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Welcome to Firstlinks Edition 375

  •   16 September 2020
  • 5

Weekend market update: The Australian stock market eked out a tiny gain over last week after a 5% pullback in previous weeks. NASDAQ again struggled on Friday, down another 1%, with the S&P500 off 1.1%. Despite favourable Fed words on inflation targets, the greedy market wanted even more reassurance. There are few signs of a sustained bear market yet, as these levels are little more than a stutter after a strong run since March. The main concern is a rise on COVID-19 cases, especially in Europe, with winter approaching.


There are many ways to value a company, but the most popular is to estimate the future cash flows and discount them by a chosen interest rate. The lower the interest rate, the higher the net present value. So does it follow that when interest rates are as low as they are at the moment, companies become more valuable? Perhaps, but only if the cash flows remain unchanged, and in a recession, future earnings are more difficult to sustain.

This is the dilemma facing every investment analyst, as lowering the discount rate in line with a company's cost of capital can lead to extremely high valuations. Consider what Warren Buffett said in 1994:

“The value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100% sensitive to interest rates because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in over a period of time, and the higher interest rates are the less that present value is going to be."

Hamish Douglass of Magellan says interest rates should be part of any discussion about stock market values:

"It is concerning that there is so much commentary opining on whether or not share markets are under- or overvalued without any discussion about the likely level of future interest rates. We can confidently predict that many stock markets are presently overvalued if future long-term interest rates are 5% or greater and also predict that they are attractively valued if long-term interest rates are 3% or less in the future."

Where does this leave us in current markets? We always find a way to justify expensive markets, and low interest rates is a popular reason. We also blame central bank printing and 'Robinhood' investors, the new retail players bidding up stocks in a game of chance. The reality is shown below.

The long-term median CAPE (Shiller's Cyclically Adjusted P/E ratio) from 1871 to now is about 16 (and since 1980 about 23) and at the same time, real GDP (the blue line at the bottom) has increased a median 3.3% per annum.

But the CAPE is now at an elevated 31 despite real GDP falling heavily due to COVID-19. When economic growth is low, company valuations trend down in the future. Ed Easterling, founder of Crestmont Research and author of many books on market valuations, covers this subject well. It remains to be seen whether ultra low interest rates and ultra high central bank stimulus can hold equity markets at levels that economic growth and corporate profits do not justify.

In Australia, GDP growth has remained strong in the last 30 years driven by population growth primarily due to immigration. In an ominous confirmation of what we all know, the latest ABS numbers show a 99% decrease in overseas arrivals in August 2020 versus a year ago. Martin Conlon's article this week argues the disconnect between stock prices and economic reality has become a giant Ponzi scheme in a casino-like market.

Also in this week's packed edition ...

The $50 billion Listed Investment Companies (LICs) and Trusts (LITs) segment of the Australian market is struggling to find the right business model. Most trade at a discount to asset values, and a new primary deal has not been completed in 2020. We check the ways fund managers are addressing the problem with new structures, and investors should agitate for more LICs to do the same.

In our Interview Series, we meet Jordan Eliseo of Perth Mint, which is experiencing massive growth in demand for physical gold and gold ETFs, including from SMSFs and institutions. Here's all you need to know about gold.

Last week's survey drew well over 400 responses, and Leisa Bell has collated the fascinating results into different articles. As always, it's the comments which are most revealing. See what readers think of the early release of super (hint: Not Happy Jan), the severity of the Victorian lockdown (hint: Not Happy Dan), who will win the US election (hint: lots of support for Trump), forecasts for stock markets (hint: better times ahead). More results next week.

The survey also confirmed half our readers are trustees of SMSFs, and we must not overlook the administrative tasks of the role. There are particular obligations during the pandemic, such as documenting if you took a lower pension in FY20. Nicholas Ali provides a quick checklist to ensure your SMSF remains compliant.

Andrew Wilson outlines a difference between managing retirement income using an SMSF versus a pooled fund, drawing out implications of selling fund units in a down market.

And amid the billions of dollars that the Federal Government is throwing at the pandemic to support the economy, Ashley Owen asks whether we can afford it.

This week's White Paper from Fidelity International explores longer-term implications of work and business due to the virus, including a move to greater collaboration and decentralisation by companies.

Graham Hand, Managing Editor

A full PDF version of this week’s newsletter articles will be loaded into this editorial on our website by midday.

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September 18, 2020

The Financial Times in "Coronvirus: free to read" repots on deaths in excess of normal for many countries during these times. In the UK they are estimated to be over 65000 and in Sweden above 5000, as examples. So virus deaths do not seem to equate to flue deaths.

Bob Burford
September 17, 2020

Michael you have been brainwashed by the likes of the ABC/SBS/BBC/ New York Times and Washington Post. The virus is not as deadly as you believe it to be and mostly the deaths are of aged people with serious under-lying condition's, unfortunately they would have most probably had the same outcome with the flu.The chance of it killing a healthy person under the age of 60 years is very very slim. Yes every life is important but cars kill people but we don't take them off the road. The World as lived with the flu for 1000,s of years and as killed many more millions if not billions of people and we have not shut the World down for the flu. Now on to businesses, Michael, without these businesses no jobs would be produced and they take all the risk, sometimes re-mortgaging there homes to set those businesses up. Dan as a guaranteed wage each week, business owners don't. We must live with the Covid virus and manage it the best we can, time will show millions of people had this virus and didn't even know they had it. Tell me are you at present getting a govt hand out? ask the business owner what he gets?

September 18, 2020

Bob I want you to consider facts relating to this COVID strain that are only skimmed over by Media. Our neighbour is a research scientist on the front line collaborating with scientists all over the world on COVID and the biggest concern they have is that the virus is affecting other cells in the body in a way not seen before, which is giving them great concern for the future impact on society's health. Their message which has strengthened with the more research they do and data produced is that "You do not want to catch this virus as it could be severely damaging to your health in the future." Very tricky situation as no doubt economies need to re-open, but perhaps we all need to heed the warnings of the scientists and wear masks in public spaces until the threat has passed.

September 17, 2020

"Not happy Dan"?
Clearly comments straight from the business community who'd be outraged if they got what they wanted, which would result in Covid taking off again and the whole state shut down with even more severe restrictions.
Its hard to satisfy business which has little understanding of the issue and only has its eyes on money. As Andrews said (not reported in the right wing media) "if we opened up we'd only have to shut down again in 3 weeks time". Funny how business just doesn't want to get it.

Chris Davies
September 17, 2020

Unhappy with Dan because government/public service lack of endeavour and incompetence has killed 100's of Victorians and laid waste to businesses and incomes.


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Weekly Editorial

Welcome to Firstlinks Edition 379

It is trite and obvious to say the future is uncertain, and while COVID-19 brings extra risks, markets are always unpredictable. However, investing conditions are now more difficult than ever, mainly because the defensive options for portfolios produce little income. We explore whether investing rules have changed with new input from Howard Marks.

  • 15 October 2020
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Have the rules of retirement investing changed?

In retirement, we still want to reduce stock volatility while generating cash flows. The two needs have not changed, but the reward expected in the old days from interest payments has gone. What should we do?


Tech continues to run on rising prices not profits

The global tech run paused in September but the boom is driven by rising prices rather than actual profits. It will end when global confidence in the prospect of endless monetary and fiscal stimulus runs out.

Investment strategies

When defensive assets become indefensible, turn to tech

During COVID-19 and the economic recession, we are seeing a surprising new entrant to the defensive sector grouping. Technology shares have been behaving a lot like defensive shares such as food and utilities.

Interest rates

10 reasons low interest rates may limit growth

Ultra low interest rates could be counterproductive for economic growth. Policymakers need to rely less on monetary stimulus and be mindful of the side effects they are creating, especially for retirees and savers.

Financial planning

What the RC, Budget and Keating mean for aged care

Although the Aged Care Royal Commission (with Paul Keating) and Budget announcements gave the aged care sector high profile, the welcome 'granny flat' changes came with inadequate extra Home Care Packages.

Investment strategies

Is currency exposure an unwanted risk or source of returns?

As more Australians invest overseas, currency exposure represents a new risk. 50% hedged, 50% unhedged was once a popular ‘least regret’ approach, but there's a move to currency as a return source.


High growth and low rates incompatible with current share prices

The unrealistic value creation through lowering discount rates while assuming high growth shows a sensible link is critical. Interest rate assumptions need as much valuation focus as the cash flows of the business.



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