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April 2022 Investment Review: Share markets decline as interest rates rise further

Talking points

  • After bouncing back in March, share prices declined over April.
  • Australian equity investors were cushioned from the severity of global equity markets by outperformance from the Australian market and the depreciation in the $A.
  • Bond yields continued to move higher as high inflation persisted.

 

 

International Equities

 

 

Global share markets responded negatively to further interest rate increases over April. As was the case earlier in 2022, higher interest rates disproportionally impacted “growth” orientated equities. Those companies reliant on earnings growth in future years (rather than current earnings) typically have their valuations more heavily influenced when interest rates rise. Inflation combined with some lower than expected profit results from growth companies (e.g. Netflix) last month created a significant fall in “growth” styled equities. With the United States having considerable exposure to growth sectors, such as Information Technology, the US underperformed the broader global average, with the S&P 500 Index dropping 8.5%. Losses in other developed markets were less significant. The UK once again moved against the trend, rising by 1.0% as it continued to benefit from increased oil and energy prices.  

Share markets in emerging economies outperformed those in developed economies last month, with the MSCI Emerging Market Index declining 3.5% in local currency terms. There were positive returns in oil exporting regions, with Middle Eastern markets producing solid results. However, Chinese share prices continued to decline with the ongoing COVID related lockdowns in major cities, generating considerable uncertainty over the near term outlook for economic growth and company earnings.  

Global infrastructure and property sectors again performed better than equities overall. With cashflows in these sectors often closely linked to inflation, support for property and infrastructure assets has been relatively strong over recent months.

 

Australian Equities

Losses on the Australian equity market were less than the global average last month, as has been the pattern for most of the past quarter. The ASX200 index outperformed global equities by 15.6% in the 3 months to April. Relatively low exposure to “growth” styled equities and high exposure to resources & energy are two key contributors to this outperformance.

Australian energy stocks continued to advance last month, supported by a further 4.4% increase in the global oil price. However, there was some reversal of the recent appreciation in resource stocks, with the sector falling in value by 4.2% over April. This weakening was at least partially attributable to a 7.2% fall in the iron ore price, which is likely to have been impacted by the uncertainty over the Chinese growth outlook. As was the case globally, Information Technology stocks recorded a large decline, with the sector falling by 10.4%. Losses in the sector over the past year are now 22%.

More defensively positioned sectors increased in value over April. Utilities were the strongest, rising by 9.3%. A 12.4% jump in AGL’s share price made a significant contribution to the Utility sector’s performance. AGL is currently proposing a demerger of its energy retailing and electricity generation businesses, while the ongoing prospect of a takeover of the company could also be providing share price support. Outside of utilities, other defensive sectors such as Consumer Staples, Property Trusts, and Healthcare posted positive returns.

 

Fixed Interest & Currencies

The pattern of higher inflation leading to higher interest rates continued over April. In Australia, evidence of the uplift in inflation was provided in the release of the March quarter Consumer Price Index data, which showed the latest inflation rate to be 5.1%. This was followed by the decision of the Reserve Bank to lift the cash interest rate from 0.1% to 0.35%, which is consistent with the recent trend set by central banks across the globe. With inflation continuing to exceed expectations, bond yields have moved steadily higher. Last month, US 10-year Treasury Bond yields jumped from 2.32% to 2.89%. Despite having lower cash and shorter-term yields than the US, Australian longer-term interest rates remained above US equivalents, with the Australian 10-year government bond yield rising from 2.84% to 3.12% over April. As has been the case over each of the first 4 months of 2022, rising bond yields led to negative returns for fixed interest investors.

 

With the further increase in US interest rates, there was strong support for the $ US last month. As a result, the $A declined from US 74.8 cents to US 71.5 cents. This deprecation helped soften the impact of falling US equity valuations for Australian investors with unhedged exposures. The $A was, however, stronger against both the Euro (up 1.2%) and the Japanese Yen (up 1.9%) over April.

 

Outlook 

The magnitude of the change in bond yields over recent months appears to have moved beyond market consensus on the likely path of cash interest rate movements. Bond yields are higher than is implied by most economist forecasts of future cash rates. The relatively sudden removal of central bank bond buying (through their quantitative easing programs) may have led to a shortfall in bond demand, thereby creating a price fall (yield increase) beyond the fundamental or logical valuation. If this is the case, then a premium is currently available in bond yields, which should ultimately be rewarding for investors. 

What does this mean for fixed interest investors? Opportunities to take on more duration (interest rate term) exposure in fixed interest portfolios should now be considered. The short to medium term section of the yield curve appears particularly attractive (3-year government bonds in Australia are now yielding 3.0%), with yields above the most reasonable estimates of inflation averages for the equivalent period. Investing to take advantage of this duration premium appears to be a more robust strategy than holding large amounts of cash or taking on too much credit exposure at this time.

Whilst the rise in interest rates may have provided more conviction around the most appropriate approach to fixed interest, the outlook for equities is less clear. Rising interest rates have definitely been a major factor behind the weakness in equity markets this calendar year. However, if bond yields have “overshot” fundamentals (as implied above), then perhaps the risks to equities from this point forward should be considered lower as further increases in bond yield become less likely.

There are, however, other contributors to equity market risk outside of the interest rate factor. Although the economic backdrop remains reasonable with solid employment and household spending prevailing, profit margins have come under increasing pressure in recent months as input costs, particularly labour, are forced higher. Not all companies can pass on higher costs in full, and previously expected earnings growth forecasts could be challenged.

Notwithstanding the increase in risks associated with company earnings, equity prices have already materially declined over recent months, reducing the potential for further decline. Global equity valuations are now 12.1% below the level recorded at the close of 2021. Far more significant declines have been recorded in Asian equities, global smaller companies and sectors such as Information Technology, which may now be offering compelling value when compared with the broader global equity asset class.

If you have any questions or want to discuss your investment strategy then please book at chat with me.

 

 

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2022-23 Federal Budget summary

Treasurer Josh Frydenberg handed down the 2022-23 Federal Budget and as expected in an election year, delivered a big spending Budget with the focus on cost of living support and defence.

We have been busy detailing and summarising what we feel are the key measures announced from a financial planning perspective. For our ongoing service package clients, your adviser will be in contact to provide guidance on changes which impact your strategy.

 

Superannuation

Extension of the temporary reduction in superannuation minimum drawdown rates

The Government has extended the 50 per cent reduction of the superannuation minimum drawdown requirements for account-based pensions and similar products for a further year to 30 June 2023. The minimum drawdown requirements determine the minimum amount of a pension that a retiree has to draw from their superannuation in order to qualify for tax concessions.

Given ongoing volatility, this change will allow retirees to avoid selling assets to satisfy the minimum drawdown requirements.

 

Individuals and trusts

Cost of living tax offset

The Government will increase the low and middle income tax offset (LMITO) for the 2021-22 income year. LMITO is targeted at low- and middle-income earners that are most susceptible to cost of living pressures.

The LMITO for the 2021-22 income year will be paid from 1 July 2022 when Australians submit their tax returns for the 2021-22 income year. This proposal will increase the LMITO by $420 for the 2021-22 income year.

 

Paid parental leave

The Government is investing $346.1 million over five years, from 2021-22 to introduce Enhanced Paid Parental Leave (PPL), which is fairer and provides full flexibility for eligible working families. These changes will increase families’ choice to decide how best to manage work and care. Eligibility for the scheme is also being expanded.

 

Affordable Housing and Home Ownership

The Government will increase the number of guarantees under the Home Guarantee Scheme to 50,000 per year for 3 years from 2022-23 and then 35,000 a year ongoing to support homebuyers to purchase a home with a lower deposit. The guarantees will be allocated to provide:

  • 35,000 guarantees per year ongoing for the First Home Guarantee (formerly the First Home Loan Deposit Scheme)
  • 5,000 places per year to 30 June 2025 for the Family Home Guarantee
  • 10,000 places per year to 30 June 2025 for a new Regional Home Guarantee that will support eligible citizens and permanent residents who have not owned a home for 5 years to purchase a new home in a regional location with a minimum 5 per cent deposit.

 

Addressing Cost of Living Pressures – temporary reduction in fuel excise

Global oil prices have risen significantly since the Russian invasion of Ukraine. The Government will help reduce the burden of higher fuel prices at home by halving the excise and excise-equivalent customs duty rate that applies to petrol and diesel for 6 months. The excise and excise-equivalent customs duty rates for all other fuel and petroleum-based products, except aviation fuels, will also be reduced by 50 per cent for 6 months. The Government is responding in a temporary, targeted and responsible way to reduce cost of living pressures experienced by Australian households and small businesses.

The measure will commence from 12.01am on 30 March 2022 and will remain in place for 6 months, ending at 11.59pm on 28 September 2022. Under the measure, existing policy settings for fuel excise and excise-equivalent customs duty, including indexation in August, will continue but on the basis of the halved rates. At the conclusion of the 6 month period the excise and excise-equivalent customs duty rates will then revert to previous rates, including indexation that would have occurred on those rates during the 6 month period.

The rate of excise and excise-equivalent customs duty currently applying to petrol and diesel is 44.2 cents per litre. This measure will halve the rate on petrol and diesel to 22.1 cents per litre from 30 March 2022, with the price faced by consumers expected to be reduced by a larger magnitude given GST will be levied on the lower excise rate.

The Australian Competition and Consumer Commission will monitor the price behaviour of retailers to ensure that the lower excise rate is fully passed on to Australians.

 

Digitalising trust income reporting and processing

The Government will digitalise trust and beneficiary income reporting and processing by allowing all trust tax return filers the option to lodge income tax returns electronically, increasing pre-filling and automating ATO assurance processes.

The measure will commence from 1 July 2024, subject to advice from software providers about their capacity to deliver.

 

Business

Small Business – skills and training boost

The Government is introducing a skills and training boost to support small businesses to train and upskill their employees. The boost will apply to eligible expenditures incurred from 7:30pm (AEDT) on 29 March 2022 (Budget night) until 30 June 2024.

Small businesses (with an aggregated annual turnover of less than $50 million) will be able to deduct an additional 20 per cent of expenditure incurred on external training courses provided to their employees. The external training courses will need to be provided to employees in Australia or online and delivered by entities registered in Australia.

 

Small Business – technology investment boost

The Government is introducing a technology investment boost to support digital adoption by small businesses. The boost will apply to eligible expenditure incurred from 7:30pm (AEDT) on 29 March 2022 (Budget night) until 30 June 2023.

Small businesses (with aggregated annual turnover of less than $50 million) will be able to deduct an additional 20 per cent of the cost incurred on business expenses and depreciating assets that support their digital adoption, such as portable payment devices, cyber security systems or subscriptions to cloud-based services.

An annual cap will apply in each qualifying income year so that expenditure up to $100,000 will be eligible for the boost.

The boost for eligible expenditure incurred by 30 June 2022 will be claimed in tax returns for the following income year. The boost for eligible expenditure incurred between 1 July 2022 and 30 June 2023 will be included in the income year in which the expenditure is incurred.

 

Social security

Cost of Living Payment

The Government will provide $1.5 billion in 2021-22 to provide a $250 economic support payment to help eligible recipients with higher cost of living pressures. The payment will be made in April 2022 to eligible recipients of the following payments and to concession card holders:

  • Age Pension
  • Disability Support Pension
  • Parenting Payment
  • Carer Payment
  • Carer Allowance (if not in receipt of a primary income support payment)
  • Jobseeker Payment
  • Youth Allowance
  • Austudy and Abstudy Living Allowance
  • Double Orphan Pension
  • Special Benefit
  • Farm Household Allowance
  • Pensioner Concession Card (PCC) holders
  • Commonwealth Seniors Health Card holders
  • eligible Veterans’ Affairs payment recipients and Veteran Gold Card holders.

The payments are exempt from taxation and will not count as income support for the purposes of any income support payment. A person can only receive one economic support payment, even if they are eligible under 2 or more of the categories outlined above. The payment will only be available to Australian residents.

 

How can we help?

If you have any questions or would like further clarification in regards to any of the above measures outlined in the 2022-23 Federal Budget, please feel free to book a chat with your adviser.

 

Until next time.

—Pete

 

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February 2022 Investment Review: Volatility spikes in response to invasion of Ukraine

Talking points:

  • In a month of high day to day volatility, global equities moved lower in response to the invasion of Ukraine by Russia.
  • Australian equities moved against the worldwide trend, finishing the month higher.
  • Bond yields continued to rise as the military conflict heightened inflationary pressures.

 

 

International Equities

 

 

Unsurprisingly, the Russia-Ukraine conflict over February heavily impacted European share markets. Germany (down 6.5%) and France (down 4.7%) both performed below the global market average decline of 2.8%. The United States also experienced a significant 3.0% fall, with ongoing weakness in the higher growth sectors (particularly Information Technology) adding to the market decline.

In contrast, markets with substantial commodity exposure outperformed. Supplies of oil, gas, wheat and various other base metals and rare earths are expected to be heavily impacted by the Russian invasion of Ukraine. Commodity prices jumped significantly as a result. Oil prices were nearly 9% higher over the month and have now risen 27% so far this calendar year.

New Zealand, Canada, Norway and the United Kingdom were all examples of markets that benefited from the higher commodity prices and avoided equity market decline. The Japanese market was another to outperform, with the fall in the Nikkei Index restricted to 1.8%. In periods of heightened uncertainty, the Japanese market and currency are often viewed as “safe haven” assets and can outperform as a result.

Emerging markets also had mixed results over the month. Prior to the market being closed in late February, the Russian market had dropped 36% during the month. With MSCI and other index providers announcing that Russian listed stocks will be excluded from global and regional indexes, further selling pressure is expected should the Russian market re-open.

Other Eastern European markets also performed poorly over February, with an average decline of 11.7% (excluding Russia). However, elsewhere the jump in commodity prices supported emerging equity markets, with the Middle East and Latin America particular beneficiaries.

After a large decline in January, the Chinese share market stabilised somewhat in February with a flat result, although Hong Kong reversed its January increase with the Heng Seng Index falling 4.6%.

 

Australian Equities

 

The Australian equity market outperformed global averages significantly, with higher commodity prices being the key driver. The energy sector jumped 8.6%, with resources more broadly being 6.4% higher. Iron ore prices consolidated their gains from January, which supported the larger resource stocks of BHP (up 5.4%) and Rio Tinto (up 5.9%). However, larger price gains in other commodities saw some smaller mining companies, such as South 32 (up 24.9%), perform particularly well.

In addition to the resource rally, there was also a continuation of the dominant trend in January that saw more defensive “Value” stocks outperform higher “Growth” orientated stocks. One of the explanations for this trend was the ongoing rise in inflationary pressure (stemming from higher commodity prices) and the related increase in bond yields. These higher yields reduce the attractiveness of stocks reliant on earnings growth in future years. As a result, the Information Technology sector was once again the weakest performer with a decline of 6.6%.

More cyclical consumer stocks were impacted by concerns over the potential impact of the military conflict on global growth and consumer sentiment. The Consumer Discretionary sector dropped 5.0%. In contrast, more defensive sectors including Property Trusts (up 1.4%), Utilities (up 3.4%), Consumer Staples (up 5.6%) and Financials (up 3.0%) all performed well.

Despite the strong gains from some small resource companies, smaller companies continued to lag larger companies over February. The ASX Small Ordinaries Index was flat over the month. With an annual gain of 5%, smaller companies have lagged the broader market by 5% over the past year.

 

 

Fixed Interest & Currencies

 

 

With the jump in commodity prices adding further inflationary pressure across the global economy, there was additional upward pressure on interest rates last month. Some of the rise in global bond yields was, however, tempered later in the month due to the possibility that an extended conflict in Ukraine would reduce the magnitude of policy tightening by central banks. As a result, the rise in the U.S. 10 year Treasury Bond yield was limited to just 0.04%, with the yield finishing the month at 1.83%.

Australian yields increased by more, however, possibility due to expectations that Australia would be less negatively impacted by the military conflict. Australian 10-year government bond yields jumped from 1.88% to 2.13%.

 

 

 

Stronger commodity prices and higher bond yields contributed to a rise in the $A last month. Partially reversing the depreciation in January, the $A rose from US 70.1 cents to US 71.8 cents.

 

Outlook

The outbreak of war in Ukraine has both tragic human outcomes as well as significant global economic impacts. For those specific countries, companies and commodities directly impacted, the effects are clear and potentially long lasting. However, from an overall macro-economic and global share market perspective, the consequences are less apparent. Clearly uncertainties and risks have been heightened and the fall in global share market values over recent weeks is an appropriate response to that heightening of risks. Past experience, however, does suggest there is a tendency for equity markets to recover post an initial sell-off, well before any underlying geopolitical event has been resolved. This may reflect the reality that military conflicts don’t necessarily have negative implications for longer term company earnings at the aggregate level.

For Australian investors, the geographical isolation from the military conflict, together with the high resource and energy exposure of our economy, creates the potential for at least relative outperformance from the local market.

Concurrent with the risks stemming from the war in Ukraine, investors also need to consider the ongoing implications of rising inflation and interest rates – with inflation risks ballooning further as a result of the conflict. Although central banks may be more cautious around lifting interest rates in an environment of heightened uncertainty, any relaxation of a tightening regime could further entrench inflation and then ingrain higher interest rates into the medium term.

Despite the significance of events of recent weeks, our portfolio positioning preferences have changed little. Within the fixed interest asset class, the ongoing prospect of higher interest rates remains, and duration positions should be held relatively short to avoid the prospect of capital loss on bonds.

Although risks have increased, equity exposures should be maintained near neutral levels for investors who have the tolerance to hold exposure to these risks. On balance, risks and return prospects within Australian equities have improved relative to broader global equities given events of recent weeks. As such, a slight bias towards Australian equities may be warranted. Consistent with this improved relative positioning of Australia, high commodity prices and potentially increased latitude for interest rates to rise could add support for the $A. Although high commodity prices (and high iron ore prices in particular) could correct downwards at any time, short term recent upward momentum in the $A may have further to run, and some additional currency hedging could be considered over this period.

Should you have any questions or want to discuss your investment strategy then please book at chat with me.

 

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January 2022 Investment Review: Sharemarket falls in response to interest rate outlook

Talking points for January 2022

  • Sharemarkets shifted sharply lower over January in response to expectations of higher interest rates.
  • Higher inflation prompted the US central bank to indicate an imminent policy tightening, causing bond yields to rise.
  • Despite stronger iron ore prices, the $A declined against the $US and Euro.

 

 

 

International equities

 

 

Significant losses were recorded across most major developed share markets last month. Although the declines marked the largest monthly fall since the COVID-19 crisis-related drop in March 2020, share markets remain well ahead of where they were 12 months ago. Indications from the US Federal Reserve Bank that it was likely to raise rates in March, following further evidence of inflation, appeared to be the main trigger for the January decline. Inflation has reached 7.0% in the US, the highest rate recorded since 1982. Also weighing on sentiment was the ongoing build-up of Russian military presence on the Ukraine border.

Earnings reporting season and ongoing evidence of strong economic growth failed to outweigh the inflation and interest rate concerns on the US market, with the S&P 500 Index dropping 5.2%. The heavy weighting of the US market to both Information Technology stocks and companies previously bid up in price due to higher earnings prospects explains some of the weakness in the US market. In addition, higher interest rates reduce the present value of earnings expected to be made in future years and therefore company valuations more reliant on future years (rather than current year) earnings were sold down more heavily. This rotation away from “growth” stocks had less of an impact on markets like Germany (down 2.6%) and France (down 2.4%). The UK market actually finished in positive territory (up 2.3%), with its higher exposure to energy benefiting from rising oil prices over the month.

Within emerging markets, share market performance was generally stronger as the strength in oil prices, which jumped 17%, boosted Middle Eastern markets, whilst increases in other commodity prices supported South American returns. China, once again, recorded a significant price decline, although Hong Kong’s Hang Seng Index rose 1.7%, with that market’s orientation to financials shielding it from losses.

 

 

Australian equities

 

 

Despite a continuation in the bounce in iron ore prices (up 21%), the Australian market underperformed the global average over January. Amidst the broader market sell-off, resources (up 3.0%) and energy (up 7.9%) did show a price increase.

As was the case globally, the Information Technology sector declined sharply, falling 18.4% in January, which followed a 5.3% drop in December. Other key contributors to market weakness were the healthcare sector, where a 10.5% fall in the price of CSL weighed heavily, and the financial sector, which dropped 6.5%. The fall in banking stocks may have been considered a little surprising given rising interest rates provide scope for banks to improve interest rate margins.

There were mixed results within Property & Infrastructure, with the Australian listed property sector sold down more than global counterparts, with a decline of 9.4% following a period of strong recovery. Infrastructure proved to be more stable, with global stocks broadly flat and the Australian utilities sector rising 2.6%.

 

Fixed Interest & Currencies

 

 

Higher inflation was the key focus of bond markets. Annual inflation readings of 7.0% in the US and 5.4% in the UK were prime examples. 

The higher inflation in these economies has prompted a response by central banks, with the Bank of England raising the cash rate twice in recent months, from 0.1% to 0.25%. Although the US Federal Reserve Bank has yet to change cash interest rates, it has started to wind back its bond purchase program. In January, the Chairman, Mr Powell stated that “the committee is of a mind to raise the federal funds rate at the March meeting.”  

With inflation evidently higher in various overseas economies than in Australia (where our December quarter CPI showed annual inflation at 3.5%), global bond yields rose by more than domestic yields last month. The US 10-year Treasury bond yield jumped by 0.27% to 1.79% over January, with the Australian equivalent rising from 1.67% to 1.88%. These higher yields saw bond prices fall, creating negative returns for fixed interest investors.

 

 

The higher global interest rates, and the lack of indication from the Australian Reserve Bank of any short term plans for a rate rise, may have contributed to some weakness in $A last month. Despite the strength of commodity prices, the $A dropped from US 72.6 cents to US 70.1 cents and was also approximately 2% weaker against the Euro. This currency depreciation helped cushion the fall in global equity valuations for investors with unhedged currency exposures.

 

 

Outlook

The sizeable correction on equity markets over January was clearly a response to a change in expectations around inflation and interest rates, rather than any deterioration in the outlook for the real economy and company earnings. This view is re-enforced by credit markets, which held up particularly well and implied liquidity remained abundant and the financial health of corporates generally sound. This continued favourable outlook for the real economy is driven by very strong labour markets, where further employment growth provides the promise of ongoing addition to already strong household spending capacity and appetite. With this backdrop, the risks of a global recession, or major deterioration in economic growth rates, in the near term remain remote.

January’s share market sell-off, therefore, was all about a change in the way the market valued company earnings rather than any change in earnings expectations. Given the extent to which a prolonged period of exceptionally low interest rates had caused a disproportionate growth in the valuation of “growth” orientated stocks, it was logical that a change in interest rate outlook would trigger some correction in that part of the market that had most benefited from this period of low interest rates. However, January’s sell-off went beyond just a rotation away from “growth” styled equities, with few sectors or styles immune from price fall. The broader nature of the correction creates a question as to the extent to which equity valuations can be maintained at current levels should interest rates continue to rise.

Certainly, investors should be considering the ramifications of further increases in interest rates. Despite the recent rise, longer term bond yields are still below longer term inflation expectations (in Australia for example long term inflation expectations are at 2.3%, whereas 10-year bond yields are just below 2%). These negative real interest rates are not sustainable into the longer term and further upward adjustment to interest rates is likely unless inflation retraces sharply from here. No doubt, higher interest rates may cause shorter term stress and losses on equity markets. However, fundamentally, both the real economy and equity valuations are well positioned to accommodate the 1% to 2% rise in longer term interest rates that is required in order to return normality or equilibrium to real interest rate levels.

Existing interest rates are still exceedingly low relative to inflation, economic growth trajectory and historical norms. They are not a constraint on growth and are also well below the underlying earnings yield available from equities, property & infrastructure. Due to this margin between earnings yields and interest rates, there is capacity for interest rates to rise further without de-railing the investment case for holding growth assets. If inflation does prove to be persistent, then the natural growth in earnings and real asset valuations resulting from inflation, becomes a more important component of the justification for holding growth assets.

 

Want to chat about your investments?

Book a chat with us today to discuss your investment strategy with a Pekada adviser.

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Why it pays to stay invested

Investing isn’t always smooth sailing. For some, investing can make them nervous, and you can say that volatility is the price of admission when it comes to investing. However, over time, those that have stayed calm and remained invested during volatile times have been rewarded with growth and compounding returns. Conversely, those that got nervous and potentially sold after the market had dropped were often left missing some of the best days of returns.

 

Why is it hard to time the market?

If you have a crystal ball, timing the market is easy. However, timing the market can be dangerous for the average investor without the crystal ball. The pain of an investment going down can be real, but in these times, it’s essential not to make any irrational decisions. Charlie Munger, the vice-chairman of Berkshire Hathaway, points out that selling for market-timing purposes gives investors two ways to be wrong: the decline may or may not occur, and if it does, you’ll have to figure out when the time is right to go back in.

That second point he raises can often be the most challenging part. As an adviser, I have had clients come to me who have sold out when market events have happened and converted to cash. The Global Financial Crisis is an excellent example of this. When the market dropped a considerable amount, investors may have gotten nervous, and some may have sold out. For those that sold out, if they were fortunate, they may have saved a further drop of 5%, for example, but when the market started to rebound, were they able to put the money back into their growth assets at the exact right time? Often, the answer is no. I have seen firsthand some cases where people remained in cash long after the market had returned to its previous highs, therefore meaning they missed making not only their money back but all the future gains as well.

We as humans often act irrationally when it comes to investing, which is another reason timing the market can be so hard. For example, if you sell out at a certain point and the market rises, you may experience price anchoring. This means that you feel, despite potentially no objective evidence, that it will drop back to the level it was before, and that is when you will buy back in, but what if the market never gets back to that level? Often investors would have stayed in cash and missed out on several high days, months or even years of returns.

 

Why is this so important?

With the market experiencing a slight drop in January, Morningstar researched the perils of market timing. Their research showed that if you missed the best five months since 2001, you would be 33% worse off than someone who had remained fully invested throughout. Only five months contributed to 33% of the total gains for the portfolio since 2001.

 

Their research found that US stocks outperformed cash between 1926 and 2018, thanks to just 51 months of performance. If you missed those 51 months or even some of those months, then your overall return can be significantly affected to the point where it may have been better not to invest at all.
A more recent example is March 2020. Covid hits, and your portfolio drops 20%. You get nervous, and you sell, thinking that things will get worse. Then, with markets rising again, you look to reinvest the funds by May. Have you made the right decision? No. You would have missed the stock market’s best month in two decades. Morningstar showed that someone who invested $10,000 in January 2001 would have $63,500 last December. Missing just April 2020 cuts $6,000 off that final balance, which is a significant amount.

Overseas Bank of America looked at the S&P 500 returns since 1930 and the impact of missing the best and worst days since that time. The data showed that if an investor missed the ten best days each decade, the total return would be 28%. However, had they stayed the course and remained invested throughout that time, the return would have been 17,715%. Sure, if you managed to miss the worst days, then your return is a lot higher, but I would argue this would be nearly impossible to do for the average investor.

 

This shows the importance of remaining calm and invested. Usually, when we invest, we invest for a purpose. We have a goal in the future that investing is helping us work towards. We should always come back to this, the why. Sometimes good investing can be boring. However, staying the course and remaining invested will often result in good returns over a long period. These returns can be the difference between retiring early for many people, and therefore it becomes vital to not blow this away by making an irrational decision.

As always, if you have any questions regarding investments and strategies, feel free to email me at zac@pekada.com.au

 

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How vital are fees when choosing a super fund?

I’m not sure about you, but I don’t go to the cheapest hairdresser, I’ve been burnt before. On the other side, I also don’t pay thousands of dollars for my haircut either (although, maybe in Melbourne at the moment, I may have to in order to get a booking now that lockdown is over). I go somewhere where I feel the cost is reasonable, and I am happy with the outcome. With most things in life, the price is important but what should usually be most important is the value you get from that cost. This is the same way that you should be thinking about your investments and your superannuation.

 

Doesn’t lower fee’s mean more money in my super?

This is often a way in which people think, and it’s not necessarily wrong. Lower fees can often mean more money come retirement, but it’s not that simple. We need to look at the total return. If you’re paying 1% less in fee’s that can be great, but not if the more expensive investment outperforms the cheap one by 1.5%.

The most discussed cheap super option is the HostPlus Indexed Balanced Option. This fund’s popularity and investment are primarily due to the barefoot investor. Whilst this investment is cheap with investment fees of 0.06%. However, this is not the only factor we should consider when choosing it for our superannuation.

We first need to make sure that it’s appropriate for our risk profile. That means do we have the tolerance for the volatility that the growth assets within the fund will bring, or potentially, is this balanced fund below our risk tolerance and therefore, we may be missing out on long term returns by sitting below our risk profile. For instance, if you are a growth investor and chose the Indexed Balanced Option instead of the Shares Plus option, which is arguably more in line with the risk profile of a growth investor, you would have saved 0.93% in fees each year. That, however, only tells you part of the story as the Indexed Balanced Option over the last ten years averaged a 9.2% return whilst the Shares Plus Option averaged 10.64% for the same period. So we are leaving you potentially 0.51% worse off each year.

This also doesn’t mean that we hunt the best performing fund as historical returns don’t always correlate to future returns. However, investing in a manager with a proven track record is usually a good idea. The main point of this is that fees and fees alone should not be the basis on which you invest your super. Outside of fees and investments, other factors should be considered when choosing your superannuation.

 

What other factors should I consider?

As we’ve discussed above, fees and returns are significant, but other things need to be considered when deciding how we will invest our retirement savings. One of the more pressing issues with a lot of investors is not only the allocation of my investments in terms of how much I have allocated towards growth and defensive assets but also how my money is invested. Ethical and sustainable investing is becoming very popular as more and more people become concerned about the threat of climate change and other pressing social issues. If you are passionate about protecting the environment, then usually you would want your investments to reflect that and whilst most of them are getting better, not every super fund has an appropriate ESG option available to invest in. When looking at ethical and sustainable investing, what one person might consider being ethical and sustainable, another may not. So, it becomes crucial to see how those funds are invested in ensuring that they align with your wishes.

Another critical thing to think about when looking at what superfund option is best for you is what insurance options are available out there. This becomes especially important if you have insurance already within your current fund. You may not be able to get those insurances somewhere else due to medical issues you have had since getting those insurances. This becomes crucial to think about as once insurances are gone; they can be hard to get back. This is a necessary mindset to get into when looking at changing super funds as well, don’t look only to what you will gain but also to what you may be losing.

Other things that may be important when looking at your superannuation can be factors as simple as login access and how good the customer service is. However, the main point of this blog is to illustrate that there are many different reasons for choosing a particular super fund and investments. It’s all about choosing the best option for you, not necessarily what works for someone else or not for the simple reason of fees alone.

As always, if you have any questions, feel free to email me at zac@pekada.com.au.

 

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The great normalisation of interest rates has only just begun

Back in June 2019, the Reserve Bank (RBA) Board meeting minutes stated that households are net borrowers in aggregate”, which contributed to their view that on balance “a lower level of interest rates was likely to support growth in employment and incomes and promote stronger overall economic conditions.”  I subsequently wrote to the RBA and sought clarification, given that households are not net borrowers in aggregate. Their response advised that the comment was in reference to interest-bearing net borrowings, rather than total net borrowings. Perhaps this was the intention of the authors, however the lack of this qualification in the minutes makes the statement incorrect – households are in fact large net savers in aggregate. 

The above point is important. There is currently a general perception that high levels of debt in the private sector preclude the RBA from materially lifting interest rates. This view would appear to be reflected in the current yield curve. Ten-year government bonds are yielding 1.9%, which remains below the RBA’s target range for inflation and the bond market’s expected long term inflation rate of 2.3%. Hence bond market pricing assumes monetary policy will remain exceedingly loose, with the general level of interest rates remaining below inflation for most of the next decade (i.e., bond markets are assuming negative real rates will continue). 

Underpinning bond market pricing and the RBA’s statement above is the conventional view that a higher level of interest-bearing liabilities than assets results in household spending being negatively correlated to movements in interest rates, i.e., lower interest rates will boost spending and higher rates will restrict spending. The efficacy of this relationship, however, has been brought into question over the past decade when the spiralling down of rates to record low levels failed to show any material boost to spending, or indeed inflationary pressures. In the decade ending December 2010, the cash interest rate averaged 5.2%, which coincided with an average rate of growth in real household consumption spending of 3.8%. In the following decade ending December 2020, the cash rate average had dropped to 2.2%, with household spending growth languishing at an average growth of 1.5%. A lower propensity of households to spend, despite the materially lower interest rates in place, is indicated by a rise in the average household savings ratio over the 2 decades from 1.9% to 7.5%.

Hence the relationship between interest rates and spending is complex and may not follow expected conventions, particularly, it would seem, when interest rates are very low. Provided below are 3 examples of factors that may have worked against lower interest rates stimulating spending in the way policymakers would have expected over recent years:

  • Clearly retirees living off interest income have their spending constrained by lower interest rates. However, in addition, those approaching retirement are required to accumulate larger savings in a low interest rate environment in preparation for lower interest earnings in retirement. So, whilst pre-retirement age groups may have very little by way of interest-sensitive assets (the majority is likely to be held in the form of property and equities), the lowering of interest rates may lead to lower spending and higher savings by this cohort.

 

  • At the other end of the age scale, first home buyers are typically required to save larger deposits once low interest rates are in place, given the tendency for housing prices to rise as interest rates fall. Again, this group’s spending may be negatively impacted by lower interest rates, despite them having a relatively low pool of interest-bearing assets (or liabilities) prior to making the purchase of a house.

 

  • Those households with existing loans are the group most expected to increase spending when interest rates fall. However, in reality there will be a mixed response to lower interest rates by borrowers. Many will maintain existing repayment levels and run-down loan principal. Others will hold larger balances in mortgage offset accounts to further reduce interest expense. Increasingly over recent periods, some borrowers have opted for fixed-rate loans, removing the conventional link between policy interest rate levels and spending levels. 

 

Given the spectacular lack of responsiveness of inflation to interest rates on the way down over the past decade, there must be a serious question over the extent to which the small increments in interest rates assumed by bonds markets in the years ahead will have the necessary moderating effect on inflation to bring it into line with target. Perhaps, therefore, larger interest rate increases will be required to have any material impact on spending and inflation.

 

 

How high can interest rates go?

A common argument used against the proposition that interest rates need to return to “normal” levels is that the level of debt has become so elevated that normalised interest rates could not be sustained by the real economy. Having purchased my own first property in 1990 and subsequently dealing with mortgage rates in the 15-16% range, the proposition that the economy has minimal capacity to absorb a cash rate not much higher than 0.1% does deserve some critical analysis!

Whilst government debt has clearly ballooned in recent years, borrowing by the private sector has been far more constrained. In fact, the relatively slow rate of expansion in private sector credit is one reason why loose monetary policy over the past decade has not been associated with higher spending and inflation. In September 2021, the level of private-sector borrowings outstanding was $3.2 trillion, or 1.5 times the annualised Gross Domestic Product (GDP) of the Australian economy. Ten years earlier, the ratio of borrowings to GDP was 1.4 times. Hence, there has been remarkably little growth in the relative size of credit outstanding given the magnitude of the decline in the price of credit (interest rates). 

Part of the explanation for the relatively muted rate of growth in credit is the high rate of principal repayment on loans, which has been facilitated in part by record-low interest rates. However, even if we ignore the improvement to household balance sheets made by existing borrowers and focus on the position of recent first home buyers (the group most vulnerable to rate rises), the evidence still suggests there is capacity to absorb interest rate increases. In the 10-years to 2021, the average size of loans approved for first home buyers has increased from $318,000 to $455,000. However, despite the high principal balance, lower interest rates have meant that the interest servicing cost on these new loans has fallen from $24,800 to $20,600 per annum over the same period (assuming standard variable home loan rates – currently 4.5%). At the same time, wages have increased, resulting in the interest servicing cost as a percentage of the average wage declining from 35% to 22%. It is apparent, therefore, that much of the pain of higher housing prices for first home buyers has been felt via a much larger deposit requirement, rather than the size of the loan repayment.

Hence, given that interest rates are a fraction of what they have been throughout past economic cycles, and that there has been only a very measured increase in private sector debt, there would appear to be considerable capacity for the private sector to absorb higher interest rates. If this is indeed the case, then the current policy of holding cash interest rates at an artificially low level is going to become increasingly difficult to justify. Economies have typically operated well when the prevailing level of interest rates is above that of the rate of inflation. Positive real interest rates provide the incentive for capital accumulation and subsequent investment in productive assets. A prolonged period of negative real interest rates will increasingly direct investments to real assets, such as property, whereby the stream of rental income, being inflation-linked, is destined to compound at a higher rate than the cost of capital (the interest rate). If rents rise faster than borrowing costs into the long term, almost any capital value for the real asset can be justified mathematically (Sydney real estate being a case in point). With these metrics in place, the incentive to invest productive assets, such as machinery, which depreciate over time, is reduced on a relative basis.

The long-term policy objective of central banks should be to return the general level of interest rates to being above the level of inflation. As would appear to be increasingly likely, long-term inflation is expected to return to the target 2% to 3% range. In the past, cash rates have averaged approximately 1% higher than inflation. In addition, typically, the shape of the yield curve is positive, with 10-year government bonds being an average 0.6% higher than the cash rate. As such, a cash rate of 3.5% and a 10-year bond yield of 4.1% should not be considered extraordinary. This is, however, a long way from current bond market pricing and, indeed, central bank guidance. 

With the labour market currently strong and job vacancies at record highs, the rationale for delaying the change to normality in interest rates is becoming less clear. Inefficiency in resource allocation, inequity in wealth distribution and lower rates of homeownership are some of the prices being paid for the current policy. These considerations will start to weigh more heavily on central banks in the absence of the case for “emergency settings”. Positive real interest rates are needed for long term economic efficiency, growth and equilibrium and should not be feared by central banks, nor indeed share market investors.

 

Brad Matthews 

Brad Matthews Investment Strategies

 

 

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November 2021 Investment Review: Omicron variant weighs on market confidence

Talking points for November 2021                

  • Equity markets fell in response to the emergence of the Omicron COVID variant.
  • Bond yields pulled back from recent highs.
  • The $A dropped sharply as commodity prices softened and renewed COVID related growth concerns took hold.

 

 

International Equities

 

 

After consolidating the gains from October, global equity markets dropped into negative territory in the final week of last month. Growing evidence of the high rate of transmissibility of the Omicron COVID variant was the major catalyst for the turnaround on markets. The US market fared better than most, with the US S&P 500 Index decline restricted to 0.7%.

Losses were significant in Europe, where non-Omicron related case numbers rose, prompting some reintroduction of restrictions on activity. However, losses on the Hong Kong market were even larger, with the Hang Seng Index falling 7.4%, to now be at its lowest level for 12 months. Ongoing concerns over the earnings outlook and regulatory constraints on Chinese technology, financial and property companies continued to weigh on market sentiment.

It was also a difficult month for emerging markets, where the Omicron variant potentially provides a greater threat due to the lower vaccination rates. Overall, emerging markets declined 3.2% over November.

 

Australian Equities

 

Losses on the Australian share market were slightly less than the global average, with the S&P ASX 200 Index falling 0.5%. A significant 6.9% fall in the finance sector contributed to the decline, with CBA (down 11.0%) and Westpac (down 17.9%) the most notable movements. The market was unimpressed with the Commonwealth Bank’s September quarter trading update, where it detailed that income was down 1% over the three months. Similarly, Westpac’s full-year results (for the period ending September) were announced at the start of November, with the bank’s share price falling steadily after that.

The energy sector also contributed to the overall market decline, as it dropped 8.3% over the month. This reflected a 6.6% drop in global oil prices from recent highs. Several countries (including the US and China) announced that strategic oil reserves would be released onto the market in response to shortages and higher prices for the commodity. Although iron ore prices also continued to weaken, the Australian resource sector bounced back from some recent losses, partially because some of the impacts of weaker commodity prices was neutralised by the sharp drop in the value of the $A.

Some of the more defensive sectors on the Australian market performed relatively well last month, possibly due to a pullback in bond yields. Property Trusts, healthcare, utilities and consumer staples all posted positive returns.

 

 

Fixed Interest & Currencies

 

 

 

November was another month of high activity on bond markets, with some of the increase in yields recorded in October being reversed in November. The Australian 10-year bond yield dropped from 2.09% to 1.69% over the month but remained well above the 1.12% recorded at the end of August. Yields also fell at the short end of the yield curve. The 2-year Australian government bond declined by 0.16%, but at 0.53%, the yield still implies a material tightening of monetary policy by the Reserve Bank within the next 2 years. 10-year bond yields fell slightly from 1.55% to 1.43% in the US. This fall came despite the Federal Reserve Chairman, Jerome Powell, suggesting that the tapering of bond purchases may have to be brought forward due to higher inflation than expected.

 

 

Following a substantial rise in October, the $A dropped sharply in November, moving down from US 75.5 cents to US 71.4 cents. The fall is likely to be in response to weaker commodity prices, a narrowing in the interest rate differential between Australia and the US and the broader concerns over the Omicron variant and its potential impact on economic growth. The weaker Australian dollar did have the effect of softening the impact of falling global equity values, with equity investors who held unhedged currency exposures experiencing an increase in valuations, despite the weaker underlying equity markets.

 

 

Outlook and Portfolio Positioning

The news of the emergence of a new COVID variant last month reminded us that the COVID crisis is ongoing and will continue to influence well-being, lifestyles, economies and financial markets for at least many months ahead. In the final week of November, the reaction on financial markets echoed the moves that occurred when the crisis was first realised in the March quarter of 2020. Equity markets declined, the $A dropped, bond yields fell, and the global property & infrastructure sectors experienced a disproportionate fall.

Although the pattern of response was similar, the scale of movement was much smaller than that which occurred in early 2020. The last two years have demonstrated the robustness of corporate business models in particular, and investors were well justified in not panicking in response to the latest evolution of the COVID virus. There remains little evidence that the broader global economic expansion is faltering, with strong labour markets, particularly a sign that further growth in production and spending is likely. As such, the economic backdrop remains supportive of company earnings and equity markets more broadly.

If further progress in the economic recovery remains the central or expected scenario, then perhaps the pullback in bond yields last month was premature. Central banks around the globe have adjusted their positioning and commentary over recent weeks, and bond markets can no longer expect that they will be immune from negative policy surprises. With longer-term bond yields still below longer-term expected inflation rates, either an increase in yields or a downward shift in the inflation outlook is needed to avoid the current imbalance. If this imbalance were to persist through a prolonged period of economic growth, the escalation in asset prices would be untenable in terms of its impact on wealth inequality and housing affordability. Evidence is building that central banks view inflation as being more persistent (rather than “transitory”), implying higher interest rates will follow. 

 

 

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What are the 8 dimensions of wellbeing?

 

When you think about wellbeing, you often think about your physical health. Are you exercising enough, eating well and keeping healthy habits? But, in reality, it is so much more than that.  

Your wellbeing is a conscious and deliberate process of making choices that help us to live our best life. A life full of purpose, satisfying work and play, joyful relationships, a healthy body and mind, financial confidence and ultimately happiness. 

According to research, a person’s wellbeing can be measured against eight dimensions of wellness: physical, spiritual, social, emotional, intellectual, occupations, environmental and financial.  

Each dimension means something different to everyone. Understanding what it means to you can help you uncover what you value in life, where your strengths are and what you might need to work on. 

Physical

The Physical Wellness Dimension involves things that keep us active and healthy. Our physical wellbeing is so important to our mental health, longevity and ensuring we live our best lives. This doesn’t mean we must all be athletes. But it does mean building good physical health habits, having a healthy diet, exercising regularly, and having the appropriate health care for our needs. The more we are in tune with our bodies and what they need, the less likely we will be to become reliant on the healthcare system or even our families and loved ones. 

Intellectual

The Intellectual Wellness Dimension involves things that keep our brains active and our intellect expanding. It’s about mastering new skills, learning new things or helping to educate others. Having the time and resources to keep your mind active and supporting your loved ones can help you live a long life. 

Spiritual

The Spiritual Wellness Dimension is a broad concept that represents one’s personal beliefs and values and involves having meaning, purpose, and a sense of balance and peace. It includes being able to volunteer your time to support causes that mean something to you and help others to live a more purposeful life. 

Emotional

The Emotional Wellness Dimension involves the ability to express feelings, adjust to emotional challenges, cope with life’s stressors, and enjoy life. It includes building and nurturing relationships to strengthen our support networks and ensure we have the resources to spend time and money on those we love and the things we enjoy in life. 

Financial

The Financial Wellness Dimensions addresses your financial wellbeing. It covers your income, debt, savings and investments as well as your financial literacy. It also means having the resources to support and protect those you love. To live your best life, you need to be confident in your current financial situation or your future financial prospects.  

Occupational

The Occupational Wellness Dimension involves aligning your work to what you value in life. Ensuring that you pursue work that has meaning and purpose and reflects your values, interests and beliefs. Living your best life means work shouldn’t feel like work. 

Social

The Social Wellness Dimension involves having healthy relationships with friends, family and the community. Living your best life means living a life where you participate with others you care about and have the time to do so. 

Environmental

The Environmental Wellness Dimension involves living in an environment that promotes positive wellbeing. Such as preserving areas where we can live, learn and work, providing pleasant, stimulating environments that support our wellbeing and offer the natural places and spaces to promote learning, contemplation and relaxation. We need to create the right environments to help us live our best lives now and into the future, for both ourselves and our loved ones.  

Our financial advice process will help you to uncover which areas of wellbeing are most important to you and how close you are to living a life aligned with those areas of wellbeing.  

Our advisers will then work with you to set goals and shape strategies to make sure you are on the right path to living your best life. A life full of purpose, satisfying work and play, joyful relationships, a healthy body and mind, financial confidence and ultimately happiness. 

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Why values matter

We all have values that we live by. They are the motivational drivers that help us determine what’s important in life. They give meaning to the things we do. They are individual to us, guide our behaviour, and allow us to feel fulfilment in life. 

But we’re not always consciously aware of what our values are. In fact, many of us rarely spend time stopping, thinking, and considering our values. 

Not knowing what we truly value in life can lead us to make bad decisions, inconsistent with what we want to achieve in life. It can cause us to escape into bad habits or look for quick wins to uplift ourselves. 

It’s easy to dismiss values too. We focus on what our society, culture or community values instead and try to meet these expectations. We don’t spend the time to articulate what our top five values are. And, it takes a lot of effort to know and accept what you value. This will often lead to decisions being made that don’t lead us to live our best life. We hit key turning points in our lives and do what society or others expect us to do. Not what we want to do for ourselves or those we love.  

For example, many of us from a young age are encouraged to save for our retirement. We spend the majority of our lives working hard so that we can do all the things we want when we retire. In fact, this is drilled into us so much that we are saving more than we need for retirement, with many people leaving their retirement savings untouched or spend down only a little.  

There’s a school of thought that suggests saving makes us feel happy and fulfilled. However, this is just a mask for what behavioural economics calls loss aversion, the observation that human beings experience losses asymmetrically more severely than equivalent gains. This overwhelming fear of loss leads us to make bad decisions, behave irrationally and, ultimately, give lawyers the job of bequeathing our assets to those we love. 

Understanding our values can help us make better decisions. In the above example, it can help us reduce our fear of loss and turn it into a positive gain, by giving our money meaning and spending it on something that is truly important to us. Our values help us define what success looks like for ourselves. And when we begin to live a life that meets our success criteria, we feel more fulfilled and happy – even if it means spending the savings we’ve spent years to create.

 

Values matter 

So, values matter to all of us. They are our guiding principles or guardrails that can keep us on track to living our best life. And, when we achieve our goals we feel a sense of meaning and purpose. We feel good about ourselves and driven to continue to live a life full of purpose. 

But defining what you value is hard. There are so many words to choose from. You’re often too busy to stop and wonder what really matters. This is where we come in. 

Using a framework based on the eight dimensions of wellbeing, we can help you to uncover what you value in life. We work with you to determine a set of household values then set goals and tasks to help you live a life more aligned with your values. We also keep you accountable, helping you to make decisions that take you closer to achieving your goals. And, we measure how you’re going and help you see the successes and failures, so that we can continue to make the best choices for both now and in the future. 

 

 

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