The Fallacy of Forecasts

Elon Musk. Steve Jobs. Jeff Bezos. Bill Gates. Mark Zuckerberg. Jack Ma.

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A very successful string of names. You might call them entrepreneurs. World changers.

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At some time, each was named the best CEO on the planet. Arguably the Julius Ceasars or Albert Einsteins of our generation. Each have improved our global economy and dramatically reshaped our future.

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I’d argue the most fascinating background of the list is Jack Ma. Raised by a very poor family, struggled with mathematics and called himself ‘Jack’ since he couldn’t pronounce his own name.

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Ma only recently admitted he could not afford to buy his first computer until he was 33. In the face of such adversity, how did Jack Ma become the wealthiest person in China before turning 50, then decide to retire that year?

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Each holds very differing backgrounds, characters, motivations or what ultimately spurred them to success. To not worry about their competitors. To never be annoyed by slandering media commentary. Most importantly the ability to focus on their long-term goal. To not be distracted by short-termism. To not be concerned about failing. These very same rules apply when investing.

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The most open and amusing quote I ever read on the secret to investing was from one of America’s most famous traders, Bernard Baruch:

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‘If you are ready to give up everything and study the whole history and background of the (stock) market and all the companies whose stocks are on the board as carefully as a medical student studies anatomy – if you can do all that and in addition, you have the cool nerves of a gambler, the sixth sense of a clairvoyant and the courage of a lion, you have a ghost of a chance.’

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Even the smartest of minds can’t outsmart the market. So today I’ll touch on a couple of very important topics – the sad lessons learnt by DIY investors during the pandemic, followed by the current market and how we see the year ahead post this recent market correction.

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Challenging investment markets such as those currently, cause many to throw their hands up in desperation.

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The fact is being too conservative or idle with investment capital leads to significant, long-term inflation erosion. As strange as this may sound – the largest risk to investors in these markets is to walk away from risk.

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Griffith University recently published a report which analysed more than 42,000 switching decisions made by Australian DIY Super investors. This data was compiled with the assistance of Iress, who collated the investment pricing and data for Griffith University.

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The results were both sobering and saddening to read. Griffith’s findings again prove that successful investing is an emotional art. How critical it is for investors to be guided by a trusting, qualified financial advisor.

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It’s during these corrections, crashes, crises and pandemics that causes us as advisors to grow a few more grey hairs and really justify our fees while managing significant capital across so many different Families.

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In comparison to the Financial Crisis, the sheer level of panicked DIY investors who switched their Super funds during the pandemic was more than triple that of the GFC.

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Switching is when a Super Fund investor instructs their Super provider to change their asset mix or risk profile.

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During the pandemic, nearly 1 in 4 Australian Super Fund investors told their fund provider to change their portfolio mix.

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Griffith University found the average switch during the pandemic resulted in poorer fund performance in comparison to doing nothing, more than 70% of the time. The average loss made was more than $36,000 per decision. The most common error was moving to cash near the market low, or instead, selling low and buying high.

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According to Griffith University, this average ‘bad switching’ decision made by DIY Super investors resulted in a decline of their Super Fund value of 18.1%, in comparison to if nothing had been done. This short-term, irrational and unguided decision, on average reversed 7 years of an individual’s retirement strategy.

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Griffith University’s research could not collate transaction costs or tax consequences. The research was also unable to measure the emotional stress leading to these poor investment decisions.

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These huge losses realised by the Australian Super industry during the pandemic has now forced regulators to review the process of how easy it is for a DIY investor to make these poor decisions.

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Nowadays, snap decisions can be done via a simple phone call or tapping on a mobile application. Griffith University concluded while technology has resulted in much better access and control of Super Funds, the lack of direction and poor emotional control has eroded the technological benefit. (Source: Super switching triples during pandemic’, AFR, 7 December, 2021.)

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During the pandemic lows of March and April 2020, we advised each of our clients not to sell. We instead advised many of our clients to complete the reverse strategy taken by these DIY investors. Investing cash during the low, as well as selling bonds to buy more shares and growth assets.

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Which leads me onto the most common question clients are now asking of us: is this the beginning of the end? Have the good times finished?

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If you’d been living on a deserted island since Christmas (when markets peaked), to return back to reality today, you would wonder why share markets have corrected. One word has created the selling: Inflation (which Ryan wrote about in detail during our last note).

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The word ‘inflation’ is not at all new. It comes as absolutely no surprise. We flagged inflation as the single largest risk to the market 12 months ago, while we listened to both the Australian and the US Central bank heads preaching, they would ‘leave the cash rate at near zero until 2024, or 2025’. The fallacy of forecasts!

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During our client events of last year, I jokingly said on stage that Phillip Lowe and Jerome Powell were both lying through their teeth when they promised to leave the cash rate at zero.

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Our firm’s view throughout 2021 was we would instead see the first interest rate rise from the US Fed during 1H 2022. Four years earlier than promised. Where to from here?

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Initially, during tightening cycles, investors react like deers in headlights. How much higher can rates go? How quickly will rates be raised? What will this do to asset prices and the serviceability of our debt? The result is this classic, significant rotation away from growth assets, into value (income) assets.

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Globally, you see the very same re-allocation of capital every time the World’s central bankers tighten monetary and fiscal policy to reign in economic expansion.

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In my short 35-year career, I’ve experienced this during the early 90s bond crisis, the tech boom of the late 90s, the 2001/2002 Iraqi War-era coupled with the industrialisation of China, and more recently the post-GFC QEI to QEIV 2011-2013 period. Equity markets wash around, with investors playing tug-of-war between value and growth. While the media enjoying feeding us that apparently, the next crash is coming.

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Our view?

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Let’s look at the facts. There is no recession in sight for Australia, the US or globally. Unemployment remains at record lows. Corporate earnings remain strong, well above consensus. With earnings season well underway and a weaker market, the PE of 19.2 times earnings on the S&P500 looks very attractive, given forward cash rate expectations. (Source: Factset earnings update, 28 Jan 2022.).

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Inflation is rising. House prices and used car prices have skyrocketed – not just in Australia, but globally. Timber prices have almost doubled. Container freight costs have doubled. Petrol in Australia is now above $2.00 per litre. The reason why central banks are raising interest rates. Rising interest rates is not a bad sign. It’s a great sign. The US expansion is a great story. The US has expanded from an annualised basis of 2.5% over the past two years to more than 5.6% during 2021.

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Wage growth equals more optimism (wealth effect), as well greater turnover within an economy. Allowing for an economy being able to produce what is demanded, given global stock levels at record lows. Companies can’t make cars, boats, furniture and food fast enough! Is this a bad thing for the economy?

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This recent selloff in technology companies and the growth sectors of the market will be short-lived. As with all previous tightening cycles, value is now expensive, while growth is once again cheap. This is reflected strongly by the diverging performance across our core client portfolios. ARK (Disruption) down 55% over 12 months, while Infrastructure (Rare) and Global Property (Resolution) are up between 25% and 35% respectively.

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The best inflation hedge and logical investment strategy in every economic cycle is investing in companies that are able to grow earnings (E). If the ‘E’ rises, so too does the share price over the long term. Investors don’t necessarily need to realise ‘E’ in the form of dividends. As long as ‘E’ is allocated to good use, share prices will continue to rise.

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The market is now pricing ahead five interest rate increases in the US this year, the first increase being delivered next month. The impact on the economy, due to raising interest rates, is well understood by regulators and is a normal function of an expanding economy. Coordinated policy response will work. Central bankers will contain and control inflation. That’s their job.

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Rising interest rates does not signal the end of a bull market.

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2022 will be a very volatile year for markets. Be prepared for lower returns over the coming years.

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The single biggest risk to investors in this environment is walking away from risk.

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Our advice has and will remain – do not be distracted by short-termism. Keep your eye on your long-term goals. Take a leaf out of Jack Ma’s book.

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Regards,

Craig

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