Our latest thoughts update

It is now clear that with social distancing and the current lockdown we have an interim mechanism, until there is a vaccine, to avert a catastrophic health crisis and collapse of the health system. It means that we quickly move on to the next phase of finding the optimal balance between the economic and health impacts. I find that amazing given the nations prospects just 4 or 5 weeks ago. It highlights just how dynamic and unique this situation is and how well its been dealt with on all fronts here in Australia.

At its core, the decisions that need to be made next by government are not about assets or lives, but something more fragile and far more important, and that is the systems upon which they are built. So, while many will argue whether we should prioritise lives over the economy or the economy over lives, I think they have their priorities wrong. The priority of government in these times must be to preserve the integrity of the systems themselves that are fundamental to the future of our nation. Macro not micro.

What that means in practical terms is that once the health system has been stabilised and the coronavirus relatively contained, the government will move to reopen the economy up to the point that is required to stabilise it. It will likely mean releasing the lockdown valve enough to enable the economy to restart, but not to the point that we let the health system become overwhelmed. It will probably mean living with a higher level of new cases in the virus than we see now. A balance will be found.

Although the economy is not fully reopening until a vaccine is available, it will likely be progressively reopened or at least moved between higher and lower lockdown levels for months at a time. I think the most likely scenario to evolve will be one where we alternate between say 2 months of lock down followed by 2 months of lower restrictions before reverting to lockdown again, if required. Any increased economic activity that isn’t from government spending will be a significant and real bonus in the interim.

While all of this is good news, I still think the next month or so will be quite difficult for general sentiment as bad economic figures come out at the same time as people start to feel the impact of the slowing economy on their daily lives. The economic data will continue to generate headlines as the worst figures since the Great Depression. It will be worth remembering that we know the government is committed to borrowing huge amounts to ensure we get through the next 12 months and we know there is a vaccine coming soon.

I remain optimistic on the 12-month view and genuinely believe that the economy will bounce back quite quickly, post vaccine. However, it is difficult to know how bad the economic news will be in the very short term and any negative surprises will not be well received by the market. This will present opportunities. While we have commenced buying modest amounts of specific companies this month, we are taking a conservative approach, and will continue to do so in several tranches over the coming weeks and months.

Latest thoughts on the impact of coronavirus and the two biggest questions

We’ve seen a lot develop over the last two weeks. The majority of governments around the world are now taking this crisis as seriously as it needs to be taken from both a health and economic perspective. As far as I am concerned there are two main questions that have occupied my thinking relating to business and in turn investment markets. Firstly, how long will the economic shutdown last? And secondly, how quickly can the economy recover? Both raise more questions than answers at this point because there are simply so many unknowns. However, I have concluded that the answer to the first question is a logical one, while the answer to the second question is more complex.

I believe the shutdown will continue until there is a vaccine. That is the reality. The shutdown and restrictions in place will need to continue in some way shape or form until then. While a vaccine will literally cure the disease, until then everything is about managing the spread of the virus. If the virus is around, even in relatively low numbers, and the government was to lift restrictions then we are going to see it spread again in a second and third wave along with increased restrictions each time. From everything I have read a vaccine is a 12 month proposition. But we are going to find out just how quickly this can be done though, as however many billions of dollars are needed to create a vaccine, it is going to pale into insignificance against the trillions it will save the global economy.

With regards to how quickly the economy can recover, that is much more difficult to answer. No one knows the answer. I am optimistic that a version of the ‘business hibernation’ plan will work and the recovery will be swift. Everyone is going to feel the pain but everyone is going to work out how to get through the 12 months and get to the other side. In simplistic terms, the approach to managing the nation and its people’s expectations should simply be focusing them on the basics. The government needs to make sure everyone has food, shelter, water and power for the next 12 months. If you’ve that then you’re going to get through and live to fight another day. There is lots to work out here logistically but much of this is being put in place, rent and mortgage payments being deferred, wages and essential bills being covered. It gives everyone the best opportunity to restart, quickly and unimpeded, once everything reopens.

In Australia, Scott Morrison and the Federal Government, while initially slow to act, have caught up quickly in the last 2 weeks and are managing both the health and economic crises well in my view. Morrison is increasingly looking like a war time leader in his press conferences. The Government has a strategy and they are implementing it quickly. It’s not going to be perfect, it’s a crisis, that not how it works but they are stepping up and throwing everything at it. Meanwhile, The USA and a number of European countries are doing a terrible job of managing the health side of the crisis but appear to be responding ok from an economic perspective with massive stimulus packages across the board. It is worth noting that when announcing 6.6m new jobless claims for the week in the USA, the stock market actually went up. This goes back to what the impact of data being relative to expectations, as per my last note.

While share markets across the world have improved recently, we probably haven’t seen the bottom or the end of volatility. Fear will likely return in due course as the significant economic impact of the shutdowns across the world will bring both data and images that will draw comparison to The Great Depression. It may feel like that in the coming months. The media will love it. Investors will not. So shares will likely fall again based on fear. Do not be surprised by any of this. But the situations are completely different. That downturn continued for years (1929-1933) as governments of the day cut costs and spending and there was no end in sight. Today we have governments that are doing everything they can to stimulate the economy and we know that it is likely there will soon be a vaccine that will enable the economy to reopen for business. The foundation for today’s economy is very different and there will be good opportunities ahead.

My latest thoughts on coronavirus and what’s next

We have never seen such a unique and rapidly changing situation as this before. There are periods in history that are analogous to what we now face, but nothing close enough to really provide a road map. Regardless, there are still key aspects of this event that stand out to me as especially important to consider. In this case unlike most economic disasters, where everyone wonders what will spark the turnaround, with this one we know – once the virus is gone everything reopens – that’s the spark for the turn around. We know it’s coming; it might be 6 months or 12 months but its coming. This aspect is unique, its good news and it should remain front of mind going forward.

Once the virus is gone, and events are back on and people are traveling again, the speed with which the economy bounces back will ultimately be determined by how well everyone deals with the next 6 months. From a Govt perspective the entire world really needs 6-12 months of bridging finance. That’s got to be the mentality. They need to go hard and go early. The Govt approach must be to do whatever it takes to get through that immediate window until we reopen. If they do that we will be in a good position once we get to the other side. As much as we have now seen announced by the Federal Govt, State Governments and the Reserve Bank, we will see more in the coming weeks and months. As Govts will all over the world.

As much as Govt can do, everyone in the community is going to take a haircut. I emphasize that because to put ourselves in the best position for 12 months’ time as a nation I believe the individuals and businesses most badly impacted are going to ask for, and get, short term concessions that 3 months ago would have been unthinkable. Now they are needed. Individuals and businesses will get temporary reductions in rent, reduced interest rates, deferments of interest payments and deferments tax payments. These measures will help in the next 6-12 months so that the economic impact, while harsh in the short term, will hopefully get us to the other side in without creating a long-term problem for the economy.

My biggest concern in the face of rapidly rising unemployment is the flow on effect to the banking system and in turn property prices. However, I am optimistic that the record low interest rates we have, and the short-term nature of a pandemic will provide the banks and property owners the tools to manage through the worst of it. I cannot emphasize enough that knowing there is a point at which everything reopens is a critical advantage over past economic downturns. It may mean that instead of foreclosing and forcing a sale the banks may be more likely to be flexible and provide either interest only payments or possible even interest to be deferred or capitalised for those who lose their jobs. It all matters.

While the economic consequences are ahead of us, the share market has already factored a lot of this in. That is why markets are down so quickly. Over the coming months as the bad economic news is released its critical to understand and remember this. It is all about “expectations” from here. Is the bad news what was now expected or is it better or worse than expected? The bad news won’t move markets as much as how that news aligns or doesn’t align with what is already factored in. It also means that share markets will also turn around well before the economy does. In the meantime, we remain busy being patient and waiting for the dust to settle as we look for opportunities.

Latest thoughts on the impact of coronavirus for portfolio investors

A lot has happened since my last note just a week ago. Markets are down significantly, and the world is adjusting to the realities of what this pandemic means. Regardless of this our strategy remains the same. We hold our portfolio investments for the long term with a focus dividends and portfolio income. We are not concerned with short term fluctuations, regardless of their size. This will come and go and in 12 months or so the world will be back to business as usual.  

With regards to the coronavirus disease, it appears that the countries that have best managed the situation have moved early with regards to lock downs and social distancing measures. The early numbers show that these measures are very effective at slowing the spread of the virus. Those countries that are slow to implement these measures quickly find their hospitals and healthcare system under siege and are forced into more severe lock down measures in the end anyway.

Therefore, I now believe that lock downs and social distancing are going to be an essential tool in the fight to slow the spread and help our healthcare system cope. We are seeing more and more events being cancelled and I think it’s probable that we start to see this at scale in the coming weeks. The exponential growth in the number of cases from here means these measures are going to be critical and the earlier they are implemented the faster the overall turn around will be.

I remain convinced that the Federal Govt will go as far as necessary to manage the impact of this on the economy. The recently announced $18 billion stimulus package is a good start. But I believe there will be more announced in the coming weeks as required to support people, business, the economy, and more importantly in the short term, the health system. I also expect this to be the case from governments around the world.  

With regards to investment markets, we are starting to get into attractive buying territory. We are seeing the share prices of very good companies fall to unreasonably low levels. That’s not to say these prices won’t go lower, given the current level of uncertainty, they probably will. But if you’ve got a long term view the coming weeks will provide opportunities that don’t come along very often.

Thoughts on the impact of the Coronavirus

My latest thinking on the impact of the Coronavirus is this. I think the RBA will end up cutting interest rates again and will ultimately go to zero. I think the Federal Govt will release a massive stimulus package because of concerns of the economic impact of the virus. However, I don’t think it is going to be as bad as everyone fears. The key figure that leads me to think this is that it appears that children and young people either don’t get it or only get it very mildly. It appears the death rate of ages 0-9 is almost 0% and for 10-39 age group it is 0.2%  

If these figures in relation to younger people hold, I think they are a game changer. Once families realise that children are not materially impacted, I believe they will quickly revert to their usual routines and spending habits. It may also mean schools won’t be closed, weekend sport won’t be cancelled, and the family consumer will continue to spend, travel and go out again as quickly as they stopped. It may mean concern about the economic impact is overblown and that the share market may recover more quickly than expected.

Perhaps more importantly the fact the Coronavirus may lead the Federal Govt to release a big stimulus package could be a blessing in disguise for the economy. Without the Coronavirus I think that the already deteriorating Australian economy would be left to languish without the stimulus it needs. The economy may now get the injection it so clearly needs and by accident, the fears surrounding the Coronavirus may help the Australian economy, recover more quickly from its pre-existing woes than we could ever have expected it to.  

From a portfolio perspective, we are not sellers. We still hold cash and are looking for good opportunities in oversold companies. We would like to deploy this cash sooner rather than later. This is especially true if you are a retiree or long-term investor. Cash is not a particularly attractive asset as it earns you perhaps 1% pa when you can comfortably collect dividends of around 5% pa when invested. If you are a patient long-term investor, the short-term volatility we are seeing now won’t matter much in 20 years, the income you receive does.

Market volatility and Coronavirus (COVID-19)

I’ll make this short but wanted to comment on concerns around the Coronavirus disease (COVID-19)

In relation to the health issue:

• Transmission rate of about 2.6 newly infected from 1 case.

• Fatality rate of about 2.5%.

• The health risk is significant, much more severe than the standard flu, but not as severe as some early concerns.

In relation to the timeline and economic impact:

• It appears that China’s government has enacted measures that have slowed down the spread of the virus there.

• Slowing down the spread of the virus in other populous nations is critical. This is the current concern with new outbreaks recently.

• It will take time for the full economic impact to be understood as Governments react and as people’s daily routines and spending habits change.

In relation to the volatility in financial markets:

• There will be buying opportunities in the coming weeks as markets react further to the situation.

• I would not be in a hurry to add stocks at this point but prefer to be patient and take a wait and see approach.

• I would hold existing cash awaiting opportunities.

How much do you need to retire?

A typical client comes to us with a range of assets that they accumulated in an ad-hoc fashion over time rather than from executing a master plan. Not everyone who is wealthy is financially sophisticated; often they were just really good at what they did. They are usually just really good at running their construction or earth moving business or they’re great doctors or lawyers.

Most of our clients are not financial experts; they wouldn’t need us if they were, but they are smart, and they know the value of getting the right advice to help them optimise their position. I once had a client with $10m ask me if they had enough to retire. As much as it surprised me, it was a great reminder that everyone worries about the same types of things when it comes to retirement:

·         How much do we need to retire?

·         Do we have enough to retire?

·         How long will my money last?

There is not one simple answer because everyone’s situation is different, but these are easy questions to address. In financial terms, the three questions above are all a variation of the same equation, the basic variables of which are income, expenses and capital.

But for the purpose of the general concept, simple numbers are the best place to start. If you require income of $100,000 p.a. to meet your expenses in retirement and a typical investment portfolio produces income of 4% p.a., then you’ll need $2,500,000 in capital.

If you have more capital than this then you’ll be fine. If you have less capital than this then you have a decision to make, and you can either reduce your expenses or you can deplete your capital. There is no right or wrong answer it is up to you. But you need to understand the numbers.

I can’t emphasise enough how important it is to understand the context here and the impact of even the most basic variables. If we change the assumption for the typical investment portfolio in the scenario above to, say, 2.5% p.a., then you’ll need $4,000,000 in capital to generate the income figure of $100,000 p.a.

With regards to dipping into capital in retirement, people tend to fall into two camps; those that are petrified of spending any of their capital and those who are petrified that they won’t use it all before they die. My philosophy here takes into account real life, not just the financial side. When you’re 65 maybe you live for another 30 years, maybe you live for 2. But I’ll say this, life is short, and I have not yet seen anyone get healthier and more active as they got older.

The reality is that your first 10 years of retirement are going to be your best, so make the most of it. If you are 65 and have $3,000,000 in capital and you spent $50,000 from your capital to have an amazing holiday every year for 10 years does it matter that at 75 your capital has reduced to $2,500,000? Probably not. What if you don’t make it to age 75?

Obviously, the above scenarios are basic and don’t take into account specific circumstances, but the overriding concepts and philosophy still apply. For our clients we complete sophisticated financial models that include a range of assumptions around returns, inflation, tax structures and scenario planning to ensure they are prepared for the future and have peace of mind. Certainly, if the three questions at the start are keeping you up at night then it’s probably time to get that type of advice and start planning properly.

What if Labor wins the election?

Australian Federal Election 2019

The battle between Bill Shorten and Scott Morrison is not likely to overwhelm us with charismatic and inspiring speeches. Rather, it’s likely to be the political equivalent of a street fight. In short, I suspect Shorten wins because Australians vote leaders out if they annoy them, rather than vote a leader in. The Liberal party leadership issue annoyed a lot of voters.

Another important trend is that times have changed in the era of social media, and people are generally more progressive in their thinking than in the past. A good example of this is the same-sex marriage vote where roughly 70% of the population voted for it . Go back 20 years ago and it’s probably 70% against. This is the case in relation to many issues and many of the old heads on the conservative side haven’t picked the change in the community’s view. It will be a close fight and a lot can happen between now and then, but it appears the election is Bill Shorten’s to lose at this point. 

What does this mean for our clients? Many of our clients have already raised concerns around the upcoming federal election. Specifically, the concerns raised relate to some of the policies the Labor party have proposed in relation to property (negative gearing and CGT) and dividends (franking credit refunds). These are attention grabbing policies, but also typical of parties testing the pre-election market or appetite for these types of policies.

Negative gearing: The potential removal of negative gearing is far more nuanced than politicians seem to understand. This is not a strategy of wealthy property owners. The wealthy property owners actually have little to no debt. They have paid their properties off. This is a strategy of people on good income, using debt to try and build their wealth – that’s a lot of people. But here’s the thing, removing negative gearing doesn’t just impact those people, it also impacts those who aspire to buy an investment property in the future. That is a lot more voters than many appreciate and why I’d be surprised if it gains real support. In fact, I think it’s hard to find a group of voters that will actually support this proposed change. Let me know if you can think of one.    

Franking Credit Refunds: Another key proposal relates to removing the refunding of excess franking credits. Many people have investment portfolios that result in dividends with franking credits attached (tax already paid by the company) that offset the tax from their overall income. Where people have franking credits in excess of the tax owed, they receive a refund. The proposed change would now result in those refunds being lost, impacting self-funded retirees in particular. However, it’s worth noting that before the year 2000 that was how it worked. Back then portfolio construction included detailed consideration of the total income and total franking credits received so that franking credits were not lost or at least could be well managed. I would expect this to again become an important management strategy for investors. 

Superannuation: Regularly changing superannuation rules effectively undermines the integrity of the superannuation system. Both sides of politics are guilty of this because they don’t appreciate that to have confidence in the system people need to feel that the goal posts won’t move. But it is inevitable that politicians look at the massive pool of money within the superannuation system, crunch the numbers, and see that even a small percentage change will result in a windfall of billions of dollars. So, they always propose changes, usually to make the system ‘fairer’ because who would argue with a fairer system, right? But everyone has super now, and they don’t want the government touching it, so when this happens the voter outcry causes them to shelve the proposal.

In conclusion, I would be surprised if these policies actually become law in the form initially flagged. Typically, significant changes that impact a lot of people are met with voter outrage and are shelved, diluted or grandfathered all of which result in minimal real impact for those initially targeted. We are watching these developments closely and planning ahead.