1. Rates normalisation

The 15 years after the global financial crisis (GFC) in 2008 have been characterised by central banks willing to backstop even a modest decline in economic activity by reducing rates, and even resorting to quantitative easing – traders call this the “Fed put”’ (option). 

These strategies were feasible due to several decades of low and falling inflation – central banks could afford to flood the economy with stimulus as it seemed to have no upward impact on prices. 

These measures were accelerated during COVID-19 when emergency measures were deemed necessary; with rates close to zero and governments throwing money at the economy, fiscal and monetary policy were extremely stimulatory but any inflation was deemed to be transitory.

Clearly, those days are behind us. Inflation has fallen from its post-COVID-19 peak but is still high despite rate hikes of 400-500 basis points [4-5%] across most developed economies. 

Investors who’ve only ever seen low or falling inflation, and low and falling interest rates, will have to adjust to an environment where central bankers need to keep rates high to fight rising prices and falling purchasing power for households. 

The consequences for households, businesses and economies are likely to be harsh, but not evenly distributed. Those with little to no debt and strong cashflows could benefit, while those at the other end of the scale might suffer. Assets will be priced according to a discount rate of 5%, not zero – a much higher threshold for investment. 
 

2. Geopolitical risk and its consequences

Russia’s invasion of Ukraine was a nasty shock following 70 years of relative peace in the West after the Second World War. 

Recent tensions in the Middle East are adding to global uncertainty, and making it more challenging for nations to cooperate peacefully, particularly in matters of trade. 

At the same time, COVID-19 exposed the risks of globalisation as some supply chains froze or collapsed. Unilateral decisions on the trade of specific goods are becoming more common. The US has recently banned the sale of Nvidia chips to China, China has banned the sale of Apple iPhones to government employees and Australia felt the impact of China’s trade wrath with domestic wine, barley, coal and other exports hit with bans or excessive tariffs. 

BP and Shell among others were forced to abandon significant oil and gas operations in Russia, writing off billions of dollars. 

Geopolitical tensions, when combined with the lessons of COVID-19, have led governments and businesses to rethink manufacturing locations and practices. Bringing manufacturing onshore or to nearby countries - onshoring and nearshoring – may be expensive, but it has become a necessary cost for businesses concerned about maintaining their supply chains in the event of ongoing geopolitical uncertainty. It seems unlikely that we will see a return to the expansive globalisation trend of recent decades. 

Despite the threats, Australia remains a safe, well-developed market with a wealth of natural resources, making it an attractive trading partner and investment destination for many nations, in nabtrade’s opinion.
 

3. The return of the cycle

One basic principle of economics is that business, economies and markets move in cycles. When conditions are positive, businesses spend to expand their operations, hire more people and are more willing to take risks. 

Households do the same – they spend more when their wages are high and growing, and enjoy more discretionary expenditure such as travel and luxury goods. 

As central bankers in particular are forced to hike rates and keep them high, it is likely that that backstop – the Fed put – is no longer reliable, in nabtrade’s opinion. Businesses with too much debt will lay off staff, and potentially fail. 

Households with too much debt will default on their personal loans and mortgages if they lose their jobs. These factors compound as businesses and households spend less, forcing more business losses and more unemployment – the hard landing many economists are warning of. 

As awful as these consequences are, they are common when the economy starts to contract; for those who’ve experienced three decades of nearly uninterrupted economic growth in Australia, this may come as a shock.

For investors, it is possible that macroeconomic conditions will become more challenging. On one hand, you can now get a reasonable return on a term deposit, and for many, this is a great outcome. 

For those seeking long-term gains, however, the prospect of higher rates and an uneven economy makes investing a less simple proposition. 

Despite this, there will always be sectors growing at extraordinary rates and achieving great things. Seeking out those sectors is the hard part, but two long-term trends appear to offer tailwinds.
 

[Editor’s note: Do not read the following analysis as a recommendation to invest in resource or technology stocks. Resource stocks can be affected by volatility in commodity prices, exploration and/or production risks, and may not suit conservative investors. Investing in emerging technology companies can also have higher risk due to uncertainty with technology development and product acceptance. So-called growth stocks, such as technology companies, can also underperform when markets expect interest rates to rise, as has been the case this year.]

4. Decarbonisation 

Global efforts are underway to limit global warming to 1.5 degrees Celsius above pre-industrial levels and, for the US, to achieve a net zero emissions economy by 2050 (whitehouse.gov.au). 

This ambition – along with the shorter-term US goal of reducing its greenhouse gas emissions by 50-52% from 2005 levels by 2030 - will require extraordinary commitment and investment. The somewhat misnamed US Inflation Reduction Act includes $AUD520 billion for clean energy and decarbonisation initiatives. Bloomberg New Energy Finance estimates that investments of US$3.1 trillion and US$5.8 trillion per year will be required to meet the global 2050 target for net zero.

There are potential beneficiaries of these extraordinary numbers, including some  Australian resources companies that produce the lithium, copper, nickel and other materials required to power the transition from fossil fuels to renewables. 

Some of Australia’s most successful business owners are also enthusiastic about the prospects for solar and hydrogen.  
 

5. Technology

Technology has transformed our lives far beyond the extraordinary uptake of iPhones and Netflix. The current hype around artificial intelligence has the power to transform many fields including medicine and finance, and while the technology – and its adoption – may not justify the current valuations of existing global players such as Nvidia, there is no doubt that Artificial Intelligence (AI) will be in widespread use in the near future. 

As with any cutting-edge technology, it is challenging to determine the winners from the also-rans, and the long-term implications of this trend are yet to be fully understood. 

For investors, however, the macroeconomic and geopolitical headwinds shouldn’t deter you from looking to the future, and considering the potential opportunities ahead.

DISCLAIMER

All analysis at 19 October 2023.  This information has been prepared by WealthHub Securities Limited (WSL) (ABN 83 089 718 249)(AFSL No. 230704).  

The content is distributed by WealthHub Securities Limited (WSL) (ABN 83 089 718 249)(AFSL No. 230704). WSL is a Market Participant under the ASIC Market Integrity Rules and a wholly owned subsidiary of National Australia Bank Limited (ABN 12 004 044 937)(AFSL No. 230686) (NAB). NAB doesn’t guarantee its subsidiaries’ obligations or performance, or the products or services its subsidiaries offer.  This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice.  Past performance is not a reliable indicator of future performance.  Any comments, suggestions or views presented do not reflect the views of WSL and/or NAB.  Subject to any terms implied by law and which cannot be excluded, neither WSL nor NAB shall be liable for any errors, omissions, defects or misrepresentations in the information or general advice including any third party sourced data (including by reasons of negligence, negligent misstatement or otherwise) or for any loss or damage (whether direct or indirect) suffered by persons who use or rely on the general advice or information. If any law prohibits the exclusion of such liability, WSL and NAB limit its liability to the re-supply of the information, provided that such limitation is permitted by law and is fair and reasonable. For more information, please click here.