It's good to feel uncomfortable

A client recently asked me to describe the last few years of investing. With one word. The word that came to mind was rollercoaster. A rollercoaster for both valuations and for emotions.

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During the 2008 financial crisis JP Morgan’s head of economics described the global economy as ‘a dying patient being kept alive via intravenous drip’. By 2009 investors had been convinced by the media the World’s financial system would collapse. That share markets would continue to fall indefinitely. Perhaps to zero valuation, until public companies no longer existed. Investing was fruitless since anything you bought continued to halve. Let alone trust your cash to a bank that might not exist.

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Then dawned the 9th of March 2009. The day of the low for markets. Sadly, investors had spent the previous 18 months selling and deleveraging. Almost 1.5 decades later and how things have changed.

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Following a recent global pandemic and a (another) major market collapse during 2022, the global stock market (MSCI) remains more than 420% higher, with the US stock market up more than 740% from this 2009 low point.

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It’s doomsday short-termism which as an advisor I’ve lived through over the decades, which convinces us all that things will never get better.  Three years ago, the streets of New York were filled with body bags, cemeteries lined across Long Island. Little wonder Governments panicked. Using the benefit of hindsight, it’s now clear that to protect us all from what was predicted to be a potential obliteration to the human species, ridiculous economic stimulus was needed. And boy was it delivered. Free helicopter money from Governments, coupled with the gift of free debt from Central Banks created more damage than good over the medium term for investors.

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The era of zero interest rates squeezed the inflation genie out of the bottle, while also leaving the underlying financial system prone to some serious plumbing stresses. Reflected by the recent collapse of the Silicon Valley bank followed by the closure and rescue of the 140-year-old institution which was Credit Suisse.

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We all now know the extraordinary combination of ultra cheap money and heavy government stimulus created a tidal wave of inflation no-one saw coming. Admittedly prices originally surged due to supply chain disruptions, then compounded further by soaring oil prices due to Russia’s invasion of Ukraine, with further fuel to the inflation fire from the sharp rebound in consumer spending from lockdown freedom (the covid revenge spend).

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A zero cost of capital wasn’t normal and was delivered to the population to rescue us from the pandemic pessimism. Now Central Banks are grappling with the post pandemic ‘revenge spend’ which continues to see rampant spending across all generations. Essentially bringing forward future years spending to today, whether that be on travel, restaurants, or renovations.

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Travel to Noosa – you can’t get a seat at a restaurant. Your weekly grocery spend at the Woolies checkout remains 50% higher than 18 months ago, because retailers can get away with it. Today you’re paying more for an economy airfare to London than for a business airfare three years ago.

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In the previous three decades leading into the pandemic, the World was enjoying the fruits of globalisation success. Prices were stable. Geopolitical risks were low. Rampant technological advancements drove cost cutting and greater margins.  

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Before Covid-19, the population didn’t even discuss the level of inflation. Nor did borrowers really care if they had a fixed or a variable loan. A new acronym ‘mortgage cliff’ was born in Australia during 2022.

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Independence of Central banks around the World is now under the spotlight and ripe for reform. We’ve heard from the head of the Bank for International Settlements (BIS) Thomas Jordan admit that using interest rates as the main tool to deal or control economic problems is now ‘taking its toll and is no longer effective’. The US Federal Reserve’s respected ‘dot plot’ (which predicts where each Fed Board member forecasts the cash rate will be) will now be dropped as it’s simply, ineffective.

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Back to Economics 101. There are two simple tools used to control spending within an economy. Monetary and fiscal policy. In basic terms, changing interest rates is referred to as monetary policy. For the past three decades, it’s been the main tool used for developed countries to manage economic spending. The other main economic tool is fiscal policy, or the Government’s control of taxation and economic spending.

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Monetary policy is carried out by independent central banks so such as our RBA, until the news of last week – which will see the RBA’s powers stripped and a new board to instead make this decision.

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In Australia, it’s been forgotten it was the Howard Government’s push for Federalism and fiscal reform which saw the separation of monetary and fiscal powers, to enable our RBA to control interest rate setting independently. Now these powers are being stripped, due to the mess created from the urgent free money handed around during the pandemic.

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Both our Federal Government and RBA were jointly thanked for rescuing our economy during the pandemic. Consequently, when it came time to reverse the flow of capital, to extract this free money back out of the Australian economy, our Government walked away leaving the difficult job solely with the RBA.

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The reason why there’s much more renewed pressure our Government be jointly to blame for the asset bubble created. Instead of solely using monetary policy and jacking up interest rates to chase down inflation, rather Australia’s spending should instead be constrained by greater fiscal (Government) tools. Such as higher taxes or higher GST to restrict further spending, rather than crucify those with debt.

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Markets are now convinced that Central Bankers around the World are finished hiking interest rates and looming on the horizon are interest rate cuts. This week we’ve seen two of Australia’s retail banks (ANZ and WBC) declare that Australian property won’t fall by another 15% as expected, instead the housing market will finish 2023 flat.

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Will these economists be right? The honest answer is no one really knows. Forecasts don’t mean a thing. The only thing that can deliver truth with forecasts is the passage of time.

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Markets began living through a very painful cleansing process during 2022, which will likely extend much longer. Overvaluations are now facing the reality of a more normalised cost of capital. The reason why our RBA paused on hiking rates any further, as the RBA can’t yet determine the damage created by the lagging effect of 11 successive rate hikes.

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Interest rates will most likely never be 0% again for as long as we live. Zero rates were fantastic for all asset classes and a godsend for those investors who used leverage, such as private equity. This wealth effect is now unwinding, in readiness to prepare for the new, fresh bull market.

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Since the turn of the century equities and bonds have generally moved in opposing directions, which survived wars, crises, bear markets and most economic cycles. That was until the year 2022. According to JP Morgan, the vintage of 2022 for investors will most likely prove to be one of the best years to invest – the same as hindsight also proved for the year 2009.

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Investing is never comfortable. As unusual as this may sound, you need to feel uncomfortable with your investments to make a return. It’s an important part of the investment journey. Having the right asset allocation or a great investment portfolio won’t drive your long-term returns. It’s instead the conviction to remain invested throughout the toughest of years which generate returns. 2022 was certainly one of those years. We all now look forward to a whole new dawn!

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Until next time,

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Craig

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