What will be the next big thing in investing?
With many commentators, be they financial journalists, investment managers or perhaps those around the Sunday barbeque predicting the next big thing… ‘will it be lithium to create batteries for EVs, biotech or ESG investing for social good or the return of small cap companies’… it may be time to reflect on where we are in the cycle of things, as the next big thing could well be a return to normal!
Not the ‘new-normal’ of the past two years nor that of the past decade, but the long-term normal where interest rates are not close to zero, inflation doesn’t exist or is very low and where companies fuelled by low or zero cost debt, can see their stock prices rise rapidly, with new and seasoned investors alike jumping on-board for fear of missing out.
In planning to write this article I recalled a quote from Jeff Bezos, founder and executive chairman of Amazon, in response to a question he says he is frequently asked regarding the Amazon retail business ‘What’s going to change in the next 10 years?’ His reply, ‘I almost never get the question: What’s not going to change in the next 10 years?’ and in turn he says he believes that in 10 years, Amazon’s customers will still want low prices, speedy delivery and a vast range of merchandise from which to choose; Amazon, just needs to continue to deliver.
So, in applying this thought to a return to normal, for those that may not have seen a couple of investment and economic cycles or may have forgotten that they exist, let’s have a look at what has not changed as we step into a dramatically different phase for global and domestic economies.
What to look for?
The backdrop of rising inflation and interest rates, a war in Europe leading to an energy crisis, supply chain issues in China and falling house prices in Australia needs to be balanced against the Australian economy being at full employment, interest rates rising but returning to long-term normal levels and Australian companies by and large having strong balance sheets and may be positioned to take advantage of global opportunities.
The recently completed companies reporting season has matched or exceeded expectations, suggesting those with ‘normal’ fundamentals have done well. However, the other side of the results announcements is the future; what are the prospects for continued growth and what will underpin it are equally important going forward.
In looking to the future, the fundamentals apply. Over coming years, companies that:
- have low debt or debt secured at low rates and well into the future,
- are able to control their margins; monopoly-like or regulated pricing and
- operate a diversified business; not reliant upon one business line or market will most likely be able to withstand the challenges ahead.
The reverse also applies. In particular, those companies which have existed on a diet of low cost debt, have created excitement around a single product, such as a technical development yet to come to market or are unable to increase margins to offset rising finance and labour costs, may struggle. So too, for companies that are reliant on offshore markets, if these markets suffer an economic downturn.
These are all important signals to be alert to or better still, to ask company management about at forthcoming AGMs, which typically follow annual announcements by a few months.
What does a return to normal look like?
I’m not about to predict when a return to normal may occur, however below are the key considerations of what will drive it.
Inflation will be a key driver of a return to normal. Since the early 1990’s the RBA has looked to maintain inflation in a band of between 2%-3% on average over a cycle. At the time of writing the rate of inflation in Australia was last reported as 6.1%, however for most of the past decade it has trended below this level. It is now higher than in 1994 when it hit 5% however, the rate of inflation in Australia is currently below the UK (10%) and US (8%).
Interest rates are the main tool the RBA has available to tackle inflation.
While it can be uncomfortable to see interest rates rise for those with loans, inflation out of control can be equally uncomfortable for depositors, who may receive returns on deposits below the inflation rate. In this context, the RBA is expected to continue to increase rates over coming months as a measure to control inflation.
Commentators are divided on how much and how many more rises we will see, but there seems to be some expectation that when the rate of increase slows or is on hold, the RBA may believe it has reached an appropriate point or is taking a look to see if inflations is holding or trending to a satisfactory level.
The economy and its resilience will be an important factor. In this regard, Australia is well placed given the recent reporting season and the strength and low debt of many companies balance sheets. While it may be a little uncomfortable, given the circumstances, the challenges in Europe have seen a pick-up in Australian exports of commodities such as gas, LNG, coal and grains, with many businesses in these sectors seeing record years.
The above are all important to keep an eye on, however, one topic we have not touched on here is property prices, which not only have impacts on the economy also impact individual’s perceptions of well-being and wealth.
In our next issue, we plan to take a look at what has happened to property and to see where we may be with regard to a return to ‘normal’.
Until then if you are concerned about any aspect of your investment portfolio and the impacts of change, please talk with an accredited SMSF Specialist in your area, click here to use SMSF Connect’s Find a Specialist tool.
Ian
Source: https://smsfconnect.com/investing/issue-37-what-will-be-the-next-big-thing-in-investing