Investing and New Challenges

Inflation is here. While it took some time to fully show up in the official figures and be acknowledged by learned economic scholars, us mere mortals who engage with increasing prices throughout the economy on a day-to-day basis long knew something was up. Whether it be the price of a supermarket sausage increasing by 20%, paying thousands extra for a car, or another dollar on a cup of coffee, we knew what was happening.

As we’ve seen, this has prompted a reaction from central banks, which will prompt reactions in other areas, including asset prices. Let’s take a look at some of them, what might happen (because we never truly know) and how we might best react to take advantage.

Firstly stockmarkets. Something not widely acknowledged was what occurred back in January. The ASX All Ords (excluding dividends) fell more than 10% by January 27, but almost no one noticed it happened. By late April it was back to where it started the year. Since April it’s again fallen to be around 13% down (excluding dividends). This is the average intra year sell off we’ve become accustomed to seeing on the ASX over the past four decades. The fall is nothing out of the ordinary.

Globally, there’s been more pain. The major MSCI World Index is down around 18% (excluding dividends). While in the US, markets have surpassed the 20% fall that signals a bear market. Ironically, emerging markets that were punished after Russia’s invasion of Ukraine have flatlined since and are down 12%. While there’s been nowhere to hide, we do have a value tilt in our portfolios. Value stocks have been flat to slightly negative, meaning the falls have been smaller than these quoted.

Where to from here? We don’t know, but historic returns in the US following declines are worth considering.

Markets do bounce back and historically 10% and 20% declines are accompanied with recoveries in the subsequent years. Markets price in whatever is plaguing them, before eventually moving on.

As always, our message is sit tight, but what else can you do? Focus on ensuring your money ends up in a more favourably taxed environment. Contributing to superannuation if markets are falling can be a tough one for people to get their head around. “Why would I put money in if it’s going down?” We had someone recently bemoan they’d just contributed to their super and the market went down.

What they’d overlooked was they were griping about seeing the market lose a couple of per cent, when they’d saved 22% in tax by making the contribution in the first place! They were still well ahead in comparison to the money being left outside super.

Next, take your adviser’s advice about rebalancing. Volatility isn’t going away. Markets may rally strongly, then sell off heavily, then rally strongly before further heavy sells. These movements will have investors moving through the emotional rollercoaster.

We all feel great during any recovery, only to see ourselves panicked when the market turns down again. It’s important to take advantage during the rallies. If you and your adviser have put in place targets to rebalance your portfolio, then take advantage when they are reached, and sell. This isn’t market timing; it’s just harvesting gains when they appear. It means your spending is taken care of and you’re not worrying during a future sell off, nor are you having to sell during a future sell off at a depressed price.

What about other assets?

Real estate. Moreso than the stock market, real estate has been pumped by cheap money. We’ve seen prices screaming higher based on the belief interest rates would not be rising until 2024. Then the RBA changed its tune. RBA governor Phil Lowe offered a defence this week, suggesting that rates being on hold until 2024 was based on the RBA’s expectations of inflation. Given the RBA’s accuracy at forecasting maybe it would have been safer if they’d said nothing.

Whether implied by the RBA or assumed by the borrower, it matters little now. Interest rates have increased and they’re going to increase again. The impact on the real estate market? The simplest way to judge is doing a quick calculation on what a buyer can afford. If a buyer qualified for a million dollar mortgage last year, but the same buyer would only qualify for an $800,000 mortgage this year, it suggests the ability to bid will fall and house prices will follow.

For those who did buy recently, if they bought a house to live in and have no need to sell, no big deal. You just won’t get those windfall gains we’ve previously been accustomed to during years of falling rates. If someone stretched themselves, has little equity and are forced to sell due to a life event such as a relationship breakup, it will be very painful. Especially in the housing markets that saw nosebleed prices.

What about that other stuff that was meant to replace money? Cryptocurrencies. There were various stories told about bitcoin and cryptocurrencies. Hedge against inflation. Portfolio diversifier. An alternative to transacting within “the system”. All are dubious right now.
Cryptocurrencies have reacted poorly to inflation and have been belted as markets price in interest rate rises, much worse than other risk assets. A few years ago, the diversifier argument was credible. Bitcoin moved independently of stocks, but today bitcoin is more correlated with US stocks, albeit with bigger swings than stocks. Cryptocurrencies offer little downside protection from stockmarket sell offs.

Being outside the system is a boast people only make when things are great. It’s somewhat reminiscent of the tagline from the old science fiction film Alien. In Alien it was: In space no one can hear you scream. In this case: In crypto no one cares if you scream.

There’s no sympathy when people lose their shirt on an unregulated asset or platform. Several stablecoins, which are dollar pegged intermediaries that allow users to keep their money in the crypto environment and not have to convert back to real money, have failed recently. Billions have been lost. There have also been issues with crypto platforms either collapsing or restricting withdrawals. The suspicion is they can’t cover the withdrawals. More losses.

What about the old high yield property or mortgage offerings with no volatility? Don’t even bother. Another one called Remi Capital fell over last month. It offered 7-16% fixed returns. Complete rubbish! $60 million of investors’ money went down the toilet. The stories of retail investor losses are harrowing. Life savings gone. Worse, ASIC’s oversight is in question with the Remi failure. An investor who struggles with market volatility, will struggle even more with seeing their capital disappear instantly. That’s followed by years of investigations to see if anything is even recoverable.

It’s not meant to be a consolation that other assets are falling, have proven unreliable, or collapsed. It simply highlights that there’s nothing new under the sun.

Always be mindful not to extrapolate current events too far into the future. With inflation currently high and interest rates increasing, it’s tempting to believe it will be the norm, but nothing occurs in a vacuum. US Tech companies struggling with profitability have already been laying off workers. This signals that belts will be tightened. Rate rises may play a role in dampening inflation more quickly than we expect.

Capitalism continues to work. Businesses will reprice and innovate according to changing conditions. Returns will re-emerge, but as always, they won’t come in a straight line.