I am, and I will remain an optimist because I believe optimists win in life, and in investing.
I wrote my last note about financial markets on the outbreak of the Ukraine conflict, and I reflected on the Certainty of Uncertainty in navigating geopolitics. Since then, we have seen a continuing stream of heart-wrenching images of Ukrainians fleeing their homes for the safety of neighbouring countries. The brutality of war takes an enormous human toll and creates uncertainty for us all.
From an economic point of view, the war in Ukraine will have mixed effects. Russia only represents 1.5% of global GDP so the direct impact on global growth is minimal. Businesses with direct links with Russia will be impacted, as will investors whose portfolios were overexposed.
However, Russia is one of the larger producers of commodities globally, including wheat, iron ore, coal, gas, and nickel. Where sanctions are effective, the remaining supply of these commodities will be in greater demand, and prices will rise. We are seeing direct evidence of this at the petrol pump right now. Europe, particularly Germany, is dependent on gas for about 25% of its energy needs and of this, 40% comes from Russia.
Last night, the Federal Reserve increased interest rates for the first since 2019 as inflation in the United States reached seven per cent, feeding into greater concern for consumer prices, particularly for the poor. Interestingly, markets shrugged off the rate rise, indicating that it was needed and expected.
In searching for a way to describe the current feeling in the world, one of my favourite words came to mind – Discombobulation. I use it when I have that topsy-turvy feeling, but the cause is hard to pinpoint. As coincidence would have it, I came across an article from futurist Phil Ruthven AO. His full article makes very good reading.
Discombobulation has a meaning that sounds like the word’s pronunciation: volatility and unpredictability. Every decade brings surprises, good and bad, but discombobulating ones are rarer – being the 1910s, 1930s, 1940s and 1970s in the last century.
In the early part of one of those decades, the 1970s, a one-time US Vice-President said at the midst of his problems and an investigation by the District Attorney, “if you’re not schizophrenic these days, then you’re just not thinking clearly”. This statement could be used again as an excuse these days by many aberrant leaders.
That was half a century ago, but the 1970s were the last truly discombobulating decade. The United States was defeated in Vietnam, and their president, Richard Nixon, was impeached and subsequently resigned. Australia elected a Labor government for the first time in 23 years, which was controversial, some would say unlawfully, sacked by John Kerr our then Governor-General, in 1975. A huge stock market crash occurred in the late seventies. We had runaway inflation that took decades to bring under control and unprecedented oil price rises. These were some of the standout events that punctuated the decade.
We are just into the 2020s, but it already looks like another volatile decade with issues such as:
- a pandemic
- warmongering (Russia into Ukraine, and others thinking of equivalent incursions)
- fascist dictators-cum-kleptocrats by the handfuls
- democracy now falling to less than half the world’s eight billion citizens
- a stock market correction, perhaps ‘crash’, in some countries
- rising inflation and interest rates, off a very low base
- scary climate changes with inadequate responses by too many nations, and
- the rise of populism based on fiction and lies instead of rationality.
And they are only the ones we know about. What else lies in store?
The scorecard for the early part of the 2020s is sobering but at least we now have a word to describe how we’re all feeling.
With inflation emerging as a threat to economic growth, Australia remains a lucky country. Our unemployment rate at four per cent means that everyone who wants a job should find one. This will cause wages to rise, which have been stagnating for years outside the trades and professions. This is a good thing as those in low paid service industries plays catch up. It will take a lot to upend the Australian economy.
But what of inflation for investors?
Inflation always impacts the poorest members of society the most. With no means other than a wage, they must pay higher prices for goods and services, which usually leads to a fall in living standards. For investors with means, the story is different.
As the purchasing power of each dollar reduces in the face of the increasing cost of goods and services (this is what inflation is), cash is the one asset that will lose the most value. Holding large amounts of cash in the current environment may feel safe but is guaranteed to be wealth eroding on the other.
All markets will likely be more volatile than we have seen in the recent past, so where to invest one’s hard-earned wealth. I won’t enter the debate about crypto-currencies being an inflation hedge – I am yet to be convinced but accept I may be proven wrong.
Business, (capitalism if you want to call it that), is one of the greatest forces for good on the planet if it is placed in the right hands. Good businesses, run by compassionate and responsible leaders create long term value in society, for consumers and for shareholders.
Good businesses will continue to grow, innovate, and create value despite the uncertainties we face. Never has it been more critical to have a portfolio of growth-oriented assets in your portfolio.
While we probably face a rocky period ahead, it is essential to remember that the market doesn’t have a memory. The market cannot remember what happened in the 1970s when we last had inflation. We also know that even if markets are volatile, the long-term value-creating of a business causes the stocks in our portfolio to recover and then continue growing.
Reacting to uncertainty is rarely rewarded
For example, when markets fell in March 2020 at the onset of the pandemic, US markets fell by 20%. That’s a big fall. Investors who controlled their response to the fall were rewarded with a 56% increase in the following twelve months.
I started this article by declaring I am an optimist in life and investing. Firstly, I believe in the capacity of humans to overcome evil and solve problems. I also believe in the spirit of innovation that has seen us create extraordinary advances for all humanity, and I believe in the capacity of business to create value.
Is the system perfect? Certainly not, but I will always bet with markets and not against them. Markets represent people coming together with ingenuity to navigate a path through any crisis. We have banked on that ingenuity in the past, and it will serve us well again.
I leave you with a graph of the S&P500 index for the past 90 years. I know this is a common message for those who are regular readers of my column. There are many reasons to be fearful during this time, but there is one big trend justifying optimism – even after inflation is adjusted!
Over the months ahead, you will see many news reports catastrophising the effects of war, inflation, and while there may be real challenges ahead, cool heads need to prevail. This is a time to be close to your adviser to ensure you are completely comfortable with your financial plan and your investment strategy.
No matter what is going on in the world, I encourage you to join with me in looking forward with optimism.