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As I See It: December 2022

Greetings to you all and Happy Christmas

The approaching holiday period gives us an opportunity to reflect on what has been three long years.  The virus has worked its way around the world causing chaos to normal market conditions and many people’s livelihoods and in extreme cases, their health. The most recent previous experience of such an event was the Spanish Flu, just after the First World War, which again lasted three years and was followed by several years of great prosperity colloquially known as the “Roaring 20s”.

Circumstances were of course compounded by the Russian invasion of Ukraine and the impact that this has had on energy markets exacerbating inflation related issues. Western governments reduced interest rates to effectively zero for much of the course of the pandemic before raising rates this year as economies rebounded. This has had the effect of making guaranteed returns more attractive and risk-like returns from shares relatively less attractive.

One thing that seems clear is that many people are very tired.  I am looking forward to a good long break where we can reassess many aspects of our lives including investment philosophies. The business will close briefly over Christmas and New Year returning in early January ready for another year. The historical graph below shows equity markets between the Spanish Flu of the last century and Coronavirus some 100 years later.

Graph:  Historical Equity markets (Source:  NY Times)

Are We There Yet? – Rising Interest Rates

Historically rising interest rates has been poor for all active assets and this year was no exception where money in the bank actually was the best performing asset class for the year. This is quite a rare occurrence and, in the past, has been followed by quite a strong recovery for equity markets.

It is important to remind ourselves that governments only lift interest rates when economies are strong and buoyant and have the capacity to expand, possibly creating inflation. Once it is clear that inflation is reducing quickly, and supply chains are becoming more normalised, then it is highly probable that interest rates will actually drop possibly as soon as later next year.

As a metaphor the patient is taking the last bout of antibiotics just to make sure that the virus is definitely killed. The risk of course being that economies are forced into unnecessary recessions due to excessive rising of interest rates which impacts on both good and bad organisations equally. At this stage it would appear the rates may peak around February/March 2023 and this will be an important time for locking in fixed interest returns where available (this would include term deposits and annuity rates).

Graph:  Historical RBA Rates (Source:  Tradingeconomics.com/RBA)

Graph:  Interest Rates and Housing prices (Source:  CoreLogic/RBA)

Key Future Indicators

The best guide to probable future interest rates in two years, is looking at two-year bond rates to pay to cash. There is a real risk that rates are lifted too high and that the economy is going into unnecessary recession for a longer period than needed, leading to higher unemployment and wasted assets. It is important to remember the policy holders are making decisions based on historical data which can be superseded by future events.

The graph below shows the reduction in both freight costs and energy costs over the last few months all of which will help to reduce inflation. There remain some unknowns, such as the resolution of the Russian invasion of Ukraine and the speed of China reopening its economy after its zero COVID lockdown policy.

As always is better to make decisions on a full 5-to-7-year business cycle rather than the overnight news, which is so often distorted to sensationalism rather than good business judgement. On balance next year looks to be more stable for the markets.  It does look like at least the US economy will go into a mild recession. Domestically the reopening of China is important for our exports which should help us avoid a similar fate.

Graph:  Falling freight Costs (Source:  Kiel Institute)

Graph:  Asset Class performance 2022 (Source:  BetaShares/Bloomberg)

Property Markets

The residential property market is naturally being impacted by the decline in demand due to rising interest rates. If you were to look back a few years, current interest rates are not particularly high relative to historical averages. One of the impacts of rising interest rates has been quite an increase in rent, particularly in the inner cities, which again will impact on affordability and discretionary spending.

Hopefully this will right itself through catching up on our immigration targets encouraging overseas students and working visas into the country. All asset classes and property prices do go through cycles and the best way to plan for the future is to give consideration as to the growth of the property market over the previous 50 years (attached).

Some of the bottlenecks, such as people living in houses bigger than their needs closer to retirement is being alleviated, with the opportunity to downsize and move a substantial amount of money to bolster superannuation without impacting on Centrelink benefits for the first two years at least.

Graph:  Residential Property Valuations (Source:  Corelogic)

Overseas Perspective

I have been able to travel overseas for the first time in three years to both Japan and India, and it is clear that on a global basis that Australia remains one of the great countries in the world to live in.  With a global population of 8 billion looking to improve their lives, investing and living in Australia does look increasingly attractive. In context, both Tokyo in Japan and New Delhi in India have populations greater than the entire Australian population.

We remain in a very fortunate position, particularly our export opportunities into the Asian region and China more specifically. We also have a far higher dividend yield on our blue-chip shares than many of our competitors which allows for a greater amount of income than other countries.  It is my hope that we can bounce back well next year as a country and get back to the kind of lifestyle and values they have underpinned our nation over the years.

We will get a rest for the next couple of weeks and will be raring to go in the new year

With our best wishes
Tony and Fiona

Posted by Dr Tony Virtue, Principal


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