Are we ready to ‘Capitulate’?

2022 has been a tough economic year.  Not all bad news here in Australia but serious headwinds in China, Europe, the UK, the USA and most other continents.

In Australia we have been relatively shielded by our export industries with Iron Ore, Coal, Natural Gas and agricultural produce being in demand just about everywhere. Of course we have had a little bit of rain…?  (Queenslander’s can definitely sympathise with our NSWelsh and Victorian residents at the moment).

Our Covid experience was expensive but would now be classed as behind us, while a country like China is still dealing with its zero tolerance policies. 

Xi Jinping has now organised his next 5 year term.  (A slightly scary but short read is in this link that outlines how Xi Jinping has consolidated his power, putting him on par with the likes of Mao Zedong Ways-chinas-xi-jinping-amassed-power-over-decade-2022-10-10 ).  China continues to be impacted by Covid shut downs and even though this is easing slightly, they are dealing with the huge property development failures in the country.  Annexing Taiwan is something the current government is committed to though many commentators would argue the way the West has responded to Russia has given the Chinese Communist Party pause, but not indefinitely.

South America has its own problems though its economic impacts are not as visible to the world.  The flood of refugees crossing into the United States is the most obvious indicator. Brazil and Venezuela are just two examples though Venezuela has finally had some positive news after seven years of recession (worldbank.org/en/country/brazil/overview, venezuelas-economy-grew-17-q1 2022-08-23).  The recent strong Gross Domestic Product (GDP) growth in Venezuela needs to be tempered with the reality that their GDP has dropped from over $400 billion, a decade ago, to $50-$60 billion in 2021. 

South Africa and Northern African countries have their own significant troubles to deal with, both economically and socially. Energy is a major concern for South Africa but for countries like Zimbabwe, Sudan, and Nigeria, their currency has been in freefall leading to massive inflationary pressure.  Zimbabwe has seen its currency depreciate by 97% (1 Jan 2022 – 7 Sep 2022) to the US dollar.  By comparison our dollar (AUD) has depreciated by around 17%.

In Europe, the PIGS are back.  Portugal, Italy, Spain and Greece’s deficit and debt issues were never really resolved and largely shored up by support from other EU partners – Germany being the most influential.  Germany now has its own concerns with an energy crisis. (Even Greta Thunberg is telling them to turn their nuclear plants back on! Greta-Thunberg-says-germany-should-keep-nuclear-power-plants-running ).  The crisis has tempered Germany’s interest in supporting the Euro and market forces are now impacting the PIGS access to funding as interest rates increase to better reflect the underlying default risk.

On top of this we have the war in Ukraine and the threats of Armageddon weapons use, from Russia.

The Middle East has played into this by restricting oil production that is causing price shock at the petrol pump and any success seen from the Abraham Accords (After-two-years-what-state-Abraham-accords ) seems to be stalling.

Have I depressed you enough yet? 

So against that background how are investment markets doing?

The short answer is not very well. 

All of those variables and a lot more, which would take too long to discuss here, are impacting sentiment.  That sentiment is already reflecting in the investment markets.

A quick summary of the market since 1 Oct 2021 to 30 Sep 2022 (12 Months)

The upshot of the last twelve months is that there has been nowhere to hide but cash and over the last two years cash was almost zero.

For the same period 12 months earlier (1 Oct 2020 to 30 Sep 2021)

If you invested $100,000 in the AAN Core, 1 Oct 2020 by 30 Sep 2021 it would have been worth approximately $122,000.  12 months later on 30 Sep 2022 it would have dropped to just over $106,000. 

You could have sat in cash over those two years but you would have earned around 1% so your $100,000 would be worth $101,000. A much smoother ride but not a great result.

So what does the information above tell us?

There is a lot of uncertainty out there. 

None of the above is news and all this information is readily available to professional investors and ‘googlers’ alike.  The reversal in markets are the visible impacts of analysts and investors factoring this information into the current pricing.

Markets are ‘relatively’ efficient in interpreting this data and pricing the impacts, but that doesn’t mean we are out of the woods yet.

What do we know?

Investment cycles follow a pattern and the point of maximum risk is when markets are going through a ‘euphoric’ stage.  (Think Alan Greenspan’s, ‘Irrational Exuberance’ speech of May 1996 before the 1997 Asian financial crisis which was then followed by the tech bubble that well and truly burst in 2002).

Based on the information above, ‘Euphoric’ is not a word being thrown around at the moment?

The ‘Investment cycle’ does follow a pattern but the length of the cycle can vary.  There is no ‘new paradigm’ as we (investors) all drive this cycle so we see this repeat through every decade.

Behind this cycle investors are going through their own set of emotions and this is described as the ‘Cycle of Market Emotions’.  An example is below.

So where are you on this graphic?

It is a genuine question and we want our clients to answer this question mentally and then consider where you are now sitting on the risk curve.

If the point of maximum financial risk is up there with Euphoria, then that is not where we are. Despite this, over two years, investors are still in positive territory. 

This part of the cycle is where real investment loss is realised.

If you mentally answered ‘Capitulation or despondency’ then maybe this will give you some encouragement

We don’t know what will happen in the next six to twelve months BUT we do know downside risk is much lower than it was back in 2019 and last year in the 2021 bounce.  Investment markets could certainly decline further but we could also be seeing close to the bottom.

In sailing parlance, you have weathered a large part of the storm, with relatively little damage. Would now be the time to abandon ship?

Behind all that negativity above is some green shoots of good economic news and there are always companies that will recover faster, outgrow the competition and provide a better return on equity.

Sentiment impacts all companies but those that are well managed, with little debt, solid infrastructure and resourcing and a compelling proposition tend to outperform through this period and that is what our investment philosophy is focused on.

For retirees, this is why we have a two year cash buffer.  We don’t want market fluctuations to impact on the quality of your life and your plans. Additionally, many of you would be finding the structural changes we made to investment portfolios in March and July of this year has increased dividends from your current holdings. In portfolios like ‘The Core’ that yield is over 5.0%, which is substantially offsetting your current spending so your cash reserves are stable. 

• You may have also noticed the changes have reduced volatility – now less than 50% of the comparable market volatility. 
• The increased exposure to large high quality stocks is historically the right place to be in this sort of market. Our Australian equity exposure has the largest exposure it has had to top twenty stocks, since its inception in 2015, and this is adding to the dividend profile.

For accumulators saving towards medium and longer term goals, there is a sale on!  All the good quality ‘stuff’ is much cheaper than it was in February and yes, history would tell us it will be more expensive in the future.  Exactly ‘when’ is still the variable we can’t forecast, but price rises are getting closer every month. 

As per the cycle above, we are a long way from ‘Euphoria’ and a lot closer to ‘Relief’.

As always if you have any concerns please do not hesitate to contact us.

Regards,
Paul Forbes, RFS Advice CEO