Should You Participate in Share Buy Backs?

If you hold shares in major companies such as Commonwealth Bank (CBA) and Woolworths (WOW), you will have received an offer from the company to participate in share buy backs. The offer document and process look quite complex and confusing but it’s worth understanding how it works and why.

Whether it is worth participating and selling some of your shares back to the company depends very much on the entity that you own them in. Depending on how the buy back is structured, the simplest answer is often that buy backs are great for low tax rate entities. If the shares are owned in a higher taxed entity, then it may be a terrible deal.

I’ll use CBA as an example to explain how it works.

At first the offer looks confusing because CBA are offering to buy back your shares at a discount. Where the buyback offer is that CBA will buy some of your shares at a 14% discount it appears to be a bad deal. At face value it results in you receiving $86 a share when you could sell them on the share market at $100.

Why would you do this? 

The key is in the make up of that $86. CBA are proposing $21.66 is capital and $64.34 is a fully franked dividend. If it was an offer of $86 all capital, it doesn’t make sense. It’s the use of the franking credits in the structure of the offer that makes it work. 

The fully franked dividend component is for tax purposes a large dividend. Like any fully franked dividend, the tax credit is added back on as a credit for tax previously paid. It is real money. So, the price becomes $21.66 plus $64.34 plus the franking credit of $27.57 for a total of $113.57 per share.

Let’s assume you own Commonwealth Bank shares in your self-managed super fund which is in pension phase where the tax rate on income and capital gains is 0%. Let’s also assume the current price on the stock market for CBA is $100 a share. 

So, for a SMSF in pension phase participating in the buy back, the effective sale price of your CBA shares is actually $113.57 which is a significantly higher price than you could achieve by selling the shares on market.

It’s a great deal for SMSF’s in pension phase. However, these numbers change as the tax rate goes up.

For a SMSF in accumulation phase where the tax rate is 15% those franking credits are only partially refunded because the fund pays 15% tax in super accumulation phase and so you only receive a refund for what’s left after you pay tax. There is also an element of CGT to consider although significantly discounted. For a SMSF in super accumulation phase the effect price is around about $101.21 which is slightly better than selling on market. 

If the shares are held in a company paying 30% it simply doesn’t make any sense. The franking credit component is fully absorbed. You’d be selling the shares at $86 in the buyback when you could sell them for $100 a share on market. 

For high income earners with CBA shares in their own name the figures would be even worse. Not only would the franking credit be absorbed but you may need to pay additional tax on the difference between your tax rate and the franked dividend component. 

For the companies themselves it is an excellent deal. In the case of CBA, the way its structured uses their excess franking credits, they get to buy back their own shares for $86 a share.

You to need to crunch the numbers for your specific situation to consider your tax rate, potential CGT and check the details of how the buy back is structured in each case. But generally speaking, the way they typically work makes these style of share buybacks excellent for SMSF pensions, closer to break even for SMSFs in accumulation phase and terrible for anyone with higher tax rate such as companies and high-income earners.

General advice warning. 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.

This Is a Good Time to Take Some Profit

With reporting season basically complete it looks like corporate Australia is in pretty good shape. While I’m mindful of the fact that those results are all in the past and largely pre-lockdown, it is clear that the financial positions of our biggest companies are as strong as ever. BHP, Rio Tinto, the big banks, Wesfarmers and Woolworths all had great results. Many are seeing record profits and paying out increased dividends. With excess capital, low levels of debt, their balance sheets are in such good shape that many are returning that capital to shareholders via special dividends and share buybacks. 

This is a positive as not only do investors get a bonus return it’s generally a sign of sound corporate management. If the companies are flush with cash and they can’t find ways to use those funds, either by reinvesting them within the business or using them to fund a new acquisition, then it is most prudent that management return the capital to the shareholders. In any case, with low levels of debt and the cost of borrowing being so cheap any takeover is more likely to be funded by debt or a share swap.

While corporate Australia is in good shape the stock market has already priced this good news in. The consensus is that lockdown has only delayed the recovery. In fact, for the past 12 months, the ASX has priced this in and at current levels doesn’t seem to put any weight on any downside risks or consider the potential that a recovery may not be a foregone conclusion. There is a chance that we go into recession. It is possible that the economy, even as it likely rebounds in the December quarter, doesn’t recover as quickly as everyone expects.

So, in my view, this is a good time to take a bit of profit. While I also think the economic story for Australia is still positive and that the economic recovery has only been delayed by recent lockdowns, I don’t think the stock market is really factoring in the potential risks emerging, including possible new covid variants and increasing geopolitical risk. Overall, I think there is more downside risk than upside at the moment. Company valuations are high on almost any measure. In the coming weeks, it won’t take much for markets to start to worry about some of these risks and for the ASX to pull back 5-10%. 

I think it’s a good time to make some minor adjustments and take a small amount of profit off the table. Recently, we’ve started reducing our exposure to financials including Commonwealth Bank, retailers like Wesfarmers and Woolworths, tech such as Xero and Afterpay. These are great companies that have performed really well, and we continue to hold them. However, in my opinion, at such good prices it is prudent to lock in a little profit and reallocate capital to better value stocks or cash for future opportunities.

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.

Small Business Failure Is the Biggest Risk Emerging in the Economy

It has been about a month since my last update on Covid19 and the emergence of the delta variant. Without a doubt the NSW State government have made a mess of this in the last few months, somehow creating a worse outcome for both the health of the people and the economy. 

It is clear that the only way out of long-term lockdowns is by getting the population as close to fully vaccinated as possible. In a perfect world, it would be 95% plus but it’s going to take too long to get to that figure before we end up with mass civil unrest and small businesses collapsing. I expect both NSW and VIC to end their lockdowns in November once over 70% of the population are fully vaccinated.

From an economic perspective, the prospect of the lockdowns ending is obviously good news. People can go back to work and companies can get on with doing business. If this all goes ahead, then we will likely see pent up demand for goods and services and a great Christmas period to boost the economy back into gear.

From an investment portfolio perspective, at the moment, the share market remains largely unaffected regardless of whether we are in lockdowns or not. In many cases, the large companies listed on the stock market are somewhat insulated and have diversified income streams from across the world. They have access to capital and the ability to negotiate favourable terms with suppliers due to their size and scale.

That is not the case for all businesses.

The area I am increasingly concerned about is small and medium sized business, the real engine room of the Australian economy. In my opinion, there is a growing risk to the entire economy emerging as small business continue to be neglected by all sides of politics while bearing the brunt of the impact from lockdowns. They have neither the voice of unions like workers nor the deep pockets of the corporates.

Extended lockdowns for any reason, be it lower vaccination rates, materially higher ICU and death rates, or a new variant, will be a problem for many businesses already on the edge.

These businesses depend on local customers and have neither the size nor scale to access capital or negotiate favourably with suppliers when in trouble. They are increasingly finding themselves at the mercy of their banks and their landlords, both of whom are effectively accumulating unpaid interest and rent as debts. Small businesses have no leverage in this situation as it plays out.

It doesn’t show up as a problem at the moment because the banks are capitalising the interest and using it to increase their loan book. Landlords in many cases are accepting whatever the small business can pay as rent and accruing the unpaid rent as a debt. It all looks good on paper. At some point, the reality is that these amounts need to be paid.

When this side of the equation starts to play out it will be a problem. If small businesses are left with nowhere to turn then many will go broke. It’s that simple, it becomes their only option.

If there is a material spike in small businesses collapsing in the months ahead then there is the very real possibility that this leads to flow on effects for almost everyone; for the economy, unemployment, the property market, the banks and ultimately the big corporates listed on the stock market.

Significant economic problems always seem obvious in hindsight. Usually, they seem to come out of left field because everyone is too distracted or complacent to spot the real problem emerging. For years governments across the world have bailed out the biggest institutions because they are too big to fail. However, if we are not careful, it will be our disregard for small businesses that will be our economic downfall.

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.

Death by a Thousand Cuts – How Fintech Is Disrupting the Banks

The big banks here in Australia have just released very strong results, which is great news for investors. Increasing dividends and share buybacks during a global pandemic show just how strong a position they are in.

However, there is an undercurrent of change brewing that can’t be ignored. In my view, the banks are in the early stages of being disrupted and this process will play out over the next 10 years or so. It’s not going to happen quickly, but the seeds have been planted and new competitors will ultimately change the way bank’s function. Structural change will eventually compress their margins and reduce their market share, starting with their most profitable products.  

Yes, I know they currently make billions of dollars and record profits year after year. That doesn’t matter when it comes to technological change. They are not impervious to disruption and their success over the past 30 years doesn’t make any difference going forward. In fact, their position as high paying dividend stocks that the market seems to love perhaps makes investors all the more complacent.

So here I want to outline my thoughts on how this is starting to happen, specifically to the banks, and to flag it as a very real issue to be aware of in the years ahead. You need to understand the issue early because once it happens it’s too late.  

Fintech (Financial Technology) continues to grow as a sector with thousands of companies emerging across the world. Unlike Amazon in retail, it appears to me that no individual fintech company will singlehandedly disrupt the banks, rather the reality is that collectively they all will. Not the banks themselves, but their individual products. Because of this the disruption to the big banks will play out a little differently.

But we have seen this type of disruption before.

Back in the early 1990’s newspapers were exceptional businesses. Very profitable. The businesses that disrupted them did not create better newspapers. But one by one the newspapers lost their most important revenue streams and core products, their cash cows.

It was death by a thousand cuts.

Back in the 1990’s there was no Seek, no Realestate.com.au, and no Carsales.com. There were only newspapers. As the internet evolved it allowed a new generation of companies to emerge and cherry pick the most profitable parts of the newspaper business. New online marketplaces developed and led to exciting new platforms that would become the leading companies of the next 30 years.

This is how the banks are being disrupted. One by one their most profitable products are being picked off. Afterpay and the buy now pay later sector is just one example. New payment companies such as Square, Stripe and PayPal are another. But there are dozens emerging across all their product lines. They are leaner, nimbler and provide cheaper, more efficient alternatives. 

Technology and the internet especially have been the catalyst for disintermediating markets. Wherever there is an intermediary the internet has created extremely efficient ways to cut the middleman out.

Banks are ultimately intermediaries.

They have done a great job in presenting both sides of the market as separate products ranging from term deposits, cash accounts, credit cards, home loans to personal loans. But really, they are just the middleman between depositors and borrowers. They take a cut from both. It’s a great deal for them.

It can be difficult to be bold on issues that are not obvious right now. This is especially true when the companies concerned appear to be at the peak of their powers and profitability. It is far easier to talk about tech disruption when a company or industry is in the middle of it. At that point though it’s too late for investors and the company share price will reflect the structural problems.

That said we still hold the big banks in our client portfolios, and they are still great businesses. But don’t just blindly follow the crowd. As an investor its far more important to consider disruption before it is obvious to everyone else, and the market factors it in. That process has already started. Although it may take many years to play out you cannot allow yourself to be caught off-guard by the threat nor miss out on the new opportunities that emerge. 

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.

The Importance of Company Culture

One of my favourite books is a short read called ‘Staying at the top’ by Ric Charlesworth. I bought it when it first came out in about 2002. I was in my mid 20’s and nowhere near the ‘top’ let alone having to be concerned about staying there. But I was fascinated at the time with reading as much as I could about those who performed at the highest level and how their minds worked. Any book by Ric Charlesworth was at the top of my list.

For those not familiar with Charlesworth his achievements are as impressive as they are diverse. He played first class cricket for WA, was captain of the Australian hockey team winning a silver medal at the 1976 Olympics, he obtained a medical degree from the University of Western Australia before then commencing a 10-year career as a federal member of parliament. He later led the Australian women’s hockey team as coach to 2 consecutive gold medals at the 1996 and 2000 Olympics.

A genuine modern-day polymath.

In his book, Charlesworth emphasises that the real measure of success for a high performing team is not just to win or achieve a goal, but it is in sustaining that elite level of success over the long term. He points to values, teamwork, continuous learning, and resilience as needed to reach the top. But to stay there requires more. He talks about redefining the challenge, refreshing the team, avoiding recycling, and facing your foes. To me, that is everything to do with renewal and creating a sustainable culture.  

I think of the San Antonio Spurs, the New Zealand All Blacks, the Hockeyroos all incredible teams that not only achieved the highest level of success but maintained it for years. The common theme in these organisations is culture. It is perhaps the most important ingredient in the creation of sustained success. A great culture is at the core of great organisations.

The opposite is often true. For every one of those teams listed above, there are a dozen where success was only fleeting or followed by scandal and a dramatic fall from grace. The Australian Cricket team (2018) and the Essendon Football Club (2013) come to mind. Their success wasn’t built sustainably. Short term focus, the wrong incentives, corners cut, and bad habits set in. Something goes missing in the cultural fabric of those once great organisations. There are always signs but we tend to ignore them.

I also think these principles apply equally to business and the companies we invest in. In a data driven world where statistics, metrics and quantifiable results rule the business world, the quality of an organisation, their leaders and their culture are perhaps one of the most underrated aspects of identifying great companies. It is also one of the most difficult areas to assess.



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.

Afterpay, Square and the Buy Now Pay Later Sector

Yesterday’s announcement that USA listed Square (NYSE:SQ) will take over Afterpay (ASX:APT) demonstrates just how important the Buy Now Pay Later (BNPL) sector is on a global scale.

In my opinion, the Afterpay deal with Square makes a lot of sense for all stakeholders. Jack Dorsey is a visionary leader in the Steve Job mould. He has grown both Twitter and Square into multi-billion dollar companies that have changed the worlds of media and financial services significantly. Afterpay shareholders will in due course receive shares in Square, an emerging and disruptive financial services company well positioned for the next decade.

When we first looked at Afterpay in 2017 for clients at about $5 a share I had my doubts about it. I was initially concerned that it was just high-risk consumer debt that would eventually become bad debt. But the more closely we looked it was clear that BNPL was in fact disruptive and a far better option for consumers than the alternatives. At its current price of $129 per share Afterpay has become one of the best investments we have ever made.

BNPL has been around in one way, shape or form for years, whether as credit cards or the Harvey Norman ‘interest free’ debt that emerged in the 1990’s. This is a classic example of the incumbents being complacent and ultimately being disrupted. The biggest losers with the emergence of BNPL, especially domestically, are the big banks and their ridiculously high interest rate credit card products.

It reminds me of the famous quote from Amazon founder Jeff Bezos when he said, ‘your margin is my opportunity. That is the case here. I would personally prefer young people don’t use consumer credit at all. But if they are going to, they are better off if they use Afterpay rather than a high interest rate bank credit card.

Perhaps the biggest surprise is just how slowly the banks have been to react along the way. I will never understand why one of the big banks here in Australia didn’t take over Afterpay a few years ago for a fraction of the current price. From here expect more consolidation, strategic partnerships, and takeovers. The BNPL sector is here to stay and is just another example of the changing financial system and traditional banking sector being disrupted.

It also shows just how short-sighted, fearful, and low conviction share market investors can be. It was just 2 weeks ago that Afterpay and the BNPL stocks were smashed on the news that PayPal and Apple were entering the sector. Like most things with the share market that was an overreaction. What it did highlight to me was that the big players are beginning to wake up to the potential opportunity in this sector. BNPL is still in its relative infancy, and these new entrants show there is a long way to go here.

More to the point Apple and PayPal coming to the party was a signal to me that we were about to see a lot more activity. Consolidation amongst the couple of dozen incumbents as well as the bigger first movers looking to develop strategic partnerships with larger players such as Amazon, Alibaba, or the big financial institutions. All of this activity really just helps the BNPL sector become mainstream faster and creates awareness in a product that is significantly better than the competition.

I think Afterpay and Square both have outstanding long-term potential, and I am really excited to see what they can achieve together in the years ahead.

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.

My Thoughts on Bitcoin

Everyone has heard of bitcoin these days. Most people understand it is a digital currency and have seen its meteoric rise from about US$1 in April 2011 to over US$60,000 in March 2021. It currently sits at about US$37,000 today (27 July 2021). Putting US$1,000 into bitcoin back then would equate to US$37m now so it’s no wonder people are tempted to invest just so they don’t miss out again. Bitcoin is of course extremely volatile and in any given month could just as easily halve as it could double in value. But as long as it continues to be volatile it will gain headlines and investor attention.  

So, what is bitcoin, and how does it stack up as an investment?

Bitcoin is a digital asset. If you own 1 bitcoin that’s it, that’s what you own. Just as you can buy 1 ounce of gold, or you can buy 1 US dollar. That’s the asset. There is limited supply, 21,000,000 bitcoins to be exact. Nearly 19,000,000 have been mined and are in circulation with the remainder not yet in circulation. You can buy a part of a bitcoin as they are divisible into 100,000 parts. But for all intents and purposes a bitcoin is its own measure and a separate store of wealth.

The real question is why would you hold your wealth in one commodity or currency over the other? The reason many of the early adopters, miners, and buyers of bitcoin hold it is that they believe it is a better way to exchange, transact and store wealth. They believe that the future of money is in a digital form, decentralised and not controlled by a central bank or government. I think this is likely true, and I am certain that the future of money will be cryptocurrency in some format.

I also believe in the next decade cryptocurrencies and their associated technologies such as blockchain, smart contracts and non-fungible tokens (NFT’s) will become mainstream and change the world in ways many people haven’t even considered yet. There are now hundreds of competing cryptocurrencies, different technologies and applications emerging, bitcoin is just one, the first one. But I don’t think it will be bitcoin specifically that wins the day in the long term. There are some flaws inherent within bitcoin that make it susceptible to one day being disrupted by a better, more energy efficient cryptocurrency or technology.

At that point what is a bitcoin worth? Probably nothing.

From an investment perspective, my personal view is that bitcoin itself is really just a commodity given its limited supply. But as a commodity, a bitcoin has no real utility outside of being a digital store of wealth. If there is a better store of wealth one day, then funds will flow out of bitcoin to the better option, and bitcoin effectively becomes worthless. That is the biggest risk with bitcoin in my view.

In the meantime, bitcoin remains the biggest name in cryptocurrency. So, for the foreseeable future it appears likely that more and more money will flow into it. If demand for bitcoin exceeds the supply, then this will force the price up. If bitcoin eventually becomes mainstream, then that is likely to translate into huge demand pushing prices to much higher levels. Recent reports that Amazon are preparing to take bitcoin as payment indicates that it is well on its way.

That’s the conundrum with bitcoin. As volatile as it is, the price will probably reach many multiples of its current price in the years ahead. However, you need to be forever mindful that bitcoin has no inherent underlying value or utility beyond being a digital store of money. If there are better and more popular cryptocurrencies that emerge in the years ahead then funds will flow out of bitcoin and the price will go down dramatically.

In my opinion, the probability of this eventually happening make it too high risk and speculative for most long-term investors, including myself. However, I do think that cryptocurrencies and their associated technologies more broadly do have huge potential and will provide very interesting potential investment opportunities in the near future. I’ll write more on these in due course.

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.

What Does the Delta Variant Mean For the Economic Recovery?

The emergence of the delta variant of Covid19 is causing real concern not just here in Australia but across the world. While many countries were returning to normal life, the accelerating spread of the delta variant has slowed this.

What does this mean right now?

It means the global economic recovery will be slower. But it also means that the risk of inflation is reduced in the short term and that Central Banks around the world may leave interest rates on hold for a little longer.

From a stock market perspective, it's likely capital switches from the ‘recovery’ stocks and traditional companies poised to benefit from an imminent recovery, back to the big tech stocks.

Locally, it may mean that the eagerly anticipated capital management programs we were expecting from the big banks will be on hold or scaled down for now.

As we enter reporting season, many of the companies reporting great results will not see the expected share price impact. Those numbers simply reflect a materially different environment to what the market now anticipates.

This virus also continues to mutate and spread. So, I do not think that the delta variant is the last of it. I expect that the future will include new variants and booster vaccines. In other words, these concerns will reappear from time to time in the months and presumably years ahead.

Overall, my view is that the economic recovery will remain well on track, if a little delayed. However, the Federal Government will need to reinstate many of the programs and initiatives they previously put in place last year for business and workers.

Federal and state governments will most certainly now need to prioritise the vaccination program. It may be the only way out of lockdowns from here.

In Sydney, we went back into lockdown on June 26 and after almost a month, it does not look like we are heading out of it any time soon. Looking at the numbers I think this outbreak is similar to the one that put Melbourne into lockdown for 112 days.

In my opinion, best case scenario is that this ends up being a 3-4 month lockdown and worst case we are in lockdown until NSW is at 70% of the population vaccinated (maybe November).

The current concerns around the delta variant bring with it the potential for similar investment opportunities to those we saw in back March and April last year when Covid19 first hit.

Specifically, in relation to Covid19 impacted stocks, I am much more interested in buying great companies with earnings that have been hit hard in the short term, but very likely to return to normal post covid, over companies that get a one-off boost from sales brought forward.   

In short, I don’t think it hurts for share markets to pull back from recent all-time highs. I also think that governments and businesses have at their disposal all the necessary tools to navigate the situation and for the global economic recovery to continue, though at a slower pace. I remain keen to buy stocks where the market overreacts in the short term and opportunities present themselves.

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.

Australian Investors Need to Think Global

Microsoft, Amazon, Facebook, Google, Walt Disney, Coca Cola, Tencent, Alibaba, Nike, McDonald's, Visa, Tesla, Netflix, Spotify, Sony, Samsung, TSMC, Johnson & Johnson, LVMH, Salesforce. All massive global organisations, with incredibly strong brands, across a broad range of exciting growth industries. Huge opportunities. I do not believe you would find anything near an equivalent business to any of those listed here in Australia. So why, when the world is changing so rapidly, are most investors sitting on their hands holding 5 banks, 3 mining companies, a couple of retailers and Telstra? The reality is that if Australian investors do not have exposure to international shares going forward, their investment portfolio will be left behind over the long term. There are a few reasons for this.

Firstly, as I alluded to, there is very little genuine diversification in our market compared to the global market. The share market here is dominated by a handful of stocks big banks, big miners, Woolworths, Wesfarmers, CSL and Telstra. The ASX200 is made up of 30% financials and 20.3% materials. In fact, the 12 biggest companies by market capitalisation on the ASX represent about half of the entire market capitalisation of the stock exchange, or about $1 trillion out of the $2 trillion worth of companies listed on the ASX.

Secondly, Australia is also small, really small. The ASX accounts for about 2% of the global share market. A lot of big fish in a small pond. This dynamic makes it more difficult to find stocks that are great businesses as well as undervalued. Everyone knows about every stock. But there are great companies and opportunities across the world that many are missing out on. Unless companies are operating as global businesses, and in 2021 that is entirely possible, then many companies here are limited to a market of 25 million people. Stock market investors need to think much more like venture capital investors going forward and look at businesses that are global and scalable. 

Thirdly, asset prices here will continue to be forced up by sheer weight of fund inflows in the years to come. As it stands, there is just so much money in the superannuation system that it is distorting valuations of companies. This will only get worse in the years ahead. Currently, there is almost $3 trillion in the Australian superannuation system. That is more than the entire value of the Australian share market which is worth about $2 trillion. Additionally, there is about $120 billion being added each year in new contributions to the system. That is a huge amount of new cash that needs to be invested. A good percentage of which will be mandated by the super funds to go into the biggest stocks in the country. This is going to become an increasing problem for valuations, fund managers and ultimately investors.

Finally, the opportunities across the rest of the world are very different to those you can access here. There are entire industries and subsectors of industries that simply do not have a meaningful presence here in Australia. Whether it is the pharmaceuticals, technology, cybersecurity, or renewable energy the leading companies in the world are typically not found in Australia. There are no companies you can effectively include in an Australian focused portfolio as a substitute for exposure to the blue-chip companies I listed at the start of the article. You simply miss out. There are even greater opportunities being missed internationally at the mid cap and small cap end where the global leaders of tomorrow are emerging.

It has never really made any sense to me that most Australian investors invest such a high proportion in Australian stocks. While there is a level of familiarity and comfort derived from investing where you live, as technology makes access to international markets more efficient and affordable and research commoditised, it can no longer be ignored. In the decade ahead, diversification away from the Australian share market will be critical. Not only to reduce exposure to a concentrated number of stocks in a small local market, but to access the incredible opportunities increasingly available to all investors across the world.  

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.

Are We Entering a New Cold War?

The rise of China as an emerging superpower presents unprecedented opportunities and challenges for the world. Given recent tensions between China and the USA and their ongoing trade war, it raises questions about what it means for the future. Is it possible that we are entering a new Cold War? 

The short answer, in my opinion is yes, we already have. 

It might have started as a trade war, but it is now much more than that. Ultimately, it’s the rising superpower competing with the established one. At the moment there are half a dozen or more different issues of serious disagreement between the countries that could at any time take a turn for the worse and lead to serious escalation.

While there are obvious differences in political and economic ideology between communist China and capitalist USA, and their allies, this isn’t the only complication. Over the years, the trust between the two nations has been lost to the point that it becomes difficult to repair the relationship. 

The new reality for the world is that China and the USA are not only competing in economic terms. It’s a battle for power and influence in the global hierarchy for the next century and beyond. So, whether it's in relation to the South China Sea, Taiwan or another issue, we will continue to see posturing and positioning as they test each other out. 

Let’s not be naïve either, as the incumbent superpower, strategically, it is very likely that the USA would prefer to have whatever battles they need to have, sooner, while China are not yet as powerful. The US does not want a conflict, or the threat of conflict, when the countries are the same size and certainly not once China is more powerful. 

I don’t think this is a dramatic statement, simply an obvious one. 

The general assumption by many has been that there may be conflict decades down the track when China is able to challenge the USA as an equal. I think everyone is looking at it wrong. History has shown that, where their strategic interests are at risk, the US will take whatever action they deem necessary to nullify it. As such, it is my view that the threat of potential conflict is actually greater in the near term (this decade).

Obviously, this is an extremely complex issue. It will likely be the most important geopolitical issue of this century. It is not just about global politics, because after decades of globalisation, the impacts of these emerging risks have never been greater, or more widely felt, for all nations and industries. Certainly, businesses in many industries are already having to rethink how they manage their business to mitigate the risks. I also think investors should be taking these risks into greater consideration when making investment decisions.  

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.

So, here we are again. Lockdown

The whole issue of Covid-19 and how to manage it is probably the second most polarising topic I have seen in 10 years (the most polarising was easily Donald Trump’s presidency). There are many different perspectives and people don’t hesitate to share their particularly strong views on the best way to deal with it. Ironically, I’ve not heard anyone say: “well it’s hard to know, this is new territory, there are going to be mistakes but we’ve got to pull together and work it out as quickly as we can.” No one says that, instead everyone is an expert because they listened to a podcast and have a mate who also agrees with them.

What I have observed is that no one is objective on this issue. Everyone’s view is directly impacted by the most serious impact Covid-19 has on them and their family. If they are running a café in the CBD and face financial ruin, then lockdowns are ridiculous, and we need to learn to live with Covid-19. If someone has a child with pre-existing health concerns, they will tell you vaccines are essential to protect the community, and anyone not vaccinated is being irresponsible.

Understanding that the paradigm everyone views these topics through is important to separate the macro from the micro when discussing these topics. None of these individual views are unreasonable. If lockdowns will potentially ruin your business, then your view is not unreasonable. If your loved ones have pre-existing health issues your view that everyone needs to get vaccinated is not unreasonable. Conversely, if you are worried about the side effects of the vaccine, and want to wait, your view is not unreasonable. That’s the individual decision and views.

In terms of how this plays out from a macro perspective, we need to look at the best outcomes that can be achieved from a financial and economic perspective as well as health perspective. There will be collateral damage and criticism regardless of the decisions made and those people will reasonably have a grievance at the individual level. But from a big picture perspective, in the best interests of our nation, everyone would agree on one thing: We need to get back to normal life as soon as possible. We also have the means to do this but for some reason we continue down a path of indifference, half measures and state-based decisions.

To achieve a return to normal life as soon as possible the number 1 priority of the Australian Federal and State Governments must be getting the majority of the population vaccinated. From a health perspective it minimises the risk to everyone of death or illness as a result of Covid-19. It also minimises the interruption from a business perspective from lock downs and other restrictions and gives the economy every chance to move forward unimpeded. I say majority because people must be able to choose. They may have valid concerns and freedom to choose is a critical part of our society. However, there are plenty of incentives that can be introduced to ensure the majority are motivated to get vaccinated.

The current lockdowns are hardly a surprise, and it is very easy to see that Australia is lagging most of the world with our vaccine roll out. Currently Israel have over 60% of their population fully vaccinated, Chile and Hungary above 50% and the USA and UK over 45%. Australia sits well and truly behind most of the world at 4%. Ultimately, this will slow down our economic recovery. Overwhelmingly, Australia has managed the pandemic extremely well. Compare our situation to other nations and it’s clear that many other countries have endured major problems. But we have become a victim of our own success. As well as we managed the early stages of the pandemic it has led to complacency across the board.  

Other countries were desperate and thankful for a vaccine because thousands and thousands of people were dying, and their hospital systems were overwhelmed. In Australia we were not desperate, we were slightly inconvenienced, some people were concerned. But the majority of Australians went about their lives much as they did before, occasionally wearing masks, standing further apart and using more hand sanitiser than we probably needed to.  

There are a range of reasons for the slow up take and roll out of the vaccine. Regardless, I would expect that the current situation will be the catalyst for the government to step up the roll out and for the majority of the population to get vaccinated. Until this happens, we are going to continue to face the prospect of interruption to business, social restrictions, and potential health issues. Once it’s done, we can move forward as a nation and return to normal.

What You Don’t Invest in Matters

The poor results from recent high-profile IPO, Nuix and other well-known brands such as Adore Beauty, are an important reminder that sometimes the best decision is not to invest even when everyone else seems to be. I had multiple clients ask about those companies and others at the time when they were the next hot investment. There are a few simple rules that are worth keeping in mind to help decide if an investment is good for you or whether you might be better off ruling it out. This is especially useful when markets, or a sector of the market, has performed very well, and the market becomes flooded with new opportunities. Personally, if I can find a reason not to invest, a deal breaker of some kind, that’s great. It saves me a lot of time and effort and I can move on the next deal. 

With regards to Nuix, my notes at the time in response to client queries include: I am undecided (unconvinced). There are a few issues which make it less attractive than it appears at face value. The IPO/float process appears to have been well managed and structured to maximise the returns on listing day (good publicity, marketing and control of the stock allocations to increase demand). I think businesses in the data industry are complex and difficult to understand business models. Unless we really understand the model, we would keep clear. In relation to the float, they raise only $100m in new funds for the business to grow whereas $875m is existing shareholders selling down. It’s a company where the founders and management own very little of the company, majority are large institutions who invested many years ago. There is a lawsuit pending from one of the original co-founders. 

One of the first considerations for me is whether the company being listed is raising money to grow or if it’s effectively an exit. There’s a big difference between a founder raising capital to grow their business to take it to the next level and a large institution taking a company they invested in years ago to the market to sell it. In the first case, the founder will retain as much of the business as possible while raising funds to fuel growth and expansion. In the second case, the institutions may have invested much earlier and are pricing the float at the best possible price to maximise their return. If the majority of the proceeds raised are being used to fund the exit of existing institutional investors, then that’s not usually a great sign regarding their view of its future prospects.  

Another area I am very wary of are IPOs led by large private equity firms who have taken over a well-known brand that had fallen on hard times. They buy them cheap and get to work restructuring the business over 2-3 years before re-listing the company on the stock exchange. High profile examples in the last decade that come to mind include Myer and Dick Smith. You’ll often find that while the profit number looks great ahead of the listing, and the turnaround hailed a success, the reality is often that the business hasn’t received the level of the capital investment needed to sustain the performance or the business. It’s only after the sale or IPO that the lack of investment or other issues become a problem and cracks start to appear. Suddenly, six months or a year after the float, the company starts missing their profit guidance and shortly after the share price falls accordingly. So, while new IPOs are much talked about, they are not always as they seem. It is important to look beyond the positive PR and sales pitch and more deeply at the underlying motives of all the stakeholders before committing any capital.


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.

Why the Semiconductor Shortage Is a Major Issue for Everyone

A couple of months ago I wrote an article outlining 10 themes for 2021 and it is already time to add a new theme to the list. There is a critical shortage of semiconductors that will soon be felt in every part of the economy. If I was to redo my list today, I would rank this new theme in the top three for potential impact. It’s a serious issue that is beginning to impact some businesses, but it hasn’t really been felt by consumers in the main and certainly hasn’t yet been factored in by markets. This is a complex issue that encompasses about 5 of the 10 themes I previously identified. 

Semiconductors are critical to the production of electronic devices. In today’s economy that means everything. It’s no longer just computers and phones, semiconductors are prevalent in every industry, from cars, washing machines, microwaves through to kid’s electronics, video games and toys. But its far bigger than consumer goods, semiconductors impact industry, business, government and military operations. Beyond the everyday devices highlighted above, the future demand for semiconductors is only going to increase as technology becomes more sophisticated and becomes increasingly embedded in our daily lives. In the future, robotics, autonomous vehicles, AI, data centres, streaming and the internet of things are just some of the new areas that will see massive demand in semiconductors. There is huge growth in this sector. 

But right now, there is a shortage looming that is going to create problems for consumers and business. There are several factors at play here. Increased demand for devices during the pandemic for manufacturers already at capacity. Logistics problems and additional supply chain shortages due to Covid-19. It also highlights just how vulnerable the world is to the fragility of the global supply chain. Perhaps most importantly, about 60% of the semiconductor market comes from Asia with an increasing amount forecast to be controlled by China in the years ahead. Western nations are concerned from a national security perspective in the event of escalating tensions with China. 

As we have seen in Australia firsthand, in a variety of industries, China has no problem using demand for commodities as leverage and strategically positioning business decisions for political gain. This is a problem. You need a reliable supply. This is especially true for a product as critical as semiconductors. So, countries are going to move to ensure future supply. That means building out the capability to not only meet future demand for semiconductors but to ensure reliability of the supply chain for business and stability to mitigate national security risks. The USA and many nations in Europe are already planning to open more manufacturing facilities in the years ahead to keep up with demand and secure supply. 

There are very real and potentially dramatic consequences from the current shortage as it flows through the global economy. We are already starting to see the impact with prices of some devices jumping significantly, and others unavailable. While in the US, some automotive manufacturers are already having to shut their manufacturing plants due to the shortage. The questions will soon be very real about how this impacts the manufacturers of many devices and products around the world from Apple, Nintendo and Tesla through to small and medium size businesses in a variety of industries. This issue will impact prices, sales and profits. 

At the high-end, companies such as Intel, TSMC, SK Hynix and Samsung will continue to manufacture semiconductors, and this is a significant growth opportunity. The demand for semiconductors will likely continue to grow for decades to come. But like any other boom, sometimes there are even greater opportunities to be had in the companies that provide services to these manufacturers. Like the old saying ‘sell shovels in a gold rush’ I think there are even more interesting opportunities to be found in the companies in this part of the market that can provide machinery and services to such a rapidly growing market. 

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.

Lessons on Work, Money and Life

This week’s post is a little different. We’ve hit a few significant milestones in our house in the past few weeks and it has made me more reflective than usual. Recently, my wife and I celebrated our 25th wedding anniversary and just last week the youngest of our 4 children turned 18 years old. As I approach my 45th birthday and think back, what advice would I give to myself at 18? Or more importantly, as I look forward, what advice would I give my kids for the years ahead?

This is what I would tell them about work, money and life:

1. Make every single day count. There is one thing I know for sure, it’s that time stops for no one. That doesn’t mean be constantly busy or rush. It means be mindful, not wasteful.

2. Do what you love. Everyone says that these days, but people still struggle with it. Do what you really love, and you’ll end up being successful and more importantly, happy.

3. Give it a go. Whatever it is you really want to do, just go and do it. There will never be a perfect time, so don’t overthink it, just do it. If it doesn’t work out, then just start again.

4. Don’t be scared to try new things. If you don’t know what you want to do, try a bunch of things. You’re not going to find your passion thinking about it. Get out there and do.

5. Learn good habits. This goes for work ethic, health and fitness just as much as financial discipline. Start off by making it easy and build on it every day until its unbreakable.

6. Develop a good daily routine. This follows on from good habits. Almost everyone who I’ve seen succeed has a reliable routine. It’s what helps you get through the tough times in life.

7. Choose your partner wisely. It will probably be one of the single biggest factors in the happiness of your life. This applies to love and business.

8. Pick your battles. Don’t get distracted from your goals by everything that goes wrong or every problem that appears. Save your energy for the fights that really matter.

9. Enjoy the journey of life. It goes quickly and very few times is anything as serious or grave as it may seem. So, stress less and enjoy each day as it comes.

10. Buy books. The best investment you can ever make is to buy a book for $30 to get the insights a world class expert gained over a lifetime. It remains the best deal I’ve ever seen.

11. Spend less than you make. Always. Save and then invest. Once you build your savings add to your investments regularly. It doesn’t matter if its shares or property as long as you invest.

12. Credit cards are dumb. Pay cash. If you can’t pay cash, then guess what? You can’t afford it. Only use debt to buy appreciating assets like property and even then, with caution.

13. Start a business when you are young. Whatever it is you want to try once you’ve learned the basics try it. Start small scale and assume you’ll fail. But learn by doing.

14. Turn off notifications. And most social media for that matter. If you don’t consciously turn off from it, you’ll be distracted from your own goals by the barrage of addictive marketing.

15. Learn about money. Understand the magic of compound interest, the importance of cash flow and how to read a balance sheet. Invest don’t speculate.

16. Learn the power of words. They impact all your relationships, your ability to communicate at every level and negotiate the outcomes you want in life. They matter.

17. Be a lifelong learner. Be curious about the world. Travel and open your mind to other cultures and views. Most importantly never stop learning no matter how old you are.

18. Embrace change. In your everyday life and in the way technology is changing the world. Understanding how the world is changing is one of the most interesting parts of what I do.

19. Take regular holidays and breaks. Spend time with family and rest. I try to take a short mini break every 3-4 months if I can. Rest, rejuvenate and smell the roses along the way.

20. I assume I’ll die in 10 years. For perspective, it reminds me that life is short and to get on with it, but at the same time it's far enough away that I’m not too worried about it.

21. The meaning of life. In my younger years I gave a lot of thought to this and concluded it was a waste of time. There is none. It’s up to us to create whatever we want from our lives.

22. Have fun. Remember to laugh and enjoy every day if you can.

Feel free to share with your kids or grandkids if you think it may provide them with useful insights.

Are Defensive Assets Still Defensive?

I remember when I first started in the investment industry in 1998. A conservative self-funded retiree investing $2,000,000 in term deposits at 5% was easily able to secure a retirement income of $100,000 pa. It also doesn’t seem that long ago that I was able to lock in 7.00% pa fixed for 12 months on a term deposit for clients. That was 2007 just as the GFC hit and changed the investment landscape forever. Today, the best you can get for a term deposit is around 0.30% and that same $2,000,000 generates income of only $6,000 pa for the risk adverse investor. It is an incredible difference, a massive pay cut and reduction in the standard of living for people in that bracket.

What it means in reality is that the most conservative investors have to choose to either dip into capital or increase the level of risk they take to access higher yielding investments. For more sophisticated investors and larger portfolios this is still a problem. The allocation of funds to growth investments such as stocks and property tend to dominate investor attention. However, depending on the investor, traditionally a portfolio would have an allocation of somewhere between 10-50% to defensive assets too. These assets, such as cash, term deposits, domestic and international bonds, corporate bonds and hybrid note securities are intended to diversify risk, provide income and stability of capital. 

In today’s low yield environment how suitable are these options really? Cash and term deposits earn next to nothing. The yield on international bonds is so low that in some cases it’s actually negative. The biggest problem for bonds is if interest rates go up. It’s going to be a massive problem for bond investors. The value of bonds is more volatile than many investors appreciate. If the government bonds you hold are paying 1% on a $100 bond, then it’s going to be worth a lot less next year if the yield on new bonds issued is 2% on $100 bond. The higher interest rates rise the greater bond values will fall.

Bank hybrid note securities are interesting. They are considered at the riskier end of the defensive style assets and sit somewhere between shares and a bond, but they remain relatively attractive for a couple of reasons. The yield is a reasonable 2.5% to 4.0% but most importantly many have a floating interest rate. In other words, if interest rates go up, so too does the yield on the hybrid notes. This provides investors with higher income and will help them retain their capital value too.

My point here is that in the past, government bonds would provide yield and capital stability. But because of the unusual times we live in I don’t believe bonds provide either very well anymore. Increasingly, investors are allocating a greater proportion of their portfolio towards growth assets and reducing their exposure to defensive assets. It’s hard to disagree. While I favour holding cash to take advantage of potential buying opportunities, for most defensive assets there is a lot of potential downside risk and not a lot of potential upside gain. If we do enter a phase of rising inflation, investments that provide a hedge against subsequent rising interest rates are preferrable to those that don’t. To that end, it may be worth considering the potential benefits of floating rate investments and inflation linked bonds going forward as part of the allocation to defensive assets.

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.

What’s next for the Post-Covid Economy

It’s been about a year since I last wrote about Covid and how I saw it impacting the economy. It makes interesting reading to review the notes I wrote in March and April last year. The timeline and key actions played out broadly how I predicted. Governments worldwide pulled out all stops to keep the economy going, there were bouts of lockdowns and reopening, and the vaccine came along within a year or so. Despite the differing approaches in Australia between the states, as a nation we have done extremely well managing covid. We are now on the path to recovery. 

So, what’s next?

USA

The USA looks to be well on the road to return to normality. They are getting close to having 50% of their population vaccinated (first dose) and given many in the community have already had the illness they are getting very close to 75% of the population having immunity. This is incredible especially when you consider how badly they handled the early stages of the pandemic. They are far closer to a full reopening than most other countries including Australia. This is very positive for the US economy and US stocks and will flow through to drive growth in the global economy too. 

Australia

In Australia, the psychology behind the take up of the vaccine here in Australia has some really interesting cultural subtlety to it. Australians don’t like being told what to do and people appear wary of a vaccine that has been developed in record time. In the end, the majority of the population will get vaccinated here in Australia but it when they are ready and after a few people they know have had it. This might sound overly simplistic, but it is how people often think. Regardless, the economy is progressively reopening, and while we are lagging other western nations such as the US with our vaccination programs, I believe we will catch up quickly once we see other nations reopening their borders and international travel starting again without us.

Travel

Travel will be back, probably in the second half of this calendar year in the US and 2022 here in Australia. There is so much pent-up demand, just ask any mum and dad with a few kids. Disney recently reported that their resort bookings are back to 2019 levels. Corporate travel might be a little more subdued with the Zoom effect likely an ongoing trend for cost conscious business. But I’m broadly bullish that travel and the industries impacted by it will be reopening soon enough.

Inflation

Inflation will likely appear, but it will create volatility rather than a sharp correction in markets. The reason being that over the next 12 months the debate that has been between camps arguing “inflation vs no inflation” will change to “is inflation here to stay vs it’s a temporary jump”. So, there’s going to be volatility while the answer to that becomes clear. This transition period will be really important for markets because at the moment inflation and the rising interest rates that it will bring aren’t factored into asset prices around the world. The uncertainty around whether it’s a short term jump due to covid recovery and stimulus will save the market a more abrupt shock compared to inflation appearing due to long term issues. 

Unemployment

Unemployment is remarkably low at 5.5%. Given this time last year we were looking at mass job losses, this is great news. However, in April even though the unemployment rate improved the number of jobs fell. Delving into the numbers reveals fewer jobs, fewer hours worked and thousands of people who stopped looking for work. This isn’t necessarily a problem, and I expect job numbers to return steadily in due course, but the unemployment rate isn’t as good as the headline figure appears. In a jobs market approaching theoretical full employment, you’d expect to see greater wages growth, and employees demanding higher pay. In this market, there seems to be a general sense that it's good to have a job rather than people asking for a pay rise.

The Banks

The Banks are well positioned for the recovery with interest rates at record lows for now and the worst of the pandemic over. They have more capital than required which will likely mean the introduction of capital management programs and their dividends are returning to their pre-pandemic levels. In a low yield environment, with dividends of say 7% including franking credits, with the prospect of capital returns, and some capital growth, the banks will become especially attractive to investors in the next 12 months. 

Central Business Districts

Central business districts (CBD’s) around the country will return to their pre-pandemic glory sooner than people think. Many will tell you that working from home spells the end of the CBD, but I don’t think this is the case in reality. While working from home as a trend is here to stay, I think the empty space will refill soon enough. The company leasing 6 floors may only need 4 floors going forward but those 2 surplus floors will be sublet or relet to other businesses who can now access a CBD address for the same or less than they pay in say North Sydney. People want to be where the action and energy is. 

Summary

I think the Australian economy is in a very strong position. The huge government spending programs have helped keep the economy ticking over. I do think the size of the budget deficits and the amount the country is borrowing is excessive, but that is a discussion for another day. But as we look ahead to the next 12-24 months, we are in a great position. 

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.

Why Amazon Rules Retail

Regardless of the short-term movements in the market and the potential for rising inflation, the major companies of the next decade will continue to be tech companies. Regardless of the economic trials and tribulations ahead, technology will continue to change the world and determine what the future looks like. These companies are often more difficult to understand and value than traditional businesses and it is critical to look beyond the basic valuation metrics and ratios traditionally used in assessing stocks. There are a few reasons for this.

Firstly, the best tech companies are not focused on profit. They are racing to solve a problem and then win their market. That means scaling fast and capturing market share. Profit comes much later. This is a counter intuitive concept for many to become comfortable with, because one of the most basic business concepts for years has simply been that good businesses make profit and bad ones don’t. The internet started to change that 25-30 years ago with companies like Amazon relentlessly reinvesting in the growth of the business above all else. From a stock perspective, the profit figure will always be low and PE ratios went out the window. What matters more is the business model and the subsequent growth in customers, subscribers and revenue.

For years Amazon was derided by stockbrokers and investors as being ridiculously expensive. One of the main reasons was the stocks very high price to earnings ratio of 1,000 (or more). For context investors would typically see 10-30 as reasonable and 30+ as higher for a growth stock. In other words, the share price was many times the profit per share. Investors were bewildered at just how expensive the stock appeared and the media loved leading with news headlines about the crazy valuations. But they simply didn’t understand the strategy that Amazon and Jeff Bezos were pursuing. I am not saying we would buy the stock at any price, but profit wasn’t Amazon’s goal back then and it’s still not.

I am fascinated by Amazon and their business model as it evolves, especially the growth of their Amazon Prime subscribers. These customers pay a subscription fee to access a range of products, services and further discounts. With the infrastructure inherent within their business model, it now enables Amazon to sell almost any product, to anyone, anywhere in the world. With the scale they now have as they grow their fee-paying subscribers, they will eventually be able to sell products at cost. That’s why they are a threat to almost every retailer in the world. In the future, you will not be able to buy products more conveniently or more cheaply than with Amazon. After taking decades to build their strategic position it makes it very difficult for traditional retailers, who need to make a profit on the goods they sell, to compete with Amazon in the future.  

For Amazon, it really is about winning the whole market and gaining as many customers as possible. More importantly though and more difficult to identify is the strategy that I think will secure their dominance for the years and decades ahead. I am always very interested in the number of Amazon Prime subscribers when they release that information. The subscription fee is just the start. Eventually, they will be able to increase their subscription fee significantly and they won’t lose customers because the savings customers realise will still outweigh not having the subscription. These are the types of companies we are looking to include in our portfolios across industries. 

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.

Why are markets worried about inflation?

Inflation is low, so why is everyone worried about it? Basically, inflationary concerns exist because everyone knows it’s coming at some point. You simply can’t print as much money as governments around the world have printed, borrow as much as they have borrowed, all designed to stimulate the economy, and expect there to be no inflationary impact eventually.

This issue really started with the GFC. Presented with the potential for another Great Depression, governments worldwide decided to manage the issue over 20-30 years rather than see a very sharp 3–5-year problem as was seen in the 1930’s. So, to avoid a more damaging catastrophe, governments started quantitative easing programs (a form of printing money) and borrowing money to stimulate their economies. Those that led the way in the crisis, such as US Federal Reserve Chairman Ben Bernanke, were students of the great depression and well positioned to guide the US at that moment. To be fair, a few years of government deficits to smooth out what would otherwise have been a tough landing, is a sound policy in the middle of a once in a generation financial crisis.

However, there are a few problems with this approach in practice. Firstly, governments are terrible at correcting these budget deficits, and once you start, it’s difficult to reign it in. The deficits become entrenched structural deficits. Secondly, governments become reliant on borrowing money to stimulate their economy, not just in times of crisis, but every time there’s the hint of a problem. So, instead of going into deficit for a few years and getting these issues under control, governments constantly run deficits and their debt increases. Thirdly, that extra money is in the system in some way, and more is added to the economy each day. It’s the last point there that causes markets the most concern. Some inflation would be okay. That’s what central banks worldwide are hoping for, enough impact to get the wheels of economic growth turning. But everyone is so impatient these days. If things aren’t moving fast enough, then there’s ever increasing pressure on governments to do more. So, they do more. More stimulus means more borrowing.

What markets really fear is that enough has already been done, but that it takes longer than everyone thought to work its way through the economic system - years instead of months, decades instead of years. If that is the case, the concern is that the global economy has been flooded with money and that prices will increase substantially in the years or decade to come. There’s already a lot of money in the system and that is driving up asset prices across the world, from commodities shares, bonds and property. While this inflation isn’t driven by everyday consumers, they will be the ones who are eventually impacted. So, when markets drop on inflation fears, its not the prospect of inflation itself that is causing the jitters. It’s the fear of an inflationary period that may have been years in the making. The overriding concern being that such an inflationary period could potentially result in a dramatic rise interest rates.

It seems farfetched at the moment as inflation is very low, and interest rates are basically zero. However, the possibility of a high inflationary period is the underlying fear within today’s markets, in my opinion. Its not the signs of inflation per se or even inflation emerging that spark concern. Instead, it’s the fear that the prospect of inflation rearing its head is the start of a new problem that will impact all of us. As always though, those risks will bring with it opportunities.

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.

Is it time to take profit on tech stocks?

Is it time to take profit on tech stocks? Well, yes and no. While the phenomenal gains we’ve seen in technology stocks over the past 12 months are probably not sustainable in the short term, it doesn’t necessarily mean they are mispriced or overvalued. Having said that, part of the recent run has simply been due to the weight of money into these stocks as investors globally moved money away from traditional businesses and those that were negatively impacted by Covid. So, what we have seen and will probably see more of in the next few months, as the economic recovery gathers pace, is a lot of that money rotating out of tech companies back to where it came from.

In reality, we have seen some of that occurring already from time to time over the past few months. You’ll notice those days when the markets haven’t necessarily moved much but tech stocks are down sharply, and the financials and industrials are up about the same. That’s really just the weight of money from investors moving money between sectors. Tech companies have performed really well, so we have been taking some profits from time to time, which we think is prudent, and reinvesting into those more traditional businesses that will benefit from improving economic conditions in the 12 months ahead.

However, taking a 5 to 10-year view, there is no place I would rather be invested than tech. To be clear I am not talking about high-risk venture capital; that’s a separate discussion. I am talking about the market leaders such as Apple, Amazon and Microsoft as well as, more importantly, the emerging leaders such as Atlassian, Spotify and Zoom. These types of businesses, and others like them, are the future. They are global businesses that solve problems in new ways. They create new markets and can scale quickly. They disrupt and overtake the existing companies that have become complacent and profit focused.

So, while I am very mindful of the rotation out of tech and agree that taking profits from time to time is prudent, we are very bullish on tech in the long term. As the economy improves and the traditional financials, industrials and Covid affected stocks recover, we will likely see tech stocks pull back. I am not concerned with that as these are long term investments. These tech companies will continue to be a core part of our investment portfolio’s going forward and when our preferred stocks are down, we will continue to add to our core holdings as opportunities present themselves.

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.

10 Themes for 2021

Having navigated the Covid pandemic over the past year, and as we look ahead to the next 12 months, it’s worth remembering this: there will always be another crisis. The next big problem. Some predictable, but many are not. But, when you look back and reflect over the events that occurred in the heat of battle it becomes apparent, with the benefit of hindsight, that these crises often present the best investment opportunities. Over the course of 20 years as an investment manager and investor I’ve seen it time and time again. It’s worth understanding exactly what this means because people are generally uncomfortable with uncertainty, and it’s easy to jump at shadows.

Certainly, in April 2020, with the share market in Australia having fallen 38% in about 4 weeks and the dramatically escalating Covid crisis, it did not feel like that was a fantastic time to invest. But it was. In February 2009, after about 16 months of the GFC crisis and a 56% fall in the Australian share market, it did not feel like that was a fantastic time to invest. But it was. In the face of extreme uncertainty, it is difficult to hold your nerve let alone have the courage to make further investments. But ultimately that is the key. Understanding the interplay within the macro themes, that ultimately impact and shape the future of the world, provides us with the insights needed to have conviction in the investments we hold.

To that end, we’ve outlined 10 key themes facing investors and businesses in the next 12 months. Some represent risks to be managed, others are opportunities, some are both. But in our view, these are all critical themes to keep in mind, as they will shape, not only the financial and economic outlook, but also the future of our society and the world at large. These themes, in order of potential impact, are:

1. Low interest rates

2. Stimulus

3. Covid / Covid vaccine

4. Economic flow through to business

5. Continued rise of technology

6. China risks

7. Inflation risk

8. Rise of crypto

9. Property market evolving

10. Govt debt

I will be writing more on these themes over the course of the year and look forward to sharing my unique insights on a broad range of topics, some relating to investment, some not. Hopefully you find them thought provoking and interesting.

Regards

Dion Guagliardo