Author: Leigh Jobling, Partner, TAG Financial Services
Well, what a year 2021 has been. Despite the pandemic, lockdowns, no international travel, and many sectors of the economy doing it tough, investment markets have been outstanding. While the Australian share market has been relatively flat since 30 June this year, by-and-large, asset prices have continued their upward trend.
So how can we attribute such financial prosperity in financial markets when there are still many uncertainties and reasons to be cautious.
Low Interest Rates
We have had abnormally low interest rates for some time now. Many central banks around the world continue to provide financial stimulus to ensure easy access to money at extraordinarily low rates. Low rates mean cheap money can be borrowed to buy capital appreciating assets. Hence, the growth in the share and property markets.
Low rates also mean investors looking for a real return (where their money is growing faster than inflation), need to invest to preserve the value of their money. While cash and many parts of the bond market are not providing the necessary return, money finds its way into shares and property.
Booming Housing Market
Much of the recent buying in the property market has been new home buyers and owner occupiers (as opposed to investors) panicking about the increasing prices and pushing beyond their budgets to secure a home. While government intentions are admirable, most of the home buyer initiatives have simply driven up prices and benefitted the bottom line of the developers.
Surprising Company Profits
Share market values are simply the sum of a range of company profits, multiplied by a profit factor (PE ratio). Even through the pandemic, while we could not travel, go out for dinner or buy a new car (because there were not many around!), many industries thrived, including online retail, building and construction, mining, and many service businesses. While other industries have clearly struggled (most notably travel, tourism and hospitality), most of the economy has held up well. This has supported corporate profits and in-turn a healthy share market. Company profits have not been as negatively affected as many anticipated.
What 2022 may bring
The euphoria of big returns from shares and property may start to taper. 20% returns are unsustainable and as enthusiasm wanes, so does the likelihood of the big returns.
Inflation
In recent months we have heard a lot about inflation due to increased cost of production and logistics (shipping and transportation and storage). A labour shortage has kept unemployment low and demand for workers, as our economy re-opens, has meant increased employment costs. Labour shortages will correct as borders re-open and backpackers, seasonal workers, international students and immigration re-commences. However real wages growth, resulting in inflation (due to rising demand for goods and services with limited supply) will mean 2022 and 2023 may be challenging.
Life without stimulus
As life returns to “normal”, the markets will re-value assets based on prospects for economic growth, unemployment rates, and longer term interest rates. As governments wind back stimulus measures and rates gradually increase, this will likely put pressure on prices of appreciating assets. Government stimulus since the GFC has been an abnormal ‘shot in the arm’ for markets, but this will not continue at previous levels for long and the US has already announced further reductions in money supply.
Tech Boom or Bust?
The technology industry has certainly been one who has benefited from the effects of the last two years. Around 20% of all companies on the ASX200 index make a loss. Many others make a very small profit which does not justify their valuations. Several tech companies are expected to make big profits in the future. Let’s hope they do, otherwise there will be some pain coming for many investors. These companies represent a greater share of our top 200 companies than ever before.
Rising interest rates
As interest rates rise and business and households experience reduced cash flow due to higher loan repayments, consumer spending along with company spending and investment is likely to moderate, putting pressure on various aspects of the economy. Companies with low/no profits and higher levels of debt are also more sensitive to interest rate rises and this may affect share values of many industries – in particular the technology sector.
Market Correction
The big returns of 2020 and 2021 may well be behind us. While there is no reason for a severe downturn, market corrections are inevitable, and we are probably due for one soon.
Our return expectations of investment portfolios have been reduced to reflect the current and future environment where long term gains are still expected, but at a lower and slower rate.
As always, when it comes to investing, set your goals, invest with purpose, have a strategy, maintain liquidity, preserve some cash, don’t over commit and focus on the long term. Even with rising interest rates and inflationary conditions, many industries flourish and careful investment selection will be the key to future investment success. You could have bought almost any property for example 10 year ago and done very well. Investing over the coming years may not be quite so ‘easy’.
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Disclaimer: The information contained is general in nature. Professional advice should be sought before acting on any aspect on this page. Financial planning services provided by TAG Financial Advisors Pty Ltd (ABN 77 154 205 017 AFSL 415632), a wholly owned subsidiary of TAG Financial Services Pty Ltd (ABN 67 075 374 686). Copyright 2021. Please do not reproduce without the expressed written consent of the author.