One thing that investors cannot ignore in 2020 is the risk of recession and a potential fall in interest rates.
We consider that interest rates are a sound proxy for economic growth and can be thought of as a function of simple supply-demand. For example, when economic growth and confidence is strong there is a commensurate increase in credit demand driven by business investment.
As such we believe today's interest rate environment reflects a credit environment where supply outweighs demand for credit; typified by the large fall in bond yields over the past 12 months. This fall in interest rates affects everyone: investors cannot obtain sufficient real yields in less risky assets, whilst lower serviceability requirements and debt covenants encourage borrowers to take upon more debt.
History tells us that these circumstances can change suddenly without warning.
Our solution to this issue is:
1) Invest locally, but think globally - By investing in local markets, risk is cut significantly via less exposure to currency fluctuations and a consistent legal environment. A free-floating currency like the Australian dollar helps an economy adjust relative to global competitors during times of recession. Global markets should be monitored due to the connect nature of the global economy in this era.
2) Conservative Asset Allocation - Investors should diversify their capital allocation strategies across asset classes. For example, holding a reasonable portion of cash can allow investors to take advantage of investment opportunities in times of sudden stress.
3) Invest in earnings growth at reasonable prices - in a time of low growth and returns, companies that are growing rapidly can be a great source of rare, out-sized returns at relatively low risk. Careful assessment must be made to ensure that the opportunity can growth throughout economic cycles, leading to a lower risk profile.
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This wire is part of the ‘One thing investors can’t ignore in 2020’ series. To download the full ebook please click here.