Jumping at Shadows

It’s been my experience over the years as an observer of markets and human behaviour that our fear in response to possible outcomes is usually disproportionately (and incorrectly) weighed against its probability of becoming a reality.

For all the concerns about an issue they usually don’t come to pass. On the occasions where there is a bad outcome we fear an even worse outcome, which usually do not materialise. We are very good at being fearful, but we are not very good at allocating a level of rational probability to that fear.

In other words, things are never as bad as they seem, and investors spend far too much time worrying about unlikely events becoming reality. The opposite is also true. Rarely are things as good as we think. The reality is far more boring, somewhere in the middle.

With this new covid variant it is no different. Listen to the media and it sounds bad, but we don’t actually know anything useful at this point. The number of “what if” articles I am seeing in the media is ridiculous and just a waste of time and energy. We will deal with it if it is an issue.

A big part of the current reaction to the emergence of the new variant is that everyone is tired of it. Everyone has had enough of the pandemic and just wants to go back to living a normal life. So, we are more sensitive than ever to the prospects of going backwards. The media love it and are pushing those buttons hard. This is probably the biggest risk going forward, pandemic fatigue.

There are going to be new variants. We know that. We also know the drill about how to manage them. Until we have answers on a couple of key questions, I just don’t think it is worth worrying about. From an investment perspective there are two questions I need answered in relation to the new variant and that’s pretty much it.

1. Is it resistant to the vaccine?

2. Is it more deadly?

If the answer to these questions is “no” then it’s not a big deal and in a few weeks, everyone will have moved on and the rest is just noise.

If it is resistant to the current vaccines, then we go back to the original drill. It will take time for new vaccines to be developed and then distributed. But this time we know how it works and have the foundations in place to manage the next steps. It might set the recovery back 3-6 months (that’s a guess).

I hope to add to our positions in December if markets fall further and if the new variant is vaccine resistant, I expect to buy again in January if the market overreacts.

There are going to be new variants. There will be more of them next year too. At this stage we should know the drill well enough that we can wait and see if it’s a problem. Then make rational decisions to deal with the actual situation. Life will go on. We need to stop jumping at shadows.

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.

Dividend Dance

In Australia, investors and companies have become twisted in a little knot around dividends that needs to be undone. Dividends in Australia are just too high. I know no one wants to hear that but it has to be said and it needs to be discussed. More importantly, if our companies are going to remain competitive on the global stage it needs to be addressed because times have changed. The way businesses grow has changed and unless we review some of the practices that have evolved, our company’s risk being left behind their global competitors.

Over the last 30 years investors, especially self-funded retirees and SMSF investors, learned the benefits of having a portfolio of stocks paying generous fully franked dividends. It started in the 1990s as the level of share ownership in Australia started to explode. The old adage at the time relating to banks stocks was why invest money on term deposit at say 5% (remember those days!) when you could buy the same banks shares and get 6% fully franked dividends and participate in the growth in shares too. Made sense.

From there people started to understand that a diversified portfolio of blue-chip companies paying fully franked dividends was a great way to generate a retirement income. It wasn’t too difficult to construct a portfolio focused on income that could generate say 5% per annum with some growth too. For someone with say $5m in capital to generate retirement income of say $250,000 pa. It was also cleaner and neater than property, better diversification, without the headaches of tenants. This approach has been very successful and become very much mainstream. It does make sense.

But today, investors in Australia have become too focused on the dividend return instead of the overall return. The rationale is sound, but in this era of continuous innovation, it’s worth reconsidering this strategy and whether it is still as appropriate today. I am not saying company profits or cash flow are not important, in many respects they are more important. I am talking about whether investors and companies, by focusing on higher dividends is causing them to make decisions to their long-term detriment.

In many cases in the past, it has resulted in the dividend payout ratio creeping up over time. This isn’t a great sign, and it has happened more and more over the last 10 years as companies face pressure to continue paying high dividends. But it’s really important to understand that a dividend yield of 3% from a company that pays out 50% of its profits is not worse than a 4% dividend yield from a companying paying out 100% of its profits. In fact, it’s probably a better managed company. This is often overlooked by investors.

In this new era of continuous innovation, it is more important than ever for companies to reinvent themselves. That means reinvesting in their business to lead the next phase of change. ‘Blue chip’ companies in mature or maturing businesses need to recognise this and prioritise reinvesting profits back into the business to innovate or they are going to be disrupted by those who do.

That means not paying out dividends or at least paying out much less in dividends. But because these dividends are the foundations of retirement incomes, a large part of the investment market is dependent on them. The companies that pay the dividends know this. Major companies face significant backlash from self-funded retirees and large superfunds if they were to reduce their dividends.

The irony is that the shareholders will complain about companies adopting this strategy because they receive lower income, but its ultimately for the long-term benefit of those exact shareholders. The reality is that in a business environment changing at the pace that it is, paying out dividends that are too high simply doesn’t leave enough in the company to reinvest in its future. So, while in the past high dividends were a sign of good profit and stability it is increasingly becoming a sign of underinvestment and future challenges ahead.

The most innovative companies in the world are in the US and they do not pay high dividends. The average dividend of the USA Dow Jones industrial average (30 stocks) is 2.4% and for the S&P500 is 2.0% and for the NASDAQ is 1.0%. In Australia, the ASX200 payout collectively dividends that equate to well over 4% grossed up for franking credits. Though this number is somewhat skewed by higher than usual dividends from big miners, the point still stands.

If this philosophy doesn’t change soon then Australia’s leading companies, beloved by investors for their high fully franked dividends, will soon fall behind their global counterparts. As our market and investors in Australia become more sophisticated it will be important that we focus more on total returns over the long term.

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.

Welcome to the Metaverse

With Facebook recently changing its parent company name to “Meta” rest assured you’re going to be hearing a lot more about the metaverse from now on.

What is the metaverse?

I think the easiest way to visualise it is if you think of the current internet experience as 2D and screen based. Then, the metaverse as the next iteration of the internet, which will be 3D and fully immersive.

If you think people today spend too much time staring into their mobile phones, then you’re in for a shock. Soon enough we will be effectively living in them. Virtual reality (VR) and augmented reality (AR) headsets will be to the metaverse what the iPhone was to the web.

I see it as being at a similar stage to the internet, domains and websites in the early 90’s. It’s starting to take shape but it’s a long way away from being functional for mainstream use. A lot is going to happen in the next 5-10 years that will take it mainstream. All the major tech companies are already heavily investing in building the metaverse. Once it starts to scale, the network effect will do the rest.

Why does it matter?

Because it is the future of the world. It doesn’t just change it. The metaverse brings together many of the technological trends emerging today including machine learning, AI, cryptocurrency, NTFs and virtual and augmented reality to create completely new worlds and experiences. The most obvious area to start is computer games but it will encompass all aspect of our lives before long, from music and fitness to the future of work and education.

Today’s most popular gaming companies understand the potential of the metaverse and are already providing the early platforms for these immersive experiences. The companies that run Minecraft, Fortnite and Roblox are at the cutting edge. Kids don’t just play these games they spend their time there socialising and creating. They experience these worlds with their friends, both from school and those they meet in the metaverse.

But gaming is just the start. The virtual economy will be massive and paying for virtual goods and services will be standard. The music industry is already starting down this path with an exclusive concert on Fortnite by Travis Scott attracting 27 million participants last year. The fitness industry through the gamification of workouts and exercise is next.

In the metaverse you will be able to travel to anywhere in the world and experience travel adventures from the safety and convenience of our own home. You’ll be able to put on a VR headset and spend a Thursday evening in a gondola sightseeing in Venice or meeting up with friends on a Friday night to attend the live Rolling Stones concert.

In the US the National Basketball Association (NBA) partnering with Facebook already provides fans the ability to watch selected games in fully immersive virtual reality from a range of vantage points at the game, including courtside seats. Imagine being able to attend any event in the world at any time from your own home and it all feels like you are there in person. This is no longer science fiction.

How to invest in it?

It wasn’t that long ago companies repositioned themselves from web based to be ‘mobile first’. Well over the next 5-10 years companies are going to be moving to ‘metaverse first’. Right now, there are several companies at the cutting edge of creating the foundations of the metaverse. No doubt there are going to be many more in the years ahead. Many are going to lose so it’s important to be strategic here.

Facebook through their Reality Labs business are very well placed to lead the way in the hardware and software of the future. They plan to spend at least US$10b this year alone in this division. However, Microsoft is equally well placed and is taking a more pragmatic, if less visionary, path to providing the tools for the metaverse through their existing suite of products such as Microsoft Mesh and Teams.

I see Facebook and Microsoft as market leaders here. To me, they are the lowest risk way to gain exposure to one of the most exciting areas of growth we will ever see. They are both great businesses, very profitable, yet are still both growing rapidly each year and have excellent long term growth potential too. I see these stocks providing a free hit to the future upside of the metaverse.

But perhaps my favourite company in this field is Roblox. Roblox reports that their 47.3 million average daily active users spend approx. 2-3 hours per day on Roblox. Talk to anyone with kids under 14 and chances are they are already very familiar with their kids spending real money to buy Roblox digital currency, Robux. The engagement metrics and revenues are amazing. This is a company consistently growing at over 30% pa and in my opinion is poised to be one of the next tech giants in the era of the metaverse.

Facebook, Microsoft and Roblox are all outstanding companies that we own in many of our growth-oriented client portfolios, and I own personally. Subject to price, I will continue to add to these holdings over time.

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

The First Domino to Fall

Wednesday last week, Domino’s was the first major company here in Australia to flag seeing inflationary pressures such as rising food prices and labour shortages. The market reacted poorly to this news with the stock down 18% for the day. Domino’s is a great business, and while and a drop like that was probably an overreaction, it is the sort of re-rating we can expect if inflation takes hold.

Higher inflation has certainly arrived. The only question is how long it is here for. I’ve previously outlined my view that this bout of inflation is primarily a result of supply chain issues and that it will ease in due course. Overlay the slowdown from China and I believe inflation is most likely a 6-to-18-month issue. Ultimately, 1 of 3 scenarios will play out. I’ve listed these below with my view on their likely probability:

1. 20% likely inflation subsides within 6 months and markets continue bull run.

2. 60% likely inflation is a consistent theme for 6-18 months and causes a significant correction before inflation eases and markets continue their bull run.

3. 20% likely inflation stays and causes a fall a permanent re-rating of all asset prices of 20% or more. The bull run is over, and we have an inflation problem.

If you look at the breakdown of the scenarios more deeply, you see the conundrum investors are faced with. When combining scenarios 1 and 2 my view is that it is 80% likely inflation is dealt with within 18 months. At the same time, if you combine scenarios 2 and 3, I also think there is an 80% chance that markets will see a significant correction due to markets re-rating on inflation concerns.

The reason this is my view is that unless there are signs that inflation will ease within the next 6 months, investors are going to start getting nervous. The prevailing view in equity markets seems to be that the inflationary pressures are going to be transitory. But 18 months is a long time. Once we enter the next phase at some point within that 6–18-month time frame, markets are going to lose their nerve on inflation, and we’ll see a correction.

I am also mindful that central banks and Governments around the world are typically not great at managing these situations and can make them worse. They are almost always reactionary and rarely brave enough to be proactive. They act too slowly, then too quickly. This is why interest rates are still at zero when they should be higher and why a massive stimulus package has been approved in the US when the global economic recovery is already well underway. It only adds fuel to the inflationary fire now.

The data in the year ahead is going to provide very mixed messages on both growth and inflation. Labour shortages and increasing wages are next and that just adds another layer of inflationary pressure. While equity markets are currently expecting inflation to be transitory, I think this sentiment will change over time as doubts creep in. We will see over the next 12 months more knee jerk reactions like that seen by Domino’s as concerns around inflation persist and are flagged more and more frequently by companies. This will be a buying opportunity in my view.

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.

China Consolidation

While the prospect of inflation and the debate over whether it is just passing through or permanent will dominate markets in coming months, I think Australia should be more concerned with the impact of the economic slowdown in China. Everyone seems so focused on the reopening of the Australian economy they are not looking at the other headwinds emerging.

China has dramatically changed course in the past 12-18 months. They are battening down the hatches from both an economic and political perspective. Their ‘Common Prosperity’ mantra is the overriding political philosophy ushering in a new period of consolidating the government’s power and control.

Unlike the West, China thinks long term. They will forgo higher growth now if consolidating makes their nation stronger and better prepared for the battles ahead. I believe this consolidation is in line with their longer-term ambitions around Taiwan and the South China Sea.

There are many examples where the Chinese government has deliberately destroyed businesses and industries and actively limited their potential profit. Combine this with the government crackdown on property debt and developers, the world now faces the prospects of a China with materially lower growth prospects.

The level of sovereign risk in the communist nation makes investment there untenable. In the past 12 months, they have torpedoed their own internet giants Tencent, Baidu and Alibaba to the point that their share prices halved. They banned all education and tutoring companies from making a profit. In September, they banned children from playing video games for more than 3 hours a week.

The philosophical differences between China and the west make investing there a nightmare. The Chinese government is not concerned about that though. This is about consolidation of power first and the economy second. But it is certainly consolidation of both.

The property and construction debt problem in China appears to be an issue that China will manage over time. While there will be serious fall out, it may not be the economic disaster that was initially feared. It is likely China still grows and we will continue to see the emergence of the middle class.

But in the short to medium term, exposure to China growth is best found via the Chinese consumer. That doesn’t really help Australia as we are highly leveraged to the building of China. But with around 65% of the Chinese population now living in cities we are starting to move to the next stage.

Ironically, a phase of manageable consolidation for the Chinese government is likely the worst outcome for Australia.

When China is building and booming, demand for our resources is high and obviously Australia does well. If China does poorly, for example a major economic disaster, then we are likely to see China launch a massive stimulus package and focus on new infrastructure. Again, great news for Australia and the iron ore price.

But if China goes through a period of consolidation, Australia has a problem. In a consolidation phase, we’re going to see sustained lower iron ore prices and lower volumes. It will impact our entire economy, starting with the mining sector and flowing through to property and the banks. I think it is likely the Australian economy is going to struggle in 2022 as it finds itself hit harder by the Chinese slowdown than almost any other country.

From an investment perspective, I think there are still great opportunities in some sectors here in Australia, but I have reduced our client’s exposure to Australian shares. I am avoiding direct stocks in Chinese companies as the sovereign risk is simply too high. Most importantly, I prefer international equities over Australian shares at the moment. I am slowly increasing our portfolio holdings in blue chip international stocks, especially in the US.

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 Rising Inflation Here to Stay?

Inflation is rising. In the US, it now sits at 5.4% pa and just last week New Zealand confirmed a rate of 4.9% pa. These are the highest levels of inflation in over a decade. The main concern evolving in financial markets right now is whether the inflation genie is out of the bottle permanently.

Complicating the issue is that many investors have long been worried that governments around the world are creating serious inflationary pressure with quantitative easing, asset purchases and money printing over the past 10-15 years.

Over the course of the pandemic, the price of many goods and commodities have skyrocketed. The biggest question now facing financial markets is whether these increased prices, combined with supply shortages, will lead to a permanent jump in inflation. If inflation does increase significantly and leads to interest rate rises, it will be a problem for everyone.

If interest rates go up, and go higher, it is a real concern and with serious implications. It would result in a one-off re-rating of asset prices across the world. Almost all assets would fall in value as markets adjust. Bonds would fall, as would most stocks, especially high growth stocks. High inflation is a big deal.

In relation to the money printing impact, my view is that we are still years away from seeing the inflationary impact of this. The reason being is that the quantitative easing money wasn’t pushed into the consumption economy. Instead, been captured within assets for now and while its forced asset prices up around the world it is going to take many more years to flow through into the economy and create price inflation.

So, in my opinion, that’s a separate issue from the current inflation spike. It’s a problem, but not today, and it isn’t the source of the inflation we are dealing with now.

I think the current bout of inflation brewing is really just due to supply chain disruption caused by repeatedly closing and opening parts of the global economy as the world went into lock down. Combine that with the unusual buying patterns that followed from consumers and businesses in the past 18 months, and you’ll obviously have supply chain bottlenecks as a result, forcing prices higher.

However, everyone brought forward a lot of spending on goods while stuck at home. They don’t need more. But no one was spending on services. That’s going to change in 2022. I expect spending on goods and commodities to fall in 2022, while spending on services increases as the global economy reopens.

If so, we will see the current supply chain bottle necks and the congestion at ports around the world start to ease. This will all work itself out in my view. It will just take time. That’s good news for inflation. In fact, there are four main reasons I am not overly concerned with the inflation we are seeing now.

The first is as I mentioned, supply chains will rectify themselves and we will likely see less demand for goods than normal in the coming 12 months. Prices are more likely to come down as supply and demand normalise.

Second, as people realise that the demand for goods is falling, a major component is removed from the inflation equation, expectations of higher prices. This removes the need for people to rush to buy before prices go up which perpetuates inflationary pressures. If prices start coming down, they will wait.

Third, ongoing impact of technology is deflationary. Shortages in any area whether its labour or energy or commodities accelerates technology trends and creates permanent additional capacity.

Fourth, the slowdown in China is real and it’s going to impact global growth. It will especially impact the Australian economy, subject to the degree to which the property sector there slows.

Regardless of how it plays out, the spectre of inflation will make for a relatively difficult 12 months with the market coming to grips with the real story as it unfolds. In my view, inflation pressures will likely subside in due course. For Australia, I am far more concerned about the impact of the slowdown in China in 2022. I think that is the emerging headwind for the Australian economy next year.

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.

Converging Technology: Driverless Vehicles

Bill Gates once said, “people overestimate what can be achieved in one year, but underestimate what can be achieved in ten years”. This is especially true of the disruptive nature of technology. It seems so far away until suddenly its right in front of you. That is exponential growth at work. 

Consider driverless vehicles. This one technological subset will probably be the most visible example of hundreds that demonstrate the convergence between automation, robotics, and artificial intelligence. Not just cars but trucks and every other mode of transport that currently requires a human to drive it. They will not only be autonomous robots they will be connected learning machines aggregating data from all users across the globe to create massive efficiency.

Soon enough families will no longer own a car. They will subscribe to Transport-as-a-service. It will save them thousands of dollars a year and be incredibly efficient. Not to mention hundreds of hours a year of time freed up for each person. By 2030 this will likely be a reality. By then many industries will have changed significantly and the companies that are the winners and losers already defined. 

Imagine the not-too-distant future where you have an appointment. You won’t need to order the car; it will know your routine and schedule. The driverless Tesla connected with Uber and integrated seamlessly to your calendar will send you a notification upon approach. The car will arrive at your front door exactly at the time required to ensure you are at your destination on time. It will consider the traffic and weather conditions and know if you will be out the front waiting or dawdle out 5 minutes later. 

Their integration though will not be without challenges or controversy along the way. They will eliminate millions of jobs, most obviously it means no more truck drivers, bus, taxi, or train drivers. Yet as we have seen throughout history, it is likely that many millions more will be created in industries that are only just emerging or not yet invented. Upskilling, education, and entrepreneurship will boom.

With over 90% of road accidents resulting from human error they will prove to be significantly safer than human drivers. But they won’t be perfect and no doubt the media will spark fear with every mishap or accident until they become mainstream. But once driverless vehicles are adopted across the board, they will virtually eliminate road deaths and road accidents. Insurance companies and road safety authorities will all be on board and in the end, statistics will win out and lives will be saved.

It has massive implications for not just the economy but society. Frees up first responders, police, paramedics, emergency wards, massively reduced insurance premiums, no one will own a car, no need for car parks as cars will operate 24/7 stopping only for maintenance, no more smash repair businesses because there are no crashes. No more car theft. Massive reductions in pollution. As with all computing devices they will become cheaper and more powerful over time. It will ultimately reduce the costs of logistics and the price of goods. 

Agriculture, mining, manufacturing, and logistics are all industries that will see once in a lifetime reduction in costs and increases in productivity. This will translate into significant increases in profits, equating to increased returns for shareholders both from dividends and higher stock prices. We are talking about trillions of dollars globally. 

This is not an incremental change; it’s going to completely change the world. All this from just driverless vehicles. So, consider the dozens of similar changes that will occur in other industries from retail and hospitality to health and finance as automation, robotics, and artificial intelligence become standard.

It is my view that investors are too focused on the short term and medium term and drastically underestimate the real pace of change. As these changes occur at an ever-accelerating rate it is more important than ever to position your portfolio for the long term (10 years plus). Investors need to consider more deeply what the future will look like, the companies that will transform it, those that will be out of business because of it and those that can adapt and will benefit from it.

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.

Technological change is just getting started

Regardless of the uncertainty around markets in the short term, there is one reason I will always be extremely confident in the long-term prospects for investors and excited about the future.

Technology.

But before I talk about what’s ahead, just think about the way the world has changed in the past 20 years. There are a whole range of technologies and platforms we use every day that didn’t even exist back then. Go back to 2001 and we were using dial up internet, the iPhone wasn’t invented yet, there was no social media, and Amazon was only selling books. Fax machines, The Yellow Pages, calendars, diaries, rolodex were standard in the office and DVDs, CDs at home. It is incredible.

The list of companies that did not even exist back then but today are household names is staggering. Facebook, Instagram, YouTube, Uber, Tesla, Twitter, Zoom, Spotify. Companies such as Google, Amazon and Netflix were only a few years old and not nearly as advanced.

A lot has changed in just 20 years.

In my opinion, the change is only just starting. The advancements we are going to see in the next 10-20 years will change the world even more than we have seen in the last 20 years. There is a ground swell of innovation and technological advancement coming. These trends will further accelerate the pace of change and disruption and their convergence will make it exponential.

Automation, robotics, energy storage, artificial intelligence, blockchain, the evolution of the metaverse, genomics and DNA sequencing are some of the most important advancements that we will see in our lifetime. They are no longer the domain of science fiction, they are very real, and will change the world forever. It will all be mainstream much sooner than you expect.

For investors, every company you hold will be impacted by these trends in the years ahead. Every investment. It’s also not just about the opportunities emerging in the companies directly involved in these technologies. These are opportunities for existing companies that will change the way business is done, reducing costs significantly and increasing productivity massively.

I genuinely believe that we are on the cusp of one of the most exciting periods of technological advancement in history. As investors its critical to keep your eye on the long-term prize. The great companies of the future will realise their potential despite any economic head winds; and in my opinion many of the companies that are emerging as the leaders of tomorrow are hiding in plain sight.

In the coming weeks I will write more on these technological trends and some of the industries that will benefit most. I will also outline my thoughts on companies I think are best positioned to profit from these trends 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.

Busy Being Patient

A month ago, I wrote that it was a good time to take some profit. While markets have dropped a little since then (around 5%) by almost any measure, share markets globally remain fully valued. We took some profit, not because I have any great prediction to make about what is going to happen next in markets. Rather, it is simple risk management to allocate capital in a prudent way.

But what next? 

Markets have performed very well over the past 12-18 months. To the point where we find stock markets well above their pre-pandemic levels. That alone tells me that either markets have run too far or that governments have over done the stimulus. In reality it is probably a little bit of both.  

As such we hold more cash in our portfolio’s than we would like. But at the moment I think that is sensible. Ordinarily we might allocate more to bonds but with interest rates as low as they have been for as long as they have been govt bonds are even more fully valued than shares. 

As far as an investment goes, cash is currently terrible. Basically, no return and in real terms, taking into account inflation, you are going backwards. However, from a portfolio perspective I am comfortable holding cash where there is increasing volatility and uncertainly, which is what we are starting to see.

There’s a lot going on in the world at the moment that reflects the increasing strain globally stemming from both recent (Covid) and past events (GFC). In addition to the full valuations on stocks, we are also now seeing an increasing range of risks emerging. 

Domestically, we are adjusting to slower growth from China, lower demand for iron ore, and now regulators & banks targeting property.

Globally, we are seeing skyrocketing energy prices and emerging energy crises in various parts of the world, supply chain issues, semiconductor shortage, China property and debt concerns, US debt ceiling, China / US tensions and concerns around rising bond yields & inflation.

Each taken individually appear manageable but as a collective the story emerging is that the world is a little out of whack (more than usual). Coming out the other side of a once in a generation pandemic, this is not unreasonable. Many of these issues are symptoms of the same problems, other are not.

So, we have fully valued markets and a global economy trying to digest almost 2 years’ worth of disruption, stimulus and stops & starts. It’s just common sense to have a little extra allocated to cash. Good performance gave us the opportunity to take some profits.

Obviously, I’d like to deploy that additional cash into investments, but there’s no rush. Opportunities will arise. Regardless of what markets do next there will always be individual investments or sectors that are underpriced or present an opportunity. This is especially true when uncertainty his higher.

While we have increased our allocation to cash, I remain bullish on the long-term prospects of the global economy and share market. Our allocation to both domestic and global equity markets reflect this.

But for now, we are busy being patient.

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 the Size of US Debt a Problem?

In the coming days, we will read about the annual Mexican standoff in the US as the Republicans and Democrats jostle over raising the US debt ceiling. It’s a ridiculous game of political brinksmanship that will resolve itself out of necessity. I expect an agreement of some kind at the very last minute.

The issue is that the US has once again run out of money and need to borrow more to fund the basic functions of government such as pay wages and social security payments. Both sides need to agree to lift the previously agreed debt limit or by mid-October they run the risk of defaulting and causing a serious problem.

The debt ceiling has been increased almost 100 times since it was put in place after the war, and not once have the US defaulted. On each occasion, Republicans and Democrats have reached an agreement and raised the debt limit, usually at the last minute, and everything continues on.

But it raises a far bigger question long-term. Just how long can the US continue to fund huge budget deficits and borrow trillions of dollars before it becomes a problem?

At the start of the GFC in 2007, the US National debt was about $9 trillion. The US then embarked on massive spending, funded by debt, to deal with the once in a generation financial calamity. By 2009, the US annual budget deficit was up to $1.5 trillion on the back of only $2 trillion in revenue but spending of $3.5 trillion.

The idea of using deficits in a time of crisis is ok. Why take the full hit in one year when you can borrow now and spread the pain over 10 or 20 years. At the time of the GFC it made sense and likely averted a global depression. Even in times of recession and economic downturns it makes sense.

Unfortunately, we all know that’s never how it works in practice. Once a government starts spending, they rarely know how to reign it back in. Well intended budget deficits, designed to smooth out a serious downturn, become structurally entrenched in the system. People across the world expect their governments to borrow rather than have to go through tough economic times.

Fast forward to 2021 and US Federal Govt has revenue of $4 trillion and spends $7 trillion annually. US national debt is now approaching $30 trillion. The debt will be much higher in the years ahead.

This is not sustainable.

We are not even close to the US bringing their budget deficits under control let alone balancing their budget, and light years away from repaying it. Modern money theory says the US can borrow and print more money to inflate their economy to the point that debt becomes comparatively smaller and more manageable. Great in theory but there are always unintended consequences.

The main reason the US can take on so much debt is because interest rates are basically 0%. If interest rates go up it’s a different story. But even then, debt in the form of govt bonds is typically 10 years to maturity so it will still take time to impact the costs of borrowing for much of their debt.

It might not matter for many years, but it will one day. It is a path whereby the US loses optionality. If anything goes wrong, they are not in a position of strength to choose their path for growth. They are reactive and need to enact measures to get through. That is not prosperity. It is policy failure.

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 In The Evergrande Debt Crisis?

There’s a lot going on in and around China right now, with concerns around their intentions with Taiwan, the South China Sea and escalating tensions with the US and its allies. But perhaps the biggest issue impacting markets right now is the imminent default and potential collapse of property giant Evergrande with over $300 billion in debts. There are many potential implications from this.

The default to bond holders, people who bought property, suppliers, the loss of equity, the impact on property and construction, will all make their way through to their domestic economy and ultimately result in slower growth and have an impact on global commodities. But it’s the fear of the unknown that is causing financial markets to become fearful.

The bigger concerns at the moment relate to the uncertainty around how it all unfolds, the potential contagion and impact on China’s financial system (including debt markets and liquidity). It is one thing for a company to go broke, that is a part of the risk inherent in doing business. But the calculus changes when the organisation at risk is a systemically important one.

My observations in relation to these types of events:

• They take time to evolve

• There will likely be contagion

• The issue is usually bigger than we first think

• There are probably other organisations in similar positions

• Government can bail out the organisations involved if needed

We’ve seen this type of issue over the course of history including the US subprime issues resulting in the Federal takeover of institutions Fannie Mae and Freddie Mac. The indebtedness of this organisation occurred with China’s knowledge, and the factors leading to the current issue at Evergrande are as a result of the Chinese regulators demands to repay debt.

The next question will be, what do the financial positions of the other major property developers look like? Moreover, how are the other large corporations with huge debts positioned. I suspect that China ultimately wants to make an example of Evergrande and will force the organisation to resolve the matter. But this is equally a warning shot across the bow to all the corporations in China, not only Evergrande.

However, we should not assume that China wants to fix the problem in the same way a western nation would. That would be a mistake. China is a communist nation, and they operate accordingly. Their focus is not the wealth of investors or institutions. We have seen repeatedly now that China is prepared to destroy companies and damage industries if it serves their political objectives.

Perhaps one of the most counter intuitive lessons for investors from democratic capitalist nations to learn is that China isn’t ruled by money. We all assume they will act commercially because that is what business is all about, being pragmatic and obtaining the best commercial outcome. But we assume they believe the best outcome is what we think it is. It is not.

While China can potentially bail out Evergrande, it will be seen as a bad example. In my opinion, a bail out is only likely if there is an existential threat to the economy, financial system, or the political regime due to the fall out. Nonetheless its worth keeping in mind that, if the need arises, the backstop is a bailout. It will occur if it is essential.

The Western World is going to find out what an economic crisis in a communist state looks like and how it will be dealt with. Some sectors and nations will feel the pain more than others with iron ore and the big miners, here in Australia, the most obvious examples in the short term.

Overall, though, it is perhaps most important to remember that the long-term growth of China and their rising middle class is a theme that will continue for decades into the future. 

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.

Ignore the noise

These days everyone understands the amount of time people can waste when they aren’t focused. The internet, social media, Netflix, and countless other apps will consume your time with endless notifications and activity unless you consciously ignore it and turn them off. 

While modern technology and media has made accessing information massively better, it’s also created such a huge volume of news and data that people have forgotten how to focus on what actually matters. They’ve become overwhelmed and distracted.

Well, it’s the same in the investment world, where a lot of time and energy is spent by investors, advisers and institutions talking about and watching the latest news, event, or announcement.

Monthly and quarterly economic data, daily share market and company movements and ongoing geopolitical issues. Everyone is too focused on the short-term news cycle.

What actually matters is really quite boring and generally uneventful. So, it often gets ignored because the new sensationalist headline, exciting development, or breaking news has caught our attention.

Very little of the noise that is produced each day in the financial world will be significant enough to matter in the very long term. Yet so many people spend far too much time trying to know everything that’s going on, when a lot of it is noise. In fact, I would say, most of it is noise.

Now, to be clear, I am not saying these things don’t matter at all. I am saying they don’t matter as much as everyone thinks they do. I am saying that too many people spend a disproportionate amount of their time concerned with variables that are less important than the ones they should be paying attention to.

Of course, how we see short term movements in markets or the economy unfolding will impact whether we add to or reduce our portfolio positions. And, while it does happen, it is relatively rare that issues that appear in the daily news cycle actually change our long-term view and the companies we hold. 

Overall, though, it is far more productive and profitable to spend your time on what really matters and ignore all the noise. That is the key. Understand what really matters as an investor. Then by default the rest is noise. That is where you need to be spending the vast majority of your time and focus.

Great companies, in the right areas, will deliver great returns over the long term regardless of whether markets are up or down next week, or whether inflation and GDP are higher or lower next quarter.

What really matters are the macro themes and technological trends that will play out over the next decade or two. What really matters is how the 20-40 global companies we hold in our portfolios are positioned, not for the next quarter, but for the next 10 to 15 years.

What really matters is having a high degree of understanding and conviction in those companies and trends. Then it is easy to focus on what matters and ignore the noise.

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.

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.