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As I See It: February 2022

Good morning and I hope you have got some rest over the January break.  For many it has been a time of brief reflection as we process the major events of recent times and make plans for this year.  In my opening client newsletter of the year, I briefly recap on these events to set the scene for the major issues investment markets will need to consider in the year ahead.

Many of us have been dealing with the rapid spread of Omnicom in our families and wider communities which has been disruptive and caused significant challenges to our everyday life. We have a strong contingent of front-line nurses in our client base, and I do want to publicly acknowledge their extraordinary public service in protecting our community at this time. At this stage numbers seem to have stabilised in NSW, but we must remain cautious and vigilant as other mutations of the virus may appear at a future date. Looking far back through history including the Great Plague of London of 1665, pandemics take on average around 3 years to work through a community until vaccinations and herd immunity provide enough protection to stop the any further spread. The sad consequence being that the weak and elderly are most susceptible to serious illness and sometimes worse. For those of you interested in looking at this in greater detail click here to read more from Wikipedia on the major epidemic and pandemics going back through history. My view remains that this is far from over and we need to put the safety of our community above all else.

The consequences of managing the economic fallout of protecting economies where people have been forced into quarantine and isolation for extended periods has led to around $10 Trillion of global stimulus from the major economies and emergency low interest rates. This translated into a re-rating of all growth assets including residential property and technology shares as access to cheap capital and supportive regulatory settings encouraged investors to take on more risk and push up the value of assets. By the end of calendar year 2021 global share markets again reached new all-time highs and the collective value of residential property in Australia approached $9.5 Trillion. In aggregate this has led to a collective increase in the nation’s wealth over the 18 months of close to $3 Trillion although the corollary of Government stimulus is a national debt at all-time highs of $1Trillion.  Effectively private citizens assets have grown funded by Government Debt. Now at some stage policy settings will need to revert to a more neutral stance as the real economy recovers and there is less need for Government stimulus. This in essence requires interest rates to rise through the western world but only at a speed that the economy can handle without creating excessive financial stress on markets. Australia last lifted interest rates back in 2010 after the economy recovered from the Global Financial Crises so this will be the first time in 12 years and a new concept to younger investors under 30. The RBA meets next Tuesday for the first time this year and markets expect a market change in their future outlook statement.

Australian Inflation Rates
Source:  Trading Economics/ABS

The RBA left interest rates unchanged yesterday (Click here) and does of course operate independently of the Government of the day with a mandate to foster financial system stability as reflected in full employment and a targeted trimmed inflation target of 2-3% annually. It does however have to consider the impact of decisions made overseas and in particular in the US as this impacts on the relative value of our currency. Last week the US Federal Reserve indicated that they would commence lifting interest rates in March probably by 25BP with a market expectation of a further 3 rises later in the year. Clearly this would be staggered and adjusted based on the economy’s recovery and the share market as a leading indicator will give a good guide as to the level of increase the community can handle. There are many moving parts to these decisions, but real and perceived inflation is probably the most relevant. Our own quarterly inflation numbers were higher than expected last week and above the higher 3% RBA target. Economists are divided as to how much of this is temporary and transient due to labour shortages and how much is of a more systemic nature.  The largest components of our increased CPI last week related to housing costs which is quite understandable given the significant increase in land values throughout the country and the knock-on opportunities for building related activities. Fuel prices have also increased sharply both here and overseas.

Key components of our CPI increases 
Source:  ABS

Part of the fuel increase relate to tensions on the Russia/Ukraine border which are festering away. I had the opportunity to visit Russia in 2008 on a financial services study trip from Australia which included a day at Gazprom their largest company who control the main gas pipes in the region and effectively under state control. The power dynamics of the break -up of the USSR in 1991 into 15 independent satellite countries has bubbled away for some 30 years with much overlap of ethnic backgrounds between the neighbouring states. To be clear this is not a new phenomenon and changes in leadership and loyalty have been part of the region’s way of life for many generations. The weaponizing of the gas pipes for economic control and regime change was readily evident when I visited Moscow 14 years ago and it is unlikely that there will be an obvious resolution of this matter. Russian troops have massed on the Ukraine border for 12 months and we are now in the middle of winter in Europe where energy supply dislocation would have the maximum effect.  Ultimately this is a wider power play between the US and Russia and the expansions of NATO in the area so let’s believe that wise heads will prevail. All have domestic audiences looking for their leaders to be seen to be tough and this conflict should be seen in this global context.

Looking forward, Australia commences its interim reporting season in earnest next week and we have important numbers due out of the large IT Tech companies in the US at the same time. On balance this is a time to be particularly cautious and to hold larger cash reserves than usual as such we will also be very circumspect with placing new client funds into the market while matters remain somewhat volatile.  We can expect wider swings in daily share prices, and this may continue for some time until a new floor settles things down. Generally larger companies paying predictable dividends do better in this market and value managers targeting undervalued companies should also be a safe haven. As an asset class any fixed rate bonds will diminish in value and aggressive growth style managers may struggle. While in the short-term interest rate rises are painful, they are needed and will eliminate speculation on the market particularly in the unlicensed cryptocurrency market. Over time the risk-free rate as reflected in major banks term deposits should rise which will be a comfort to retirees. As a metaphor rather like lifting the speed and inclination of your running machine at the gym, the initial shock can be confronting but you are fitter and stronger for the resistance over time. There remains a lot a cash on the side in the country now and as we return as a community to full capacity opportunities will arise for further astute investments.

Historical Annual Returns by Asset Class
Source:  Vanguard

On balance I remain optimistic for longer term investment prospects. We do need to accept some level of mean reversion from the new all-time highs of last month and remain disciplined through good diversification and taking a long-term view to allow markets to normalise. This is a significant time in investment markets with interest rates set to rise for the first time in a decade. As such we may need to make some adjustments to your portfolios to reflect these conditions. Internally the business remains strong and ready to serve you and your friends as we navigate the year ahead. You can read my thoughts in greater detail at www.virtueandpartners.com.au while appointments can be made at info@virtueandpartners.com.au.

With our sincere best wishes for the year ahead

Tony and Fiona

Posted by Dr Tony Virtue, Principal


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