16 Feb 2022
Global Macro-economic and Geo-political Update
The world is watching events in Ukraine and Taiwan very closely and folks are trying to determine whether Russia and China respectively will invade. Are western countries willing to go to war over Ukraine and Taiwan?
At one end of the spectrum wars will lead to major supply chain disruptions, e.g., gas pipelines from Russia to Europe potentially being closed. At the other end of the spectrum an invasion without war will lead to more economic sanctions being placed on Russia and China which would be a further step in splitting the world economically.
At the same time the parties to the JCOPA (Iran Nuclear Deal) are working with Iran to bring all parties back into compliance. If this does occur, a consequence will likely be lower oil prices. If the deal can’t be resurrected, then oil prices may continue to rise.
These geo-political events are adding to the volatility in markets.
In our previous newsletter we expressed concerns about stagflation, i.e., rising prices (inflation) and low economic growth because of the huge government debt overhang.
The U.S. gross national debt recently exceeded USD30 trillion for the first time. This figure does not consider contingent liabilities, e.g., unfunded pension funds, private debt, e.g., student loans and mortgages, and corporate debt. If any other country had this level of indebtedness they would be punished by global markets as Turkey has been. The US for the moment can get away with it because it holds the world reserve currency and is the largest economy in the world, although there will be a day of reckoning.
Fiscal stimulus provides a short-term Gross Domestic Product (GDP) kick, although there is significant academic research that shows once National Debt to GDP exceeds 60%, as in the case of the US, Japan and Eurozone, then each additional dollar of fiscal stimulus has diminishing benefits. It’s because of this that we closely watch debt market, as well as equity markets.
Inflation - Australia and US
Our concerns have turned out to be realised as the official inflation rate in Australia rose to 3.5% in December 2021 which was more than market estimates of 3.2%. We believe it is greater because Consumer Price Index (CPI) as a measurement tool is open to manipulation from changes in the basket of items that make up the index. This increase was primarily due to rising fuel prices, material shortages, global supply chain issues and increased demand ahead of Christmas holidays. Inflation in the US according to the latest CPI figure is now 7.5%, so with 12 month treasuries yielding about 1%, then the real 12 month return (after inflation) is negative 6.5% (1.0-7.5%). The below table from Bloomberg shows the price changes for 9 key US items since January 2021.
It has been reported that Walmart is now putting its meat under lock and key due to the level of theft, as the price of meat has increased by around 16%. Similarly, pharmacies are now locking up toothpaste and deodorant. These are more examples of the breakdown in US society because of the growing inequality.
You may already be aware there has been an increase in global markets volatility. The US market in January 2022 saw a major correction where the NASDAQ fell about 9% and the Dow Jones Industrial Average (DJIA) dropped around 3.3% making it one of the worst performing Januarys since 2009 for NASDAQ and since 2016 for DJIA. Subsequently, all international markets corrected including Australia with the S&P/ASX 200 falling about 6%.
In the short-term, stock markets are likely to be more volatile because of concerns over interest rate increases. Central Banks and governments want to deflate asset prices by signalling to the markets that rates will be increased, but they do not want a crash as this would severely impact on consumer and business confidence. This game of “bluff” between the markets and central banks will continue for the foreseeable future. We do not see major interest rate increases but rather small incremental ones, although the banks will be eager to increase mortgage rates more than an increase in the official cash rate, and similarly they will pass on less than the full rate increase to depositors. This is because banks manage their books to Net Interest Margin (NIM), not the cash rate.
Our strategy continues to be asset diversification by country, currency and asset class. It is important to have exposure to assets that have a stored value, i.e. property, commodities, precious metals and those companies with high levels of intangible assets, e.g. Google, as they should protect your purchasing power.
Aitken Investment Management, AMP and Magellan, etc.
Normally, we would not comment on competitors; however, as these organisations have been in the media a lot lately, we believe it warrants a comment. We recognise that no one can predict the future and no fund manager/advisor is immune from making investment mistakes which is why it is important to understand what happened in these organisations and what are the learnings.
Magellan fund performance and share price have crashed while AMP continues to go through major re-structuring and business model changes. The issues at Magellan appear to be personal and business related and appear to have a way to play out.
Aitken Investment Management (AIM) has also been in free fall with major investors, e.g., Kerry Stokes selling his 19.9% investment. Like Magellan although significantly smaller in fund size the problems appear to be both personal and business related. It appears that at the heart of the issues at AIM and Magellan are key person risk.
For the record we have never been an advocate of Magellan, AIM and AMP because their fees are much higher compared to similar product and we have been concerned about the “investment guru image” of the key individuals, so we have never invested client funds in these organisations. Ultimately, it is capital protection and returns after fees that matter.
Insurance companies across the board have increased their premiums. We have queried the insurers who say that historically the risk has not been correctly priced. It is another example of inflationary pressures. Despite the premium increases it is important to remember insurance is a capital and lifestyle protection product, and therefore plays an important role in financial risk management.
If you have any questions, please feel free to call.