As recently as two months ago, pundits and talking heads of the financial world were wondering: is it different this time? The global economy was performing strongly, the trade wars seemed to be an afterthought, and the turbulence in Hong Kong hadn’t made it to Western television screens.
Global markets were strong, consumer sentiment was positive, conservative governments controlled the US, UK, and Australia, and the financial future of the world markets looked bright.
We began to wonder; maybe, despite our concerns over the past 18 months, something has fundamentally changed.
It was considered possible that as a result of technology and efficiencies, with just the right amount of government and treasury intervention, the markets have found the sweet spot and positive momentum can be sustained indefinitely.
After all, the US was (and still is) closing in on its record for consecutive quarters of economic growth (a little over 10 years), and locally Australia is now into the 28th year of positive GDP growth.
It’s probably not different this time:
“History doesn’t repeat, but it often rhymes ”. Mark Twain
We’ve spoken and written at length about our concerns about the broader economy.
Despite the positive impacts that a Coalition victory at the federal election has had on the mood of Australian consumers, and despite the positive flow through effects of the tax cuts being initiated, none of these things attack the fundamental underlying issue facing our economy: overwhelming consumer debt.
In the past decade our consumer debt has been fuelled in part by a banking system that has been more than happy to lend against a strong property market. We saw the impact of impeding lending when in 2018 the regulator imposed tighter controls and restrictions on property lending.
The market corrected quickly. In many “blue chip” suburbs prices for homes fell by more than 20%.
Whether it was due to the shock of how quickly the market began to unwind, or an unwillingness to maintain the course for political reasons, the last few months have seen lending controls weakened once again by financial market authorities such as APRA
Where does that leave us today? As we currently stand, the Australian consumer is the most indebted in the world.
Rather than obsessing about the risks associated with world leading debt, spending energy searching on efforts to explain its sustainability, or even brainstorming solutions to the problem that don’t involve a recession, we prefer to spend our energy where it is most useful: not trying to fix the world, but instead finding ways to navigate it.
The world and its economies have always been uncertain. As investors, our job is to construct our portfolio with those risks in mind and to navigate the markets to profitable outcomes.
Not all companies are the same.
I was recently discussing portfolio management with an investor and mentioned that our Fund currently has no exposure to the ASX Top 20. She asked me if it wasn’t risky investing outside of the ASX 20 given that smaller companies tend to perform worse in corrections.
In response I noted that there have been plenty of poor performing big cap companies over the years (Telstra and QBE being prime examples), and that it wasn’t the size of a company that dictated performance, rather it was the company’s ability to sustain and grow earnings.
I went on to explain that the assumption that smaller companies underperform bigger companies is borne out from a failure to recognise that the vast majority of companies outside of the ASX200 don’t actually have earnings. As such, when the investment community loses its appetite for risk, it is those same companies that benefited from market exuberance that experience the brunt of the correction. Companies trading on multiples of revenue (rather than earnings) stand very little chance of avoiding the carnage of a market correction.
We are looking for counter cyclical companies, companies exposed to positive fundamental drivers, and companies that are likely to outperform in weaker markets, and rebound faster in recovering markets.
When in 2017 we came to a house view that there were short term risks to the Australian economy and consequently the market we made adjustments to our portfolio.
We have found value in companies that have underperformed and the market has over reacted, we have found value in companies that are performing well but lack the broker coverage to push their share prices higher, and we’ve found value in special access investing opportunities – opportunities like special placements borne out of the relationships we have built with trusted management teams over the years.
While we remain aware of the broader risks to the market, we understand that doing nothing is not an option. For one thing, investing in cash is a certain way to go backwards on an inflation adjusted basis.
Staying out of the market just because it looks complicated and uncertain is a sure way to give up the vast majority of your potential returns.
What we’ve found is that investing in the stock market is much like driving down the highway; it’s best to keep your eyes on the road, and your mind on the destination.
When distractions occur (as they inevitably will), it’s analogous to a fly landing on your windscreen.
True, the fly is real, and true that it can draw your attention. But focusing on the fly rather than watching the road is likely to end in disaster.
The same is true with investing: Everyday prices go up and prices go down. Each time an investor reads a newspaper or turns on the TV or radio, they are inundated with ‘news’ and distraction.
Those prices are real, and those risks are equally real. However, focusing on those near term fluctuations will end in investment disaster in much the same way as not focusing on the road.
Our job as investors continues to be to distinguish between the real goals of our investment journey and the distraction.
For those that can see past the distraction, all market types provide opportunities.
For those investors who are easily caught up by the distractions, we thank you for the opportunities you provide to us.