Waking Up From Hibernation

19th of May, 2020

Any significant market decline can be emotionally difficult for any investor.

This decline is even more so as we have been thrust into isolation without the comfort and support of friends and family around us. The structure of our work has been demolished as we now grapple with the issues of working from home. Further, we have leisure time with no leisure activities which has led to the increased consumption of social media and the emotional and often ill-informed and poorly researched reporting of this continuing health crisis.

Such an environment is draining, depressing even, for many.

At Calnan Flack we have continually talked about the need to understand that investing is an emotional process and you need to ensure you have your emotions in check.

Investor memory will typically equate this decline to that in 2008/09 and as such not only bring about a repeat of the same investor emotions but also the belief that what we are enduring will turn into another GFC type event.

There is a big difference in what we are currently experiencing. It is the manifestation of a mid-cycle decline. Although it did not start like a typical cyclical event, it will end like one.

Same Same, but Different.

It’s a Health Crisis, not a Credit Crisis and this is what we expect. A mid-cycle event should not be credit related, thus we can look to similar periods (2000/03, 1980/82, 1964/65) to provide some guidance as to what to expect.

These periods will differ from end of cycle events (2007/09, 1987/92/ 1972/74) which are driven by a Credit Crisis.

With time on our hands, rather than hibernating within Netflix, it’s a great opportunity to speak to others about their market and cycle experiences. I urge you to compare your and their experiences of 2008/09 to 2001/02.

Understand that the emotional response can be very similar, but the underlying drivers are quite different. Please be self-aware of your personal investor psychology and the impact it can have when you are interpreting the current news.

Human ingenuity will solve this pandemic. Never underestimate our ability as a species to solve problems in the most innovative ways when we are adequately motivated.

There are many very inventive minds currently at work to resolve this Covid19 issue and I will back them in to come up with a solution.

This means that the clock is ticking on the impact that this pandemic will have. The longer it goes on, the harder it will be to navigate a way out.

We have said for many years that we are currently in the midst of a technology boom with prodigious gains being made. Dr Robert Vagg has presented many times on the Innovation Cycle at our Calnan Flack Forecasting Conferences, demonstrating not only the influence that this cycle has, but showing just where we are within this cycle – and we are on the UP of this wave which will ensure that as a species we continue to grow and expand. We have hardly scratched the surface with AI, robotics and 5G.

The health pandemic will not stop this growth. It may slow it for a little while, but it will NOT be the end of our productivity gains.

This concept is clearly shown when we compare the NASDAQ Index to that of the All Ordinaries. The NASDAQ is a technology index and the All Ords is dominated by the banks that have been continually pressured by APRA the Australian regulator, to beef up their balance sheets, increase their already strict lending criteria and constricting the growth of their lending books.

This regulatory suppression placed on the banks has limited their growth which is reflective in the historic performance of the All Ords.

But the Banks have prepared themselves well for just this sort of crisis.

They have bulging Capital Adequacy Ratios and the level of non-performing loans are spectacularly low. This coupled with record low rates that have helped enable over 50% of borrowers to be +6 months ahead on their loan repayments placing the banks in pretty decent shape.

This is interesting when compared to the US banks who had restrictive legislation placed upon them by the Obama administration, ensuring that a GFC styled credit event could never happen again. Trump quickly repealed the  legislation allowing them to grow their lending books and help the booming technology driven economy to flourish.

The world is in hibernation, for now.

We find ourselves at the depressive juncture of the Mid-cycle decline. Although infection rates in Australia have declined, the world is sealed away inside. Ships are docked.

Planes are locked in hangers while machines lay idle.

Unfortunately, there will be collateral damage for some brought about by financial and emotional strain. On the positive side with crisis comes opportunity and those with strong cash flows or robust balance sheets will be well placed to capitalise on the economic opportunities that will present.

Business with old, slow or outdated practices will be left in the wake of those that quickly adapt and use the crisis to create efficiency gains, resulting in greater market share and profitability.

The government and banks will do whatever they can to keep house prices bloated. A material deterioration in house prices will ensure this crisis moves from health to credit, which will have MUCH bigger ramifications, will be harder to handle and this is something that they do NOT want to have to deal with.

Housing prices up = No Credit Crisis = Stimulation = Prosperity into the longer-term cycle top.

Much has been written about how this health crisis will change society. That it will bring about the death of airlines as we will no longer be confident to travel, nationalism will become a required way of thinking as we seek to shore up our borders and supply chains so we become the self-sufficient island that we once were.

Personally, I can’t see this nostalgic philosophy manifesting into reality. It was David Ricardo who proved via his Law of Comparative Advantage that we are all economically better off when we specialise and trade.

As I see it the days of Australian made textiles and cars are over. Consumers just won’t pay the price for Australian made because of our cost of labour. Part of the cost is because we are a skilled workforce and have adapted the production of higher valued goods and services like energy, agriculture, food production, education and tourism.

There is a caveat I would like to place here and that is the return of technologically driven manufacturing where technology is the driver of the production process and not poorly skilled or poorly paid workers. Those companies that adopt the new technology and new more efficient processes that allow products to be created that are cost competitive will definitely be winners from this economic wash out.

As with any correction, it is the new, dynamic and highly productive companies that will create the new and improved economy to bring home the final boom.

New business models will emerge. New production, technology and processes that drive increased efficiency will enable the new apex businesses to dominate as the survival of the fittest. It is the development of new technology and the adaptation of it that will be felt far longer than our aversion to getting on a plane to enjoy a cheap Bali holiday or buying a Korean made car.

Although it may be some time, until we again shake hands our time locked up inside our own homes has a limited shelf life. We are a social, pack animal who needs to stimulate the sense of touch.

And when this pandemic passes, governments worldwide at national, state and local levels along with the central and commercial banks will be doing their utmost to stimulate us back into prosperity.

The same old tried and true playbook of using debt to inflate our economies and resuscitate our way of life will be implemented. We are likely to see extraordinary amounts of credit created that will flow into our economies and ultimately speculative assets. Amounts that will dwarf what we have seen previously, it always does in the second half of the cycle.

The boom will be driven by credit where the biggest boom will ultimately turn into the biggest bust!

Please stay safe for now, as we all get ready to come out of hibernation.