An Excellent Disappointing Result

Yesterday, Microsoft results were released. After the news, the shares immediately dropped over 6% in after-hours trading as headlines called it a ‘disappointing result’. Analysts referred to the result as ‘below expectations’ and questioned when investors would start to see a return on investment for the $US14 billion spent last quarter on AI (Artificial Intelligence) infrastructure.  

Seems grim. Just how bad were their results?  

Well, revenue was up 15% year–on-year. In their important Azure Cloud division, revenue was up 29% for the quarter with guidance for 2025 for growth ‘slowing’ to 28%. Profit was up 10% to $US22 billion. For the full year, revenue was $US245 billion and net income was $US88 billion.

This is an excellent result from an outstanding company. So why the drama and consternation?  

Share markets and investors are incredibly short-sighted. The primary reason for the fall in the share price was that however well a company performs investors want more. The share price went up too much this year on expectations that were too high. Investors expected 31% revenue growth and were concerned about the level of capital expenditure for the quarter.  

Microsoft is only just getting started in building out its capabilities to win the AI arms race. This is a multi-decade investment. It is madness to expect to see a return on investment on a quarter-by-quarter basis. This is where long-term investors need to look beyond the noise in the financial media and quarterly results. Understanding the big picture is critical.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Are bonds back?

Normally government bonds are boring, but if you’ve followed the bond market over the last couple of years, they’ve been anything but. Not in a good way either. As US bond yields moved from effectively 0% to now 5% it has created huge losses across the world. Those holding those losses include some of the world’s best investors and biggest institutions. Some of the world’s biggest banks and pension funds are sitting on hundreds of billions in losses. Luckily at this point, not many have had to realise these losses but make no mistake they are there, and they are potentially a problem. 

The higher bond yields go though, and the closer they get to a peak, the more compelling the case for investing in high quality fixed rate bonds. For our portfolios we hold overweight positions in defensive assets already but its primarily made up of cash, term deposits and floating rate bonds and notes. The question becomes whether bonds are becoming more attractive than those assets and indeed whether they are becoming more attractive than equities on a risk adjusted basis. When you consider their much-improved income there is a case emerging for increasing the allocation to high quality low risk bonds. 

During the period of extremely low interest rates, I strongly recommended against holding fixed rate bonds in investment portfolios. Rates at almost 0% were a historical anomaly that were never going to stay that low and when they eventually went back up, the value of bonds fall. Meanwhile, investment managers everywhere seemed to be blindly allocating to bonds as a defensive asset when a unique set of global factors collided to create a once-in-a-lifetime bubble in bond prices.

Who can forget the weird anomalies that the era of super low rates created for bonds? There were the 100-year bonds issued by Austria paying less than 1% pa (they’ve since lost as much as -70% in value. But don’t worry if you hold them until the year 2120, you’ll get your money back). Crazy stuff. Then there were the bond yields for countries such as Germany, Sweden and Switzerland who saw the yields on trillions of dollars of their bonds go so low that they went negative for a period of time. Investors actually paid these countries to hold their money for them. Madness. It was always going to end in tears as soon as a level of normality returned. 

That’s where we are now as far as bond yields go – more normal bond yields. Not much else in the world is normal right now but that’s part of the turmoil ahead as the world adjusts to these changes. However, with bond yields having increased so much it is now time to step back and reconsider fix rate government bonds as an investment. The case for bonds is starting to become attractive on both an absolute return and a relative basis. I expect money from equities will soon enough start flowing into the bond asset class in a substantial way. 

You can now get 5% from US Government bonds, still considered to be the global benchmark for a risk-free investment. What it means is that every other investment needs to pay you more than this to be worth your while. How much extra will depend on the type of investment and the level of risk associated with it. For other countries bonds its similar rates but heading higher, for higher quality corporate bonds it’s more like 6-8% and for lower quality companies more like 9-10%. 

If, like me, you are bearish on the stock market and believe we are still headed for a recession (my base case) or a deep recession (possible) then the case for bonds is becoming more compelling. The more the economy slows, the more likely it is that governments need to lower interest rates down the track. In that case, falling interest rates will deliver bond investors a further gain as bond values increase. While I think there is economic and financial pain ahead for investors if interest rates across the world staying higher for longer, there is a positive for investors as bonds emerge as an opportunity.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

There is a Shift Happening

In recent weeks there has been a significant shift in the prospects for long-term interest rates. Both the 10-year and 30-year US bond yields have spiked to highs not seen since the GFC in 2007 as the notion of interest rates being higher for longer finally seems to be kicking in. The 10-year US bond rate hit 4.3% and the 30-year US bond yield hit 4.45% up from their lows of under 1% in 2020.

So why is it happening and what does this all mean?

In a normal market, you’d expect the yield on bonds to be higher the longer the term of the investment. However, for the past year or two that hasn’t been the case. The US has had an inverted yield curve with short-term bond yields being higher than longer-term bond yields. That curve is generally associated with a pending recession because when inflation spikes, the bond market expects interest rates to go up in the short term and those higher costs to put the economy into recession. Conversely the expectation is normally that to recover from the recession interest rates will later need to fall to assist a recovery.

These increases in bond yields may seem counter intuitive as they’ve occurred at a time when many investors believe interest rates will come down on the back of falling inflation rates in recent months. However, many other aspects of the global economy remain surprisingly resilient, including unemployment. While that remains the case it’s difficult to realistically expect interest rates to come down just yet. Equity markets especially may be getting ahead of themselves by expecting a continuing decline in inflation back to the target rates of central banks and a subsequent reversal in interest rates.

Now though, it appears the bond market is starting to realise that interest rates are going to be higher for a lot longer. Not a little bit longer. A lot longer. These rates may even be the new normal. When the 10- and 30-year bond yields move like this it is a material shift in the way risk is being assessed. Bond markets are generally very good at assessing and adjusting for risk while equity markets tend to be more optimistic, have more variables to consider and are slower to react. Bonds investors are demanding a higher premium to lend money for the greater risks associated with investment including default.

There is a lot of debt across the world and many nations have huge budget deficits. Those deficits are met by countries issuing even more debt by way of new bond issuances every year. On the back of many years of budget deficits and increasing debt, the rising interest rates across the world means governments that are refinancing maturing bonds will also need to pay a lot more than they were previously. That puts many nations under even more pressure and makes them even less creditworthy.

But in an increasingly competitive debt market for nations and companies, problems arise if there is too much borrowing and not enough investment demand to fund it. It creates a couple of potentially problematic situations. The first problem is that borrowers who are weaker or less credit worthy will have to pay significantly more on borrowings. The second problem arises if nations or companies are not able to secure the funds at all. While government borrowers might be less likely to default when they can issue more bonds in their own currency, this compounds other problems such as inflationary pressures.

The reality is that this recent spike in long-term US bond yields will mean a recalibration of the pricing of all debt across the board. These bonds are the benchmark for what investors consider to be ‘risk-free’ so all other debt is progressively riskier and as such will need to have their pricing adjusted. This means all debt is going to be more expensive. From the bonds of other countries, states, and municipalities to the debt of large, medium, and small corporations, the flow-on effect is significant. Everyone will be paying even higher interest rates as a consequence.

All of this becomes a problem as the weakest of the borrowers in all these different categories start to really struggle. Some may not get finance in the future and that has serious implications for countries and companies where this occurs, and it will occur. This is all part of the slow-motion aftereffects of such rapid rate increases, there are unintended consequences, and the fallout isn’t always manageable. So be wary as to the quality of the bonds or credit investments that you hold in your portfolio and understand that the reason you’re able to get higher returns is due to the higher risk that is embedded in the investments you hold. That risk is real and if you get it wrong it can lead to disastrous outcomes.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Investing Tactically

The benefits of having a diversified portfolio across asset classes are well understood. Strategic asset allocation offers several key benefits for an investment portfolio. Firstly, it provides a disciplined and long-term approach to investing. By setting a fixed allocation based on an investor's risk tolerance, financial goals, and time horizon, strategic asset allocation helps prevent knee-jerk reactions to short-term market fluctuations. This reduces the likelihood of emotional decision-making, which can often lead to poorer results. Instead, it encourages investors to stay the course and maintain a well-diversified portfolio that can weather various market conditions over the long run.

Secondly, strategic asset allocation seeks to achieve a balance between risk and return. By spreading investments across different asset classes, such as stocks, bonds, and cash, it diversifies the portfolio's risk. During periods of market volatility or economic downturns, certain assets may underperform, but others may act as a buffer, mitigating potential losses. Over time, this balanced approach has the potential to deliver consistent, more stable returns compared to more aggressive or concentrated strategies. Additionally, strategic asset allocation allows for periodic rebalancing, which entails selling assets that have outperformed and buying those that have underperformed, effectively "buying low and selling high." This disciplined rebalancing process helps maintain the desired allocation and can enhance returns over the long term. It’s the general principles of diversification and strategic asset allocation.

But sometimes it’s important to be more dynamic in your decision-making process. The diversified nature of the portfolio assets allocation was meant to help weather any storm. While equities can be more volatile in tough times the bond portion of the portfolio provides the less volatile and more defensive fixed income assets. But in 2022 both equities and bonds experienced significant declines. At one point the Bloomberg Aggregate Bond Index down -20%, which is almost unheard of for safe, secure, boring old bonds. The reasons were very straight forward. It was due to the rapid rise of interest rates, as fast an increase as there has been at any point in the last 40 years. This is why it is important to avoid being too complacent or passive in your investment approach.

When once in generation events occur, sometimes your decision making needs to adjust. In 2022, with interest rates rapidly rising from almost 0% to 4%-5%, it was apparent that this would impact both stocks and bonds negatively. It is important to be able to think tactically here and make dynamic decisions with regards to your investment portfolio. We took the view that in this situation we wanted to be underweight both equities and fixed interest. It meant increasing our exposure to cash, term deposits and floating rate bonds. By doing this, we avoided losses on the bond component of the portfolio while minimising losses on the stock component that year. At the time, many portfolio managers stuck with their strategic asset allocation and lost a lot of money. Thinking and acting tactically was critical in generating a far better outcome for our clients.

Now in 2023, as interest rates approach their peak that situation is rapidly changing again. It means that where we avoided fixed rate bonds previously these are now becoming much more attractive. Interest rates on fixed rate bonds are much higher, offering a very reasonable yield, and the prospect of rates going much higher from here is lower. So, the risk of capital loss is minimized. If inflation continues to cool and rates do come down, there is the prospect of these bonds increasing in value. With the recent improvement in equities, it provides the opportunity to take advantage of higher share prices, lock in some profit and reallocate that capital to the more defensive part of the portfolio at attractive prices.

While strategic asset allocation provides an essential foundation for a well-diversified and disciplined investment approach, there are times when a more dynamic and tactical decision-making process is necessary. The events of 2022, with the unprecedented rise in interest rates impacting both equities and bonds, serve as a stark reminder that complacency in investment strategy can have adverse consequences. Recognising unique situations and being willing to adjust allocations accordingly can be the key to navigating through challenging market conditions successfully. As we move forward through 2023, with interest rates approaching their peak and changing market dynamics, the importance of flexibility and adaptability in portfolio management becomes even more important.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Setting Up a New Portfolio

As I speak to our clients and podcast guests, I continue to see extraordinary business owners who are fantastic at running their business but who’ve never managed investments before. It’s a completely different ball game and it can be daunting. You need to learn, but who do you learn from? When you don’t know how to do something the most difficult part is working out who does. I strongly recommend reading books by the very best in the world. But even then, investment philosophies vary so greatly that what works for one investor doesn’t necessarily work for another.

The first rule is to keep it simple. If you’ve been successful in business, you know how to bring information together and make decisions based on what makes the most sense. So, keeping it simple means only doing what makes sense to you. Importantly, it means don’t make investments you don’t fully understand because you think the person telling you to do it knows better. No one cares about your money more than you do. So, it’s critical to understand the investment and the rationale behind the advice. Sayings like ‘If it sounds too good to be true it probably is’ might be a cliche but are also true.

Those that sell their business suddenly have a large amount of capital to invest. Ironically, while that kind of generational wealth brings with it security, it also brings a high level of anxiety. Founders are suddenly confronted with the prospect of not only making investment decisions they often haven’t had to make before, but they are also acutely aware that in many cases this money, regardless of how much it is, is all they have. It’s a very different mindset when you transition from a business owner making millions of dollars a year in profits to an investor where the amount you’re investing is the amount you have for the rest of your life.

Whether you have $10m, $100m or $1b to invest, the process is very similar, especially in such volatile times. In these situations, invest slowly over time. Regardless of how great the investment opportunities are or how great they seem, take your time, and invest progressively. This is simple but an important part of mitigating the risk of markets falling substantially after you invest. Of course, it can work the other way too and markets can jump up but in the current situation, there is more risk to the downside than the upside. But when you are setting up your family for generations, taking months or even years to fully invest protects the downside while ensuring you have funds available for opportunities that may arise in unique situations.

From there it’s a matter of structuring your investment portfolio for the long term. Rule number 2 is to diversify your risk. Diversification across asset classes such as property, shares, bonds, and cash are critical. But so too are the underlying investments within each of these sectors. Spread your risk because when one asset class performs poorly, you expect the others to have performed well and offset your losses. While diversification within an asset class is similar, if you hold 20 stocks and you have a couple of poor performers, you’d expect the good performers to mitigate this. At its most basic level, it ensures that if an investment fails you don’t have too much of your portfolio in any one asset.

So, keep it simple and ensure that you understand the investments you make. Don’t make an investment because everyone else seems to be doing great investing in it. This is the dumbest reason to invest, and I’ve seen more people lose money from investing in these ways than anything else. Diversify, across asset classes and then further in specific investments within those asset classes. Average in over time to hedge your timing risk, especially when investment markets are uncertain and overvalued. 

Lastly, you need to be able to sleep at night. That is the final test, can you sleep at night with the investments you have? If you can’t then it’s either because you don’t understand your investment properly or you’ve taken too much risk. Always make sure your investments pass the sleep test.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

How We Are Investing in the AI Boom

From both a business and a lifestyle perspective, AI is the single most exciting technological development I’ve ever seen. It will be the biggest game changer in the history of the world. Not only will fortunes be made here but it’s going to change our lives in so many ways. There are going to be massive gains in productivity and huge reductions in friction in every type of daily task. If I was a young person looking to start a business, it would be in the AI field. If you are in business, you need to be looking at incorporating AI or you’ll be left behind. It is genuinely revolutionary.

But what is the best way to invest in AI from a long-term portfolio investor’s perspective?

How you access this theme depends on the level of risk you are willing to take. For most investors, there are 4 common ways. I utilise 2 of these in our portfolios and 2 I steer clear of.

• Big tech companies

• Listed AI companies

• SPACs or Themed ETFs

• The broader market

The big tech companies are seeing the most immediate impact in share price movements as the market grasps the enormity of the opportunity and those who are poised to benefit the most. The big tech companies such as Microsoft, Alphabet, Amazon, Apple, and Meta have broadly seen a resurgence on the back of this theme. Most of these companies are great businesses and we hold them in our client portfolios. Right now, for a few reasons they are probably close to fully valued though. While the AI angle has driven share prices up the bigger factor is the flight to safety. In times of uncertainty, the big tech stocks have replaced consumer staples as the ‘recession proof’ businesses for investors who believe consumers will continue to use their products no matter what. Similar sentiment drove their prices up in covid too.

Listed AI companies are all the rage right now and most of them are speculative, expensive and will likely fail. I see this every time a new technology arises from the internet dotcom boom and bust in the late 1990’s and early 2000’s through to the crypto and NFT boom and bust more recently. The key point to recognise is that just because a technological theme is real or going to change the world it doesn’t mean all the companies in the space will. This will play out just like those booms and busts before them. There will be some companies that will flourish and will be what Amazon was to the dotcom boom and bust. But it is really difficult to find individual winners in an emerging technological theme. It takes a massive amount of capital investment to get a technology into the mainstream, very few win, most will lose. Go back as far as you want from air travel to the automobile, it’s the same story. For these reasons, we avoid direct investment in listed AI companies in the early phases.

Similarly, Special Purpose Acquisition Companies (also known as SPACs) and Exchange Traded Funds (ETFs) are often created by fund managers in one way shape or form to provide investors access to a theme that is popular. They raise funds and invest in many different companies or shares within a theme on behalf of investors who don’t have the necessary expertise themselves. However, I’ve seen these types of structures surface in different forms over the last 25 years and I have rarely seen them work in practice. Managers charge huge fees and hold millions of dollars in cash to invest in the popular theme, it collectively drives up prices and the funds end up having to invest the funds at overinflated prices in lots of companies that ultimately fail. The theory of diversification to access the theme doesn’t seem to work as well as promised when it’s a new technology. I would avoid these structures and investment vehicles.  

Lastly, AI’s impacts across all industries will see many untapped areas for long-term investors to access the benefits of AI in the same way that worked for many in the internet boom. The introduction of the internet didn’t just provide great results for technology companies, it was ultimately adopted by almost every industry and delivered incredible benefits for revenue, productivity, and cost reduction. There are many examples of this. Just think about the way the banking industry has changed in the past 30 years. There are many blue-chip companies that integrated the new technology and remain blue-chip companies today. But there are also many examples across so many industries from entertainment, retail to newspapers and travel that didn’t and ended up going bust. This is where the real theme of AI will benefit investors over the next decade. Understanding the existing industries that will benefit and those that will be disrupted is key, and then the impact on all the individual companies in your portfolio. It will be just as important to avoid the losers as it is to pick the winners.

The most important thing to remember as an investor is to be patient even though everything seems to be moving fast. AI technology is still in its infancy and as exciting as the opportunities are right now it’s very uncertain and going to be very volatile along the way. Some businesses will be too early, some won’t execute, and many will fail. But make no mistake, this will be a massive opportunity for more than a decade. It is still super early, and AI’s capabilities are going to grow exponentially over the next several years. This is going to be a truly once in a generation opportunity that will manifest over many years in many ways, many we can’t even envisage yet. So become familiar with AI and learn about it because it will impact every company in your portfolio in one way or the other in the years ahead.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Property Trust

One of the defining parts of the GFC was seeing the impact of a credit crunch on large property fund investments. These funds held billions of dollars in all types of property including offices, retail and commercial. Like any investment, these include both good and bad managers. Often when these investments perform badly it’s for relatively obvious reasons such as too much leverage. However, the GFC highlighted a different twist on the problem with debt.

In the lead-up to the GFC, credit was easy to source, it almost didn’t matter how much debt you had as you would just refinance it on new terms when it came due. But once the GFC hit, the music stopped, and it was far more difficult. It led to both good and bad property assets becoming distressed, and not because there was too much leverage or difficulty making repayments. It was because if you couldn’t refinance the loan it had to be repaid in full. This became a major problem that wasn’t expected.

Many big property players had become so complacent during the times of easy money that they forgot the fundamental rule of managing the maturity of their debt. With no refinancing available, the only options became asset sale or default. It was a catastrophe with many funds caught out. The only thing worse than being caught out with a default or having to sell assets in a fire sale is having it happen when everyone else is too. It led to many property trust structures collapsing and investors losing millions.

Fast forward to 2023 and there is an element of this beginning to emerge again. In the USA alone, there is almost $1.5 trillion of commercial real estate debt due in the next 12-18 months. There are two parts to this problem emerging. Firstly, that debt is going to be refinanced at much higher rates and that’s obviously a big problem for organisations making repayments. It may mean that many organisations are not even able to gain approval to refinance under the new terms given the new rates change all the financial models they previously applied. That’s one aspect where failure will occur.

The second part of the problem is going to be those that can theoretically afford to refinance may still miss out. With financial conditions tightening and banks being far more selective, there will be a significant number of organisations that will miss out. Lenders will move from friendly facilitators of business to ruthless corporate vultures pre-emptively picking and choosing the assets they support and those they don’t. Understanding the bank’s place in the pecking order of default will play an important role in their decision-making and which assets and organisations succeed and those that fail.

This time there is a lot of debt not just linked to property assets but also a range of business and other financial assets. The key to property trusts and corporations surviving all of this is making sure they get ahead of any potential credit crunch. They need to refinance sooner rather than later and ensure they have sufficient access to capital, so they are not forced sellers at the wrong time. Make no mistake when push comes to shove in these situations, the deck is very heavily stacked in the bank’s favour. In a time of crisis, the banks will make the decisions that are in their best interest, not the borrower.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Why I’m Selling this Rally

In a world beset by geopolitical tensions, high inflation and interest rates, banking collapses and uncertainty, the stock market has been surprisingly resilient this year. So far in the calendar year 2023, the Australian stock market is up 3.8% while in the USA the S&P500 is up 6.9%. The NASDAQ is up an astonishing 19.4%! That’s more than resilient, that’s almost a bull market. Now obviously stock markets are still well off their highs of 2021, but it does highlight the difference between what is evolving in the global economy and how stock markets are reacting.

I’ve said before that the share market looks out 6 to 18 months ahead of current economic issues. So, does this recent rally indicate that the market is comfortable with where the global economy is heading? I think the answer to that is a simple no. I also think that there is so much uncertainty in the world right now that the usual playbooks have been ripped up and it’s almost become every investor for themselves. Investors are confused and there is little advantage in knowing what others are doing because, well, they are probably wrong.

The big question is are we through the worst? I think that’s unlikely. I think we are only getting to the end of the beginning. As tricky as the last 12-18 months have been, the real economic woes are yet to play out and until we have that phase underway, share markets will continue to be confused. Right now, that confusion has resulted in stocks being higher than they probably should be. I believe this is an excellent opportunity to sell further and add to the cash in our client portfolio’s.

While share markets have been relatively resilient, we are seeing real volatility in markets that are traditionally very stable. For example, the yields on 2- and 10-year US bonds have been moving up and down like a yo-yo in response to the re-rating of risks from bank collapses to inflation expectations. The yield on the 2-year US bond has moved from 4.06% to 5.05% and back to 3.79% over the last 10 weeks. These are incredible moves that are anything but normal. It highlights the conflicting nature of much of the data coming through and just how difficult it is to get a read on critical data. How the data ultimately plays out will determine the direction of both the economy and the share market.

I am still convinced that the share market will pull back as it becomes clearer that we are heading into a global slowdown. I expect the market to retest those lows of 2022 and possibly head lower. To me, there is so much evidence that points to a slowdown that I think it’s prudent to sell further into the current strength we are seeing in the share market. It’s impossible to know where markets go in the short term so you can only ever make decisions that are prudent for the long term. Cash remains king. If the market continues to go up after we sell a little, I am more than happy to sell some more.

As resilient as the share market has been I don’t believe that this is an accurate reflection of where the market should or will be. One of the simplest tests for whether you have enough cash when you enter a downturn is how you feel as the market falls or when the next crisis arrives. Are you excited because of the opportunities you see becoming available or are you worried as markets fall? If you’re feeling nervous, then that’s a pretty good sign that you don’t have enough cash.

Our current focus for our client portfolios is weighted to protecting capital and minimising losses in the event of a market downturn. This is a unique time in the history of the world. There is really no precedent for the current situation and so it is difficult to predict how badly the global economy will be impacted. A lot of this is mitigating those risks and being ready. It is not about making money right now; it’s about protecting it. If in the next year or so the world has muddled through and it turns out there is no major downturn, then that’s great. There will always be opportunities to make more money when times are good or at least more predictable. But in the next year or so we will know for sure just how all the current events and variables have collided and their impact on the global economy. Sometimes treading water is what you need to do to ensure you survive.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

The Market Ahead in 2023

In recent months, share markets have been relatively resilient and some of the bear market fear has dissipated. So, is the worst of the share market turmoil over and is it time to buy?

The short answer is no.

My view remains that this market has another big move down ahead. How I think the market and economic events unfold over the next 12 months is this. Europe continues to fall into a deep recession for all of 2023. The US goes into a recession too. Ultimately dragging the rest of the world’s economies into a recession. My priority remains protecting investors’ capital. I am prepared to miss out on short-term gains by being under-invested if I am wrong. In my opinion, this remains one of those periods in time where protecting the downside risks is significantly more important than any potential opportunity. It is prudent to be cautious in this environment. We will still have our capital intact and can invest in great opportunities in due course. What I don’t want to do is invest too early when sentiment is overly positive because everyone wanders back outdoors in the eye of the storm. The real economic storm is still ahead.

In 2022 all the talk was about inflation and interest rates. That will continue in the early part of 2023 as central banks around the world are forced to over-tighten and create deeper problems. My view is that in 2023 the key topics will become company earnings, global recession, and unemployment. Unlike any previous downturns in the last 20 years, where constant bail outs and money printing supported markets, government’s hands are tied this time around. Countries around the world will simply need to endure an economic downturn the old-fashioned way, take some pain and come out the other side with a better foundation for future growth. It’s not the worst thing that can happen and frankly, if we’d all faced up to a couple of downturns in an organic way, we’d be far better off right now.

But in any case, if Europe and the US are in recession, and China continues to battle covid then it’s difficult to see how Australia avoids an economic downturn in 2023. I know everything seems pretty good now and it doesn’t seem like we are anywhere near a recession, but a downturn is heading our way. When you look at how the world is positioned, a deteriorating global economy is pretty obvious. The problem for most investors in accepting the impending economic reality is that there is a major difference in what we all see and experience right now in our daily lives versus what we can’t yet see and experience in the near future. Overlay what most investors optimistically want to see and it’s often only when things are undeniably bad that it’s finally accepted.

Over the next 6 months, I think we see corporate earnings deteriorate and consequently real cost-cutting across the board. Then the job losses really start to kick in. First with European companies, then the multinationals with significant exposure to Europe, before flowing through to the rest of the global economy. They have started in tech already but will become mainstream in due course. The tricky part for investors will be when we start to see inflation fall, share markets will start to celebrate the return of low interest rates. That’s going to be a monumental head fake for markets as the dream of a return to lower inflation and lower interest rates becomes an economic nightmare in the form of a global recession. In 2023 the downturn will get real. The real economy will start to suffer. That’s when stock markets will enter the final phase of this bear market and crash back below the lows of 2022. If inflation stays persistently high, it will only make the downturn worse.

That said, there is an important distinction to make here between the share market and the economy. I expect the economic situation across the world to deteriorate for most, if not all of 2023. But while I expect the share market to fall significantly as the economy weakens, by mid-year, investors will be looking ahead to how the global economy will be starting to recover in 2024. Share markets don’t wait for the actual economic recovery, they are looking 6-12 months or more into the future. So, while I expect more share market pain ahead, the real buying opportunities will present themselves around the middle of 2023, as the deteriorating economic situation is still unfolding. Take note of that because the time to be bold and buy stocks is when it feels like the economy is starting to look quite bleak, but before the economy is at its worst.

General Advice Disclaimer. This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Old Dogs, New Tricks.

These days there is a lot of focus on companies being disrupted and the new companies challenging the status quo with cutting edge technology and ideas. The warning to the old companies is ‘adapt or die’. There are many examples of companies that haven’t from Kodak to Blockbuster. It’s easy for investors to see the shiny new technology companies and look down their nose at large companies to see who is going to be disrupted next. But not all the incumbents are slow moving laggards.

In fact, there are many outstanding businesses that have been around for 50-100 years that continue to reinvent themselves decade after decade. They may not have the appeal of the new tech companies, but they have an enviable track record of delivering results and tremendous brand loyalty and pricing power (important inflation hedge). These are companies that are easy to ignore and label as boring companies. But the way they continue to embrace change they are clearly leveraging the most exciting technological trends emerging in the world today. Here are a few standouts:

McDonalds (founded 1942) In 10 years I don’t think McDonalds will employ nearly as many young workers as they do today. Stores will be fully automated. We are already starting to see this in stores as they move to automate customer ordering. This is a business that will be able to automate every aspect of its business. From ordering to preparation and cooking to delivery of orders. Incredible brand loyalty is evidenced by McDonalds recently raising prices in the US by 6% due to inflationary pressures and have reported that these increases have been implemented without issue across the business. They have pricing power and will be able to protect their margins as they can pass on increased costs.

Caterpillar (founded 1925) Caterpillar is fast transitioning from an old school machinery company to a robotics and automation company. They have a reputation for making extremely high-quality products and have built very strong customer loyalty over time. From a branding perspective whenever you see a company that can sell their own branded clothing and boots at a premium price you know they have a market leading brand and customer loyalty. They also have hundreds of autonomous trucks operating on mines around the world. Many of these machines each cost millions of dollars. This is not an operation that is easily replicated due to their scale, quality, and brand loyalty.

Walt Disney (founded 1923) In an era where content is king there probably isn’t a company with a better suite of entertainment brands than Disney. Beyond the Disney banner, over the years they have acquired a stunning collection of the world’s most popular franchises, from Star Wars to Pixar to Marvel. To leverage this content and monetise it 2 years ago Disney started Disney+ their own version of Netflix but built on the back of the Disney catalogue and content library. In just 2 years since the launch Disney+ have reached over 118m subscribers and created a new recurring revenue stream worth billions of dollars out of nowhere. For comparison Netflix has 200m subscribers. Both are forecast to hit over 300m subscribers in the next 5 years or so which is extraordinary.

Walmart (founded 1962) Their size and scale provide them with access to an unprecedented ability to leverage the revolution in automation and robotics across almost every aspect of the business. Walmart may not have the pricing power of the others on this list but almost every aspect of the supply chain for supply markets is being reinvented by automation and tech. From the way the products are made and grown, to the way they are sourced and delivered to the store, the way the shelves are stacked to the way their products are bought, paid for, and even delivered to the customer. There are just so many costs and inefficiencies being removed from the supply chain. It’s going to equate to lower prices and higher profits. They have been using autonomous trucks in the USA for the past few months.

The demise of companies often isn’t really that difficult to predict. They have a product or service that was popular but fail to change as new products or services emerge. In many ways, it’s the same with the rising companies riding the wave of new technological trends. Relatively easy to spot as they provide a better product or service using the latest technology. But for long term investors that is only a part of the equation because both are on the same product or business cycle, just at different stages. The great companies are those that are able to sustain success over a very long period of time and have a proven track record of navigating change and technology over the course of decades, not just years. 

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.