Introduction

Our newsletters always focus on macro-economic and geo-political developments because at the end of the day it is changes in these that impact on returns. We acknowledge that individual stocks can “shoot the lights out” or “fall like a rock”, however you need to be very lucky or unlucky and that is why we generally avoid stock picking. Our approach is aimed at capital protection through diversification and themed based investing.

Changing Global Economic Framework

The war in Ukraine and resulting sanctions on Russia has increased the pace of change in the global financial system that started a number of years ago when Saddam Hussain stopped selling oil in USD and it is now impacting on all countries. In previous newsletters we have referred to them, including the de-dollarisation, rise of crypto-currencies, shift in economic power from the west to the east with the rise of China and India, 3D printing/Robotics and Artificial Intelligence (AI) which means that manufacturing can become localised again as the cost of distribution becomes the major cost of production, and the high level of debt as a percentage of GDP in all major democratic countries, e.g. USA, Japan, Euro-zone, etc. This debt cannot be repaid through tax increases without causing a global depression, so central banks have taken the only route available by printing money and creating inflation to “devalue” the real value of the debt or viewed another way reduce the purchasing power of money.

China’s zero covid policy is now impacting on world trade as ships are lining up off Shanghai with lock downs now spreading to Beijing, and there is no end in sight. In Europe, Poland has stopped purchasing gas from Russia and Germany has indicated it will do likewise.

It is too early to tell whether the “west’s” strategy of financially strangling Russia while simultaneously weakening their militarily is working. We note that historically major regional and world wars occur after a series of “calculated steps/mis-steps” and it is very concerning that Russia is now threatening use of nuclear weapons and attacking Ukraine western based supply lines. Further “mis-steps” could see the world stumbling into another world war.  

Debt and Equity Markets

It is well reported in the press that interest rates are rising because of inflation. There are predictions of between 6-8 increases this year in the US and a lesser number in Australia.

The Australian Consumer Price Index (CPI) rate published on 27 April 2022, shows the inflation rate of 5.1%. This is the highest in many years and makes a mockery of a cash rate of 0.10%. This means that real returns are now negative 5%. The cash rate will be increased.

Since 1 January the S&P 500 index has fallen 12.95% (as at 26 April 2022). This in part reflects the factors outlined above, e.g., war in Ukraine, but also the market is factoring in the impact of interest rate increases on stock valuations. Specifically, one key valuation measure is the discounted future cashflow of a stock. An important assumption in this formula is the discount rate (interest rate) that is used. As interest rates rise then so does the discount factor and the higher the factor the lower the value. Hopefully, this simple explanation helps in understanding one of the reasons why equity markets have moved down.

The following graph shows the trend of interest rates and asset prices over the last 30 years and what may happen in the future.

Therefore, as equity markets revalue stocks because of predictions on future interest rate settings, at the same time analysts will be considering changes in company earnings which may be very positive or negative. Netflix is a case in point where its valuation has been hit by both the changes in earnings because of the loss of subscribers and the impact of expected interest rate increases. Equally, BHP has had a major run up in its share price this calendar year because of its strong earnings and flight to hard assets, (e.g., commodities) and countries see Australian miners replacing Russia as a source of minerals.

What Next?

At this stage because markets globally are down, including Australian residential property that has turned the corner, so we see no point in converting any unrealised loss into a realised loss. Equally, we can see some opportunities in store value assets while sitting in cash for the immediate future cannot be faulted.  In some instances, we are adopting dollar averaging strategies for specific investments where we believe it will either turn around in the future, or pay a good dividend yield, or both.  

If you wish to discuss, please feel free to reach.