21st October 2022

Wear more sunscreen, drink more water, make better money choices? As it turns out, professional investors are also not immune to the odd moment of “if only I had …”. This week, the AFR spoke to nine professionals about the lessons they’d teach their past selves, given the chance.

The insights include recognising that volatility doesn’t last forever and that the future is unknowable, no matter how much research you do – things worth keeping in mind amid stubborn inflation and rumbles from the International Monetary Fund about global financial stability risks.

When markets fall (regardless of the asset type), it can be stressful – no one likes to see their wealth decline. As we point out in this week’s ‘wealth wisdom’, the trick is to focus on what you can control.

Also in this issue, three themes for Q4 (what will be driving markets in the run-up to Christmas), whispers of a $5 million super cap, Year 12 economics and more.

According to Fidelity International there are but three themes expected to dominate Q4 2022 as the world navigates this changing landscape.

1. Soft, hard, or crash landing

• The Fed appears fully committed to getting inflation under control, even at the cost of significant demand destruction. Nevertheless;
• US economic data is proving relatively resilient – The labour market is still healthy, inflation remains high, and the US dollar continues to strengthen.
• Expectations for a hard landing in the US are being pushed out to mid-2023.
• Recession in Europe appears imminent. High prices and the threat of gas storage depletion are sapping consumer spending and hobbling industry.

2. China – all eyes on the Party Congress

• China is continuing to loosen policy where most developed markets tighten, and it has room to go further still.
• China has ramped up both fiscal and monetary support in response to the economic downturn triggered by zero-Covid policy lockdowns and a worsening property crisis.
• This support should improve the outlook for China as we head into Q4.
• Chinese earnings are also expected to improve as companies begin to enjoy a post-Covid recovery and lower commodity prices.
• Sentiment could also improve further following this week’s party Congress. While President Xi is likely to retain all his leadership positions for an unprecedented third term, adjustments in other leadership ranks could offer clues for the forward path of economic policy and serve as a catalyst for a more progressive growth policy.

In the past, Chinese leaders based their legitimacy on their ability to provide economic growth. Now with the economy slowing, Xi looks to be trying to shift the basis of legitimacy from economic growth to national security (tellingly, the congress report contains 91 mentions of the word “security”)

3. From monetisation to fiscalisation

• Much now depends on how governments, many of which face their own separate domestic challenges, will try to support households and businesses over a winter of severely elevated gas prices.
• The risk of fiscal largesse in an environment of high inflation and rates has been underscored by the UK’s mistakes that triggered a collapse in sterling and a sharp rise in gilt yields necessitating interventions by the Bank of England.
• The ECB, meanwhile, is trying to normalise monetary policy, despite the near certainty of recession across Europe.

It would seem there are a number of unknowns clouding the outlook for the remainder of the year. Questions abound over central banks’ hiking paths across developed markets – The balance between raising rates too much and not raising them enough is a tough tightrope to walk indeed!

We don’t know yet how cold the north’s winter will be, along with the knock-on implications on gas demand, nor how the current phase of global financial conditions will impact future policy settings.

We are acutely aware that markets will likely turn well before the uncertainty around economic outcomes clears. Markets will be volatile for a while yet, and current volatility is not reflecting a mid-cycle correction where ‘buy-the-dip’ is necessarily the right strategy. We are in the midst of a more classic business cycle. Pro-cyclical policy has led to overheating, asset price inflation and the need to tighten. The extent of the over-stimulus and its reflection in inflation means that a US/Europe recession is a likely outcome of policy tightening. This will take time to play out, and there will be casualties which are yet unknown (albeit we are starting to see more signs of stress – like the UK).

However, as we have mentioned many times before, if you look at the history of economic cycles, recessions are very common. And what is certain is that after every recession comes recovery. The cycle never dies! For those of us that have seen it before we reflect, stay calm and maintain a long-term perspective with the wisdom and knowledge that we will survive.

According to Financial Services Minister Stephen Jones

“If you’ve got massive retirement balances in a superannuation fund, it’s pretty hard to argue that that’s for retirement income (the objective of superannuation)”, he told Sky News.

ASFA estimates the measure would affect around 11,000 Australians (those currently with more than $5 million in super).

Whilst Chalmers has said there are no plans to announce a revised superannuation limit in next week’s budget, he has flagged a discussion could be had down the track.

Whilst a good idea, in theory, we do question just how much revenue it would actually deliver. By our (rudimentary) calculations, the number would only be in the hundreds of millions – a big number, yes, but not a game changer.

Like any super ‘tinkering’, it also brings with it a layer of complexity. For example, if a person has close to $5 million in their super account, how will the government rule on market fluctuations and their impact on the cap?

Mmm… Regardless of intent, it is our experience that super changes tend to be fraught with unintended consequence.

Chart #1 – Shows that leading economic indicators (blue line) have turned negative for the first time since the pandemic, pointing to a US recession.

Chart #2 – Depicts midterm elections in the US. The passage of the Inflation Reduction Act boosted the Democrat’s odds of winning control of House and Senate in the summer, but the momentum is beginning to wane. Whether this waning has an effect on Biden’s attitude towards how hard and how fast rates continue to rise remains to be seen…

Chart #3 – The forecasted rates expectations for the remainder of 2022 and into 2023 continue to move higher. This is in response to the more aggressive Fed tightening indicated in the September Federal Open Market Committee (FOMC) dot plot. The median FOMC rate projections for this and next year were raised by 100 and 80 basis points (respectively) since June.

Chart #4 – Shows that inflation expectations and actual consumer inflation have come down from their peak but remain well above their pre-pandemic levels.

The future value of an investment is the initial investment multiplied by its return compounded over time. Let’s take a 50-year-old investor with $100,000 in their super who wants $500,000 by the time they turn 70. There are three ways they can achieve this goal:

1. Invest at a higher return – the investor will need to average returns of 8.4% in order to achieve their goal.
2. Invest for a longer timeframe – if the investor starts at age 45 instead of 50, they only require a 6.65% return to achieve their goal.
3. Increase their initial investment – if the investor invests an additional $30,000, they only require a 6.97% return to achieve their goal.

It is natural for investors to focus on markets since that’s what is measurable and ultimately dominates headlines. Unfortunately, the reality is that we can’t control markets, only the risks that we expose ourselves to (asset allocation and selection). Although it may seem more exciting to ‘fasten your seatbelts’ and pursue high returns, a combination of prudent asset allocation, wise saving habits and starting young is a far more successful formula.

It’s Year 12 exam time, and Angus Dennis of Australian Ethical checks the latest subject changes in the Economics exam, and finds far more focus on the issues of equality and sustainability. An interesting read for all economic enthusiasts out there and can be found here.

Our thoughts are with anyone sitting the exam now or in the coming weeks, and best wishes to all students.

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