Much that was Unprecedented has become Precedented!

The pandemic has affected all of us one way or another. Some of the effects are obvious, while others are evolving more slowly over time. We have all had to adjust our lifestyles and re-look at our goals.

Many short term goals have been altered for us by the pandemic (such as having to cancel travel plans), and it is wise to start looking at medium and longer term goals and thinking about how we might change them. Admittedly this is difficult because we don’t know the future course of the pandemic, how long it will last, or when (or if) a vaccine will be discovered. Nevertheless, it is time to at least start “thinking about thinking about” your goals.

While it is tempting to waffle on about the various ways that the pandemic has impacted us, I am sure you would prefer I concentrate on the financial side of things.

Trying to predict the future course of markets is always difficult, even in the best of times.

In these “worst of times” it is especially difficult, as things can change in all sorts of ways, very quickly. One institutional analyst described current markets as being “full of cross-currents”. It seems a suitable metaphor.

In any “normal” time of high volatility and maximum uncertainty, we could retreat to the safety of high security fixed interest investments such as term deposits, and put a big percentage of our investments there safe in the knowledge that our funds are going to earn a reasonable interest rate. However we don’t have that option this time. With interest rates close to zero, we need think a bit broader in the search for a return.

Perhaps never has the need for diversification been greater. This means having money invested across a range of asset classes such as Australian shares, overseas shares, infrastructure, gold, as well as cash and fixed interest, to name just a few. The cash and fixed interest may seem counter-intuitive given their very low return – and we all want a good return. However, it is important to pay attention to the risk as well as the return, and cash and fixed interest provides a dual function. As well as cushioning the extent of any fall, it also provides a source of funds to be tapped if necessary, and thus avoid the need to sell growth assets at fire-sale prices. It can also be used as a source of funds to invest into growth assets at low prices, and hence improve the overall recovery prospects.

While all this is happening, it is important to keep an eye on the biggest cross current of them all - the spread of Covid19. Its future course will be a big factor in determining market developments and government policy. An effective vaccine will be a huge event.

Major:

Following, I list some of the major cross currents, based on extensive reading.

“Unprecedented” is a word that has got a real workout this year, as a result of the Covid19 pandemic.

• The size of the economic downturn is “unprecedented” since the depression of the 1930’s, and the speed of the fall far exceeds that of the 1930’s.
• We have had “unprecedented” action by governments to limit the movement by people and thus control the virus.
• There has been “unprecedented” action by central banks to inject money into the economy and keep the financial system working.
• There has been “unprecedented” action by governments to keep as many small businesses as possible afloat. These have taken the form of special payments such as Jobkeeper”, targeted tax refunds, some rent assistance and assistance with bank loans.
• The stockmarket has shown “unprecedented” resilience in the face of the tsunami of economic bad news.

And so it goes. I could go on for pages, listing examples, but I am sure you get the point.

However, the big question for everybody with money invested in the markets, whether it be via superannuation or other vehicles, is how to make sense of what is happening and try to plot a course forward.

I make no guarantees, and events could well prove me to be very wrong, but some of my observations follow:

1.    Central banks are arguably the most important financial institutions in the world, with the US Federal Reserve being top of the heap. The Fed’s actions reverberate around the world. Not only is the US economy the biggest, but the US dollar is the currency of international trade.

The Fed has been incredibly aggressive in pouring money into the system, including going where it has never gone before – buying corporate bonds. This has made it very easy for businesses to keep borrowing money, stay afloat and hopefully rebound quickly when the pandemic passes.

2.    Still on the subject of central banks, they play a key role in setting interest rates, and they are determined that interest rates will stay very low for an extended period. Just to emphasise the point, the chair of the Federal Reserve recently said that not only were they not thinking of raising rates, but they weren’t even "thinking of thinking about” raising rates. Closer to home, the RBA has also said that interest rates would stay low for an extended period of time.

3.    Low interest rates have different effects if you are a borrower or lender. For those borrowing funds (whether individuals buying assets such as a house, or businesses wanting to expand) low rates have obvious benefits. Low rates also have an important secondary effect, in that they make shares relatively more attractive, and businesses wanting to raise money on the stockmarket can do so on attractive terms. However, for those of you hoping for a reasonable interest rate on your term deposit, the outlook is grim.

4.    Central bankers have been saying for some time, that monetary policy can’t do all the heavy lifting to keep the economy going, and governments need to start spending on big scale infrastructure. There are signs that this might soon happen. Recently there have been rumours of the USA embarking on a $trillion infrastructure plan. Yes, you read that right – a trillion dollars.

Where does it lead us?

Trying to draw conclusions from the above, on the future direction of markets, is extremely difficult. There are just so many cross currents.

Many long time financial analysts, with good records, are struggling with this new reality, and there are plenty that are very bearish. Often they point to such things as record high debt, surplus capacity, and low inflation as being key factors – with interest rates thrown into the mix somewhere.

The problem is they haven’t seen anything like this before, and they don’t know what to make of it. Many things have happened which economics and finance text books never contemplated (e.g. negative interest rates).

At this point, I am about to stick my neck out and say, “this time is different”. This is a phrase that has often come back to haunt many who have used it in the past, as cycles repeat themselves and boom has turned into bust and vice versa.

However, this is not a cycle like previous ones:

• Money is plentiful, not scarce. Money supply figures are increasing rapidly as governments and central banks flood the financial system.
• Interest rates are rock bottom, and likely to stay that way for some time.
• Central banks are changing, and becoming ever more deeply involved in economies. One expression used by Jonathon Pain, author of The Pain Report, is that central banks have “gone Japanese”. By this he means that central banks are following the Bank of Japan, who have been more active in managing the Japanese economy than other central banks have been in managing their own economies.

What does this mean for you? As always, the answer will depend on your circumstances, and if you would like to discuss your situation, please get in touch. However it is not all “doom and gloom”.

Not all companies on the stock market have been impacted in the same way, and some have even benefited from the pandemic. This is reflected in the performance of managed funds, which have shown very diverse results over the last 12 months.

There is a big gap between the best and the rest.

John Cameron B.Ec.B.Comm, Dip.Bus, MBA (Exec) (AGSM)

Please Note:

The views expressed in this post do not constituent advice in any way. If you would like advice on your current situation please contact us.

Email: [email protected] Phone: (08) 9322 7818

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Black Swan Financial Planning | July 2020 | Financial Update Newsletter - https://mailchi.mp/ccec55554d99/bsefp_july_2020_newsletter