I read an article recently that proffered ‘the world has become a lot more dangerous’. This is in reference to the ongoing Ukraine/Russia Conflict and the horrors that were perpetrated in Israel on the 7th of October and no doubt the fierce response that is now occurring in Gaza.
I do not want to understate the impacts that are being experienced by combatants and civilians in these areas but unfortunately, it is far from unprecedented. As recently as May 2021, Israel was embroiled in ‘Operation Guardian of the Walls’ with missiles exchanged between Hamas and Israel as well as riots in Israeli cities.
The barbaric Isis was only officially declared defeated on December 9, 2017 and Saddam Hussein may have been executed in 2006, but Iraq remained occupied until 2011.
In the last seventy years, we have had civil wars and genocides in Angola (1974-2002), the Congo (ongoing since 1998), Rwanda (1994 Hutu massacre of the Tutsi), Bosnia (1992-95 Yugoslavia) Cambodia (1975-1978) and China (1945-1949). We also had wars in Afghanistan (by no means settled), Sudan, Biafra, the Congo, Mozambique, Vietnam and Korea – all since the second world war.
Having recently been to the United Kingdom and spent some time in Edinburgh, you don’t have to read too much history to recognise humans have a long history of atrocities against fellow humans. The Scots and English conflicts seem almost civil (though not at all) when compared to the inquisition and crusades in Europe as well as more recently, the murderous reign of Joseph Stalin from 1922 – 1952.
I understand the author’s sentiment but unfortunately, history would indicate the dangerous times we live in are very relative.
Through all the above and much more we still had investment markets and we will have them into the future.
Managing in ‘these’ times
There are reasons markets are nervous and yes, that is in part due to uncertainty and fear of contagion (either of the current conflicts expanding).
Arguably the more substantive concerns remain debt, inflation, growth and energy.
Within this nervousness and the haze of current events, it is easy to lose sight of the relative strength we have seen in markets.
A very simple example. The US S&P 500 index is up 11.24% for the twelve months from 24th October 2022 to 23rd October 2023. It was higher on the 31st of July 2023, so if you only looked at the last 10 weeks you would say it was down approximately 8.0%. Is 11% for twelve months still pretty good?
Australian Equities have not fared as well with the All Ordinaries price index 200 over the same period just positive at 0.70%.
- On the 3rd of February 2023 the All Ords was 10% higher than 23rd October 2023.
International and Australian bonds have been down and up, and commercial property has some concerns.
Part of our role is to look for quality solutions in the various asset classes and build portfolios that manage some of these risks as well as outperforming their peers. Diversified portfolios are more able to manage shocks and we add some defensive strategies that anchor portfolios in volatile markets. This doesn’t mean they can’t have negative results but historically they recover far more quickly.
We also reweight quarterly back to the initial strategic benchmarks. This means each quarter we will take profits from the better performing sectors and reallocate that profit to underperforming areas.
- This means in a bullish market, each quarter, you are taking some of the gains from growth assets and reallocating them to more defensive solutions. This will help in any eventual market correction and yes, we are always heading for the next correction.
- In correcting markets, defensive assets may be outperforming and, in that case, each quarter, we would take gains from the defensive assets and reallocate them to growth assets. This can mean we can take advantage of the eventual market growth, which will also happen.
Historically this has added to performance as well as smoothing the investment experience.
- The AAN Core fund which most of our pre and post retirees would have exposure to, for the same period as the numbers above had a performance of 8.24% for the twelve months.
- The AAN Growth which has higher exposures to both Australian and international equities (approximately 40% in each) for the 12 months to 23rd October 2023 has had a return of 9.8%.
What are the ‘contagion’ concerns?
Oil Prices and Iran
Share prices are being impacted by, amongst other things, the uncertainty of oil supply and prices. There are analysts who are concerned that Iran may decide to play a more active role in the Israel/Hamas conflict and part of their strategy could be to close the straits of Hormuz. We have talked about this Strait and its significance in previous blogs but the upshot is 20-30% of all the worlds oil and 88% of all the oil leaving the Persian Gulf goes through this chokepoint (That is United Arab Emirates, Iraq, Saudi Arabia, Kuwait and Iran). Over 20 million barrels of oil a day. Additionally, 20% of global liquefied natural gas (LNG) supplies also goes through the strait. There is one spot where the channel is only 3.2 kilometres wide.
Markets are concerned about an escalation that sees Iran take action that it has threatened before but is yet to act on.
Australia only sources about 17% of our crude oil needs from the Persian Gulf but Asia is very reliant on it and Asia is home to our biggest trading partners.
- When we say Asia, 50% of all China’s imported crude oil comes from the Persian Gulf.
- China was once self-sufficient in regard to oil but its growth has seen a massive increase in domestic demand and now 70% of its daily oil consumption is imported.
The counter argument to Iran shutting the Strait is that it does not want to upset its largest ally and customer. China is the biggest buyer of Iranian crude oil. (Actually, China buys its Iranian oil via Malaysia, as there is an international sanction on Iranian oil so buying Iranian oil would be illegal?). China has trebled its imports of Iranian oil over the past two years and it is estimated it buys 87% of Iran’s oil exports.
There is a strong view that Iran would be very hesitant to upset Beijing so any concerns on Iran shutting the Straits may be ‘exaggerated’.
China and Taiwan
Another concern would be China taking this opportunity to launch its invasion of Taiwan given the US is distracted with both the Ukrainian and Israeli conflicts. A very real possibility at some stage as per our previous blog however Naval experts believe there are only three months on the calendar that will allow for an attempted amphibious assault of Taiwan and those are April, May, and August.
To invade Taiwan the Chinese would need to land troops and even though Taiwan is only 180km from the Chinese mainland, the Taiwan Strait can have as much as 6 metre tidal surges as well as some very aggressive currents and miles of mud bogs. Mother nature is providing quite a bit of protection from September to March but it is still a risk.
How is that Crystal ball looking?
We are not advocates of simply steady as she goes and just stick to the plan. Your risk appetite is important to us and if you are concerned, there are steps that we can take to lower the risk you are taking though it is important to not lose sight of your personal lifestyle and investment objectives.
While interest rates are impacting mortgagees negatively, they have had a positive impact on cash, and more recently bond returns. The cash rate is what we call the ‘risk free’ return and there is now potential to park a portion of your assets, during particularly uncertain investment environments, and still generate enough return to almost match inflation – so your purchasing power is not declining. We would generally only recommend a portion of your portfolio in cash, as markets have a way of determinedly ignoring the consensus and uncertain times are when asset growth can be at its strongest.
- The trap for investors can be to not move back into growth assets after an adjustment. The temptation is to wait for the ‘bottom’ of the cycle, which has usually happened before the market realises it. You suddenly look back over the last month and realise the market has already rallied 10%.
Our retiree clients can draw comfort from the fact that wherever possible, we hold at least two years of income needs in cash or cash like investments. Market volatility is not going to have any real impact on your monthly income for at least twenty-four months which can give markets time to recover if a correction occurs.
For clients still saving to meet their lifestyle goals, volatility may actually be your friend and we have seen any number of seemingly serious market adjustments shrink to blip on the growth charts over any reasonable investment period.
As always, if you have any concerns please do not hesitate to contact us. That is what we are here for.
Paul Forbes, RFS Advice CEO.