Investment Matters

Some context

The early part of September has seen higher volatility in markets, and a sell-off in the most expensive technology names. The tech-heavy NASDAQ index has fellen 7.3 per cent lower in the month to date, a result reflected in the Australian Tech Index, which is also down more than 7 per cent this month. The broader Australian market is only down 2.5 per cent.

Tech stocks have been bid higher for months, in a market that became obsessed with growth at any price, avoiding as deftly as they could any companies related to the present state of human health and the economic retreat.

Possible paths following this correction will be driven a range of factors including the prospects for COVID vaccines, and the co-ordinated, or otherwise, actions of the government and central banks.

Why are they so important today, and how is this any different to the past two decades?

The difference is that globally interest rates have reached a “lower bound”, for all intents and purposes, the capacity for “cheaper money” to assist Western economies has been reached. And this point has been reached in the middle of a pandemic when economies need support.

What is different today is that if societies (banks, government and the people) believe that their economies need more activity, the price of money can no longer be the only lever to pull.

COVID has already shown that in certain circumstances there are plenty of other levers, some relate to the government (taxes and spending), and some are regulatory often related to the banking sector.

For equity owners the emergence of these co-ordinated responses increase level of certainty and reduces risk in your portfolio.

This week the highly rated UBS Australia economist George Tharenou penned an economic commentary piece entitled: "'Team Australia': coordinated policy easing ahead? RBA QE, $50b+ fiscal stimulus & regulator support".  The contents aren't as important as the sentiment of the title. Australia is doing a great job, in our view, of combining fiscal, monetary and regulatory support in the face of the pandemic. Markets and politicians are now also grappling with the fact that this new co-ordinated management task will be with us for much longer - even longer surely than the Victorian lockdown.

In the US, Federal Reserve Chairman Jerome Powell also reminded markets and politicians the critical role of fiscal policy in the coming period in the US.  This follows recent commentary in which the US central bank outlined a plan to allow inflation to rise higher and faster than would have been previously permitted without raising interest rates.

The co-ordination task prompts three questions:

•    Can the impetus from higher government spending drive sustainable growth?

•    Will increased activity and more money generated by government spending and regulatory support for the banking sector lead to higher prices (more inflation)?

•    In the face of higher prices and fiscal support will interest rates remain low?

The market has a myriad of views for these three questions.

At one extreme, participants believe that government support is transient, inflation can never emerge, and low interest rates are permanent. Such a view supports tech stocks and bonds with zero interest rates.  All other views are more nuanced. We are positioned for ongoing coordinated fiscal support that leads to moderately higher prices, and the need for central bank managed rates to remain relatively low compared to the level of inflation.

We remain bottom-up stock pickers, but the environment in which our companies operate is critical.

We express this view by owning great companies with strong market positions, such as Woolworths which are good investment in their own right, but which also benefits from an economic order which includes coordinated fiscal responses and higher prices.

At the level of the companies we invest in, their allocation of financial capacity to support their growth and operations are facing the exact same forces.

Recently we have seen cash (or liquidity) become a strong focus for companies, which have been raising capital and drawing down debt facilities in responding to the crisis.

Yet there remain a handful of companies listed on the ASX that have found themselves on the opposite end of the spectrum, those that have been returning capital to shareholders.