2nd December 2022

“Sorry” probably isn’t the usual rhetoric to feature amongst the barbs traded in Parliament House. But, when Reserve Bank governor Philip Lowe appeared before the senate economics committee on Monday, it was mea culpa all the way.

It seemed a classic political move when Greens Treasury spokesman Nick McKim asked Lowe whether borrowers who had been “induced” into taking out mortgages based on the central bank’s guidance were owed an apology. Surprisingly, it was not just one sorry, but three!

“I’m certainly sorry if people listened to what we’d said and then acted on what we said, and now regret what they have done,”

“I’m sorry that that happened. I’m certainly sorry if people listen to what we’d said and then acted on that and now find themselves in a position they don’t want to be in.”

Undoubtedly, the central bank has something to answer for, or it wouldn’t be publicly apologising. Their guilt, however, lies not so much in their guidance to Australians (that we should not expect rates to rise before 2024) but rather, in their inadequate communication around the uncertainty of this expectation

Playing their part, much of the media and market commentary did not help. Focusing on the 2024 element of the policy, little heed was given to the conditional statements around unemployment and wage growth.

In their defence, the RBA provided this guidance before Russia invaded Ukraine, which has had massive implications for their longer-term strategy. No one can fault the RBA with regard to the action they have taken – rate rises needed to happen and happen quickly. Ultimately, they are just returning interest rates from emergency to somewhat normal conditions. And, as painful as it is (and will be) for many, all asset owners benefit from a healthy economy.

For readers now holding negative equity, that is, their home is worth less than their mortgage (primarily an Eastern States problem at this point in time), it’s important to keep a sense of perspective. Residential real estate is a long-term game, and its value will very likely endure well beyond the short term. If you are a first home buyer, you should be proud of the achievement of getting on the property ladder.

Our advice is to always stay informed, but take what you read with a dose of scepticism and look for sources that aim to provide the whole picture.

It might also be worth speaking to your bank and asking for a better deal – maybe mention you’ve received three apologies from the central bank governor!

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The new reality: 5 big trends changing markets

According to investment managers Capital Group, “there is a new reality taking shape in global markets”.

Whilst many investors may be expecting a return to ‘normal’ after inflation subsides and central banks stop raising rates, many experts believe we will need to re-set what a typical investing environment will look like in the future.

Below we outline Capital Group’s five seismic shifts, as well as some of the long-term implications our fund managers and investment committee are considering.

1. From falling rates to rising rates and higher inflation

It is easy to assume that the current inflationary environment and rising interest rates are market dislocations that will quickly reverse. Bond markets, for example, are currently pricing in a return to 2% inflation (US) within two years. But in reality, these cycles often last much longer, and there is good reason to believe higher inflation is structural and likely to persist.

In this environment, investment professionals are cautious of highly leveraged companies or those raising new debt (money is no longer ‘free’). Companies with the ability to fund their own growth, as well as those with strong pricing power and dependable cash flow, will remain attractive in a high-inflation, high cost of capital world.

2. From narrow to broad market leadership

The last decade has been dominated by big tech – The FAANGs (Meta (formerly Facebook), Apple, Amazon, Netflix and Alphabet (Google)). Whilst still influential the thinking is that big tech has now reached an equilibrium in terms of its weight in the mainstream indices and its broader influence within society. Moving forward, opportunities are expected to arise from (well-managed companies) across a variety of industries and geographies.

For example: Once the disruptors, even e-commerce companies are now being challenged. Often these companies have low margins, are expensive to scale and have difficult delivery logistics to manage – only a few have done it well. Today some traditional retailers who have combined the benefits of brick-and-mortar with a compelling online shopping experience are taking back some of the share.

Leadership, governance and strong balance sheets become the name of the game. Active investment management will be integral.

3. From digital to physical assets

The last bull market was dominated by tech companies that made their fortune on digital assets (online marketplaces, streaming platforms, social media, search engines etc.). This somewhat overshadowed the fact that economies need and rely on ‘traditional’ industry. Digital-first companies are by no means going away, but investors will return to commodities and producers of physical assets.

For example, global trends such as grid modernisation, reshoring and energy security may cause a boom in capital investment across industries. These are areas where smartly managed industrial companies might have a real renaissance.

4. From multiple expansion to earnings growth

Many new investors got very comfortable with stocks being very expensive over the last five-ten years and now assume they will return to those levels during the next bull market. When rates were near zero, the market could support loftier multiples, but these days are most likely now gone.

If multiple expansion is to be limited, then stock returns will have to be powered by earnings growth. This means markets are probably not going to be as patient with unprofitable companies. Markets once paid up heavily for ‘future growth’, but with higher interest rates, will be less willing to do so.

5. From global supply chains to regional supply chains

The globalisation of supply chains is also shifting. For a generation, companies moved manufacturing to foreign soil to cut cost and boost margins. Today, rising geopolitical tensions and pandemic-induced disruptions sees companies bringing supply chains closer to home.

Consider Taiwan Semiconductor Manufacturing Company (TSMC), the world’s biggest manufacturer of cutting-edge semiconductors. After having concentrated the bulk of its capacity in Taiwan – a focal point of geopolitical concerns – the company is now building its first manufacturing hub in the US and a new plant in Japan. This regionalisation will create a more efficient supply chain for car manufacturers and technology companies such as Apple.

The full article can be found here.

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While the essence of the above five points boils down to a higher-than-normal degree of investor uncertainty, it also nurtures a more conducive environment for active management. Our approach is firmly rooted in the trade-off between value and quality, which leads to a range of themes across our portfolios that are well-suited for a broad range of market environments.

The key is to have exposure across most of these themes, ensuring that no single environment dominates strategy performance. We look for managers that are more selective at a stock level, a focus on quality will be important, as will ensuring a balanced approach to growth while avoiding overpaying.

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Kaizen

We are often asked about the meaning behind our licensee’s name Kaizen.

Pronounced ‘kai·zn’, kaizen is a compound of two Japanese words that together translate as “good change” or “improvement.” However, Kaizen has come to mean “continuous improvement” on the idea that small, ongoing positive changes can reap significant improvements. Typically, it is based on cooperation, collaboration and commitment and the belief that everything can be improved, and nothing is the status quo.

In this video, the ever-endearing James May explains the concept of kaizen whilst celebrating its company origins with Toyota.

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Chart of the week

The marathon of football/soccer — and some seriously unhealthy sleeping patterns —continues with the 2022 FIFA World Cup well and truly underway. What a spectacular effort by the Socceroos in making it to the round of 16!

Equally amazing is the scale of investment that has gone into hosting this world cup. Putting the many valid humanitarian, moral and logistical arguments to one side, it is a truly outstanding feat and makes for our chart of the week.

Let’s just hope this event is remembered for its football above all else!

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Wealth Intelligence – The Dunning-Kruger Effect

In An Essay on Criticism, the famed English poet Alexander Pope wrote:

“A little learning is a dangerous thing;

Drink deep, or taste not the Pierian spring:

There shallow draughts intoxicate the brain,

And drinking largely sobers us again.”

The Pierian spring Pope prefers to represent knowledge of the arts and sciences, with the intention of warning readers of the dangers of overestimating your abilities in a domain you don’t have much experience in. A few centuries later, two American psychologists formalised Pope’s observations with a theory known as the Dunning-Kruger effect, which is best summarised by the chart below.

The American investor Henry Kaufman once said that there are two people who lose a lot of money: those who know nothing, and those who know everything. When it comes to investing, having a degree of certainty is usually a red flag that you are underestimating the risk of your investment. If you or someone who manages your money feels certain about an investment, keep in mind a quote from Voltaire “Doubt is not a pleasant condition, but certainty is absurd”.

As the parents of teenagers.. guess where they land on the chart?

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FinSec Christmas Drive

FinSec continues with our traditional Christmas drive and this year we are supporting the Kmart Wishing Tree Appeal. The team are donating toys, books and other gifts for children, girls & boys aged between 5 years and 12 years.

If you would like to be involved, donations can be dropped to our office at level 2, 10 Greenhill Road, Wayville.

If unsure what may be appropriate, please don’t hesitate to call the office.

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Director ID Update

Finally, a reprieve for company directors. On Tuesday, 700,000 company directors who have yet to apply for director IDs were given an eleventh-hour extension. In a statement released on deadline day (30 November), ATO Commissioner of Taxation Chris Jordan said no action would be taken against directors in relation to their application if they apply for an ID by December 14.

Failure to obtain an ID could attract penalties or offences, but the tax office is promising a “reasonable” approach to supporting applications and a “pragmatic” approach to compliance.

If you are a director of an Australian company (this includes: the corporate trustee of a self-managed super fund, family trust or company director) and not yet obtained your ID number please find instructions on how to apply online here.

More information on Director IDs can be found here.

If you are at all unsure please contact us for assistance.

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Stay safe and look after one another. As always, if you have any concerns or questions at any time, please reach out to your FinSec adviser.