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Newsletter 49

24 May 2023

Global Macro-economic and Geo-political Update


The northern hemisphere is about to start their summer holiday break which traditionally is a quieter time for business and equity markets. This time, the US debt ceiling is like a dark cloud shadowing the wider economic and geo-political issues. As previously commented when the debt ceiling is about to be breached a political game is played by both republicans and democrats which ultimately results in an agreement to raise it. With the US having twin budget and trade deficits Americans are living beyond their means, it is time for the US to take steps to reduce its national debt of $32 trillion and the budget deficit of $3 trillion. These levels of debt make America the largest debtor nation in the world. Fortunately, having soft and hard power has allowed the USA to ride out the head winds with having such levels of debt. With the world economic environment changing and the emergence of China and India as superpowers there will come a point in time when the world questions America’s ability to honour its debts without a substantial loss in purchasing power. Significant structural changes are required; however, no politician or political party appears to have the will to do so.

Amongst Organisation for Economic Development (OECD) countries there are several interrelated issues limiting economic growth. The Ukraine war has seen not only North Atlantic Treaty Organisation (NATO) countries but also non-members increase their defence spending as a percentage of GDP (NATO target is 2%). This means other sectors of the economy will suffer real decreases in funding. The growth in wealth disparity between “the haves” and “have nots” is exacerbated by inflationary conditions as some governments are attempting to inflate the real value of debt away through the inflation tax while simultaneously increasing social welfare entitlements. History shows once a social welfare entitlement is enacted it is near impossible to take it away.

In newsletter 45 dated 2 February 2023, we commented that Australian fiscal and monetary policy were aligned; unfortunately, the Federal Budget where expenditure is budgeted to grow by 5.7% and revenue by 5% highlights the structural budget problems that have existed since 2003. The saving grace is that Australia’s debt to GDP ratio is low compared to the majority of OECD countries, this does not relieve the government of its responsibility to address this structural problem. This is an inflationary budget which increases the possibility of the Reserve Bank of Australia (RBA) raising interest rates again although the banks tightening of lending standards, (i.e., a “credit crunch”) appears to be now doing the work for the RBA. The bottom line is it is important for fiscal and monetary policy to be aligned which is in now no longer the case in Australia.

Ukraine War

The war continues to have major geo-political and macro-economic implications for NATO countries. Ukraine grain shipments are being blocked again and this is leading to shortages in Africa and other countries that rely on the so called “Ukraine food bowl”. Led by the US, NATO is doing everything possible to support Ukraine militarily without directly attacking Russia. The Pentagon’s stated tactic is to degrade Russia’s military capability; however, this cannot be achieved unless Russia is attacked, and its factories destroyed. Gratefully, there does not appear any appetite for such a move because of the risk of nuclear war. Consequently, the Ukraine war appears likely to drag on for years unless there is a determined effort by all parties for peace. This remains our hope.


Over 2 years ago we outlined that the world was going into a stagflation environment where there was inflation and high levels of debt which reduced economic growth or resulted in a recession. We have arrived at this point as reflected in many leading, e.g., Purchasing Managers Index (PMI) and lagging economic indicators, e.g., unemployment. As previously outlined (see newsletter 48 dated 28 April 2023) the recession will not hit all sectors of the Australian economy simultaneously.

At the same time the business and consumer world are looking at a recession, equity markets (that trade on future valuations) are looking past the recession and are trading on expected Price Earnings (PEs) and this is also reflected in debt markets where the key yield curves are inverted which means debt markets are saying interest rates must fall.  Readers of our newsletter will recognise that for 18 months now we have been saying this.


Australian unemployment rate increased to 3.7% in April 2023. This figure is still low, but increasing. Unemployment is rising in the US with first time claims for benefits jumping to 264,000 last month which is supported by figures that show temporary contracting work is down which means companies are cutting back on temporary contracting staff. Companies reduce contract staff first before cutting employees hours and the last thing they do is retrench. Another key metric is quit rates which are falling. Quit rates measure the degree of job hopping. During the pandemic there was major increase in job churning as the media reported a new phenomenon called “quiet quitting” which was just giving a name to something that has happened for years. This job hopping led to wage increases, but these appear to be slowing down as the effects of inflation, fears of recession take hold. Also, employees are seeing the potential impact on their job of new technologies, specifically Artificial Intelligence (AI). It is expected that unemployment will increase across many industries, as more tasks are automated and therefore jobs become redundant.

The US and Australian economies are both very different from the 1970s when there was wage/price inflation, because then the employment market was highly unionised and in the US there were automatic cost of living adjustments (CPI increases) in many union employment contracts. This is not the case today, in fact real wages have lagged inflation significantly since the 1990s. These automatic (CPI) wage increases led to this common misunderstanding that wage increases are inflationary, rather wages follow price settings in an economy, not the other way around.

Equity markets

The US S&P 500 index is trading at 18 times Price Earnings (PE). This is still high historically, which means there is still room for global equity markets to fall further, particularly if interest rates increase, as companies future value of earnings are discounted at a higher rate producing a lower value. Against this mathematical calculation is the “weight of money” argument. It has been reported that there is USD3 trillion dollars sitting in cash accounts waiting for a market correction, so it can be deployed.  Furthermore, each month and quarter superannuation/pension funds receive member contributions which fund managers must deploy according to members risk profiles, e.g., balanced, growth, etc. Adding to this equation is that also each quarter/semi-annually/annually pension/superannuation funds must re-balance members portfolios to bring them back into line with their risk profile. This creates a lot of market activity along with algorithmic trading where the volumes are significantly greater than retail investor activity. All these factors combined make timing the market not possible as its time in the market which is important.

Artificial Intelligence

AI, e.g., Chat GPT being the best known and which has had the fastest take up of any new technology/social media platform in history with over a 100million users signing up in less than 3 months. As outlined above AI is transforming our world and interestingly, we are even seeing technology industry leaders, e.g., Elon Musk saying AI should be limited. This is not possible, as once the “gene is out of the bottle” it is not possible to put it back in, as we have seen with the Atomic bomb.

Critical Minerals

The Critical Minerals Strategy 2022 will grow our critical minerals sector, expand downstream processing and help meet future global demand. While global demand for critical minerals is increasing, global supply is uncertain due to the market, technical and commercial risks of critical minerals projects. We have been active in this area for a few years now and positioned clients into our Copper Nickel and Lithium (CNL) portfolio to take advantage of these opportunities, as well as related investments.

Residential Property Market

We are frequently asked about the property market, which has 4 sectors of residential, commercial, retail and industrial. We do not normally comment on the residential market in our newsletters because it is in the mass media constantly; however, given that increasing interest rates are forcing up repayments we thought it important to comment and hopefully provide some tips.

As we all know the key to property investment is location, location, location. The Australian residential market has many segments, e.g., first home buyer, second home buyers, investment property and trophy home markets. As mentioned above with a credit crunch, (i.e., banks tightening credit standards) and with rising interest rates now starting to impact the first home and second home buyers with large mortgages, as a greater percentage of their take home income is going into mortgage repayments. Monetary policy takes time to work.

The investment property and trophy homes are selling well. We have seen a number of record prices in suburbs that historically have not been considered “top end”. There is a shortage of rental property and with the Federal Government budget projection of 1.5m immigrants over the next 3 years, this will put upward pressure on prices, i.e., it is a demand/supply equation. Rents have been increasing and some younger renters have returned home because they can no longer afford the higher rents. Some folks that moved to regional centres during the Covid pandemic are moving back to the city to be closer to work, family and friends. Equally, renovating costs have jumped because of increased costs of raw material and shortage of tradies.

Direct property investment continues to be a sound investment even with low yields. Investors considering a property investment must remember that like equities it is important to take a long-term view. Many folks forget that the initial transaction costs, e.g., stamp duty, legals, building and test reports are high as are the ongoing costs, e.g., insurance, council rates, land tax, etc which reduce yields, (i.e., net income from rents). State governments should remove stamp duty as was proposed when the GST came in as this negative tax creates a disincentive to move and significantly adds to the transaction cost of buying.

For those with owner occupier mortgages we have always recommended paying fortnightly rather than monthly as this reduces your principal faster, as it means you are paying more principal off each year. If you can afford it, then pay extra into your account.

We see a weakness of interest offset accounts being your cash is tied up, so it cannot be used to create wealth. A better strategy, if you have an interest offset account is to utilise it while paying extra off on the mortgage, so you are simultaneously paying more of the mortgage and releasing funds held in the offset account. In summary, Interest Offset accounts are good short-term tools for managing debt, however, to use them for long periods of time is not a wise strategy, because at some stage the debt will need to be repaid, and there could be better tax effective returns elsewhere using some or all the funds.

Home loans offered with an Interest Offset account have a higher interest rate, than those without an Interest Offset feature. The interest rate difference is as much as 2% now, so it is important to determine exactly how you will use an Interest Offset account if you get this type of home loan, otherwise it may end up costing you more than if you had taken out a mortgage without an offset facility.

Self Managed Superannuation Funds

Successive Federal Governments (both Labour and Coalition) tinker with superannuation rules. The Government is proposing to tax unrealised capital gains on superannuation balances greater than $3m. The detailed rules have not been released; however if these changes become law it will have a significant impact on the management of SMSF funds as there will need to be a higher level of liquidity to pay any tax liability. We watch this space with much interest.

As outlined in previous newsletters, we do continue to see opportunities in the store value assets. Please feel free to reach out to discuss.

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