Interest rates are expected to stay lower for longer and the looming US election seems to have eased global trade tension but investors must remain vigilant. With many moving parts, here’s our top 5 reasons to remain alert:
- Universal social unrest
- Monetary Policy running its course
- Recessionary risk
- Deflationary impact of technology
- Eventual disruption in the recent ‘growth’ investment trend (return of ‘value’ investing)
1. Universal social unrest
Globally, social unrest is significantly higher; reacting to different triggers but with similar themes:
- Climate change;
- Unequal wealth distribution (income inequality);
- Creeping authoritarianism around the world; and
- Social and political challenges.
There’ some similarities to the 1960s ‘It’s Time’ feeling. Trust is low and Governments must regain it to achieve sustainable growth – trust underpins economic growth.
Could it get worse? Will unrest spill over from the political into the corporate? Might we move towards ‘Capitalism with a social conscience’… or at least use social conscience for mutual benefit. Companies aim to read the winds of change and stay ahead of it rather than react – delayed reaction usually proving more painful than cautious foresight.
2. Monetary Policy running its course
Does reducing interest rates work once rates are this low?
$15 trillion of global Central Bank ‘spending’ since the GFC hasn’t achieved much, beyond inflating asset prices and inequality with resulting political problems. So far, Central bank action has allowed governments to hide from tough spending decisions and avoid vital reforms.
Quantitative easing (QE) is our Reserve Bank’s remaining monetary policy option – buying bonds to entice long-term interest rates even lower (maybe negative). Most of Australia’s debt is household mortgages with floating rates, largely related to the cash rate so it may not help consumers much. Indeed, QE may weaken our currency – but it’s competitive out there, so it won’t be easy.
To stimulate ourselves out of this tepid growth, consensus is that government spending and reforms are needed. Central banks have worked overtime but such future action may have diminishing impact.
The Federal government is reluctant to spend but we’re better placed than most to do so. It may now be politically and economically wise to soften its surplus focus and recast it as a ‘strategic’ policy aim. Those whose jobs would be saved may be more grateful later at the ballot box.
3. Risk of recession
Recessionary risk is rising but it’s not the main chance – last year growth was one of the slowest since the GFC and 2020 may not be any better.
After US yield curve inversion in 2019, many anticipated a US recession in 2020, with flow-on globally. But now yield curves are normalising, the probability of recession is 30% and 15% for the US and Australia respectively (Bloomberg consensus forecasts). But global recession risk will rise if Central bank policy doesn’t stimulate growth and governments resist spending stimulus.
It’s most likely we’ll avoid recession but we expect higher than average volatility during 2020.
4. Deflationary impact of technology
What’s the impact of technology and online shopping? Using Uber instead of buying a car, Netflix instead of cinema tickets, WhatsApp instead of Telstra SMS and AirBnB instead of a hotel. There’s Amazon, eBay or Gumtree for everything else.
Technology used to improve our lives and make us more efficient but perhaps these efficiency gains just accrue to large tech companies rather than broader economies?
Maybe we should expect inflation to remain so stubbornly low – is it still an accurate means for measuring true economic strength anyway?
While enjoying Uber and Netflix, let’s be mindful of how such technology impacts GDP growth well into the future.
5. Eventual disruption in the recent ‘growth’ investment trend (return on ‘value’ investing)
Driven by ever-decreasing interest rates, investors favoured ‘growth’ stocks. Australia’s WAAAX stocks (Wisetech, Altium, Afterpay, Appen Limited and Xero) are case in point. They trade on extreme multiples – Afterpay trades on a PE of more than 100x, compared with the market average of about 17x.
In the US, it’s the FAANG stocks (Facebook, Amazon, Apple, Netflix and Google). Valuations on these stocks are not as extreme but still trade much higher than average.
In paying such high premiums, investors seem willing to pay ahead for future earnings – in the case of Afterpay, 100+ years into the future.
Historically, this market trend eventually shifts to refocus on ‘value’ – perhaps when the market decides monetary policy can have limited future impact. Then investors may prefer ‘value’ again and stocks at extreme valuations could fall heavily.
This year more than most, it could pay to remain vigilant about valuation.
So what’s an investor to do? Click below to read on…
Disclaimer: All information in this article is intended to be general in nature for discussion purposes only. So you should not rely on it and seek personalised professional advice before making any decision.