By 1976 Prime Minister Harold Wilson was exhausted, drinking excessively and demoralised. Wilson’s state didn’t substantially differ from his electorate. The UK was a mess.
In the two years of his most recent run as Prime Minister, Wilson had been kicking the can down the road. With a razor thin majority of three seats in the House of Commons he couldn’t afford to upset any part of a factional Labour Party.
As Wilson resigned in 1976 the politics of procrastination had run its course. Inflation was out of control and the economy was in a tailspin. The government kept borrowing money to buy off labour unions and the Bank of England was in a desperate fight to keep the Pound from freefall.
Eventually the capital markets had enough, and Wilson’s successor James Callaghan was forced to go to the IMF for loans to keep the country afloat.
The lessons of Harold Wilson
I’ve been listening to a podcast on the predicament faced by the British political establishment in the late 1970s. It is easy to place blame along ideological lines.
However, the Tory government of Edward Heath which preceded Wilson dramatically increased welfare spending and debt. There were external factors at work as well like the oil embargo and increased industrial competition after Britain joined the European Economic Community in 1973.
Historians can argue about who is to blame. But ultimately a series of decisions which may have made sense in isolation collectively contributed to an erosion of the economic resiliency of the country. Each economic near miss wasn’t used as an opportunity to right the ship and eventually there was one crisis too many.
How resilient are Australians?
There is a point to this detour into 1970s Britain. Given cost of living pressures and the likely increase in interest rates, I’ve been thinking about economic resiliency.
This is partially a question of policy. Policy debates are important and something that the Firstlinks’ community relishes. But everyone should also focus on building resiliency into their own financial lives.
On a macro level there are areas of concern for Australians. Australia has the second highest levels of household debt to GDP in the world at 112%. Much of this household debt comes with interest rate risk.
Unemployment remains low but Australia ranks 22nd in GDP per person employed. This is 20% lower than the US and well less than half of top-ranked Luxembourg. The higher the productivity per employee the better an economy can create and sustain employment.
The low levels of economic productivity per worker and the need for consistent and growing levels of income to service high levels of household debt isn’t ideal. This is true on a national level but also an individual level.
The cause might come down to complacency. Employment has remained high as Australia has spent the last 35 years dodging recessions. The most effective way to build wealth has been borrowing lots of money and then encouraging the next generation to borrow even more.
As years pass this normalises certain behaviour. Australians are comfortable with high levels of debt and confident in finding a job. Hopefully that formula will continue to work.
Your life is the sum of your choices
Building financial resiliency means looking at life a little differently than most. This is hard to do.
Politically it requires choices that fly in the face of the way success is traditionally measured. The easiest way to win an election is to give people what they want – that is generally either more government spending that benefits specific groups or cutting taxes.
The ‘pragmatic’ choices British politicians made throughout the 70s seem stupid in retrospect. But that is only because we know how things turned out. Most of the time the same choices won elections and didn’t lead to economic disaster.
Personal success is also often defined in outwardly projecting the societal markers of wealth. That could be a nicer house, a fancy car or taking part in experiences. It is easy to dismiss the choices others make as extravagant while justifying your own.
Building resilience means giving up some of what you want now to prepare for eventualities that may never occur. And it means doing it consistently. Like most people I struggle with this.
In my own life I’ve focused on three ways of building resilience into my finances. Each involves making a deliberate mental trade-off.
I’ve minimized non-discretionary spending. It is far easier to give up something you want than something you need. By trying not to enter into long-term financial obligations it means I have more control over my spending and can quickly scale back if I lose my job.
I hold excess cash. This is not a good way to build wealth and I constantly tell people to focus on real returns. Cash is always a poor choice when you measure returns against inflation. The opportunity cost of lower returns is just some extra insurance I’ve chosen to take out on my life.
I’ve built a resilient portfolio. I buy boring dividend paying shares and widely diversified ETFs. My portfolio typically goes up less than the index in a bull market and down less in a bear market.
Final thoughts
My approach makes intuitive sense to me and I believe it fits my personal situation, goals and temperament. That doesn’t mean it is easy to follow.
As markets continue to climb I know the wealth I’m leaving on the table by holding cash. When my mates tell me about the skyrocketing shares they own - which I wouldn’t even consider - I feel the regret of missing out. I can read a Nvidia chart just as well as the next guy.
Resilience isn’t sexy. It can’t compete with the popular portrayal of successful investors who stare down risk and are rewarded with mountains of cash. What is lost in this inaccurate portrayal is the impact of randomness on results. Don’t forget that when figuring out your own finances.
Mark LaMonica
Also in this week's edition...
Liam Shorte is back with his annual EOFY superannuation checklist. He outlines 28 important issues to consider.
Dr Joanne Earl has taken the plunge and retired after a career as a retirement researcher. She shares her early impressions and focus on each of her six resource buckets she uses to stay engaged during the transition and beyond.
The common assumption that the future will resemble the past can be dangerous for investors. David Bell and Geoff Warren explore the implications of decades long market weakness on retirement planning.
Is the rise of passive investing increasing volatility? Jason Teh argues the permanent change in market structure requires more sophisticated tools for investor success.
Retirement spending follows a predictable pattern with costs ramping up later in life. Don Ezra looks at how guaranteed income can improve outcomes.
My own ode to income investing including the first - and as far as I know the only - poem on dividends.
This week's white paper is Heffron's client guide for the Division 296 tax.
Curated by Mark Lamonica and Leisa Bell
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Weekend market update
Two articles from Morningstar this week. I took a look at the top and bottom performing shares on the ASX. My colleague Sim explored top ETF holdings in SMSFs.
From Diana Mousina, AMP
Solid economic data, enthusiasm around the AI-driven growth outlook and strong earnings results pushed US equities higher this week, with the S&P 500 once again reaching a record high. The index rose more than 9% in April, rebounding sharply from a 5% decline in March and marking its strongest monthly performance since the Covid-related sell-off in 2020. This rally has occurred despite ongoing geopolitical tensions and no clear resolution to the US-Iran impasse.
Over the past week, the US S&P500 gained 0.7%, even as technology stocks came under pressure following news that OpenAI was going to miss some financial targets. The news weighed on the broader tech sector, including semiconductor stocks, highlighting the increasingly interwoven nature of the industry.
In contrast, Australian equities were down by 0.7% this week, with a decline in consumer staples, healthcare, utilities and tech. Energy stocks were the notable outperformer. Overall, US equities continue to outperform other major markets this year.
Why are markets so blasé about the war? There is clearly an expectation that some form of resolution will emerge, particularly as missile attacks have eased in recent weeks. However, we think markets are underestimating the risks - especially in the oil market.
The Strait of Hormuz, a critical global chokepoint through which around 20% of the world’s oil supply normally flows, is effectively still closed. Oil prices remain roughly double their pre-war levels, despite the relative calm in headline conflict. While there were some positive signs on negotiations earlier, talks now appear to have stalled, leaving the situation stuck in a geopolitical “no man’s land”.
Little traffic is currently moving through the Strait of Hormuz, and the US blockade of Iranian ports remains in place - factors that continue to pose significant upside risks to energy prices, even if financial markets appear largely unfazed for now.
The US is pushing for an agreement that curbs Iran’s nuclear programme - something Iran is resisting - while Iran, for its part, wants the US blockade lifted as the economic costs begin to bite. It’s difficult to see how these competing objectives are resolved quickly.
Perhaps more social media posts from Donald Trump will help. This week he shared an image of himself holding a weapon in front of a city being blown apart, captioned “No more Mr Nice Guy”. But tough rhetoric aside, Trump’s domestic approval ratings remain under pressure, limiting how much political capital he has to escalate or de-escalate the situation decisively.
In any case, we are watching oil flows through the Strait of Hormuz very closely. Oil prices rose again this week, returning to their war-time highs, with Brent trading above US$110 per barrel. This raises the risk that global sharemarkets could once again become unsettled in the coming weeks - as investors reassess the implications of higher oil prices for inflation and economic growth - potentially leading to a modest equity pull-back.
That said, it is also difficult to be overly negative on the outlook. If markets were to sell off sharply, Trump would likely step back, lift the blockade and still declare victory. As a result, while near-term volatility remains a risk, a more sustained downturn in markets is unlikely unless we see clearer signs that high energy prices are beginning to materially slow economic growth.
Another development in oil markets this week was news that the United Arab Emirates would be leaving the Organisation of the Petroleum Exporting Countries (OPEC), which is a group of oil-producing countries that control how much its members produce, to influence oil markets. It does this by setting production quotas to stabilise prices and ensure supply to consumers and reliable income sources for exporting nations.
OPEC controls around a third of global production, but this share has fallen over time as non-OPEC supply (mostly the US) has grown.
The UAE was the fourth-largest member of OPEC, accounting for close to 13% of the group’s total oil production. Its decision to leave OPEC reflects a long-running clash with Saudi Arabia - OPEC’s most influential member - particularly over the enforcement of production quotas.
The UAE has spent years investing heavily in expanding its oil production capacity and is increasingly unwilling to be constrained by output limits set by the group. These tensions have been further intensified by the current crisis in the Gulf, which has sharpened differences over how production policy should respond to geopolitical risks.
UAE’s exit weakens OPEC and means OPEC will control less of the oil market. Without the current Gulf war, the decision probably would have put downward pressure on oil prices, but this impact is being overshadowed by the current supply shock.
It was a week of central bank meetings. The US Federal Reserve kept rates unchanged at 3.5-3.75%. The last move from the Fed was a 25 basis point cut in December. The April decision was voted with an 8-4 majority, there was 1 dissent to the rate decision (Miran) who wanted to see a rate cut and 3 regional president dissents (Hammack, Kashkari and Logan) who voted against the easing bias in the statement. I thought the statement was quite neutral in its commentary and showed that the Fed is attentive to risks on all sides. The Fed is in no rush to cut rates again and the lift in oil prices and impact on other sectors means inflation will go up at a time that inflation is already a tad elevated.
The market is assuming basically no change in US interest rates this year, a big change from early this year when more than 2 rate cuts were priced in.
This meeting also marked Jerome Powell’s final Federal Reserve meeting as Chair, with his term due to expire in mid-May after serving two four-year terms. Powell confirmed that he intends to remain on the Fed’s Board as a regular governor for a period yet to be determined, contingent on a clear resolution of the legal scrutiny surrounding cost overruns linked to the renovation of the Fed’s Washington DC headquarters.
While the US Department of Justice dropped its investigation last week - clearing the way for Kevin Warsh to be confirmed as the next Fed Chair - the matter has since been referred to the Fed’s inspector general for further review. The prosecutor also noted that the case could be re-opened should new information emerge. In his remarks this week, Powell was firm in stressing the importance of protecting the Federal Reserve’s independence from legal and political interference.
It was an interesting Bank of Japan meeting. Interest rates were kept at 0.75% but it was a “hawkish hold” as there were 3 dissents (out of a 9 person board). Japan’s CPI (ex fresh food) is now expected to reach 2.8% in FY26 (from 1.9%). The Bank of Japan’s cautiousness on raising rates is keeping downward pressure on the Yen and Japanese policymakers had to intervene in the market at the back-end of the week, causing the yen to have its largest intra-day gain in almost two years. We expect a rate hike from the Bank of Japan in coming months.
The Bank of Canada held rates at 2.25%, which is a cyclical low. Rates are expected to be held steady if oil prices start to normalise. However, the central bank sounded hawkish and emphasised the upside risks to inflation given movements in oil markets. Markets are pricing in the risk of hikes later this year.
The European Central Bank kept interest rates unchanged at 2%, but warned up upside inflation risks and downside growth risks and there is a high likelihood of a June hike.
The Bank of England held rates at 3.75% with a 8-1 vote. The committee set up multiple scenarios around the impact from higher oil prices and a rate hike is a possibility later this year.
So all up, Australia is still an outlier by being the most aggressive to start the hiking cycle but other central banks may have to follow suit later this year.
We are less than two weeks away from an Australian Federal Budget and as is common before a budget we are getting dribbles of policy announcements in the news. The government looks to be seriously considering changes to the Capital Gains Tax (CGT) discount. The current rules are that a 50% discount is applied to the capital gain if an asset is held for over 12 months. Before CGT was introduced in 1999, inflation indexation was applied to assets to calculate the capital gains tax implication. Now, the government is talking about reducing the discount from 50% to 30 or 25% due to concern that the current system favours wealthy, older investors, locks younger generations out of housing, and worsens inequality. Let’s take a look at the figures. My colleague My Bui did some analysis on this over the past week.
Investors have benefited from the 50% CGT discount since its introduction in 1999, largely because house prices have risen by around 6.2% per year, far outpacing average inflation of 2.8%.
But between 1985 and 1999, investors would have done better under an inflation-indexation system. Inflation was higher at 4.4% pa, while house prices rose at a more modest 5.9%. So in other words, whether the CGT system favours investors depends less on the tax design itself and more on the economic backdrop.
And looking into the future, if home price growth slows to around 4% per year and keep inflation at 2.5%, the 50% CGT discount would actually disadvantage investors who sell within the first 20 years.
The discount is even worse for investors if inflation is 3%, which is not too unrealistic in a world of higher geopolitical risk, aging populations, rising public debt which all tend to be inflationary.
Negative gearing changes also look to be on the table. I doubt the government would consider scrapping the CGT discount or negative gearing concessions entirely as it would cause too much backlash (like the Bill Shorten campaign in 2019 to curb negative gearing) but reducing concessions is probable.
The bottom line is we can debate all day about how best to tax housing investment, but housing inequality won’t be fixed through tax alone. The real solution is to build more homes, which practically means less regulation, faster approvals, faster construction, more tradies, and less government crowding out private construction. A wider tax reform is also necessary and arguably an indexation-based system has merits, but changing CGT alone won’t change the big picture.
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