Good morning all

This is just a quick update on the state of the global financial health and the state of the stock markets due to the small correction in the United States market on Friday that included all indices including the S&P, Dow and NASDAQ which in turn will flow onto the Australia stock market today.

As you are all aware from your investment reports the markets have been producing tremendous returns over the last 12 months and beyond. Some of the press have been incorrectly assuming because of this that we are now due for a crash. It is for this reason I have put this email together; to let you know that they are incorrect and the small pull back we are experiencing is just part of the market volatility. The world markets are indeed in very good health.

Over the last 12 months all international markets including North America, European Emerging Markets and Australia have produced double digit returns on the back of very low interest rates, increased productivity due to expanded trade and the increased wealth in the Asian economies. Simple economics states that an increase in productivity will have a natural flow down through the economy and this has occurred across the globe. Obviously the main driver of the growth is low interest rates allowing easier access to money to buy assets that increase both growth and yield; this in turn increases and expands wealth. Since the GFC in 2007 the United States, being the world’s leading economy, has been on a Quantitive easing program that initially bought debt when the crisis hit and dropped interest rates to .25 basis points to stimulate the economy and ward of a recession. Since this time the US has kept low interest rates to stimulate money flow through the economy and increase productivity, which helps stimulate employment and fiscal growth. As we have all seen this has worked and the increase in productivity has flowed through to the rest of the world and growth and expansion has been the driver of very high returns.

The question many observers are now asking is ‘due to the increase in the stock markets and the higher than normal returns are we due for a stock market crash?’ The reason for this concern is since the turn of the century every 10 to 15 years we have a stock market crash of between 11.89% to 37%. As we know it has been 10 year since the last crash in 2007, which was the worst downturn, recorded of 37%. In my opinion the answer is no and not yet. Which in simpler terms is yes, we are going to have another correction at some stage but it won’t be in the next 3 years (at the minimum) due to the strength of the world economy. The good news is that this current pull back will extend a possible correction and will also make the impact all the smaller when it does occur.

The reason for the pull back on the stock market today is twofold. Firstly, profit takers are out in numbers and secondly, there is concern inflation is starting to occur in the United States which has increased Bond yields over the last 3 weeks. As productivity is growing wages are starting to grow and overall the markets are moving along nicely but too much growth causes an over expansion and then inflation starts and prices increase too quickly, which is not good for the economy. Another reason to add to the pull back on the markets is Bond yields have increased to 2.75% which means that Bond yields are starting to move above dividend returns, (just in the United States) and once this occurs people start to sell high risk returns, like shares, for lower risk returns, such as Bonds and hence this has added to the volatility within the markets. I mentioned earlier that profit takers are out in numbers, these are the sophisticated investors who short the market via stocks and CFD’s and are the sellers on the derivative markets who can add Billions to their profit, so a downside is a good thing when markets get volatile for short sellers. Hedge funds would have made their clients a nice little sum to say the least.  

As I mentioned before at this stage things are going nicely in most markets but due to inflation expectation there will be an increase in interest rates globally in 2018 at various stages. The US will increase rates in March (or at least are expected too). This will dampen returns in certain areas that require debt for normal activity while the business is expanding. Those that require debt will need to weigh up the profitability and risk once interest rates rise as borrowing becomes harder to service. You still need to remember that one of the biggest helps for driving profits of recent times is the lower wage payments that most corporations have been able to decrease over recent times. “Once upon a time” pre GFC the wage component of the majority of companies comprised of about 45% of their fixed costs. Post 2007 the wage component has fallen though the floor and is barely 30% of their fixed costs. This is due to technology and outsourcing to lower based wage earners in Asia. This has increased profits, which in turn has been passed back to shareholders and down though the economy. If you add in the technology sector such as Facebook, Google, Amazon, Ali Baba, Uber the wage component is barely 5% so profits are enormous. I must note the technology sector has changed the business landscape incredibly over the last 10 years so it’s easy to see why our portfolios have been performing so well. We will have this conversation at a later date.

Another area that needs to be touched on is the new $1.5 Trillion infrastructure program that is being due to be passed through the US Congress within the next month. This will be a huge boost to employment and expansion so for at least the next 3 years we are going to see a further upside to the world economies. There will be areas that will slow down including real estate and the breakneck speed of the Asian economy, but overall a good steady increase will occur for now. Australia will have its struggles due to the slowdown in mining and finally the slowdown in real estate in the capital cities. I must say I am pleased that Sydney and Melbourne are experiencing a decline in housing prices as this will help keep Australian interest rates on hold, which is a good thing due to our fragile economy.

On a final note we are happy to take any calls if you are concerned about your investments but for now we are business as usual.

Regards

Allan Butson