Investment Matters – Special Edition
Over the past 20 years, markets have learnt to respond to geopolitical strife in a consistent yet straightforward fashion. Like a secret password amongst the Freemasons, US soldiers in Japan or the original biblical usage, events become coded signifiers of action.
The kinetic warfare over the weekend raised concerns globally across all aspects of life. The code for the market appeared more straightforward, which means:
- Sell the companies and industries that are directly affected, remembering the Ukraine invasion…
- created almost no direct impacts for Australian companies
- other than noting those with significant agricultural impacts and implications for the many companies that relied on the highly skilled Ukrainian tech workforce.
- Buy oil
- Buy gold
- Stay confident with the remainder of the market and use any selling as an opportunity to buy cheaper stocks with firm growth profiles.
Markets less fazed by confllict between Iran and Israel
The playbook has proven resilient over the past week. As the world remains concerned and tensions escalate, markets appear less fazed.
Part of the market’s strength in these circumstances lies in its ability to both parse historical impacts and identify the limited effects that events such as these have on companies’ actual operating conditions and performance.
Let’s consider some trite examples. Notwithstanding the war, over the weekend Australians probably watched more, not less, of Netflix or Amazon Prime, consumed the same amount of coffee, and were equally likely to have paid their mortgage or rent, among other things.
Parsing in this manner also creates clear questions that require direct answers. Some answers generate an advantage for some global markets over others. Often, Australia is well placed, given our tangential relationships and commodity-focused economy.
That said, there are some obvious questions.
- Is wider conflict likely?
Unlikely. Iran is a pariah in the Middle East.
- Is deeper conflict likely?
Possible. The leaders of the belligerents are proud and stubborn; compromise is not in their dictionary. Trump is capricious.
- Will oil prices rise, and will that contribute to inflation?
Oil supply might be disrupted because either Iran’s facilities are damaged/ destroyed, or Iran seeks to blockade the Hormuz Straits. Hence, the rise in oil prices, but also within the context of rising Saudi supply over the past few months, which has placed downward pressure on prices.
- In Australia, what is the impact on interest rates?
A clear relative advantage for Australia. The US Federal Reserve is likely to remain cautious in the wake of higher oil prices and the uncertain impact of tariffs, especially over the next 6 months. The RBA is behind global markets in this easing cycle and now has the advantage of using cuts quite tactically in the face of global uncertainty.
Whilst we have argued that these higher interest rates are creating intergenerational problems, in a world in which turmoil was prolonged, the RBA has significant capacity to boost household incomes through rate cuts.
Australia is in a different position (i.e. much later and slower in cutting rates than other central banks). Interest rates will probably ease.
Change is occurring and in critical ways
In economics, the original meaning of shibboleth can be used to identify ideas which now serve merely to identify allegiance, being described as “nothing more than a shibboleth”. For investors with an eye on structural trends and history, mere shibboleths become critical opportunities to capitalise on changing conditions.
Mere shibboleths. In a world as chaotic as Trump’s, everyday ideas and maxims of behaviour are continuously rejected. Is there a plan behind such mayhem – the so-called 4-D chess versus checkers debate? It doesn’t matter.
Every time a firmly held view is challenged, the world is prompted to assess how much it believed in it in the first place. What was simply an idea for which “the means becomes the end, and the letter of the law takes precedence over the spirit.” What ideas do political parties or communities reorganise around, reemphasise original beliefs, reify behaviours, and reemphasise norms?
Reorganising carries risk for a correlated market…
…however, high-quality portfolios can position themselves to capitalise on this change.
Two investments emerge from this fact.
Firstly, investing in an index based on the historical accident of which companies are listed in the Australian market is suboptimal; by definition, you are investing in past trends.
Secondly, a portfolio typically owns 30-40 stocks; buying such a selection of companies, not the entire market, can achieve both diversification and individual exposure to emerging themes and economic changes.
Whilst the events of this week per se have limited impacts on markets, we suspect that pressure is rising. We have already had twin ‘corrections’ in the market this year. Once in February on a growth scare, and second in April on Trump’s poorly executed Liberation Day tariff announcement.
Investment-wise, the best defence against uncertainty is diversification. Our client’s Australian shares sub-portfolios are not only well-diversified but also free from the biases that come from index-hugging.
Higher levels of cash are prudent….
Clients have, on average, enjoyed higher than 14% return in their Australian equities sub-portfolio so far in FY-25. So, it is prudent to raise cash levels; we reached our highest average cash levels this week. We had increased our cash holdings through May and June, following the deployment of cash in the April sell-offs, most notably in purchases of oil and technology stocks.
Clients have been handsomely rewarded by both, including from the announced takeover of Santos Limited this week.
However, the overall market is quite expensive in terms of future earnings growth (see chart below) at a market-weighted or index level. The red dot on the chart shows that Australian stocks are quite expensive (i.e. higher on the chart), but with modest forecast profit growth (to the left on the chart).
But, note that the drivers of the relatively expensive Australian index are a small number of companies, notably the Australian banks, as well as a few expensive health and technology companies.
The individual stocks we own are rarely so expensive, but the overall market is more vulnerable at these levels.
Source: Minack Advisers
Cash returns for the next 3- 6 months are okay. Further, we expect more buying opportunities to emerge through the remainder of the year.
Summary – the clearest lesson is…
Many long-held ideas are becoming mere shibboleths in a world turned upside down by Trump and his impact.
Building a portfolio that rejects market-weighted indices, which are based on purely historical factors, and instead looking for companies that can both benefit from change and avoid the worst of the consequences, is the clearest lesson of the week.
If you are interested in exploring how a more actively managed portfolio could benefit you, we encourage you to book an obligation-free conversation.
1is the Hebrew word which the Gileadites under Jephthah made use of at the passage of the Jordan, after a victory over the Ephraimites, to test the pronunciation of the sound sh by those who wished to cross over the river
In a Masonic context, a shibboleth can be a specific sign, password, or phrase that only members of the fraternity would know, thereby helping to confirm their identity and standing within the organization.
The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.