Investing During Extreme Uncertainty
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Investing During Extreme Uncertainty

How understanding risk influences investing.

By Paul Miron
Wed, Jun 8, 2022 11:26amGrey Clock 3 min

OPINION

 

As we return to work after a Federal Election and welcome a new government, there still seems to be no end in sight regarding the war in Ukraine, a worldwide energy crisis, food shortages, supply chain issue, COVID-19 and rising costs of living alongside the prospect of further interest rate hikes.

It seems that our economic future has never been more uncertain. Or are things really all that bad for investors?

Amidst the macroeconomic upheaval in the global economy, the question remains, “How does one remain calm, continue to be invested strongly, and actually take advantage of these changes in the global economic cycle?”

 

How Heightened Risk Can Increase Market Awareness

 

An analogy can be drawn from a social experiment conducted some years ago in Drachten, Holland, by a traffic engineer named Hans Monderman. He removed all traffic signs, speed control, and traffic lights in this city. Naturally, you would expect complete chaos to have ensued. Almost completely counter-intuitively, both fatality rates and car accidents reduced, while traffic flows improved.

It all comes down to personal risk assessment; when drivers have a constant level of heightened risk awareness, they become better judges of risk more careful and prudent in an environment with fewer road signs and other traffic measures.

The same concept applies to investing. When investors are constantly thinking about risk, being self-reliant and filtering through market noise cautiously, investor behaviour changes for the better.

It also demonstrates an essential truth about life and investing – risk is a constant — what changes is both our attitude and reaction to risk.

 

Macroeconomic Forecasts

 

Investors are often lulled into a false sense of security based on what other people are forecasting and thinking, they are caught up in speculative investment trends, often with undesirable outcomes.

The most pressing economic issue impacting all investors is the nexus between inflation and interest rates. How far will the RBA go in raising interest rates to curb inflation? This is now the centrepiece of all forecasts and market predictions. If rates are raised too quickly and aggressively, it increases the risk of an exceptionally prolonged recession. If our central bank is too lax, the inflation we are experiencing may morph into something more disturbing, such as stagflation, deflation, or even hyperinflation.

Thus, the question becomes: how reliant are we on forecasts when making investment decisions?

Below are the Big Four bank economists giving their best attempt at a forecast. Interestingly the CBA and financial market forecasts would differ significantly regarding overall asset prices, from notions of a modest correction to a full-fledged market collapse.

Taking the conservative estimate, if the CBA predictions are accurate, mortgage holders’ monthly repayments will increase by 14.6%, which is aligned with the last time we experienced a rise in the interest rate between 2002 and 2008.

However, if they take the forecasts priced in by the financial market, mortgage payers would be making 39.7% higher monthly repayments.

 

Risk Tolerance

Msquared’s view is aligned with the CBA forecast; that is, we would anticipate property prices falling 15%. However, our risk tolerance towards new opportunities is more conservative as we continue to prioritise asset preservation and have adjusted our risk profile to reflect an extreme decline in property prices.

As Voltaire said, “uncertainty is an uncomfortable position. But certainty is absurd”.

Embracing the volatile world we live in enables an investor to prepare and navigate uncertainty effectively.

The one thing that is certain is Mark Twain’s dire warning that “History does not repeat itself, but it often rhymes”. Market cycles have been around since the advent of money, largely a result of people’s emotions/sentiments. In other words, the market is not driven solely by economic fundamentals.

What is certain and predictable is that market busts will inevitably be followed by market booms, and vice versa. These cycles will continue so long as people make decisions regarding money – that is – forever.

 

Paul Miron has more than 20 years experience in banking and commercial finance. After rising to senior positions for various Big Four banks, he started his own financial services business in 2004.

MSQ Capital

msquaredcapital.com.au



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More than 10,000 companies are expected to have entered external administration by the end of the 2024 financial year, a level not seen for more than a decade. Data just released by the Australian Securities & Investments Commission (ASIC) shows 1,245 companies became insolvent in May, the highest monthly number this financial year. At present, a total of 9,988 businesses have gone bust in FY24 with data from June yet to be finalised.

Deloitte Access Economics Partner David Rumbens said the surge in business insolvencies this year was a “clear sign of economic distress”.

He commented: “[ASIC] predicts that by the end of the financial year, the number of companies entering external administration will likely exceed 10,000 – a level not seen since 2012-13, in the aftermath of the Global Financial Crisis (GFC).”

Mr Rumbens said the elements contributing to this year’s surge in insolvencies include high inflation and interest rates, weak consumer spending, and the commencement of more proactive tax debt collection activities by the Australian Taxation Office (ATO).

“One of the key factors contributing to this surge in insolvencies is the [ATO] pursuing debts that were previously put on hold during the COVID-19 pandemic,” he said.

Mr Rumbens cited ATO figures showing collectable debt rose 89 percent in the four years to June 2023. This has particularly impacted small businesses, which account for approximately 65 percent of the total debt owed at about $33 billion. “But more strictly enforced debt collection is coming at a time of tough economic conditions. High interest rates and cost-of-living pressures have weakened consumer spending, particularly in more discretionary components of spending.”

The construction sector has seen the highest number of insolvencies by far in FY24, mirroring the trend of FY23. Of the 9,988 insolvencies to date, 2,711 of them are in the building sector, which faces several challenges. These include a substantial lift in the cost of construction materials that is well above inflation and has made many fixed-price contracts signed within the past few years unprofitable. There is also a significant labour shortage that is delaying new home completions and new project starts, and also adding higher costs to projects.

“The construction sector has been hit particularly hard, with construction firms leading industry insolvencies in every quarter since mid-2021,” Mr Rumbens said. “They have accounted for approximately 25 percent of all insolvencies during this period. The residential construction sector is already facing a backlog of projects to complete as a result of skills and material shortages in recent years, and increased insolvencies in the sector may only exacerbate the problem of housing shortages.”

The ASIC data shows the next biggest industry affected is ‘other services’, which includes a broad range of personal care services such as hair, beauty, dietary, and death care services. The sector has seen 939 insolvencies in FY24. Retail trade is next with 687 insolvencies, followed by professional, scientific and technical services with 585 insolvencies.

“The food & accommodation sector has also experienced a wave of insolvencies. High input costs, worker shortages, and weak consumer sentiment have put pressure on businesses. Specifically, in March, cafés, restaurants, and takeaway businesses accounted for 5.5 percent of total business insolvencies, the highest proportion in the last three years.”

Mr Rumbens pointed out that while the number of insolvencies was high, it represents a lower share of the business sector at 0.33 percent than it did in FY13 when it was 0.53 percent. “This reflects the increase of registered companies in Australia, which has risen from just over two million to 3.3 million since 2012-13. Even so, the continued lift in insolvencies since 2021 highlights the difficult conditions many businesses face at present.”

 

 

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Just 55 minutes from Sydney, make this your creative getaway located in the majestic Hawkesbury region.

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