42 years ago, I experienced what is now called ‘a light bulb moment’.
In the six months to May 1982, Japanese institutional investors purchased about 8%of Australian government bonds on issue. At a lunch-time discussion at the time, I suggested we should see the unexpected surge in Japanese holdings of Aussie bonds as an Factor-X in our investment markets.
A few months later, I felt early signs of a new and urgent obsession. It grew into a compulsive need to select the Factor-X in investment markets each year. That obsession has stayed with me for 42 years. And “the rules of the game” have changed just once - in 2009, when a sub editor at The Australian re-named Factor-X as the X-Factor.
The X-Factor is the major influence on investment markets that had not been generally predicted or allowed for, but which came out of the woodwork with a powerful effect. My list of all 42 years of the X-Factors is set out below.
To be a fan of the X-Factor, as I am, doesn’t preclude taking a view on where the economy, shares, interest rates, property and the exchange rate seem to be headed. Rather, it’s a reminder that investors need to allow for uncertainties and surprises; and diversification and awareness of risk are important to successful investing.
Sometimes, the X-Factor is favourable for investors. Examples of positive X-Factors include, in chronological order:
- the floating of the Australian dollar in 1983
- the collapse of inflation here in 1991
- our economy being little affected during the global financial crisis of 2008
- the powerful surge in share prices that began in March 2009
- the boost to most commodity prices in each of 2016, 2018 and 2020 as China avoided the hard landing forecast for it
- the sharp recoveries in the global economy and share prices soon after the Covid panic.
Other times, the X-Factor has been unfavourable. For example, and again in chronological order:
- the sharp rise in bond yields in the fake crisis of 1994
- the terrorist attacks in the US in 2001
- the Enron frauds in US markets in 2002
- the near meltdown in the global bank system in 2008
- the powerful disinflation in the 2010s
- Covid in 2020
- the sharp increases in inflation and interest rates in 2022
THE FINALISTS FOR 2023:
No world-wide recession
Some investment banks and brokers spent much of 2023 updating their earlier warnings of an imminent global recession. From mid-2022, they’d been advising investors to switch from shares to interest-bearing assets, including bonds, to limit the harm that the (expected) recession would cause.
Recession didn’t eventuate. In fact, in the second half of 2023 - the favoured timing for the economic crisis that was to trigger recession – US economic growth surged. News bulletins in the US dropped their gloomy talk. Instead, they used phrases such as “soft landing”, “economic resilience, and even the “Goldilock’s economy”.
Australia also avoided recession. Though we’ve shared the US experience of a strong labour market, our recent growth has been more subdued because our preference for variable rate debt adds to the impact interest rates have on spending.
Of course, there will be recessions in future years – but investors can be sure recessions will be fewer in number and more widely spaced over time than the predictions of ‘financial markets’ will suggest. Paul Samuelson, a famous US economist, pointed out 60 years ago that the stock market had predicted nine of the previous five recessions. Investors should keep his wise words front of mind.
Bonds v shares in 2023
Traditionally, bonds appeal to investors in difficult times because they’re seen as better at preserving investors’ wealth than shares. But this view was tarnished in 2023, when shares moved (unevenly) higher over the year, while the market value of bonds was hurt by rising interest rates. At their peak, yields on 10-year bonds rose to be more than four percentage points than at their lows in the worst days of the Covid epidemic. (When interest rates move up, the market price of bonds declines – and the longer the bond’s term to maturity, the greater the impact. (Thankfully, Australia did not follow the example of Austria in issuing a 100-year bond carrying an annual coupon of 1%.)
In 2022 and early 2023, the best ways to reduce risk while cash rates and bond yields did not appeal were floating rate securities including bank hybrids.
US tech stocks
Every review of investment markets for 2023 will doubtless feature the massive increases in share prices of US tech stocks. At times, capital gains from shares in the ‘Magnificent Seven’ tech companies (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) exceeded those in all share markets around the world.
The reasons are not hard to find: the US often generates the best commercial technology and is quick to apply it (think of Artificial Intelligence), many investors have happy experiences using the products or services of the tech companies to influence their choice of investment, and most US tech companies are adept at cutting costs when necessary to maintain high rates of growth in their earnings.
In valuing these shares, investors should avoid traditional valuation metrics such as price-to-earnings ratios and assess opportunities using GARP (that’s the acronym tor Growth at a Reasonable Price), along with carefully thought-out numbers for the increase in earnings over the next five years.
The outlook for cash rates
These days, there’s a flood of analysis and prediction of decisions the Fed and other central banks will make on their cash rates. Two things stand out. One is the high degree of market confidence that cash rates will soon stabilise and be cut in the first half of 2024. And secondly, even stern suggestions by the Fed’s Jerry Powell that interest rates could be higher for longer, have little effect on market thinking beyond about day and a half.
My thinking aligns with that of Escala’s Mark Cooper who’s said, “we've recently seen bond markets make the seventh attempt this cycle to price in a dovish central bank pivot. Even though the other six have reversed it doesn't necessarily mean this one will, as well… (But) I would say that unless the US sees a recession, it will be tough to see a big imminent global easing cycle.”
My view is inflation will run at 3-4% in both the US and here in 2024, high enough to preclude cuts in cash rates. And there’s a 2 in 10 chance of both cash rates being raised next year.
The Federal Government’s argument is that it’s a global inflation problem. In my view, the Government should recognise that much of our inflation is made in Australia.
New taxes
The Treasurer is preparing plans to substantially increase total tax revenues. His recent outline of a new tax on superannuation, and the effort going into rescinding Stage 3 of the tax reform Labor voted for in the last Parliament, shows how difficult - and brave – these will moves will be.
Clearly, the appeal of superannuation to middle Australia would be reduced. And super funds would have less incentive to invest in small companies, whose share prices are often more variable year by year.
Immigration
In the last 12 months, net immigration has increased the population by around 500,000. The intake has enabled businesses to fill vacant positions, especially in heath, retail, cafes, and construction. It’s also contributed to inflation in house prices and rents. Can I ask for tolerance in debates on immigration - many people seeking a considered reduction should not be accused of dog whistling.
And the winner is?
My pick for Factor-X in 2023 is US tech stocks. Even when the current surge in prices cools, US tech stocks can provide worthwhile returns to patient investors who have a reasonable understanding of how they should be valued.
Don Stammer has been involved in investing for many decades as an academic, a senior official of the Reserve Bank, an investment banker, the chairman of nine companies listed on the ASX, and columnist for The Australian and Business Review Weekly. The article is general information only and does not consider the circumstances of any investor.
42 years of the X-factor file
2023 The surge in share prices of US tech stocks, and the better understanding of how they should be valued
2022 High inflation, tighter monetary policies, and sharp rises in interest rates
2021 The fracturing of the long-dominant view low inflation is here to stay
2020 Covid-19
2019 Strong share markets despite repeated predictions of global recession
2018 The impact from the royal commission on financial services
2017 The positive macro influences that, globally, restrained volatility, boosted shares and kept bond yields low
2016 Election of Donald Trump as US president
2015 Widespread experience of negative nominal interest rates
2014 Collapse in oil price during severe tensions in middle east
2013 Confusion on US central bank’s “taper” of bond purchases
2012 The extent of investors’ hunt for yield
2011 The government debt crises in Europe
2010 The government debt crises in Europe
2009 The resilience of our economy despite the GFC
2008 The near-meltdown in banking systems
2007 RBA raises interest rates 17 days pre-election
2006 Big changes to superannuation
2005 Modest impact on economies from high oil prices
2004 Sustained hike in oil prices
2003 Marked fall in US dollar
2002 Extent of US corporate fraud in Enron etc
2001 September 11 terrorist attacks
2000 Overshooting of exchange rates
1999 Powerful cyclical recovery across Asia
1998 Resilience of our economy despite Asian crisis
1997 Asian financial crisis
1996 Global liquidity boom created in Japan
1995 Powerful rally in US markets
1994 Sharp rise in bond yields
1993 Big improvement in Australian competitiveness
1992 Souring of the vision of “Europe 1992”
1991 Sustainable collapse of inflation1990 Iraq invasion of Kuwait
1989 Collapse of communism
1988 Boom in world economy despite Black Monday
1987 Black Monday collapse in shares
1986 “Banana Republic” comment by Paul Keating
1985 Collapse of A$ after MX missile crisis
1984 Measured inflation falls sharply
1983 Free float of Australian dollar
1982 Substantial Japanese buying of Australian bonds