I need to know: Is it going to get worse before it gets better?

Candice Bourke: [00:00:12] Hello and welcome to talk money to me. This is your need to know financial podcasts. Thanks so much for joining us. I'm Candice Bourke.

Felicity Thomas: [00:00:18] And I'm Felicity Thomas. Now if you tune in for the first time today, firstly, welcome. Now our podcast is all about updating you on the world of business, what's going on in capital markets. We also discuss and debate investable ideas which have actually caught our eye and offer up our knowledge and expertise in financial advice and wealth strategies.

Candice Bourke: [00:00:37] So this is another one of our jam packed episode where we're going to go deep dive into the markets of the moment, talk about what's going on, and address a big question that we're chatting a lot about between ourselves and with our clients. Has the market fully priced in a recession? So what we'll do today is will look through the US market to date, will compare it to the Australian market and offer up some of those insightful, thought provoking, we hope, portfolio strategies and tactical shifts we're advising our clients to implement to write out the next 12 months because it's very uncertain, right?

Felicity Thomas: [00:01:11] That's right. Candace So I guess a good quote we heard recently was a lot of economists are saying it's not a possibility of major economies around the world heading towards recession or environment, but now it's certainty. And the question is not if, but when.

Candice Bourke: [00:01:26] And another question that's probably even bigger or more topical at the moment, playing on every investor's mind. Anyone in capital markets that manage money is how long and deep could this recession be?

Felicity Thomas: [00:01:37] Now, before we really get stuck into this chat, guys, remember, all the information we chat about on our show is not personal advice, even though we're registered advisors at shore and partners. Please note that the podcast and content discussed does not constitute financial advice, nor it is a financial product. It's based on facts known at the time, which is the 11th of October 2022, and things can change quickly.

Candace Burke: [00:02:01] Oh, my God. And like, it feels like tomorrow is going to be Christmas. All right. So now we're into the last quarter of 2022, I guess, Felicity, before we debrief about the state of the markets in the current play, I thought it'd be a good reminder for us to lay out, I guess, what a recession really means in terms of the technicalities of it and what that means for the markets.

Felicity Thomas: [00:02:21] Yeah, I think that's a really good idea because it's really about the macro at the moment and the market is really following the US stay where the US rates are right now isn't actually a crazy rate for the economy. It's really the next hundred that is going to be where central banks have not gone in a really long time.

Candice Bourke: [00:02:39] That's right. Every central reserve has to do what they have to do to fight inflation. That's the big topic. So let's go back to the basics. Right. Technical terms of going into recession, it's important to remember that we often sometimes need a refresher on what this means in the times that we're in at the moment, which is very uncertain. It's good to provide clarification. So a recession is a period of temporary economic decline, during which trade and industrial activity are reduced, generally identified by the big topline fall in GDP over two consecutive quarters.

Felicity Thomas: [00:03:13] Exactly. So it's not really as scary, I guess, as everyone makes it out to be, but obviously got runaway inflation, big interest rate hikes, the Russian invasion of Ukraine and I guess the unknown effects of the Federal Reserve's quantitative tightening policy amongst the indicators of a potential recession. Actually, only a few hours ago, Jp morgan CEO Jamie Dimon warned of a recession in 6 to 9 months time.

Candice Bourke: [00:03:39] Yeah, that's really interesting, isn't it? And I think the big thing is that the party has to end, right. We've had so much QE, we've had a historic low, low interest rates and we've had a bull run since the GFC. So it's very normal that markets do go through these periods of corrections. Now Europe is a very different state of play. They're already in a recession and the US, you know, at this point in time we're at this like kind of fork in the road. They'll be really lucky to get off with a mild recession at the current rate of things. And what the DOT is pointing to us at the moment.

Felicity Thomas: [00:04:11] Yeah, and I think it's also important to remember that rate rises were seen around the globe actually really take between 12 to 18 months for the impact to really play out in the economy and to flow through.

Candace Burke: [00:04:22] Let's look at pullback expectations and I'm going to refer to a really great article I saw recently on the Bloomberg app. If you're in the markets and you're not using Bloomberg Daily, silly you quick tip jump on every morning because it's a good little refresher on what's going on. So this article was really interesting and it obviously pointed to the longest data point we have for a recessionary style environment and that's the one and a half years during the GFC. So during that time the S&P five, hundreds of the US main index, their pull back 37% peak to trough. And interestingly, the six months leading up to the recession, the market was slightly off. Only 2%. And you know what was more interesting that I took out of this article was that it was basically flat only 4% and a lot of growth like we just mentioned in the 12 months leading up to the market crash. So the general rule of thumb here guys, is that a market will afford generally 30 to 40% from peak to trough in a full recessionary style market sell off.

Felicity Thomas: [00:05:21] And so we thumb diamonds little update. He actually thinks S&P could fall easily by another 20% from current levels with the next 20% slide likely to be more painful than the first week. Yeah. Oh God. But it's all right. It's not all doom and gloom, right? That's why we're here.

Candace Burke: [00:05:40] Well that that's what we'll get to the further part of our chat right Felicity. Because there is a silver lining always. We've got to be optimistic. Okay, so that makes sense because let's look at where we're at right now. So year to date figures. So the S&P 500 has come off about 25%. Nasdaq tech harder hit 33% locally here. The ASX market, the All Ords index has declined 13.5.

Felicity Thomas: [00:06:05] So it allows us to love our war zone.

Candace Burke: [00:06:07] We don't. You wish it was up, but no, it's not. But I guess the best global market indicator that we commonly referred to when we think of like how is the global economy faring at the moment? Is the MSCI index, which is off 31.68% year to date?

Felicity Thomas: [00:06:22] Yeah. So I guess, look, we can see this. The Australian market is a bit more resilient than the US and the rest of the world and we're actually predicting, I mean, don't hold us to this, but that that Australia does not have a recession. We avoided it in the 1997 Asian financial crisis. We also escaped it in the in the 2001 US tech wreck and we avoided the Great Recession during the GFC.

Candace Burke: [00:06:44] Yeah, I mean fingers crossed that prediction does come true. Again, it is a forecast. It's a prediction you can't hold to. You can't hold us to it.

Felicity Thomas: [00:06:52] But unless you go in just yet.

Candace Burke: [00:06:54] Then, then we're going to be like, whew! But let's look at the facts. Australians, we are referred to as the lucky country. To our credit, we do have an excellent judgement and they get a lot of criticism. But the Reserve Bank are really quite good at making the quick decisions when they need to. So recently they quote unquote what everyone's saying, you know, ease or took a pause or took a breath. They didn't do the 50 basis points hike that everyone was expecting. They took a moment to see if it's working. So we are very tactical and quick to respond, which I think is Australia's saving grace.

Felicity Thomas: [00:07:24] Yeah, so I think we really make some clear decisions here. However, it'll need to really be carefully managed I think, because if the Fed keeps raising rates, Australia may get pressured to do the same. And I'll explain why. Because when the US hikes rates, investors buy us to take advantage of higher rates. It actually forces up the price of the US dollar in relation to currencies that haven't done the hike. So unless US hikes in line with the US, the value of our currency is likely to fall in relation to the US dollar, which means for us more expensive imports, which means more inflation. So it's a bit of a catch 22. Now we've actually helped through this with our high commodity prices, which really does support our currency. And perhaps we're looking at a little bit of a decouple from the US. Like you mentioned, our 25 PIP increase shows a little pivot away from the US, so we shall see.

Candace Burke: [00:08:20] Yeah, we've got to remember also we're not on all even playing fields. Every economy has its own battles to deal with and every reserve should act accordingly. So we'll see what happens and plays out there. We're going to have a busy couple of months, I think, leading up to Christmas. Felicity, with all this data coming out and what we're going to be watching in particular is the big US banks and they're set to report their third quarter earnings very soon this Friday, in fact, when our weekly episodes drop. So let's look at the benchmarks again. So the S&P 500 index has lost about 24% or 25%, with all major US indices trading in a bear market territory currently.

Felicity Thomas: [00:08:58] Oh, that is a scary time, isn't it? A bear market? So we should probably explain what a bear market is seen as. We've been a bull market since March 2009, nine years, five months and 13 days to be exact.

Candace Burke: [00:09:12] Did you calculate that? Exactly.

Felicity Thomas: [00:09:15] Love it. It's a little bit higher than that now, to be honest.

Candace Burke: [00:09:19] Okay. All right. Yeah, it's been long in the tooth. Okay. So a bear market is definitely a prolonged drop in investment prices. Generally, a bear market happens when the broader market index falls by 20% or more from its peak to trough. So we're kind of already in that territory like we just said.

Felicity Thomas: [00:09:36] Yeah. So while 20% is the threshold, right, bear markets often plummet much deeper over a sustained period and not all at once. So, you know, although we've actually seen quite a few relief rallies, the trend is generally downwards. So eventually investors begin to find stocks attractively priced and start buying, which will often officially end the bear market.

Candace Burke: [00:10:00] And then the ball comes back, right?

Felicity Thomas: [00:10:02] Let's see.

Candace Burke: [00:10:03] So bear markets, if we look at the textbook kind of definition, they're typically characterised by investors pessimism and low confidence. So during a bear market, investors often seem to ignore any good news that's out on the table. And they still have the trend of selling quickly, pushing prices down even further because fear is their biggest driver at that point in time.

Felicity Thomas: [00:10:24] That's it. I think it's important that in a bear market is investor confidence and business sentiment, right?

Candace Burke: [00:10:32] Exactly. So what we're actually saying at the moment, which is super interesting, is investor confidence still remains relatively positive and euphoric a little bit. The data still showing us that consumers are spending generally. But because I guess like that point earlier, the interest rate hikes haven't really set in just yet. And the opposite is happening in the corporate world. The business confidence is super low. So one data point that I find interesting on that exact point is that we've roughly seen a 30% decline in the measure of popular large cap US equities since the 2020 euphoric moment. So what I mean by that is earnings have grown slightly and business profits have held up, you know, pretty well to date. But the price to earnings ratio have contracted or fallen in response to the accelerating inflation and interest rate rises. We've seen.

Felicity Thomas: [00:11:24] That. So look, if we look at the same large cap US equities PE ratios are now roughly in line with 2011 levels.

Candace Burke: [00:11:32] Yeah, roughly. And then like earlier, like two weeks ago, I remember Felicity, we flirted with the June lows of, of 2022 already. So we are super volatile at the moment. But what that's saying to me is that we don't appear to be, quote unquote, cheap and completely depressed yet in some of these stocks. Hence, a lot of portfolio managers that we tap into and listen to their research and their update. What they're really saying is it's a wait and see holding pattern before we bond top up more. Could it get worse before it gets better? So as we've mentioned, I think there's going to be a lot of data points coming in the next few weeks in terms of US earnings season, fully roll out more of what the Fed's going to tell us. So keep watching this space. There'll be lots of points to discuss.

Felicity Thomas: [00:12:17] Yeah, that's it. Because I think they obviously, you know, with unemployment low, you can see that people are still going to be spending and unemployment low is actually a good thing for the economy. But obviously everyone sees it as a negative, right, because it pushes up inflation. So what is that, catch 22? Yeah, I listened to a podcast recently and they spoke about the fact that large businesses don't want to let go of these really good staff. You know, they're kind of willing to hold on for the next 12 to 18 months because it took so long to actually find them. I think the Fed's going to have a lot of trouble because companies want to hold on to their good staff. It's going to be a really busy couple of weeks for us now. We're going to take a short break and then come back with some strategies on how to invest in a bear market. So the first strategy to consider in times like this is.

Candace Burke: [00:13:07] A drum roll.

Felicity Thomas: [00:13:08] Please make. Dollar cost averaging your friend your.

Candace Burke: [00:13:14] If in fact.

Felicity Thomas: [00:13:15] That's it or your work wife. So. So you say the price of a stock in your portfolio slumped 25% from $100 to $75 a share. If you've got money to invest and you want to buy more of this stock, it can be tempting to try and buy when you think the stock's price has traded or bottomed.

Candace Burke: [00:13:34] Problem is, remember, you'll likely be wrong, right? Sorry. Yeah, because like we just said before, the break piece could come off even more. So the stock market may have bottomed. Or that company that you're looking at on your watch pad, you know, 75 bucks a share, but it could also come off another 50% or 25% from that high. That's why trying to pick the bottom or time the market is just super risky.

Felicity Thomas: [00:13:58] Exactly. So a more prudent approach is to regularly add money to the market with a strategy known as dollar cost averaging. Now, we've spoken about this a lot. I think we mentioned it in basically every episode. So dollar cost averaging is when you continually invest money over time and in roughly equal amounts.

Candace Burke: [00:14:16] And this helps smooth out your purchase price over time, ensuring that you don't put all your money into a stock at a higher price at the one time while still taking advantage of the market dip. So another good, quick tip is if you're at the moment, you know, earning quite a nice income and you're able to save put money aside each month, let's just call it $2,000 a month. Think about a number. With all of that surplus that you're happy to put into the market might be 500 bucks a month. That's just continually topping up the portfolio.

Felicity Thomas: [00:14:46] Yeah, your advisor. Or you could set up a regular investment plan because look, there's no doubt that bear markets can be really scary. And I think for a lot of listeners, it's probably going to be your first. But the stock market has proven time and time again it will bounce back eventually. Now, the key word here is eventually.

Candace Burke: [00:15:04] That's right. And a second strategy that we like to deploy in the current kind of volatile times that we're seeing in a bear market for sure, is diversify your holdings. So boosting your portfolio, diversification so that it includes a mix of different asset classes, means another valuable strategy to put to work in a bear market or actually not. Right. It's just a general good rule of thumb to do the benefit of portfolio diversification is that it increases the probability of having some sectors of the market perform well and hold up better than others, while others are more prone to being sold off.

Felicity Thomas: [00:15:38] Yeah. So because bear markets typically precede or coincide with economic recessions, investors often favour assets during these times that deliver steadier returns irrespective of what's happening in the economy. So I guess this defensive strategy might mean adding the following assets to your portfolio.

Candace Burke: [00:15:55] My favourite dividend paying stocks. So even though the stock prices are going up in the way you want it to all the time, investors take reassurance that they're still getting paid in form of a dividend, so they're still getting rewarded by the company profits and earnings at the end of the day. And that's why companies that pay higher than average dividends will be appealing to most investors during a bear market. It's a bit of a safe haven and a lot of investors rushed to those.

Felicity Thomas: [00:16:20] And now we've got bonds which haven't actually performed very well over the past, you know, five plus years. But now they're actually making an attractive return and they're an attractive investment during shaky periods in the stock market because their prices, you know, often move in the opposite direction of stock prices. So I think that bonds are an essential component of any portfolio. But you need to look at adding high quality, potentially short term bonds that may help ease the pain of the bear market. And we're actually going to look at doing an episode with some bond experts really explaining what a bond is, because I think, again, a lot of listeners don't really understand the bond market. Yeah.

Candace Burke: [00:17:00] So stay tuned. We can't wait to bring that one to you.

Felicity Thomas: [00:17:02] And then I guess hybrids, right? Because they're half equity, half bond. Again, just listen to our episode with Cameron Duncan. He is the hybrid expert and we'll go into a lot more detail. So, you know, having a diversification of asset classes really does help cushion the blow. Yeah, we've got a third strategy, which I think is a great one. And the way we're positioning, you know, investing in sectors that perform well in recessions. Yeah.

Candace Burke: [00:17:28] So what do we mean by that? Well, if we see a lot of portfolio managers at the moment, what they're doing is they're tilting away from high growth, you know, and more towards traditional value stocks. So this basically means that we need to be more selective as investors about the growth stocks you choose in the portfolio at the moment and perhaps look further up the curve to more value, you know, blue chip, quote unquote, large cap monopoly style businesses such as Apple, when you think of, you know, the biggest companies loyal to Microsoft, for example.

Felicity Thomas: [00:18:00] So we're not saying go sell all your growth tech. Positions. We know growth in the sense of mature businesses is okay because there's a lot of value. I think another point to add here. Time is really the only solution to all of this time in the market with the right policy. From a macro perspective as well as I guess investment policy, you know, if it's not the right policy, it's going to be your enemy. So other traditional like typical stocks we like to look at or sectors is utilities and transportation. So think APA and Transurban. Also look at energy. Think old and new. So I think old energy for the next 18 months. Think Woodside, Chevron and new energy firm a bit longer. Have a longer time horizon like uranium plays.

Candace Burke: [00:18:45] Yeah. And further to that, like anything really ESG, right? And then you've got your kind of no brainer bread and butter play on word here. Food staples, fast food in a large discount retailers and packaging. That's a really good sectors or sectors to invest in at the moment. So think elders. We actually did an episode on Elders with Mark Allison. He really talks about the benefits of holding agriculture, particularly in this environment that we're in MacDonalds so that, you know, food staple, fast food, Walmart, Amcor, AMC is the card on the ASX, another sector and I guess one of the most famous quote unquote recession proof or resilient sectors which I spoke about in the last or iPad. Is health care the big H. So in the Australian market you got CSL, you got Sonic Healthcare, you got Ramsay Offshore, Johnson Johnson, Pfizer, Merck and CO. The list goes on.

Felicity Thomas: [00:19:38] That's it. So really a girl's got to eat and unfortunately, you've got to go to the doctor sometimes.

Candace Burke: [00:19:44] And who doesn't love a Big Mac?

Felicity Thomas: [00:19:46] Things happen. I love a Big Mac. That's my favourite. And then you think we are not running away from tech, right? Think mature tech. So we've mentioned Apple and Microsoft already. I think it's also really important to look at cybersecurity as recession resistant. So think companies like CrowdStrike on the Nasdaq. You know, I've mentioned this company a few times on the podcast, actually reading an article on a few different cybersecurity companies recently, even though these are solid businesses that have been sold off 34% for the year, you know, this is something that you need to look at because nothing really has been too safe. But I think here this is where the dollar cost averaging comes in, right?

Candace Burke: [00:20:24] Yeah. Nothing has been too safe. That's so true.

Felicity Thomas: [00:20:26] So in summary, we're bulls on those sectors and then picking out really the best companies within these more recession proof sectors which have strong pricing power, solid balance sheets, ideally pay a dividend to help ride out this volatility.

Candace Burke: [00:20:41] Or if they don't pay, you know, a whopping dividend, at least you can see that they're reinvesting back into the business. Right.

Felicity Thomas: [00:20:47] They like free cash flow. Right. That's super important. And you know, we want to look at earnings, earnings, earnings.

Candace Burke: [00:20:52] Yeah. And you want a really resilient sector. But not only that, you want, you know, sound management board, everyone working to the best advantage of all shareholders, not just the top end of town. So that's what we're keen on versus let's talk about the other side, right? So we want to at the moment reduce your exposure in the recession environment that we're kind of heading into to high cash burn businesses. So pre-revenue business models not don't want any of that or we want a low amount of that. We want to tilt away towards interest rate rise sensitive businesses.

Felicity Thomas: [00:21:24] Yeah, I think here we need a clear run rate to cash flow, positive or clear cut or less, to invest in those high growth speculative ideas. Because let's be honest, I'm not going to remove them from my portfolio completely.

Candace Burke: [00:21:36] Yeah. And it's important to remember that if you're a long term investor, these are all kind of tactical tilts we're talking about are really good for the next 12 to 18, 24 months. But if you're thinking, I couldn't care less, I'm in the markets for 30 years, then it goes back to the businesses you want to own for the long term and the sectors that you want to be in.

Felicity Thomas: [00:21:55] Everything's on sale.

Candace Burke: [00:21:57] Everything's on.

Felicity Thomas: [00:21:57] So I love.

Candace Burke: [00:21:58] Things on.

Felicity Thomas: [00:21:59] Sale.

Candace Burke: [00:22:00] And if you're if you if you start your investment journey today, for example, you listen to a podcast and like, wow, that was great insights. I'm going to jump in the market. Well, maybe steer away from those high cash burn businesses first. And I'll tell you why, because the higher growth rate, more speculative, you know, stocks or sectors or small and mid-cap are the first to get sold off. And we've seen exactly that play out today. So companies that recently IPO'd, they've been sold off aggressively in the past few months so think DoorDash that came to the market at a to IPO price back at the end of 2020 that's off now 67% year to date. So more than those indexes that we mentioned, the start of our show trading around 47 bucks at the moment. Ouch. So that would be an easy tilt that we can avoid that short term pain. And our final point for today is what we always come back to time and time again is focus on the long term.

Felicity Thomas: [00:22:55] That's it. You know, investing really is at least a five, seven, ten year play. And, you know, the bear markets really take. The result, I think of all investors, you know, these periods are difficult to endure. History has shown you probably won't have to wait too long for the market to recover. And if you're investing for a long term goal, such as retirement, that bear markets you'll endure will actually actually be overshadowed by bull market. So that is, I guess, light at the end of the tunnel money you need for the short term goals though, please don't put them in the market. Generally, those you hold for only less than five years shouldn't be in the market. Make sure you don't put any money in the market that you're going to need for short term cash flow issues. Just don't do.

Candace Burke: [00:23:36] It. Yeah, exactly. Resisting that temptation to sell investments when markets are plummeting off is really difficult. You know, that is behavioural finance one and one. We all suffer from this from some period of time. But it's one of the best things that you can do for your portfolio is to avoid it. So if you have trouble keeping your hands off your investments during a bear market, you know, maybe consider seeking advice. I guess a really good quote in this current market and exactly on this portfolio mentality is from the legend Ben Graham, who said, and I'm going to read a quote, The market is a weighing machine in the long run. And in the short term, the market is a voting machine merely being a popularity contest. So Buffett, one of his students, further added to this and said that the votes count in the short term and unfortunately they have no literacy tests in terms of voting qualifications. So I guess what he's saying in a nice way of saying it is the fears that inspired this market sell off will eventually disappear and markets will recover and stocks will become popular once again.

Felicity Thomas: [00:24:41] Try not to get too caught up in the noise. Your playbook will have to change a little bit for the short term. So like we said, take our above points and if you can't keep your hands off your portfolio and stop you from selling, you really should see a financial advisor and help and get them to manage your investments for you in both the good times and the bad times. And with that being said, we can't wait to actually meet you all this weekend at Fine Fest.

Candace Burke: [00:25:06] Yeah, we are so pumped for this Saturday. We look forward to seeing you all there and answering any questions you've got and just generally catching up with you all.

Felicity Thomas: [00:25:15] Now we've actually had a lot of you reach out to us already, which we're absolutely loving. So you can reach us at Tim Tam at Equity Mates dot com or just go check out our business website WW dot CFO group dot com there are you awesome.

Candace Burke: [00:25:28] Well, that's a wrap to our show. So before we sign off, please remember although listen I financial advisors and partners as always, our discussion today does not constitute as personal financial advice. As always, go out and seek professional financial advice. Shoot us an email if you've got any questions before you make your investment and financial decisions.

Felicity Thomas: [00:25:47] We will see you guys on Saturday.

Candace Burke: [00:25:49] See you then.