It is exciting coming into the Christmas and Festive Season break and I am sure we are all looking forward to it. Hopefully, the gathering of families, the excessive appetite for all things yummy (and fattening), and the sense of warmth and well-being will help us overcome what has been a very poor year for portfolio valuations and equity performance.
Markets, over the past few weeks, has also had a burst of optimism, and equities across the globe have risen, improving net annualised returns and reducing the negative overall returns for the year.
Interest rates and, subsequently mortgage rates have steadily increased in Australia as well as in the US. In the US, there is a fundamental housing shortage, and the housing trend is quite positive with millennials looking to buy their own homes. Therefore, the pullback that rising rates would cause is somewhat offset by the shortage and increasing demand. Additionally, unlike in Australia, the US housing market provides a 30-year fixed interest rate with about 90% of that market locked in at around the 4% mark which has had little impact on affordability and cashflow as rates increase. This, in turn, means that as long as jobs remain secure, spending in the economy is likely to remain strong.
Unfortunately, in Australia, this long-term rate lock is not available, and the majority of our market is sitting on variable-rate mortgages. Therefore, increasing mortgage rates will cause stress in coming months which is likely to put downward pressure on housing prices from 2023 onwards. However, home ownership is a fundamental focus for most Australians, and we also have the millennials looking to get into their first homes. The covid era over the past three years has also resulted in a greater trend towards savings due to shortage of goods and inability to travel. This bodes well for affordability when house pricing comes off somewhat in 2023 but, consequently, also provides support to the housing market in due course.
We have seen large multinationals reducing their footprint in regard to staffing over the last couple of months. However, the labour market in the US still remains very tight with more jobs available then those looking for jobs. We do expect a recession in the US next year but believe it will be shallow and short-lived based on demand, the tight labour market, and increased savings and lower personal debt position since covid.
Similar to the US, our labour market is also very tight. This means job security should allow most Australians to afford the increased cost of living due to the energy crisis in Europe and increasing incidence of covid in China leading to increased supply chain disruptions and slowdown in consumption. This, in turn, has led to shortage of raw materials (and increased costs) and increased cost of living both in energy as well as food. Unfortunately, our continued reliance on China for the purchase of our goods/resources, does mean a slowdown in that country will have negative consequences for our economy as well. We expect, much the same as in the US, a mild recession in Australia next year as well.
Our focus has shifted to a tilt towards companies that reside in the ‘value’ space of the investment spectrum. These are companies that trade at more reasonable price to earnings multiples and represent good ‘value’ when compared to growth stocks like those in the technology sector for example. Further evidence of this is that the S&P 500 index in the US is down about 17% whilst NASDAQ (more of that growth exposure) is down 30%! Longer-term, equities are staring to present some good opportunities so long as one takes a longer-term view and looks at fundamentals and not just pricing and hype.
As per the charts above, the Federal Reserve is expecting GDP in the US to fall next year and in 2024 but the number is still above the longer-term average. This is also the expectation for unemployment given the tight labour market we spoke about earlier. The expectation and hope is that inflation reduces in coming years.
Even so, much of 2022’s potential performance depends on all the things no one can accurately predict right now. Inflation is key to any change in outlook—specifically, how sustainable current trends are and whether inflation proves to be a non-event or continues to run up. By mid-year 2023, we should know what the level of inflation is, and that will set the tone for the second half of the year.
No one can predict when a market hits bottom, but the data suggests that buying when markets have sold off, rather than capitulating and selling, tends to provide the better outcomes. This is clearly illustrated in the charts below:
Most important to keep in mind is that the underlying investments are sound and based on fundamentals in our portfolios. Eventually, when the market stabilises and subsequently starts to move up, so will the investment portfolios. Just as markets hit a peak in December 2021, it will do so again in the near future.
“There will always be Bull markets followed by Bear markets followed by Bull markets —John Templeton
“Choose to be optimistic, it feels better.” —Dalai Lama XIV