|We wanted to document some of the conversations we’ve been having with clients around the state of the markets and the economies in this disturbing and unusual time.
The Summary Version
- We are probably in the world’s deepest recession since the Great Depression.
- Huge government stimulus and suspension of normal obligations is significantly reducing the financial impact households are feeling.
- This stimulus won’t last and the coming reality could be painful for households.
- WA is in a blissful bubble relatively speaking. Let’s hope it continues.
- Investment strategies were moved more defensive prior to the pandemic and still feel appropriate for the times.
- Share and property markets may still hit a wall. The share market bottomed in 2009 well after the Global Financial Crisis (GFC) hit in 2007.
- The extremely low level of income earned through holding cash, term deposits or bonds may mean the businesses owned by our fund managers are in more demand and become more expensive in the future.
- Through the careful filtering done by our fund managers we enjoy the relative stability and high-level of income being paid by a good quality basket of sensibly managed businesses in stable countries such as Australia.
- We need to be patient and watch this COVID induced shock evolve as it will have a multiyear impact.
- We need to keep the lines of communication open between you and your advisor to ensure we adjust should your circumstances or goals change.
As you would’ve heard, most of the economies in the world are in a severe recession brought on by the pandemic induced lockdown and other changes in behaviours due to the virus.
The job losses are extreme when compare to most recessions and have been compared to the peak of the great depression in the 1930s. The Australian unemployment rate is currently ~8% however the Job Keeper stimulus which is paying businesses to retain their workers, could eventually see many of those workers laid off.
The Fiscal Cliff!
There’s been huge levels of government support to limit the long-term economic scarring of the coronavirus impact. The Lowry Institute estimate the Australian government spending is expected to increase the Commonwealth’s Net Debt debt by 80 percent or 15% of GDP. It is a daunting number, but well within Australia’s capacity to sustain. You could say that the economies are on life support and if we think about Australia there are the following initiatives in place:
- The Job Keeper stimulus which is paying employees to retain their workers and there is the increased unemployment benefit which is called Job Seeker;
- Those with reduction in hours have been able to withdraw up to $20,000 from their super and to date approximately $30 billion has been removed from super by over 2 million people;
- Businesses with a 30% reduction in turnover have received significant tax subsidies,
- Families and businesses have been able to put loan repayments on hold;
- There has been rent relief for businesses and landlords have been banned from evicting renters;
- There has been a moratorium on insolvency and bankruptcy for businesses for six months to cease the normal process of insolvent businesses going into administration.
The following chart shows the cumulative level of the stimulus and it’s tapering.
All of this stimulus will eventually end and much of it was due to end in September this year, however gradually those deadlines are being extended. These were all ending at about the same time, which could’ve caused a massive shock.
Yet in this environment housing hasn’t collapsed and share markets seem amazingly buoyant.
Given we would’ve agreed that the share markets were overvalued in February even without the global pandemic, this is quite surprising.
During the GFC, some share markets around the world fell 50% and property in many countries fell 50% as well. The GFC was triggered by excessive lending to people who couldn’t pay the loans back, who bought overpriced housing in the US. It was a big market reaction to what seems very isolated event in comparison to this global pandemic. How then can the share and property markets be so comfortable?
There are many answers for that including the fact that interest rates are at extreme lows, meaning that the traditional investments of cash, term deposits and bonds as a source of income, are paying next to nothing and that means income investors increase their allocation to good quality companies and properties. Also the huge level of spending and income support from government has given a large percentage of the population more disposable income, which has had some surprising effects.
- Robin Hood is a share trading software program app in the US which became the play thing for people in lockdown given sports betting ceased, they had more money and plenty of time. This is lead to a massive increase in mum and dad traders entering the market.
- When we look at the fact we can borrow against our houses at 2.2% in Australia and then buy a high growth diversified investment portfolio such as the one we use, which paid 6% income in July, there is demand created by that also.
Another reason for the optimism of the share market is the belief or hope that the economic rebound will be quick if the coronavirus impact lessons either through herd immunity or a vaccine. There is much discussion about the shape of the recovery being a V shape meaning it drops fast and recovers quickly or a W where it drops recovers and then drops again before recovering.
In the video here Hamish Douglas who manages the hugely successful international investment fund Magellan, interviews Janet Yellen who was the previous US Federal reserve chairman. It’s a bit heavy going but Janet shares her view that whilst the initial recovery could be quick, there will be remaining scarring that will mean it could be a number of years before the level of economic activity gets back to where it was. They also discuss the US election.
There is and will be scarring left by this crisis. The trade war between the US and China which was concerning us and the markets last year has now escalated to the point where most of the world is upset with China. So it is now a global trade war as each country’s aim is to protect itself at all costs so the mood and behaviours are now very different to the last 10 or 20 years of free trade and rules based trade diplomacy.
The European Union which is a delicate political union centred around a currency has many stresses. Whether or not this crisis leads to further fragmentation and destabilisation is unknown, and the physical act of Brexit still has not been implemented yet.
It has accelerated the US movement of pulling back from being the stabilising force politically and militarily for the world and the enabler of free trade which underpinned the evolution of many countries development. You might be interested in this youtube video where Peter Zeihan discusses the state of global power.
Are there any positives?
So they are all the things we know about that concern us but there are always positives so let’s consider some of those.
- Firstly humanity continues to innovate, evolve and regroup. The economies will recover and even if it takes 3 to 5 years then that really is normal and over the course of our lives becomes a small period of time.
- There are some very strong businesses who will continue to make more profit each year through this period and we use very experienced investment manages to seek out the strong businesses for our investment portfolios. Many of those strong businesses are fairly stable, are very cheap, are still paying strong dividends, and when compared to the income payable from cash term deposits or bonds, seem very attractive.
- We are viewing this crisis from Australia who went into it with a very low level of government debt (relative to most other developed countries) so it has huge capacity for the stimulus and support programs being enabled and will exit this crisis still in a relatively healthy fiscal position compare to most other countries in the world.
Current Investment Strategy and Positioning
Our client base as a whole was relatively conservatively positioned going into this.
- The level of debt within our client base has never been lower and even our high-growth portfolio has 25% of the money in defensive holdings rather than shares and property. Both of these were deliberate strategies given the risks we saw in 2019 even prior to a Pandemic.
- We haven’t recommended people engage in the “multiple investment property funded by huge debt” strategy and it is been 10 years since we last recommended someone take out a margin loan to double up their investment exposure.
- The businesses owned within our portfolios are a carefully filtered selection of high-quality, well run, profitable businesses which are attractively priced. So when we hear the statistics of the extreme over valuation of some of the high flyers in the tech sector etc we are not exposed to those on valuation grounds.
- At this point hindsight shows we should have got very aggressive again in March and we should have more exposure to the expensive global leaders such as Tesla, Zoom etc. However we are still happy to focus on quality AND reasonably valued investments to reduce risks and by doing so we give up some upside at times.
There is a strong and compelling argument that the extremely low level of income earned through holding cash, term deposits or bonds that the type of holdings within our portfolio that tend to pay strong fully franked dividend will remain in strong demand and may even face a new wave of demand. If this holds for a few years, it could push the valuations much higher as more investors throughout the world appreciate the relative stability and high-level of income paid by a good quality basket of sensibly managed businesses in stable countries such as Australia.
On balance we are comfortable with the positioning of the portfolios and we aren’t making large changes at this point with our clients unless they have had a significant change in their circumstances.
However is it also worth recognising that the bottom of the share market after the GFC and the 1929 great depression did not come until over 2 years after the initial shock. If and when the markets have a decent pullback, we will see that as a buying opportunity using the capacity that is sitting within the funds to move those defensive holdings into the good quality shares and property market opportunities. Also at these times our specialist fund managers will also rotate out of strong defensive businesses into higher growth businesses when they see a compelling risk / reward trade-off.
The next 6 months will be very telling as we will experience the unwinding of much of the stimulus, we will know what the second wave of the coronavirus looks like and we may have vaccines and we will certainly have better treatment programs. The level of economic damage from this crisis will be more evident and we will see how optimistic the share market and housing markets are at that point.
It is important that we remain patient with our investment strategy, keep the next few years in perspective, keep the lines of communication open between our advisors and our clients so that changes in their circumstances are accommodated within their investment strategy, and be comfortable in the fact that we have wonderful seasoned investment managers actively managing their portion of our clients money on a daily basis.
A moment of gratitude!
For those of us in WA we can also be thankful at this point how our state has coped, and we can hope that we manage the anticipated second wave well. We may even see WA economic outperform the east coast due to the strength of the mining industry, the healthy WA State budget, the impact of us all holidaying at home, the fact that our Housing market has become relatively cheap and there is a building stimulus to keep construction trades and business busy.
If anything in this update has raised questions or concerns don’t hesitate to contact us.