20 June 2022
Graham Middleton Newsletter — 20 June 2022
Reserve Bank of Australia Gets Serious about Increasing Interest Rates
Coping With Bear Markets in Housing and Shares
The RBA made its second interest rate increase this year on 7 June, this one of 0.5 percent. The stock market immediately fell by 1.5 percent and with further interest rate increases forecast, the share market has since been weaker. Interest rate increases will inevitably lead to a faster cooling of the housing market. New listings and house auctions have fallen and will fall further as more interest rate increases occur in coming months. Those who borrowed to the maximum to buy a house at the peak of the market are facing considerable pain as their monthly home loan payments increase several times this year. If they have other saleable assets they will be considering cashing in those assets to reduce their mortgage. Most will be forced to restrain their living expenses to pay their mortgage payments. The situation is likely to worsen over the next 18 months.
New Government Facing Realities?
The direction of interest rates was known prior to the election. The Labor Party in opposition repeatedly argued that the then government was not spending enough across a range of programs and had its wishes been granted, the budget deficit would have been much greater. There is little basis for the new Treasurer to blame his predecessor. The new government must now produce its budget and is setting out to dampen our expectations.
Energy Prices and Winter Weather Causing A Rethink: Survey Shows Australians Approve Of Nuclear Power
Pressure from green political parties across Europe and in Australia resulted in a shortage of affordable energy from the moment that Russia’s invasion of Ukraine began the process of Europe reducing access to Russian oil and gas. Europe quickly abandoned its carbon reduction targets, restarting nuclear facilities, importing more gas from other than Russia and firing up coal fired plants to capacity. The surge in electricity and gas prices and the inability of solar and wind to provide continuous power have seen demands to extract more gas and for major producers to reserve more for Australian consumers, ignoring the fact that in order to raise the billions of dollars required to open large gas fields and build the enormous processing plants required it was necessary to contract the sale of gas years in advance. The gas companies cannot break those contracts. State governments in NSW and Victoria have blocked or delayed the development of new major gas fields in the belief that green solar and wind generators would solve their energy needs. Political leaders have been found wanting. Australian business and private users are demanding more gas and the rectification of faults in the remaining coal powered electricity generating plants. A recent survey indicates that a majority of Australians now view nuclear power as being a sensible option. It is ironic that as one of the world’s major producers of gas, coal and uranium, Australia is facing a domestic shortage of gas and electricity.
Share Markets, Beware of Dead Cat Bounces
The Australian stock market fell by 1.5 percent on the day that the Reserve Bank increased interest rates by 0.5 percent. They have since fallen further over a succession of days and there is a fear of a global recession. As further interest rate increases are forecast, expect share markets to continue falling. The stock market decline during the Global Financial crisis lasted about 21 months from peak to bottom. The Wall Street crash of October 1929 was initially thought to be a one-off event but kept falling and the US economy bottomed in 1932. It may be 18 months or more before this present interest rate cycle peaks and share markets bottom out. There will be temporary bounces along the way but expect the downward trend to continue. Do make superannuation contributions, but adopt cash and near cash investment options until the interest rate cycle approaches a peak. Our family superannuation fund is above two thirds invested in cash and bank hybrids with a low weighting of shares. The Reserve Bank expects inflation to peak in December at 6.9 percent. Estimates by the US Federal Reserve are significantly higher.
Are Buy Now Pay Later (BNPL) Companies in a Death Spiral?
Zip Co Ltd hit a high share price of $12.35 on 19/2/2021, but on 14/6/22 was trading at 52 cents—a 96 percent fall from its peak. Sezzle hit its high of $11.34 on 28/8/2020 and was trading on 17/6/2022 at 28.5 cents cents a fall of 97.5 percent. As higher interest rates on home loans and other borrowing cause a rise in BNPL bad debts and as their funding sources dry up, BNPL businesses are threatened with extinction.
Afterpay was taken over by Square (since renamed Block) at the top of the market but the bad news is that it was a scrip takeover and Block’s share price has joined the rest of the BNPL industry in a financial meltdown. Analysts at Jefferies which once had a bullish price target price on Afterpay now reckon it to be worthless within Block. It is now impossible for BNPL companies to raise more capital in financial markets and bankers are unlikely to lend more to the sector. The bad debts of its borrowers are eating away at remaining capital. A difficulty is the cost of recovery of the myriad of small debts in the BNPL sector.
Investors in the Buy Now Pay Later sector have lost vast amounts of money and the sector’s continued existence is in doubt. As 30 June end of financial year approaches those BNPL investors fortunate enough to have current year realized capital gains will be considering sale of BNPL stocks to realize offsetting capital losses.
I definitely won’t be buying into the BNPL sector whose faulty business model was destined to implode at the first stage of serious global economic weakness.
Stocks for Tough Times
Expect share markets to fall further over the next 12 to 18 months as interest rates increase further. The first to recover will be companies with sound businesses and strong balance sheets, and which have the ability to raise additional capital near the bottom of the market. This is what occurred at the bottom of the Global Financial Crisis (GFC) around June 2009. A host of businesses with weak balance sheets and poor cash flow will be relegated to the unwanted stock list. Weakening economies separate good businesses from weak businesses. Now is the time for SMSFs to be hoarding cash and ignoring buy recommendations. History demonstrates that investors not afraid to cash out of weak stocks early, even at losses, will be in a strong position to buy quality stocks at lower prices when the interest rate cycle reaches its zenith, possibly in about 18 months.
The market wisdom has long been that “your first loss is your best loss”—i.e. Sell poor performing stocks early.
The Time to Buy?
Most people get interested in stocks when everyone else is. The time to get interested is when no one else is—as Warren Buffett says, “You can’t buy what is popular and do well”.
Bond Markets Are the Share Markets “Canaries in the Coal Mine”
Historically coal miners carried canaries in cages to warn them of dangerous gases. Long term government bonds perform a similar function as the yield demanded by buyers increases the resale value of bonds falls. The bond market is predicting further significant increases in interest and falling asset values.
Australian Bond markets are pricing in Reserve Bank interest rates of 2.9 percent, up from the low point of 0.1 percent. At this point base home loan rates will be close to 5 percent. Both the US Fed and our RBA have indicated that further interest rate rises are on the way.
The Hidden Force Influencing Housing Demand
Hidden behind the housing statistics is the huge surplus of bedrooms across major population centers. In good times, young adults leave their parents homes moving into rented accommodation and swelling demand. The number of people per dwelling falls and stories of housing shortage including rentals abound. If unemployment rises and some young adults are forced to move back to spare bedrooms at their parents’ houses, rental vacancies occur. The impact of this hidden surplus of accommodation is frequently ignored by those commenting on housing. The real estate industry has a vested interest in talking up the housing market.
Higher Interest Rates Mean Lower Loan Approval Limits
The amount banks are prepared to lend depends on their calculation of the amounts that borrowers can afford to repay with a safety margin built in. As interest rates increase, individual borrowing limits fall and the price that they can pay for a house is reduced. The entire housing market falls as interest rates rise.
Those first home buyers planning to upgrade find that they have difficulty in selling their existing home and the number of potential buyers of more expensive homes decline. It becomes particularly important to sell before buying in a falling market.
Expect housing prices to decline further over the next 18 months.
Builder Failures Set to Increase
The latter stages of every building boom see a significant number of builders becoming insolvent as rising labor and building material costs increase and scarcity of key inputs cause completions to be delayed.
Some Crypto Assets Have Failed and Others Continue to Fall
Crypto exploded in types and numbers of investors (speculators) but is being exposed in a world of falling asset values and threatened recession. In buoyant economic times there are large numbers of people prepared to speculate on types of ‘investment’ that they would not normally consider. Crypto was born in better times and flourished for a time based on the greater fool theory. Bitcoin spawned many imitators. In tougher times signified by big collapses in share and bond markets investors will desert crypto assets in droves.
Cryptocurrencies like bitcoin cannot exist as a unit of account of future purchasing power because their value is too volatile.
Cash Flow Practices and Other Businesses
Dental and veterinary practices with strong patient bases will survive the economic downturn. History shows that pet owners gave priority to care of their pets during the last Australian recession and that veterinary practices were among the businesses least affected. Dental practices also survived in good order.
Financial Success for Dentists
Financial Success for Dentists: Rules for How to Approach Your Dental Career sets out the key strategies which make dentists successful. It is specifically written for those dentists and dental specialists owning their own practices and for those aspiring to own practices. Among the topics included:
· Understand key practice valuation criteria.
· Learn how some dentists inadvertently reduce the value of their practice by $500,000
· Avoid long term errors when purchasing your practice.
There are many accountants, financial advisers, marketing consultants, web site designers and practice advisers who give advice from their particular disciplinary experience, but very few have the wider breadth of experience to define for their clients the key rules to follow to optimize their practice and their long-term financial outcomes. An otherwise competent financial adviser may have little understanding of what makes one practice much more successful than another. Many accountants have detailed knowledge of the taxation rules but cannot identify if a dental client has broached invisible barriers to practice growth or a threat to practice goodwill value.
I spent 33 years examining dental and veterinary practice financial outcomes and reviewing the key strategies and decisions which separated successful Australian dental and veterinary practices and practice owners from the less successful and this led to relevant conclusions and advice to dental practice owners.
A complete and comprehensive career guide for mature and aspiring dentists.
Based on real life situations and a lifetime of dealing with dental practice ownership outcomes this book is worthy of Text Book status for every dental teaching school.
—Merv Saultry, Founder Dental Innovations Network
To Obtain a Copy:
· Go to the Delany Foundation website at http://www.delanyfoundation.org.au
· Click on the Donations tab and make a donation of minimum $60. This is easiest by Mastercard or Visa.
· Email graham.george.middleton@gmail.com confirming that your donation has been made, as well as your name and mail address
· A copy of the book will be mailed directly to you
All production costs and mail costs are met by me personally, so all money donated goes to the Delany Foundation which contributes toward the running of schools in Ghana, Kenya and Papua New Guinea. Naturally donations above $60 are welcome.
The donation to obtain this publication will be the most cost-effective practice advice most dentists will ever receive.
Please Pass On
If you like these newsletters, please pass them on to colleagues. Past newsletters and articles in Australasian Dental magazine on business issues are at grahammiddleton.com. I can be contacted directly at graham.george.middleton@gmail.com
General Advice
I sold my interest in a financial services and accounting group on 30 June 2020 and have no intention of starting another financial services business. My website is now available at grahammiddleton.com.
Readers should seek professional advice before making significant financial decisions. Be sure to test new advisers by asking them questions to which you already know the answers.
Those who find my newsletters of value to them are asked to consider making a donation to the Delany Foundation, a registered charity which assists schools in Papua New Guinea, Ghana and Kenya. Delany Foundation c/- Holy Cross College, 517 Victoria Road Ryde NSW 2112.
Best wishes to all readers
Graham Middleton
