factor in structural issues such as working from home for office property and online shopping for retail centres and it’s going to be more important than ever to be selective with your exposure to REITs and property. 

Fixed interest bond values will be under pressure too. In simple terms, if you bought a 10-year bond for $100 last year and it pays 2% pa no one is going to want to buy it from you at that price if the new bonds issued in a year at $100 are paying 4% pa. So, investors are going to be stuck with either 10 years of much lower income if held until maturity or a significantly lower value on the bond if they sell. I prefer bonds and notes with a floating interest rate so that as rates increase so do the rates on the security. This provides investors with an inflation hedge and a welcome pay rise as rates increase.

Be careful with unlisted investments. Investors are often attracted to these investments because their values are more stable. This is one of the dumbest investment misconceptions I have ever heard, and it’s perpetuated by those with a vested interest in the assets. Asset managers from small asset managers to the large industry funds like unlisted assets as they appear more stable. But the reality is that it’s just not valued every day the same way assets listed on the share market are. If interest rates rise and asset prices fall then those unlisted assets won’t be worth as much if you sell them. It’s as simple as that. There is a lag time here to be mindful of.

As interest rates rise, share markets will continue to be volatile. But share market investors do expect volatility and do expect markets to fall from time to time and occasionally crash. It has happened repeatedly over the decades. It is not abnormal. Markets run too far in the good times and then retreat, usually too far, in the down times. It presents opportunities and I look forward to buying at more reasonable levels.

What I am more concerned with right now are the other asset classes where bubbles have evolved and will also come to an end as rates now rise. Property, bonds, and unlisted markets and their investors are far more complacent than the share market in this regard because these markets do not usually experience the level of volatility that is ahead. It means there is likely to be systemic risks within those markets that have developed over many years. The fallout from rising interest rates may well be more harshly felt than many investors and stakeholders in these areas expect going forward.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

10 Themes for 2022

For all the uncertainty over the last 2 years with the pandemic, investment markets across the world had performed very well. However, 2022 is already shaping up as a more difficult year for investors with the All-Ordinaries index down over 6%, the S&P500 down over 8% and the NASDAQ down 13% all in the last few weeks. Markets are going to continue to be challenging as we move from an environment of low interest rates, low inflation, and significant government stimulus to one of rising inflation, higher interest rates and a wind back of government stimulus.

From an investor’s perspective, I think the pandemic will largely be over by June as the omicron variant continues to spread throughout the world like wildfire over the next couple of months and we move to the endemic phase. Obviously, a more serious variant could emerge, but for investors, I expect we are through the worst. If that’s the case, then all of these issues slowly start to rectify themselves. The disruption to supply chains will work themselves out over the next 12 months and with that inflation will ease too. Interest rates will then stabilise.

To me the most important theme is the continued rise in all facets of technology, not only for 2022, but for the next decade and beyond. It underpins everything. It determines the areas we invest in and those we bypass; it determines the companies we buy and those we avoid. It is central to our investment thesis and generating returns over the long term. Outside of the big tech giants there has already been very significant falls in the prices of pure tech stocks. This is not unreasonable given their high prices and adjusting for rising interest rates. However, as markets retreat exceptional long-term buying opportunities are emerging in this area. Patience is key.

Perhaps the biggest threat to the Australian economy is the slowdown in China on the back of their property and debt issues. China appears to be dealing with this situation so as to protect the country from any major financial catastrophe however, as always, their methods are opaque and do not provide the outside world with great confidence in the overall system. Importantly China’s president, Xi Jinping, needs to ensure the nation’s stability as he locks in his next term later in the year. What is most clear though is that the Chinese economy is slowing, and that Australia’s economy will be directly impacted by this.

While there are always geopolitical concerns and the risk of conflict it appears to me that the USA and the west will have a more challenging time than usual in 2022. Russian troops at the Ukraine border are the latest to add to ongoing threat of China invading Taiwan. I expect China and Russia to coordinate the timing of their provocations as to apply pressure on the USA and its allies, forcing them to either prioritise one potential conflict over the other or spread themselves thin. Either way, rising geopolitical instability is an emerging concern to note.

Energy as a theme is similar to technology in that it encompasses several important sub-themes. Captured here is everything from oil and gas to uranium and renewables. Importantly ESG may be the most influential sub-theme here as energy use, production and sustainable business practices are increasingly prioritised by investors, consumers, and leaders across the world. On the flip side under-investment in traditional energy will create distortions in markets and potentially create opportunities. Demand for energy globally will continue to rise and will likely require a pragmatic approach to avoid dislocation in energy markets in the short term. Big opportunity in multiple areas.

Overall, the inflationary pressures driving interest rate rises are a short-term game changer, even if it’s just for the next 12 months. Higher interest rates not only mark the end of easy money but the end of easy investing across all asset classes. Add to this a slowdown in China, rising geopolitical risks across the world and the now familiar backdrop of pandemic and there is more uncertainty than ever. Looking ahead the investing environment for 2022 appears more challenging than it has in recent years. The key variables that were previously so conducive to growth have turned and a tougher outlook will be the result. Returns on most asset classes will be lower than we have come to expect. As always though there will opportunities that present themselves despite the challenges.

10 themes for 2022

1. Continued rise of technology

2. Rising interest rates

3. Inflation risk

4. Covid variants and vaccine

5. Supply chain disruption and economic impact

6. China economic issues

7. Geopolitical risks

8. Energy

9. Govt debt and spending

10. Bond market concerns

Everything on Demand

My major takeaway from 2021 is a simple one, and as basic as it may initially sound, it is a foundational pillar of my investment thesis about the future.

People today, of all ages, have come to expect life to be easy.

It may sound like the start of a ‘get off my lawn’ style rant from an old man, but it is not. It’s an observation of the way society and the consumer has evolved over many years. It is especially important to understand because the overriding psychological mindset of the population drives all consumer behaviour and ultimately the businesses and stocks, we invest in.

Almost all of the technological trends evolving today are driven by removing friction from existing processes and creating faster, more efficient ways of doing business and consuming goods and services. The rise of the entire buy now, pay later sector is a case in point. We expect life to be easy. We want everything now and we don’t want to wait. We want tv and movies streamed on demand. We want our food delivered on demand.

On the downside, we have come to expect governments to bail us out on demand. We have come to expect employers to fix our problems. We don’t expect to deal with any of the pain. We talk about accountability but rarely with respect to our ourselves. As a society we seem unable to deal with a situation if isn’t easy. Presumably giving every kid a trophy for the past 35 years hasn’t helped this.

Today, the relationship between government and the people has developed into a similar dynamic to that of the parent and the spoiled brat child we all know from somewhere. Parent says no, spoiled brat cries, parent gives in. It is a recipe for disaster for both the future of the child and the economy.

What has been lacking is for government to ignore the cries of the people and let them endure a degree of genuine hardship, for their own good in the long run. For the last 15 years, pandering governments have offered continuous accommodations, money printing and economic stimulus at the hint of every problem.

Thankfully, this will soon stop.

The fact that there is now higher inflation, regardless of the causes, will necessitate governments increasing interest rates and pulling back from their excessively accommodative stances going forward. It will be interesting to see if governments hold their nerve. In the past they have not followed through, but it is now overdue.

Of course, this goes in cycles.

Hard times develop resilience and patience in the population. Whether through The Great Depression or WW1 and WW2, the generations that lived through genuinely tough times had their work ethic and perspective on life shaped by those experiences. It also shaped the consumer behaviours of the day and the companies that grew to meet their needs. It’s no different today as companies meet new needs. 

Conversely, success leads to complacency and then to failure and ultimately change. It applies to nations as much as it does to technological disruption or your favourite sporting team.

From a societal perspective, those that experience relatively easy times become complacent and entitled. In the absence of any unexpected and genuine hardships, the rise of technology will continue to enable easier and easier lives, facilitating everything ‘on demand’ and the expectation of more to come.

In my opinion, the continued rise of technology is the most important and impactful investment theme in the world today. But the most important factor driving the consumer behaviours, that build the businesses we invest in for the future, is overwhelmingly that people have come to expect their lives to be easy. 

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Old Dogs, New Tricks.

These days there is a lot of focus on companies being disrupted and the new companies challenging the status quo with cutting edge technology and ideas. The warning to the old companies is ‘adapt or die’. There are many examples of companies that haven’t from Kodak to Blockbuster. It’s easy for investors to see the shiny new technology companies and look down their nose at large companies to see who is going to be disrupted next. But not all the incumbents are slow moving laggards.

In fact, there are many outstanding businesses that have been around for 50-100 years that continue to reinvent themselves decade after decade. They may not have the appeal of the new tech companies, but they have an enviable track record of delivering results and tremendous brand loyalty and pricing power (important inflation hedge). These are companies that are easy to ignore and label as boring companies. But the way they continue to embrace change they are clearly leveraging the most exciting technological trends emerging in the world today. Here are a few standouts:

McDonalds (founded 1942) In 10 years I don’t think McDonalds will employ nearly as many young workers as they do today. Stores will be fully automated. We are already starting to see this in stores as they move to automate customer ordering. This is a business that will be able to automate every aspect of its business. From ordering to preparation and cooking to delivery of orders. Incredible brand loyalty is evidenced by McDonalds recently raising prices in the US by 6% due to inflationary pressures and have reported that these increases have been implemented without issue across the business. They have pricing power and will be able to protect their margins as they can pass on increased costs.

Caterpillar (founded 1925) Caterpillar is fast transitioning from an old school machinery company to a robotics and automation company. They have a reputation for making extremely high-quality products and have built very strong customer loyalty over time. From a branding perspective whenever you see a company that can sell their own branded clothing and boots at a premium price you know they have a market leading brand and customer loyalty. They also have hundreds of autonomous trucks operating on mines around the world. Many of these machines each cost millions of dollars. This is not an operation that is easily replicated due to their scale, quality, and brand loyalty.

Walt Disney (founded 1923) In an era where content is king there probably isn’t a company with a better suite of entertainment brands than Disney. Beyond the Disney banner, over the years they have acquired a stunning collection of the world’s most popular franchises, from Star Wars to Pixar to Marvel. To leverage this content and monetise it 2 years ago Disney started Disney+ their own version of Netflix but built on the back of the Disney catalogue and content library. In just 2 years since the launch Disney+ have reached over 118m subscribers and created a new recurring revenue stream worth billions of dollars out of nowhere. For comparison Netflix has 200m subscribers. Both are forecast to hit over 300m subscribers in the next 5 years or so which is extraordinary.

Walmart (founded 1962) Their size and scale provide them with access to an unprecedented ability to leverage the revolution in automation and robotics across almost every aspect of the business. Walmart may not have the pricing power of the others on this list but almost every aspect of the supply chain for supply markets is being reinvented by automation and tech. From the way the products are made and grown, to the way they are sourced and delivered to the store, the way the shelves are stacked to the way their products are bought, paid for, and even delivered to the customer. There are just so many costs and inefficiencies being removed from the supply chain. It’s going to equate to lower prices and higher profits. They have been using autonomous trucks in the USA for the past few months.

The demise of companies often isn’t really that difficult to predict. They have a product or service that was popular but fail to change as new products or services emerge. In many ways, it’s the same with the rising companies riding the wave of new technological trends. Relatively easy to spot as they provide a better product or service using the latest technology. But for long term investors that is only a part of the equation because both are on the same product or business cycle, just at different stages. The great companies are those that are able to sustain success over a very long period of time and have a proven track record of navigating change and technology over the course of decades, not just years. 

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Jumping at Shadows

It’s been my experience over the years as an observer of markets and human behaviour that our fear in response to possible outcomes is usually disproportionately (and incorrectly) weighed against its probability of becoming a reality.

For all the concerns about an issue they usually don’t come to pass. On the occasions where there is a bad outcome we fear an even worse outcome, which usually do not materialise. We are very good at being fearful, but we are not very good at allocating a level of rational probability to that fear.

In other words, things are never as bad as they seem, and investors spend far too much time worrying about unlikely events becoming reality. The opposite is also true. Rarely are things as good as we think. The reality is far more boring, somewhere in the middle.

With this new covid variant it is no different. Listen to the media and it sounds bad, but we don’t actually know anything useful at this point. The number of “what if” articles I am seeing in the media is ridiculous and just a waste of time and energy. We will deal with it if it is an issue.

A big part of the current reaction to the emergence of the new variant is that everyone is tired of it. Everyone has had enough of the pandemic and just wants to go back to living a normal life. So, we are more sensitive than ever to the prospects of going backwards. The media love it and are pushing those buttons hard. This is probably the biggest risk going forward, pandemic fatigue.

There are going to be new variants. We know that. We also know the drill about how to manage them. Until we have answers on a couple of key questions, I just don’t think it is worth worrying about. From an investment perspective there are two questions I need answered in relation to the new variant and that’s pretty much it.

1. Is it resistant to the vaccine?

2. Is it more deadly?

If the answer to these questions is “no” then it’s not a big deal and in a few weeks, everyone will have moved on and the rest is just noise.

If it is resistant to the current vaccines, then we go back to the original drill. It will take time for new vaccines to be developed and then distributed. But this time we know how it works and have the foundations in place to manage the next steps. It might set the recovery back 3-6 months (that’s a guess).

I hope to add to our positions in December if markets fall further and if the new variant is vaccine resistant, I expect to buy again in January if the market overreacts.

There are going to be new variants. There will be more of them next year too. At this stage we should know the drill well enough that we can wait and see if it’s a problem. Then make rational decisions to deal with the actual situation. Life will go on. We need to stop jumping at shadows.

This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Dividend Dance

In Australia, investors and companies have become twisted in a little knot around dividends that needs to be undone. Dividends in Australia are just too high. I know no one wants to hear that but it has to be said and it needs to be discussed. More importantly, if our companies are going to remain competitive on the global stage it needs to be addressed because times have changed. The way businesses grow has changed and unless we review some of the practices that have evolved, our company’s risk being left behind their global competitors.

Over the last 30 years investors, especially self-funded retirees and SMSF investors, learned the benefits of having a portfolio of stocks paying generous fully franked dividends. It started in the 1990s as the level of share ownership in Australia started to explode. The old adage at the time relating to banks stocks was why invest money on term deposit at say 5% (remember those days!) when you could buy the same banks shares and get 6% fully franked dividends and participate in the growth in shares too. Made sense.

From there people started to understand that a diversified portfolio of blue-chip companies paying fully franked dividends was a great way to generate a retirement income. It wasn’t too difficult to construct a portfolio focused on income that could generate say 5% per annum with some growth too. For someone with say $5m in capital to generate retirement income of say $250,000 pa. It was also cleaner and neater than property, better diversification, without the headaches of tenants. This approach has been very successful and become very much mainstream. It does make sense.

But today, investors in Australia have become too focused on the dividend return instead of the overall return. The rationale is sound, but in this era of continuous innovation, it’s worth reconsidering this strategy and whether it is still as appropriate today. I am not saying company profits or cash flow are not important, in many respects they are more important. I am talking about whether investors and companies, by focusing on higher dividends is causing them to make decisions to their long-term detriment.

In many cases in the past, it has resulted in the dividend payout ratio creeping up over time. This isn’t a great sign, and it has happened more and more over the last 10 years as companies face pressure to continue paying high dividends. But it’s really important to understand that a dividend yield of 3% from a company that pays out 50% of its profits is not worse than a 4% dividend yield from a companying paying out 100% of its profits. In fact, it’s probably a better managed company. This is often overlooked by investors.

In this new era of continuous innovation, it is more important than ever for companies to reinvent themselves. That means reinvesting in their business to lead the next phase of change. ‘Blue chip’ companies in mature or maturing businesses need to recognise this and prioritise reinvesting profits back into the business to innovate or they are going to be disrupted by those who do.

That means not paying out dividends or at least paying out much less in dividends. But because these dividends are the foundations of retirement incomes, a large part of the investment market is dependent on them. The companies that pay the dividends know this. Major companies face significant backlash from self-funded retirees and large superfunds if they were to reduce their dividends.

The irony is that the shareholders will complain about companies adopting this strategy because they receive lower income, but its ultimately for the long-term benefit of those exact shareholders. The reality is that in a business environment changing at the pace that it is, paying out dividends that are too high simply doesn’t leave enough in the company to reinvest in its future. So, while in the past high dividends were a sign of good profit and stability it is increasingly becoming a sign of underinvestment and future challenges ahead.

The most innovative companies in the world are in the US and they do not pay high dividends. The average dividend of the USA Dow Jones industrial average (30 stocks) is 2.4% and for the S&P500 is 2.0% and for the NASDAQ is 1.0%. In Australia, the ASX200 payout collectively dividends that equate to well over 4% grossed up for franking credits. Though this number is somewhat skewed by higher than usual dividends from big miners, the point still stands.

If this philosophy doesn’t change soon then Australia’s leading companies, beloved by investors for their high fully franked dividends, will soon fall behind their global counterparts. As our market and investors in Australia become more sophisticated it will be important that we focus more on total returns over the long term.

This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Welcome to the Metaverse

With Facebook recently changing its parent company name to “Meta” rest assured you’re going to be hearing a lot more about the metaverse from now on.

What is the metaverse?

I think the easiest way to visualise it is if you think of the current internet experience as 2D and screen based. Then, the metaverse as the next iteration of the internet, which will be 3D and fully immersive.

If you think people today spend too much time staring into their mobile phones, then you’re in for a shock. Soon enough we will be effectively living in them. Virtual reality (VR) and augmented reality (AR) headsets will be to the metaverse what the iPhone was to the web.

I see it as being at a similar stage to the internet, domains and websites in the early 90’s. It’s starting to take shape but it’s a long way away from being functional for mainstream use. A lot is going to happen in the next 5-10 years that will take it mainstream. All the major tech companies are already heavily investing in building the metaverse. Once it starts to scale, the network effect will do the rest.

Why does it matter?

Because it is the future of the world. It doesn’t just change it. The metaverse brings together many of the technological trends emerging today including machine learning, AI, cryptocurrency, NTFs and virtual and augmented reality to create completely new worlds and experiences. The most obvious area to start is computer games but it will encompass all aspect of our lives before long, from music and fitness to the future of work and education.

Today’s most popular gaming companies understand the potential of the metaverse and are already providing the early platforms for these immersive experiences. The companies that run Minecraft, Fortnite and Roblox are at the cutting edge. Kids don’t just play these games they spend their time there socialising and creating. They experience these worlds with their friends, both from school and those they meet in the metaverse.

But gaming is just the start. The virtual economy will be massive and paying for virtual goods and services will be standard. The music industry is already starting down this path with an exclusive concert on Fortnite by Travis Scott attracting 27 million participants last year. The fitness industry through the gamification of workouts and exercise is next.

In the metaverse you will be able to travel to anywhere in the world and experience travel adventures from the safety and convenience of our own home. You’ll be able to put on a VR headset and spend a Thursday evening in a gondola sightseeing in Venice or meeting up with friends on a Friday night to attend the live Rolling Stones concert.

In the US the National Basketball Association (NBA) partnering with Facebook already provides fans the ability to watch selected games in fully immersive virtual reality from a range of vantage points at the game, including courtside seats. Imagine being able to attend any event in the world at any time from your own home and it all feels like you are there in person. This is no longer science fiction.

How to invest in it?

It wasn’t that long ago companies repositioned themselves from web based to be ‘mobile first’. Well over the next 5-10 years companies are going to be moving to ‘metaverse first’. Right now, there are several companies at the cutting edge of creating the foundations of the metaverse. No doubt there are going to be many more in the years ahead. Many are going to lose so it’s important to be strategic here.

Facebook through their Reality Labs business are very well placed to lead the way in the hardware and software of the future. They plan to spend at least US$10b this year alone in this division. However, Microsoft is equally well placed and is taking a more pragmatic, if less visionary, path to providing the tools for the metaverse through their existing suite of products such as Microsoft Mesh and Teams.

I see Facebook and Microsoft as market leaders here. To me, they are the lowest risk way to gain exposure to one of the most exciting areas of growth we will ever see. They are both great businesses, very profitable, yet are still both growing rapidly each year and have excellent long term growth potential too. I see these stocks providing a free hit to the future upside of the metaverse.

But perhaps my favourite company in this field is Roblox. Roblox reports that their 47.3 million average daily active users spend approx. 2-3 hours per day on Roblox. Talk to anyone with kids under 14 and chances are they are already very familiar with their kids spending real money to buy Roblox digital currency, Robux. The engagement metrics and revenues are amazing. This is a company consistently growing at over 30% pa and in my opinion is poised to be one of the next tech giants in the era of the metaverse.

Facebook, Microsoft and Roblox are all outstanding companies that we own in many of our growth-oriented client portfolios, and I own personally. Subject to price, I will continue to add to these holdings over time.

This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.