How Much Do You Need to Retire?

A typical client comes to us with a range of assets that they accumulated in an ad-hoc fashion over time rather than from the execution of a master plan. Not everyone who is wealthy is financially sophisticated. Often, they were just really good at what they did, whether that was running their construction or earthmoving business or being a great doctor or lawyer.

Most of our clients are not financial experts; if they were they wouldn’t need us. However, they are smart and recognise the importance of seeking the right advice to optimise their position. I’ve had people with tens of millions of dollars asking me if they had enough to retire. As much as it surprises me, it is a great reminder that everyone worries about the same types of things when it comes to retirement:

• How much do we need to retire?

• Do we have enough to retire?

• How long will my money last?

There is not one simple answer because everyone’s situation is different, but these are easy questions to address. In financial terms, the three questions above are all a variation of the same equation, the basic variables of which are income, expenses and capital.

But for the purpose of the general concept, simple numbers are the best place to start. If you require income of $250,000 p.a. to meet your expenses in retirement and a typical investment portfolio produces income of 5% p.a., then you’ll need $5,000,000 in capital.

If you have more capital than this then you’ll be fine. If you have less capital than this then you have a decision to make, and you can either reduce your expenses or you can deplete your capital. There is no right or wrong answer it is up to you. But you need to understand the numbers.

I can’t emphasise enough how important it is to understand the context here and the impact of even the most basic variables. If we change the assumption for the typical investment portfolio in the scenario above to, say, 2.5% p.a., then you’ll need $10,000,000 in capital to generate the income figure of $250,000 p.a.

With regards to dipping into capital in retirement, people tend to fall into two camps; those that are worried about spending any of their capital and those who are more concerned about trying to use it all before they die. My philosophy here takes into account real life, not just the financial side. When you’re 65 maybe you live for another 30 years, maybe you live for 2. But I’ll say this, life is short, and I have not yet seen anyone get healthier and more active as they got older.

The reality is that your first 10 years of retirement are going to be your best, so make the most of it. If you are 65 and have $3,000,000 in capital and you spent $50,000 from your capital to have an amazing holiday every year for 10 years does it matter that at 75 your capital has reduced to $2,500,000? Probably not. What if you don’t make it to age 75?

Obviously, the above scenarios are basic and don’t consider specific circumstances, tax, inflation, and whole range of other variables but the overriding concepts and philosophy still apply. For our clients we complete sophisticated financial models that include a range of assumptions around returns, inflation, tax structures and scenario planning to ensure they are prepared for the future and have peace of mind. Certainly, if the three questions at the start are keeping you up at night then it’s probably time to get that type of advice and start planning properly.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

The good, the bad and 2024.

With so much bad news out there in the world for investors to worry about there’s one key element that has been strangely missing so far. Sure, there is some good news which I’ve highlighted below, but there’s nothing in there that’s really driving share markets. What is missing, despite all the bad news, from geopolitical tensions escalating to deteriorating economic data, is the absence of the bad new turning into an ugly financial or economic crisis. That is what is really kept markets from falling. There have been a few times where issues have bubbled to the surface, such as the mini banking crisis in the US in March this year, and the UK bond & pension fund crisis in September 2022, but these incidents so far have been managed and curtailed before they escalate.  

Some of the good economic and investor news out there is that:  

1. Inflation rates across much of the world have fallen reasonably quickly from their peak.  

2. Unemployment has remained low signalling a robust economy. 

3. Home prices have been resilient on the back of a supply shortage. 

4. AI and mega tech continue to grow. 

5. You can now get a solid yield on government bonds and term deposits of around 5%  

6. US GDP unexpectedly high in Q3 at 4.9% 

7. I’d like to say that this list is not exhaustive, but I can’t really think of anything else. 

8. But by all means please let me know if I am missing anything. 

The list of bad or concerning news is longer and more serious: 

1. Interest rates are looking like they will be higher for longer. 

2. Volatility in the price of oil.  

3. Consumer spending is slowing. 

4. Bond losses mounting at banks, pensions funds and other institutions. 

5. The Ukraine war is nowhere near resolved. 

6. Middle East tensions rising and the risk they escalate and spread. 

7. China and Taiwan risk. 

8. China and tensions with the US and Australia.  

9. UK inflation is still at 6.7% with rates trending higher. 

10. Risk of fragmentation in Europe as interest rates increase. 

11. Energy shortage in Europe. 

12. Japan moving away from yield curve control on their bonds. 

13. US Federal Government runs out of money every couple of months. 

14. US Federal Government’s annual budget deficit is around USD $2 trillion pa.  

15. US Federal Government’s debt is now over USD $33 trillion. 

16. Mortgage stress in Australia with 30% in distress according to Roy Morgan report. 

17. US mortgage rates hit 7.5% for the first time since Nov 2000. 

18. Rising insolvencies and bankruptcies at the highest levels since 2010. 

19. Retail sector seeing significant declines. 

20. Office property sector struggling with vacancies and higher debt costs. 

21. Corporate debt cliff as company’s refinance at significantly higher rates. 

22. China’s economy struggling with massive debts and property losses.  

23. Corporate earnings forecasts too high and may be revised downward. 

There are two main concerns with the above list. Firstly, just the sheer number of areas that are currently problematic and heading the wrong way. Secondly, the real issue is that any one of the 20 plus items on this list can escalate into a genuine crisis. What has kept investors complacent and share markets resilient is that while there is a lot of bad news out there not much of it if any has morphed into an ugly crisis situation from an investor or share market perspective.  

I don’t believe that can continue in 2024. I think investors and share markets especially are underestimating the risks that exist in the global economy. The risk that any of these precariously placed bad new events deteriorate and become a major problems that compound other areas and lead to contagion. What’s more there is the ever-present threat of a black swan event, an event no one predicts, eventuating that shocks the system. The global economy has very little room to move now.   

For long term portfolio investors, many of these issues are related and link back to interest rates being higher for longer. Its critical to understand the massive implications this is having on the global economy now and into 2024. Understand the potential risks so you make decisions regarding asset allocation as required and so you are able to take advantage of the opportunities ahead as the cycle progresses.  

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Here is the conundrum

The US Federal Reserve is between an economic policy rock and a hard place. They are committed to reducing inflation to 2%. To do that they need to raise interest rates. They have increased interest rates from 0.08% Nov 2021 and are now at 5.33%. Inflation is falling. In the USA, inflation was 9.1% Jun 2022 and is now 3.7%. But it’s not at 2% yet. As much as it’s come down, hitting the target is proving to be sticky.

So, that is the conundrum. To solve it, the Fed can take one of two paths:

A. They raise rates until they get to 2% inflation, or

B. They raise rates and stop before it gets to the target hoping that momentum carries it through to the 2% target?

The problem is that there is a very real time lag between raising rates and seeing its effects flow through to the economy.

With option A, if they increase and hold rates until the targeted inflation rate is reached then it is almost certain that the months that follow will see the time lag impact the economy very significantly. It will likely cause a recession. Interest rates will then need to be cut quickly to offset the damage. But there will certainly be economic damage.

With option B, the risk is that inflation rears its head again if they stop too soon. It also begs the question of when you stop raising and how long they should hold rates for before realising inflation isn’t going to reach the target. Higher inflation, if it becomes entrenched, is an economic cancer that will riddle a nation’s stability.

Right now, in spite of all the interest rate increases, the US economy is surprisingly quite strong. Normally a strong economy is good news for investors because it generally translates into good business conditions and in turn good returns for shares. It would normally be bullish for the share market.

So why am I bearish when the US economy is relatively strong?

It’s because it means that while inflation has come down, the underlying strength of the US economy indicates that so far, the rate increases haven’t yet slowed the economy enough. To get to the 2% inflation rate sustainably will require some economic pain. At the moment, too many of the key indicators such as unemployment and GDP still seem to be running too hot. Unless the US economy starts to slow, I think it means that rates in the US may go up further during 2024.

After trying to manage the inflation issue using option B, I think that in the end the US Federal Reserve will need to revert to option A. It will result in significant economic consequences including a recession. That’s why I am bearish on stocks and the economy. I think the relative strength we continue to see only means that the interest rate environment stays higher for longer until they get inflation well under control. Achieving that will ultimately mean the central bank will break something in the economy.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Are bonds back?

Normally government bonds are boring, but if you’ve followed the bond market over the last couple of years, they’ve been anything but. Not in a good way either. As US bond yields moved from effectively 0% to now 5% it has created huge losses across the world. Those holding those losses include some of the world’s best investors and biggest institutions. Some of the world’s biggest banks and pension funds are sitting on hundreds of billions in losses. Luckily at this point, not many have had to realise these losses but make no mistake they are there, and they are potentially a problem. 

The higher bond yields go though, and the closer they get to a peak, the more compelling the case for investing in high quality fixed rate bonds. For our portfolios we hold overweight positions in defensive assets already but its primarily made up of cash, term deposits and floating rate bonds and notes. The question becomes whether bonds are becoming more attractive than those assets and indeed whether they are becoming more attractive than equities on a risk adjusted basis. When you consider their much-improved income there is a case emerging for increasing the allocation to high quality low risk bonds. 

During the period of extremely low interest rates, I strongly recommended against holding fixed rate bonds in investment portfolios. Rates at almost 0% were a historical anomaly that were never going to stay that low and when they eventually went back up, the value of bonds fall. Meanwhile, investment managers everywhere seemed to be blindly allocating to bonds as a defensive asset when a unique set of global factors collided to create a once-in-a-lifetime bubble in bond prices.

Who can forget the weird anomalies that the era of super low rates created for bonds? There were the 100-year bonds issued by Austria paying less than 1% pa (they’ve since lost as much as -70% in value. But don’t worry if you hold them until the year 2120, you’ll get your money back). Crazy stuff. Then there were the bond yields for countries such as Germany, Sweden and Switzerland who saw the yields on trillions of dollars of their bonds go so low that they went negative for a period of time. Investors actually paid these countries to hold their money for them. Madness. It was always going to end in tears as soon as a level of normality returned. 

That’s where we are now as far as bond yields go – more normal bond yields. Not much else in the world is normal right now but that’s part of the turmoil ahead as the world adjusts to these changes. However, with bond yields having increased so much it is now time to step back and reconsider fix rate government bonds as an investment. The case for bonds is starting to become attractive on both an absolute return and a relative basis. I expect money from equities will soon enough start flowing into the bond asset class in a substantial way. 

You can now get 5% from US Government bonds, still considered to be the global benchmark for a risk-free investment. What it means is that every other investment needs to pay you more than this to be worth your while. How much extra will depend on the type of investment and the level of risk associated with it. For other countries bonds its similar rates but heading higher, for higher quality corporate bonds it’s more like 6-8% and for lower quality companies more like 9-10%. 

If, like me, you are bearish on the stock market and believe we are still headed for a recession (my base case) or a deep recession (possible) then the case for bonds is becoming more compelling. The more the economy slows, the more likely it is that governments need to lower interest rates down the track. In that case, falling interest rates will deliver bond investors a further gain as bond values increase. While I think there is economic and financial pain ahead for investors if interest rates across the world staying higher for longer, there is a positive for investors as bonds emerge as an opportunity.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

What will your eulogy say?

Over the past couple of weeks, we’ve had 2 weddings and 2 funerals in our family. It sounds like the title of a movie from the 90’s but it has very much been real life. It makes you stop and think a little more about the big picture. Those few weeks seem to encapsulate everything about the journey of life.

On the one hand, you witness the excitement of a young couple getting married with all their hopes and dreams for the future. Then a couple of days later, I was back in my hometown in WA delivering the eulogy for my uncle who passed away at age 75 after a short battle with cancer.

There’s nothing more confronting than the prospect of death. All those hopes and dreams end here. What you’ve done with your life up until then is the totality of your life and legacy. There comes a point when we all face death and the knowledge that what you have done with your life is all you’ll ever do.

I was fortunate to have been asked by my uncle to deliver his eulogy as he faced his final weeks and got his affairs in order. It was an honour and a privilege to be entrusted with the responsibility of conveying to hundreds of people the richness of a person’s entire life in just 15 minutes.

But there is so much to capture in a person’s life that makes them unique. My uncle was a hard-working family man and a keen fisherman who loved the West Coast Eagles and playing briscola, an Italian card game. But it’s the interactions with the people in our lives that we are remembered by.

It’s the second eulogy I’ve done in the past two years. It is a cathartic process that allows you to reflect, grieve and smile along the way as you remember the good and bad times. It made me think more deeply about what I want to achieve in my lifetime and how I want to spend my time before I eventually die.

There is nothing more important than how we choose to use time. It is the most precious commodity in the world. Yet your lifestyle and legacy represent two sides of the same coin. There is lifestyle. To me that’s how you want to live your life, so you enjoy every day and make the most of the time you have.

Then there is legacy. That represents how your time impacted others and what you leave behind. At the end of the day, what will you be remembered for by those whose lives you impact? But more importantly, how will you be remembered by those who matter most to you?

Afterwards, I was struck by the question. What do I want my own eulogy to say? Who will write it? I realized that the reality is we write our own eulogy every day through our actions.

So, ask yourself, what do you want your eulogy to say?

Then ask yourself what you are doing to ensure it’s written.

AI End Game

This is a partial warning as much as it is my simple and developing view on Artificial Intelligence (AI). It is one of those transformative technologies that has now progressed to the point where I don’t think it’s possible to put the genie back in the bottle. Perhaps its timely that a movie such as Oppenheimer, detailing the Manhattan Project and the creation of the first nuclear weapons has recently been released. It should serve as a cautionary tale for all those blindly espousing the virtues of an AI world as it has the potential to cause great harm and negatively change society as we know it.

I have previously written about the exciting investment opportunities that AI brings to the world. However, I am also convinced that from an existential perspective, in my opinion, AI is also the single biggest threat that the world faces today. More serious than climate change, more serious than nuclear war. Those matters are within our control as humans. AI and its progress from a certain point in the near future are not.

The world is at a similar point to where it was back in WWII when the Manhattan Project commenced. Back then it was the possibility that the Germans may have access to or may soon be able to develop nuclear weapons that lead the USA to actually create them.

Ironically, the best strategy for defending the world against the potential weapons led to the creation of those very weapons of mass destruction that cannot be reversed. But what if the USA didn’t create them, quite possibly it ends up later down the track being something that Germany did create. What happens then? That’s the alternate argument for what happens if we don’t progress with AI hard.

If I sit back and forget the obvious economic and investment opportunities and consider the future of the world (probably something worth thinking about), I am certain that the advancement of AI will lead to catastrophic consequences for humans. The prospect of a dystopian future might sound like science fiction until it happens, then it’s simply called science. It doesn’t keep me up at night because it’s not something any of us can control. The cat is out of the bag.

But unlike many who see the potential for catastrophe, I do not necessarily believe we should overregulate or slow the development of AI. The reason for this is that other countries will not slow down in their development of AI technology. Similar to the rationale for the US racing to create nuclear weapons before the Germans. Whether it’s Russia or China, in a similar vein to the development of nuclear weapons, the risk that enemies advance more quickly is the bigger threat.

AI is more dangerous in an existential sense for the human race simply because we risk not being able to control it once it becomes more advanced. This is self-learning technology, so the technology will advance exponentially to human level, and then beyond to the point where humans become redundant. That day will arrive at some point in the future, whether it’s 10, 50 or 100-years’ time, I don’t know, but it will certainly arrive. When it does, do we want that technology to be a western influenced AI or one that’s been designed and developed in Russia or China?

If AI once debased from the control of humans can cause bad consequences for us, then it stands to reason that it can also create good. So, if we apply the same game theory to this as we did to the development of nuclear weapons then the answer is to move as quickly as possible so that whatever the result it is a consequence that we control as much as possible before others do. It’s the best available decision based on the fact enemy nations may otherwise create the AI that controls the world.

It’s important to note that while for years mutually assured destruction is the theory that has kept the world’s nuclear powers from starting a nuclear war for the past 70-plus years, that will likely not apply to the world of AI. The strategy must move quickly with investment in AI technology from government that can counter the rising danger of AI from enemy nations at the same time as developing AI for the benefit of the world. It is not the best solution, the best solution would be to stop it altogether, but that is unrealistic. It may be counter-intuitive, but I believe the best practical solution is to move as quickly as possible and build the AI resources that can combat those who would do us harm.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Turning Tides

Austerity was a word thrown around during the GFC but was ultimately disregarded in favour of governments borrowing and spending their way out of trouble. With inflation now a global problem, those measures are not the economic lifeline they once were. As economic conditions worsen next year and countries find the debt to fund their budget deficits increasingly more expensive, I think we are going to see a wave of momentum changes in 2024. People and Governments can be fickle and if the experience over the past few years has taught us anything it’s that self-interest and the wellbeing of those closest to us, be it financial or health, overrides all else. When faced with decisions tied to immediate challenges that impact them directly, people tend to prioritize addressing those issues over what might have been their earlier preference for the sake of long-term causes and the greater good. So, when push comes to shove financially, here’s where I see the tide turning in the next year or so.

Taxes going up. This is obvious when we are talking about austerity measures but look for governments across the world to start increasing taxes wherever they can. This will be especially true for smaller countries who are less easily able to borrow to fund their deficits going forward. Here in Australia, the rich are an easy target, but I wouldn’t rule out an increase in the GST. When it was introduced, there were a range of assurances that 10% was the figure, primarily that all state governments and the federal governments would have to agree – and that was very unlikely. However, we are in a position where almost all governments are politically aligned, with all being Labor except Tasmania. While in the past I was of the view that voters would not stand for it, with limited ways to meaningfully increase the tax base it would not surprise me to see proposals to increase the GST to 12.5% or 15%.

The war in Ukraine. One part of this comes from the general public experiencing ‘war fatigue’. The media put this in front of us 24/7 and eventually, it just wears people down psychologically and they switch off. Another part comes from people questioning spending money on a war that they are not directly involved in. Rightly or wrongly, when people start seeing their standard of living go down and they start experiencing financial hardship, they question where money is going. In 2024, I think that tide will likely turn. The risk being that the West loses the people’s support and subsequently the political will to fund Ukraine defence efforts. Reduced funding likely ends in a Russian victory.

Climate change funding. Similarly, to war fatigue, funding climate change initiatives has been challenging in the best of economic times. When governments and corporations around the world are faced with a more immediate, or at least a more tangible issue, I expect they will defer targets and reduce spending. This is not a statement on what should happen, but how I see this playing out. It won’t just be due to government neglect or corporate greed. As individual people are faced with more immediate financial problems, whether unemployment or defaulting loans, the support for important long-term movements may well evaporate.

Working from home. This one will take time to play out. A significant flow on effect from austerity at the business and consumer level will be higher unemployment. As unemployment increases and job security reduces then employees will become more inclined to go wherever the work is. While many workplaces are happy to offer WFH, there are many that only do so because it’s the only way they can retain staff. But that tide will turn, and the catalyst will be higher unemployment. All things being equal, the employee who works in the office will get the promotion and get the new job. Workplaces and employees will rediscover the serendipitous benefits of being together in the same place. It will also lead to the reinvigoration of CBDs and eventually a recovery in office rents and valuations.

In the shifting currents of global economics, 2024 is set for change. As the burdens of budget deficits grow heavier, governments will find themselves turning to the once-dismissed concept of austerity, marked by an inevitable rise in taxes and reduced spending. While the global landscape hangs in the balance with conflicts such as the war in Ukraine, there is an increasing risk of weariness among the public—a war fatigue, that may sway support across the world. The allocation of resources, including funds for climate change initiatives, may face redirection as immediate concerns eclipse long-term priorities amid economic challenges. Additionally, the move to remote work may gradually subside as higher unemployment prompts a return to traditional workspaces. The intricate dance of economic tides in 2024 seems set to redefine not only fiscal policies but also societal priorities, as the world navigates the complex currents of change.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

A Storm is Brewing

I genuinely think the stock market recovery of 2023 will go down in history as a false dawn. There are not many real reasons for the level of optimism we’ve seen in stock markets in 2023. We’ve taken this opportunity to take profit on growth assets along the way. It is difficult to see what the drivers are to support the narratives of a ‘soft landing’ or ‘no landing’ that has become the consensus for markets as they oscillate between possible mild recession and no recession.

However, there are a number of issues that could finally come to a head in the short to medium term and act as the catalyst for a crisis. This would lead to a material leg down in share markets and potentially tip the global economy into a recession. Many of these are interlinked but anyone of them could evolve into a serious issue in its own right. Inevitably, one or more of these issues will eventuate, the bigger concern would be if there was a level of contagion that subsequently evolved into a more systemic economic or geopolitical issue. 

 The most obvious issues are:

1. Higher interest rates for longer.

2. Inflation being stubbornly higher than everyone anticipates.

3. The flow-on effects of the economic slowdown in China. 

4. The ongoing war in Ukraine and Russia’s next steps.

Any of these issues could be the epicentre of a major problem, at any time ahead. We are already seeing the price of oil pushing up headline inflation. While China’s debt and property market is a ticking timebomb that could explode at any point, as is the Russia situation. However, the one issue that stands out to me as having the most amplified impact and highest probability of creating a systemic problem is interest rates being higher for longer. If this does eventuate everything that has been building over the past 12-24 months will eventually come to a head relatively quickly. 

Rates staying higher will negatively impact corporate earnings, slow lending, reduce consumer spending and dampen economic growth. Then there are the risks to all borrowers paying higher interest rates and the risk of rising defaults from all kinds of borrowers. We are already seeing this in the US commercial property sector and that would appear to be just the start. Corporate and government bond issuances are becoming increasingly expensive and there is the looming prospect of too much debt being needed from too few investors. Then there’s the flow on effect to banks from lower margins due to paying higher rates on deposits, to higher defaults through to liquidity requirements and losses on bond portfolios. The tentacles of higher interest rates touch every part of the economy.

That said, the biggest immediate impact on stock markets may simply be over the next 3-6 months if markets finally accept that interest rates will be going higher. In the initial share market sell-off in 2022, the share market (especially tech) adjusted to lower valuations that accompany higher interest rates. It’s pretty simple financial math. Except in 2023 we’ve seen ‘multiple expansion’ which is a fancy finance way of saying prices have gone up, but profits haven’t. In other words, while markets have improved in 2023 it’s on the back of financial smoke and mirrors because in many cases profits are actually lower. 

In reality, the market was right to adjust lower in 2022 as interest rates went up. Then in 2023, AI and general hype led to multiple expansion, and everyone seemed to hope that as inflation started to fall the implication was that interest rates would too. That was wishful thinking in my mind but 9 months into 2023 and it’s still the implied view of share markets. Not bond markets though. Bond yields are moving higher. As I pointed out a few weeks ago there is a shift in long-term bond markets with yields going materially higher for 10- and 30-year US bonds. Bond markets are telling us rates will be higher for longer. 

So, in the simplest terms what should happen (this does not mean it will happen!!) is that if bond markets are right, and I expect they are, then equity markets and especially the big tech that have rallied so hard, are in trouble. On a fundamental basis, if there are sustained higher interest rates on long-term risk-free assets (for example 10-year US Govt bonds) then, mathematically speaking the share market and those stocks are going to revisit those 2022 levels. Now there is nothing that says that does have to happen, even if fundamentally it makes sense. Multiple expansions can last a long time and the simple weight of money flowing into asset classes or specific stocks can hold prices at significantly higher prices than they should be. But I would err on the side of caution and look at the fundamentals. 

If the hope of lower interest rates disappears and the penny finally drops for the share market that interest rates are going to be higher for longer then so does the support for the multiple expansion we’ve seen. Keeping in mind that there are also other serious issues from inflation and cost of living pressures to the China slow down through to geopolitical risks. Not to mention any black swan events we don’t even anticipate. We will continue to take a conservative view, taking profit on growth assets and holding an overweight position in cash in anticipation of increased volatility and rates holding higher for longer to provide us with opportunities in due course.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Why Unemployment Will Rise

So far, 2023 has been a surprisingly good year for equity markets and investors. While there are some positive signs in the global economy, there are many more reasons to remain cautious. China’s economic slowdown, corporate debt defaults, retail slow down and office property valuations are just a few examples. The good news this year has been that inflation rates across much of the world have fallen reasonably quickly from their peak in mid-late 2022. The big question for the rest of 2023 and beyond is whether inflation continues to fall and ultimately gets to a sustainable 2%-3%. There is still some way to go until victory can be declared. Central banks are hoping they have done enough and are banking on the lag effect on rate hikes coming through to finishing the job. The danger being that after the pause in rate hikes, inflation is lower but still elevated.

Unemployment is the key.

The unemployment rate realistically needs to be in the range of 4%-5%. Then you get a balance in the power dynamic between employees and business. When the economy is operating at 3.7% unemployment, it creates distortions and difficulties for businesses in a multitude of ways. No one wants to see people out of work, but the reality of the world is that labour is driven by supply and demand like any other force in the market. If there is no supply, prices go up, but then company profit falls, businesses start to struggle, and they stop expanding and investing and growth falls.

It’s a fallacy that unemployment is always better being lower. The opposite is true when unemployment is too high of course. Everyone understands that when too many people are unemployed, in other words an oversupply of labour, that shifts the power balance to the employers. They increase profits but also find there are no longer enough consumers with jobs to spend so business and the economy falter. There comes a point where balance is lost if unemployment is either too high or too low. Finding the balance between inflation and unemployment is the current conundrum for central banks across the world.

Of course, it’s always a very delicate and misunderstood topic when you are effectively saying it’s better for the overall economy if unemployment is higher. High profile property investor, Tim Gurner, found this out the hard way last week when he outlined exactly this in more blunt terms. His message was broadly right in my view, but the backlash was significant. New RBA chairperson, Michelle Bullock has previously stated on the record that unemployment will have to rise to 4.5% in order to tame inflation. She also articulated it far more diplomatically when she said that the RBA needs to rein in inflation while keeping as many jobs as possible. That is a far more politically correct way of saying that to beat inflation it will cost jobs. It doesn’t matter how you say it, the reality is there will be a cost to the economy and the people to beat inflation and job losses will occur. But higher inflation is worse.

At times like this, it’s the prospect of higher interest rates being required later that unnerves the stock market when stronger than expected jobs data comes through. Ordinarily, good jobs data means a strong economy. A strong economy generally means good conditions for business, and typically that is good for the value of the shares in those businesses. However, when central banks are increasing interest rates to slow the economy enough to reduce inflation, the by-product is going to be job losses. So, when the jobs data is strong, and unemployment stays low, it’s a sign that the rate increases are not having the desired impact on slowing the economy. It’s hard to know if that is just a lag effect or if it means interest rates ultimately need to go higher. For investors, it’s worth keeping this in mind as it’s the primary reason the share market tends to fall if unemployment data is stronger than expected in this environment.

Overall, two of the key areas to watch are obviously inflation and unemployment but there are many other variables at play that all impact these as well. Recently the price of oil has jump and there are going to be adverse implications from this on the headline rate of inflation. While at the same time the retail slowdown is real, and I expect it to be the catalyst in the months ahead to push the unemployment rate higher and subsequently then see inflation fall further in in 2024.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Hedgehog or Fox?

In his bestselling business book, Good to Great, Jim Collins talks about the attributes of the very best companies and what separates the great companies from the good companies. In fact, several of the great companies were in industries that were considered ‘bad industries’ but they prospered anyway. His research showed that “…a company does not need to be in a great industry to become a great company. Each good-to-great company built a famous economic engine, regardless of the industry.” More importantly, it was the set of leadership traits they identified in the leaders of the great businesses that saw them elevate their businesses beyond just being good. He defined these leaders as either hedgehogs or foxes.

The concept of the hedgehog and the fox represents two contrasting leadership and strategy approaches. The hedgehog is characterized by a narrow focus on one's core strengths and objectives, while the fox is more scattered, constantly pursuing various opportunities. Collins argues that the leaders of great companies tend to be hedgehogs, concentrating their efforts and focus on what they do best, rather than being foxes, who often become distracted and spread their resources too thin.

When I first read about the hedgehog and the fox a few years ago it was simultaneously both profound and obvious. What I hadn’t realised up until then was that when it came to building my business, I was a fox. It was tough to have that realisation, but I simply didn’t know any better. I had ambition, drive and worked hard. But in hindsight, I didn’t really understand exactly what I was trying to build at the time. I was always on the lookout for new ideas and opportunities. Once I read the descriptions it completely changed my mindset. The most important change was genuine deep focus and that led to patience. It was a game changer for me and the way I went about business from that point on.

Where you’ll find the hedgehog operating is at the intersection of the answers to 3 critical questions:

·         What you are deeply passionate about?

·         What drives your economic engine?

·         What you can be the best in the world at?

Refining what I am deeply passionate about was incredibly important to understand and it took me time to learn that. I love working with families and people who have built successful businesses. They are relationship-focused people who understand how to build a business for the long term. More often than not, they are hedgehogs too. I wasn’t passionate about the financial planning side. This was important to understand because it is equally important to define what you are not passionate about as it is what you are.

Moving from the fox to hedgehog mindset helped me tremendously. Firstly, it made me define what the one big thing I wanted to work on for the rest of my life was. I am deeply passionate about how the world works, understanding the inner workings of the global economy, geo-politics, and business. I enjoy the process of advising families and I believe I can grow to become the best in the world at it. The part of the process that drives the economic engine of my business is managing money for families. So, I refined the business to focus on that.

When you start trying to be the best in the world at something, your mindset shifts. You don’t have time to spend on things that don’t directly help you achieve your mission. From there I found it easy to simplify everything and focus. Unless a task, venture or opportunity directly relates to achieving your objective, then the answer is no. Once you realise you want to be hedgehog you understand exactly what almost all of these ‘opportunities’ really are – a distraction. I became very deliberate about where my time and efforts were being spent. It meant bringing in people who are equally passionate about different aspects of the business, such as Marcel for our marketing and more recently Poppy and Victoria to assist with research and administration. That process continues to evolve.

Perhaps the most surprising part was the impact all of this had on my work. Once I knew I was going to do this for the rest of my life I no longer felt in a rush to achieve results fast. It immediately made me more patient and genuinely build the business the right way for the long term. Doing that made all of my work better. Defining the answer to those 3 key questions was crucial in designing the type of business I want to be a part of for a very long time. When looking for stocks to invest in I often ask myself if the founders and management of the businesses are hedgehogs or foxes. In fact, it’s a great question for anyone in business to reflect on. So, are you a hedgehog or a fox?

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

They grow up fast.

Father’s Day is a unique day that means something different to everyone. If there is one lesson I would pass on to young dads it’s simply this — choose how you spend your time carefully. People will often say things that sound like cliches like ‘they grow up fast’ or ‘seems like yesterday I was holding them in my arms’. When you are a new dad looking 18 years ahead and worried about how you are going to pay for sport, braces, and school fees, it’s easy to focus on paying the bills and work. But those cliches everyone mentioned are also true. Time with your kids at each phase of their life is precious and fleeting. Once they grow out of one phase that time is gone forever.

In 2003 my wife, Paula, and I had four kids aged 5 and under. It was it was around then that I started thinking about the years ahead and how that timeframe exists over four distinct phases of their life. Paula hated this analogy because as they moved to the next age bracket, she could see her children were no longer babies or kids as they grew up. But it was an incredibly important perspective for me because as the kids would transition into a new phase I was especially mindful to enjoy the time along the way. The way I looked at it was in 4 phases of 5 years.

1. Ages 0–5 Baby & toddler phase

2. Ages 5–10 Kid phase

3. Ages 10–15 Teen phase

4. Ages 15–20 Young adult phase

But even being mindful of time passing, there will still be times when you still don’t appreciate just how quickly it does go by. I remember coming home from work every day was a highlight. As my keys jingled as I unlocked the front door, I would hear the sound of four little kids yelling ‘DADS’ HOME!’ as they all raced to the front door to greet me. I didn’t realise how much I loved that until a few years later, on a random day, I realized I was no longer being greeted at the door by anyone. I’d unlock the door, walk into the house, and see my wife and say, ‘where are the kids?’ before going off to find them. Sometimes as a parent, you don’t even realise how fleeting the greatest moments in your life are.

Friday nights were family movie nights in our house from the time the kids were little. We enjoyed pizza while we watched Monsters Inc or Shrek. However, even the perfect Friday night tradition my wife and I naïvely assumed would be forever didn’t last. It was eventually abandoned because it is impossible to get four teenagers to agree to watch the same movie. If they do you can be sure it ends with an argument and at least one kid storming out. Of course, what you are trying to do is raise independently minded, strong-willed individuals who won’t be pushed around. So, although it doesn’t feel like it at the time, these moments are in fact the signs that both your parenting and your kids are on track.

With the baby of our four kids turning 20 in June we are now completely out of the four phases. It’s a weird feeling. Three of our four children have moved out and work and study or do both. They are all excited about their future and have adjusted to their lives as adults relatively easily. I think this phase is harder for the parents to adjust. You go from being in the middle of raising your kids to feeling like the last 20–25 years are a blur. The hours of sport and driving them around is no longer a thing. But that’s our job as parents, from the moment we help them to crawl and then walk and send them to school, every day we are teaching them to become independent adults one day, so that they no longer need you. That’s your job. But as a parent, it takes time to adjust to when they leave the nest.

One of the most profound insights for me as a parent came when I turned 44. That was the year my oldest turned 22. I sat back and realized that I was now the same age as my Dad was when I got married at 22. When I was getting married, I’d talk to dad about life and get advice because he clearly understood everything. Once I hit that same age, I suddenly realized how wrong I was, I called Dad and we laughed about the fact that none of us really know what we are doing as parents. We all just make it up as we go along, doing the best we can and hoping we get it right more often than we get it wrong. There are no secrets to parenting. Do the best you can and ensure you enjoy your time with your kids along the way.

Full Contact Juggling

I wish that “full contact juggling” was some sort of clever metaphor I’d come up with to explain investment or living in these complex times. Unfortunately, it is not. I was on Instagram the other day and what should come across my screen but a video of a professional game of a sport called full contact juggling. Where the participants are literally juggling while trying to hit the other contestants and knock their clubs out of the air.

There might be no better example of people today having too much time on their hands and not enough real problems. Now I’m a big advocate of doing what you love regardless of what people think, but to me, this kind of thing is symptomatic of the level of hubris and complacency we have in Western society today. That’s not a social statement but an important observation because what happens in society translates into the economy. That’s the part that matters for investors.

While it may be just a silly example there are others that I think reveal more about the state of the psyche of society and more importantly the consumer today. I look at how many people, of all levels of wealth, go out for dinner at fancy restaurants and they are all sipping on $25 cocktails. These items have moved from being the luxuries that mark a special occasion to how we live our lives in the day-to-day. As an observer of consumer habits these are the little markers of hubris within society that tell you we are collectively living beyond our means and that an adjustment is coming.

Over the years I’ve often observed the seemingly innocuous anecdotal signs of excess that provide insights into the pulse of the people and the consumer. You can learn a lot just from observing the changes in daily habits over time. Even the way media headlines change over time signals shifts in sentiment as they tap into the most emotive topics of their respective readers. But paying attention to the anecdotal evidence is often a good place to see breaks in patterns that are worth investigating further into the real data. Inevitably the economy at any point in time is in the throes of being between ever more excess or austerity. These turning points between the two matter a lot.

I’ll never forget the first sign of excess ahead of the GFC. It was 2006 and I was in Perth and saw a tradesman in a brand-new top of the range fancy BMW X5 drive past me with a trailer behind and a ladder on the roof. It screamed to me that something was dramatically out of whack. Now of course it may have been a wealthy builder who was living well within his means. But that’s not the point, it was the stark break from the pattern of what ‘should be’. Being anecdotal it didn’t directly influence investment decisions, but it certainly raised the alarm to make me more cautious and dig deeper in my research on the state of the economy at the time.

At every turn, the government has smoothed the way and removed any hint of hardship. Yet what is considered hardship today would have been considered luxury by our parents or grandparents. I can assure you no one has saved for a rainy day because there are no rainy days. That fundamentally changes the mindset of a generation. For anyone under 35 this probably all seems normal. But I am really interested to see how consumer habits change once the economy starts to tighten up, especially as unemployment starts to edge higher.

This will impact companies in many industries as many of the everyday products and services we have become accustomed to and assume are minimum required living standards are actually luxuries when the economic push comes to shove. 

There is a Shift Happening

In recent weeks there has been a significant shift in the prospects for long-term interest rates. Both the 10-year and 30-year US bond yields have spiked to highs not seen since the GFC in 2007 as the notion of interest rates being higher for longer finally seems to be kicking in. The 10-year US bond rate hit 4.3% and the 30-year US bond yield hit 4.45% up from their lows of under 1% in 2020.

So why is it happening and what does this all mean?

In a normal market, you’d expect the yield on bonds to be higher the longer the term of the investment. However, for the past year or two that hasn’t been the case. The US has had an inverted yield curve with short-term bond yields being higher than longer-term bond yields. That curve is generally associated with a pending recession because when inflation spikes, the bond market expects interest rates to go up in the short term and those higher costs to put the economy into recession. Conversely the expectation is normally that to recover from the recession interest rates will later need to fall to assist a recovery.

These increases in bond yields may seem counter intuitive as they’ve occurred at a time when many investors believe interest rates will come down on the back of falling inflation rates in recent months. However, many other aspects of the global economy remain surprisingly resilient, including unemployment. While that remains the case it’s difficult to realistically expect interest rates to come down just yet. Equity markets especially may be getting ahead of themselves by expecting a continuing decline in inflation back to the target rates of central banks and a subsequent reversal in interest rates.

Now though, it appears the bond market is starting to realise that interest rates are going to be higher for a lot longer. Not a little bit longer. A lot longer. These rates may even be the new normal. When the 10- and 30-year bond yields move like this it is a material shift in the way risk is being assessed. Bond markets are generally very good at assessing and adjusting for risk while equity markets tend to be more optimistic, have more variables to consider and are slower to react. Bonds investors are demanding a higher premium to lend money for the greater risks associated with investment including default.

There is a lot of debt across the world and many nations have huge budget deficits. Those deficits are met by countries issuing even more debt by way of new bond issuances every year. On the back of many years of budget deficits and increasing debt, the rising interest rates across the world means governments that are refinancing maturing bonds will also need to pay a lot more than they were previously. That puts many nations under even more pressure and makes them even less creditworthy.

But in an increasingly competitive debt market for nations and companies, problems arise if there is too much borrowing and not enough investment demand to fund it. It creates a couple of potentially problematic situations. The first problem is that borrowers who are weaker or less credit worthy will have to pay significantly more on borrowings. The second problem arises if nations or companies are not able to secure the funds at all. While government borrowers might be less likely to default when they can issue more bonds in their own currency, this compounds other problems such as inflationary pressures.

The reality is that this recent spike in long-term US bond yields will mean a recalibration of the pricing of all debt across the board. These bonds are the benchmark for what investors consider to be ‘risk-free’ so all other debt is progressively riskier and as such will need to have their pricing adjusted. This means all debt is going to be more expensive. From the bonds of other countries, states, and municipalities to the debt of large, medium, and small corporations, the flow-on effect is significant. Everyone will be paying even higher interest rates as a consequence.

All of this becomes a problem as the weakest of the borrowers in all these different categories start to really struggle. Some may not get finance in the future and that has serious implications for countries and companies where this occurs, and it will occur. This is all part of the slow-motion aftereffects of such rapid rate increases, there are unintended consequences, and the fallout isn’t always manageable. So be wary as to the quality of the bonds or credit investments that you hold in your portfolio and understand that the reason you’re able to get higher returns is due to the higher risk that is embedded in the investments you hold. That risk is real and if you get it wrong it can lead to disastrous outcomes.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

No, you are not a tech company

The CEO of Rio Tinto, Jakob Stausholm, made headlines recently by saying "We're a tech company". It's a sentiment that sums up the thinking of many business leaders in 2023. Rio Tinto is at the forefront of advanced technology with its driverless trucks and ever-increasing use of automation in its mining operations. 

But to me, that's like calling a florist a logistics company because they deliver flowers using cars and trucks. It's important that businesses don't lose sight of their customers' needs. The customer of the florist wants flowers at a certain time and place. They don't care how they get there.

Similarly, China and other countries want the iron ore Rio Tinto mines. They don't care how good the technology is or how it's extracted from the ground. Depending on the business's product, how good the technology is has nothing to do with the end product the customer wants.

These days, every company wants to be a tech company when it sounds cool. Whether it's for recruiting or stock market valuation purposes, being seen as a tech company is popular. Often though, it signals to me that a business has lost its way and has become distracted from their core business when they start making such grandiose declarations.

So, is Rio Tinto really a tech company?

To be fair, you can make the case that every company these days has technology at its core. Indeed, to avoid being the next Blockbuster or Kodak, it's critical for companies to continue to innovate and reinvent themselves before they are disrupted.

However, if I am a carpenter who uses a hammer and nail, and the other carpenters start using nail guns and get more work done, did they surpass me because they were a tech company? No, they are still in the carpentry business, they just used the latest tools to become more productive.

It doesn't matter if you are a tech company or not. What matters is that businesses embrace innovation in such a way that they either grow productivity or create efficiencies that enable them to continue to serve their customers ahead of their competitors. If Blockbuster thought like this, they'd have understood they weren't just in the video rental business, and they'd be where Netflix is right now.

Where do you draw the line?

The flip side of this argument is a company such as Amazon. Is Amazon a tech company or a retailer? Most consider them one of the big tech companies. But at their core, they are really a retailer. They have utilised technology to create an incredible business model that serves their customers extremely well. From using ecommerce during the early the internet to warehouse robots and Ai more recently.

True innovation is not only about technology, it's about the way you use technology to better serve your customers. It's about knowing what your customers really want and being prepared to adopt technology to change your business model ahead of your competitors. The very best and most enduring businesses are not technology businesses, they are simply the ones that embrace technology to continuously innovate. That's the most important aspect of business. 

It's worth thinking about as we make decisions about where to invest. It's easy for investors to be captivated by the story around a company that wants to appear more cutting-edge than it may really be. Successful pure technology companies are relatively rare and very high-risk investments.

But there are many great businesses that are utilising technology and innovation to deliver great outcomes for shareholders. They may not be technology companies, but they are certainly at the cutting edge of innovation. From computers and the internet in the 80's and 90's to automation and ai more recently, the very best companies are obsessed with how technology lets them deliver better outcomes for their customers. Technology is the tool that allows them to evolve and even revolutionise their business model. That's more important and at the core of every great business. These are the type of companies we want to have in our portfolios.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

China Slowdown

The much-heralded China economic reopening doesn’t seem to have materialised in the way markets anticipated. At various points during Covid, the prospect of China reopening for business post covid sent markets rallying higher on the expectation of higher demand driving the global economy. But so far, the reality has been underwhelming and it appears there are more economic challenges ahead for China than many anticipated.

Yesterday’s inflation figures for China show the once-powerful engine of global economic growth to now be heading for deflation. The CPI rate of -0.3% for the period was lower than expected and the flow-on effects are massive. Lower inflation and the prospects of lower economic growth are genuinely problematic for a nation that has been all about growth for the past 30 years.

In the past, China has had many long-term trends playing into their favour driving their growth. But suddenly there are a number of these trends are being reversed and we are now starting to see these factors impacting the country negatively. China has been the biggest beneficiary of globalisation over the past 20–30 years. Combining that with a huge population and rapid urbanisation sparked decades of investment that turned China into the world’s second-biggest economy.

Yet what China faces now is a totally different situation, and I am not sure the world has really considered what all of these variables combined really mean. All these issues are well known but China has been such an economic juggernaut it’s difficult for people to look at the situation with fresh eyes and consider what all these issues converging really mean for China and the world.

The catalyst for changing these trends was Russia’s invasion of Ukraine effectively waking the world up to the economic consequences of a conflict on the global supply chain. National security became the number one issue for every nation in the world and overnight it commenced the slow reversal of globalisation. As countries extricate themselves and their supply chain dependency from China this new trend will weigh on the Chinese economy as decades of investment is slowly unwound.

Meanwhile, emerging economies such as Mexico, India and Vietnam are booming as the USA and other Western nations are reshoring their supply chains and manufacturing. Make no mistake the process of untangling the global supply chain is still underway. The global supply chain dependence on China is a bigger vulnerability for the Western world than Germany’s dependence on Russian energy. There is no quick fix so all sides are working as quickly as they can to mitigate their risk. That’s a problem for China’s long-term economic growth.

Another overarching theme is their changing demographics. China’s population is aging and by 2035 an estimated 400m people will be over 60. Population won’t be the driver of growth it once was. But the trend that really accelerated the Nation’s growth over the last 20–30 years was the urbanisation of China. As people moved from the country to the city there was massive investment in infrastructure and property. Entire cities were seemingly built overnight. But simply developing infrastructure and buildings isn’t sustainable, in fact, it might be part of the current problem.

China is now at a crossroads.

The spectre of large amounts of debt has hobbled the economy. Economic growth has been lower than expected and in the past that was the signal for stimulus from the government. More often than not in the form of infrastructure and property development. It’s unlikely to be the case this time around and those past actions are part of the problem. Large debts at all levels of government, especially local government, were used to build projects that didn’t necessarily stack up financially. There are large amounts of infrastructure and property development that provided economic stimulus and jobs at the time but sit vacant or barely used now they are completed.

This is a serious problem.

It means that many of these projects haven’t delivered the returns needed to pay for themselves. But more importantly, faced with slowing growth, it may stop the government from being able to roll out the old playbook because they have effectively over saturated the market. The property and debt issue in China has been lurking since the collapse of Evergrande back in late 2021 and there remain serious problems and questions with regards to the entire sector. I am sure grand announcements of government stimulus and investment packages are coming but China need a new strategy to reignite growth.

By way of investing in Chinese equities, I still believe the country remains uninvestable. As I’ve previously said in these notes before, regardless of how big the opportunity may seem I am not interested in investing funds where a country’s government can torpedo entire companies or even industries overnight on a whim. Business is difficult enough at the best of times and I have no interest in the space and wish those brave, naïve, greedy or silly enough to invest there good luck.

With all of these long-term trends reversing, it will be extremely difficult for China to grow in the same way they have for the past few decades as they go forward. It’s time for investors to think carefully about what these changes mean and reevaluate what the flow-on effects are not just for China but more importantly for the companies in your investment portfolio that are heavily exposed to China. Australia has benefited enormously from the growth of China but if the Chinese economy faces a genuine slowdown and they are unable to resort to their usual ‘just build more playbook’ in the same way they have in the past there are huge implications for Australian companies of all sizes.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Investing Tactically

The benefits of having a diversified portfolio across asset classes are well understood. Strategic asset allocation offers several key benefits for an investment portfolio. Firstly, it provides a disciplined and long-term approach to investing. By setting a fixed allocation based on an investor's risk tolerance, financial goals, and time horizon, strategic asset allocation helps prevent knee-jerk reactions to short-term market fluctuations. This reduces the likelihood of emotional decision-making, which can often lead to poorer results. Instead, it encourages investors to stay the course and maintain a well-diversified portfolio that can weather various market conditions over the long run.

Secondly, strategic asset allocation seeks to achieve a balance between risk and return. By spreading investments across different asset classes, such as stocks, bonds, and cash, it diversifies the portfolio's risk. During periods of market volatility or economic downturns, certain assets may underperform, but others may act as a buffer, mitigating potential losses. Over time, this balanced approach has the potential to deliver consistent, more stable returns compared to more aggressive or concentrated strategies. Additionally, strategic asset allocation allows for periodic rebalancing, which entails selling assets that have outperformed and buying those that have underperformed, effectively "buying low and selling high." This disciplined rebalancing process helps maintain the desired allocation and can enhance returns over the long term. It’s the general principles of diversification and strategic asset allocation.

But sometimes it’s important to be more dynamic in your decision-making process. The diversified nature of the portfolio assets allocation was meant to help weather any storm. While equities can be more volatile in tough times the bond portion of the portfolio provides the less volatile and more defensive fixed income assets. But in 2022 both equities and bonds experienced significant declines. At one point the Bloomberg Aggregate Bond Index down -20%, which is almost unheard of for safe, secure, boring old bonds. The reasons were very straight forward. It was due to the rapid rise of interest rates, as fast an increase as there has been at any point in the last 40 years. This is why it is important to avoid being too complacent or passive in your investment approach.

When once in generation events occur, sometimes your decision making needs to adjust. In 2022, with interest rates rapidly rising from almost 0% to 4%-5%, it was apparent that this would impact both stocks and bonds negatively. It is important to be able to think tactically here and make dynamic decisions with regards to your investment portfolio. We took the view that in this situation we wanted to be underweight both equities and fixed interest. It meant increasing our exposure to cash, term deposits and floating rate bonds. By doing this, we avoided losses on the bond component of the portfolio while minimising losses on the stock component that year. At the time, many portfolio managers stuck with their strategic asset allocation and lost a lot of money. Thinking and acting tactically was critical in generating a far better outcome for our clients.

Now in 2023, as interest rates approach their peak that situation is rapidly changing again. It means that where we avoided fixed rate bonds previously these are now becoming much more attractive. Interest rates on fixed rate bonds are much higher, offering a very reasonable yield, and the prospect of rates going much higher from here is lower. So, the risk of capital loss is minimized. If inflation continues to cool and rates do come down, there is the prospect of these bonds increasing in value. With the recent improvement in equities, it provides the opportunity to take advantage of higher share prices, lock in some profit and reallocate that capital to the more defensive part of the portfolio at attractive prices.

While strategic asset allocation provides an essential foundation for a well-diversified and disciplined investment approach, there are times when a more dynamic and tactical decision-making process is necessary. The events of 2022, with the unprecedented rise in interest rates impacting both equities and bonds, serve as a stark reminder that complacency in investment strategy can have adverse consequences. Recognising unique situations and being willing to adjust allocations accordingly can be the key to navigating through challenging market conditions successfully. As we move forward through 2023, with interest rates approaching their peak and changing market dynamics, the importance of flexibility and adaptability in portfolio management becomes even more important.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Succession

One of the best TV shows I’ve seen in a while is Succession. What the show does really well is explore the issues and power dynamic of a very wealthy family and their business. It highlights how difficult navigating succession within a family business can be. There’s an old adage that family business and wealth is made and lost over 3 generations. The basic concept is that once the wealth is made, the next generation maintains it while the third generation squanders it. Often referred to as ‘shirtsleeves to shirtsleeves in 3 generations’ it’s a cautionary tale that conveys the difficulties families face in managing their wealth and financial success over the very long term. The reality is that planning for succession is a serious topic that is too often neglected until it’s too late. The purpose of succession planning is to make sure that the family wealth passes through the generations and continues to grow. 

There are often tensions as the family patriarch or matriarch gets older, and their adult children rise within the business. It’s important to manage that situation because these issues only become more difficult and more complicated to deal with later if there’s no succession plan in place. By the time the founder passes away it’s all too late. It happens all too often, and the subsequent problems can become an emotional, financial, and legal minefield for the whole family. None of these topics are going to be easy to deal with but it is necessary to work through the issues regardless. 

Addressing these challenges requires careful planning, open and honest communication, and a commitment to the long-term success of the business. Sometimes hard conversations are needed. Seeking external expertise, implementing governance structures, and establishing clear processes can help navigate the difficulties associated with succession planning within a large family business. Obviously, it’s important to avoid any unnecessary bureaucracy but at a certain point, a family grows to a size where it benefits from introducing a more formal process for decision-making than they had in the past. Overwhelmingly, I hear from every family that goes through the process, that they wish they’d done it years earlier.

I had a really great conversation on exactly this topic during my podcast recently with Stu Laundy from Laundy Hotels. These days the family have over 90 venues and a business valued at over $1.5 billion. What was fascinating was Stu’s candour with regard to the real-life struggles that exist within his family as they mapped out the succession plan for the next generation. It’s not easy for the older generation to let go of control and change the way they run the business. What Stu and the family realised and ultimately embraced was that it is critical to have those hard discussions as early as possible because once you do you reap the rewards. So many family businesses can learn from these insights.

You’re not going to avoid conflict in a family business, but you can harness the difficult issues and turn them into a constructive process. These cover a range of topics from the family relationship dynamics, balancing various competencies and skill sets, family Interests, through to the emotional attachment of the founder and how to let go. You also need to ensure fairness and equity for all the family members and the need for the business to evolve and adapt to changing markets and technology. The benefits are significant though and help to safeguard the future prosperity of the business. The planning process helps identify the right people for the right roles and not only educates the successors but develops their talent to ensure a smooth transition and a continuation of the founder’s legacy for generations to come.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Why I Started The Dion Guagliardo Podcast

Growing up, I always loved reading stories about successful business leaders. I would devour anything I could about people like Kerry Packer, Richard Branson and Gerry Harvey who were amongst the earliest people I was fascinated with. I would buy books that featured profiles of say 20 entrepreneurs or 100 businesses. I made a habit out of purchasing the BRW Rich List (now the AFR Rich list these days) to learn how successful people made their money. I was particularly intrigued by stories of self-made people and tended to skip over those based on inherited wealth or property. My fascination lay in understanding how great businesses were built and the personality traits and leadership qualities of the people who built them.

One of my favourite lessons was from when Steve Jobs was young. At 12 years olds, Jobs randomly rang Bill Hewlett, the co-founder of Hewlett Packard to ask him for spare computer parts. An amused Hewlett not only gave him the parts but a summer internship in the factory. Years later when Jobs was quizzed as to how he did it, he said, ‘I looked him up in the phone book and made the call’. His big lesson here was that ‘I’ve never found anybody that didn’t want to help me if I asked them for help.’ He also added that most people ‘don’t get those experiences because they never ask.’ It's so easy to make the call, yet almost no one does. The very best do though.

But it’s not only the very wealthiest people that have wisdom to share. There are so many people who have built successful businesses that have a less well-known story but just as much wisdom. I thought, who is telling their stories? How are they sharing their knowledge? These are the types of people I work with and talk to every day and there are many insights to be gained from them. I’ve always found them to be generous with their time and advice. So, I thought interviewing these people on a podcast would be a wonderful way to share these stories. That’s where the Dion Guagliardo Podcast started and why it exists.

My favourite part of talking with my podcast guests is when the conversation is so interesting that you almost forget you’re recording an interview. The conversation flows and you gain insights that were simply different to what you’ve heard before. A couple of months back I interviewed Vu Tran, cofounder of Go1. The business was started by four high school friends from Brisbane in 2015 and since then has grown to a $2 Billion+ tech unicorn. But as Vu explains, that’s just the start. They have very ambitious goals for the company and where they want to take it.

What struck me most during our conversation was Vu’s take on company culture. In the business and corporate world, culture has almost become a cliché. Companies will say how important it is but often fail to articulate what their culture is, and they rarely live up to the talk. Most often, companies will espouse their wonderful culture and why they look for people who will fit their culture. This is what made Vu’s answer so interesting. “We don’t want people to fit our culture” he said almost defiantly “We want people who will enrich and grow our culture.” Interesting. “We don’t want the same culture we have now in 10 years, or we haven’t grown”.

I was always fascinated by the intelligent and considered interviewers, like Andrew Denton and Michael Parkinson who seemed genuinely interested in their guests. They were so good at building rapport. I always remember watching Andrew Denton interview people when I was young and being blown away by the way he used silence or a gentle follow-up question to break down barriers and open up a guest to a whole new level of vulnerability and openness. He not only knew how but he knew when to do it. He understood nuance and subtlety. Not many people can do that, and it really stood out to me.

As I’ve got to know my clients over the years, I have found one of the great privileges to be the lessons and stories you hear about how they made the money that I now manage for them and their family. There is nothing quite like hearing about the early days from a founder starting with nothing who went on to build an empire. But what watching great interviewers taught me was that if you ask the right questions, you’ll find that everyone has an interesting story and unique insights and wisdom to share. There is nothing more interesting than meeting a guest for the first time, hearing their story, and going on the journey of unpacking how they got to where they are today. That’s my rationale. I want to learn from the best people across all fields and I want to help them share their lifetime of hard-won insights for the benefit of everyone. Now 2 years in and approaching our 50th interview, I’d like to think we are achieving that.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Signs of Distress

There are some troubling figures starting to emerge in relation to a jump in bankruptcy, insolvency, and mortgage stress. These areas have all spiked recently as the covid era business protections are removed and markets are left to function more normally. Keep in mind that these figures are coming off a low base, but it signals a new phase for the economy. Here in Australia according to the latest insolvency statistics from ASIC (Jul 2023), insolvency rates are climbing sharply now too. During covid, insolvencies were in the 4,000-5,000 range annually. In the last 12 months, this figure has increased substantially and is now in the 8,000 to 9,000 range with 866 businesses being wound up in May alone. This is emerging across the world with places such as the UK particularly severe. The key concern is the flow-on effect through the economy. Increased bankruptcy means less jobs and less money being spent by both consumers and businesses in the economy. It snowballs from there.

At the same time, here in Australia, we are starting to see a spike in borrowers in mortgage stress. According to Roy Morgan research, over 1.4 million Australian borrowers are facing mortgage stress, up 78% from a year ago. The figure means almost 30% of all mortgage holders are in mortgage stress, which is the highest rate since the GFC. The most troubling aspect of these figures is that they’re at these alarming levels despite the economy not being in a recession and at a time of record low unemployment. If we see the unemployment rate materially rise in the months ahead, which I believe we will, these figures spike even higher. With so many people already struggling now while most people have a job, imagine the economic carnage when the unemployment rate rises. Mortgage stress means consumers have less money to spend on everything else. It slows economic growth, and it becomes a vicious cycle leading to more insolvency, less jobs, less spending and so on.

The added issue with mortgage stress for the property market becomes forced selling. It’s been a long time since we have had a situation like that with property, but I think it’s now a possibility. Distressed property owners selling drives prices down fast. Even during the GFC here in Australia, we didn’t really experience property issues in the same way the USA did. You really need to go back to the early 1990s since we’ve seen a scenario like that. It’s simple supply and demand. When you get distressed sellers, a glut of properties form and supply becomes greater than demand. The prices start to fall to meet demand. As people become more desperate prices fall even faster. Compounding this issue is the fact that buyers realise if they wait, prices will go even lower. So then demand starts to dry up and the situation becomes even worse. I’m not saying that will definitely happen, just that it could occur in this cycle. It’s on my radar and it hasn’t been before.

When we start comparing statistics to the GFC era, you need to keep in mind that in many cases we are talking about the maximum pain points that peaked at the end of the GFC in 2009. What came with that was a whole range of government stimulus and borrowing that was designed to make the upfront pain easier in order to spread out the pain over time. But we never stopped making things easier. Now, we’ve created inflation and as the economy gets worse, there isn’t a lot the government can do to help. Businesses, consumers, and families are going to have to wear the pain. Governments will lower interest rates, but we have the spectre of inflation hanging over us now so governments will be hamstrung with the policy moves they can make. So, while the GFC was bad, it wasn’t as bad as it was meant to be. Governments kicked the can down the road. We are getting closer to the end of that road.

The convergence of these variables doesn’t happen very often, but we have all the requirements for these once-in-a-generation scenarios forming in the background in this economy. It’s one of those things that when you say it, people think you’re crazy, but then when it happens, those same people will say it was obvious. Now interest rates may well still be low historically, especially compared to the 1990’s but it’s all relative. Someone borrowing as much as they can at 3% is going to be in trouble when their rates double to 6% or worse. As slow as the downturn has been to arrive once it is here it will be a problem for the whole economy and all asset classes. We’ve already had a false start in 2022 and since then everyone wants to pretend the worst is behind us. Diversify, be patient and be prepared. You don’t have time to position for it later. The time to position for the bad is when it’s still good. It’s too late to batten down the hatches once the storm hits.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Setting Up a New Portfolio

As I speak to our clients and podcast guests, I continue to see extraordinary business owners who are fantastic at running their business but who’ve never managed investments before. It’s a completely different ball game and it can be daunting. You need to learn, but who do you learn from? When you don’t know how to do something the most difficult part is working out who does. I strongly recommend reading books by the very best in the world. But even then, investment philosophies vary so greatly that what works for one investor doesn’t necessarily work for another.

The first rule is to keep it simple. If you’ve been successful in business, you know how to bring information together and make decisions based on what makes the most sense. So, keeping it simple means only doing what makes sense to you. Importantly, it means don’t make investments you don’t fully understand because you think the person telling you to do it knows better. No one cares about your money more than you do. So, it’s critical to understand the investment and the rationale behind the advice. Sayings like ‘If it sounds too good to be true it probably is’ might be a cliche but are also true.

Those that sell their business suddenly have a large amount of capital to invest. Ironically, while that kind of generational wealth brings with it security, it also brings a high level of anxiety. Founders are suddenly confronted with the prospect of not only making investment decisions they often haven’t had to make before, but they are also acutely aware that in many cases this money, regardless of how much it is, is all they have. It’s a very different mindset when you transition from a business owner making millions of dollars a year in profits to an investor where the amount you’re investing is the amount you have for the rest of your life.

Whether you have $10m, $100m or $1b to invest, the process is very similar, especially in such volatile times. In these situations, invest slowly over time. Regardless of how great the investment opportunities are or how great they seem, take your time, and invest progressively. This is simple but an important part of mitigating the risk of markets falling substantially after you invest. Of course, it can work the other way too and markets can jump up but in the current situation, there is more risk to the downside than the upside. But when you are setting up your family for generations, taking months or even years to fully invest protects the downside while ensuring you have funds available for opportunities that may arise in unique situations.

From there it’s a matter of structuring your investment portfolio for the long term. Rule number 2 is to diversify your risk. Diversification across asset classes such as property, shares, bonds, and cash are critical. But so too are the underlying investments within each of these sectors. Spread your risk because when one asset class performs poorly, you expect the others to have performed well and offset your losses. While diversification within an asset class is similar, if you hold 20 stocks and you have a couple of poor performers, you’d expect the good performers to mitigate this. At its most basic level, it ensures that if an investment fails you don’t have too much of your portfolio in any one asset.

So, keep it simple and ensure that you understand the investments you make. Don’t make an investment because everyone else seems to be doing great investing in it. This is the dumbest reason to invest, and I’ve seen more people lose money from investing in these ways than anything else. Diversify, across asset classes and then further in specific investments within those asset classes. Average in over time to hedge your timing risk, especially when investment markets are uncertain and overvalued. 

Lastly, you need to be able to sleep at night. That is the final test, can you sleep at night with the investments you have? If you can’t then it’s either because you don’t understand your investment properly or you’ve taken too much risk. Always make sure your investments pass the sleep test.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.