The stock market is all about looking forward and knowing the past so you can be ahead of the curve.
Two banks in America failed last week and there are expectations that other banks are also close. How does this happen? A simple explanation of how banks work is, you deposit your money in the bank they pay you interest and then lend your money to other people at a higher interest rate.
So how does it go wrong? On the back of the Global Financial Crisis (GFC) interest rates fell to stimulate the economies across the world. Access to cheap credit saw people increase their spending, and governments borrowed more money, flooding the world with cash.
The increase in available credit has led to inflation, which in turn has pushed up interest rates to try and reduce inflation. Investors are now moving money into the backs for risk free income similar to what they would receive investing in higher risk equities.
Banks do not want your money.
I have noted that the big four Australian banks fixed interest rates are lower than the smaller banks. For example, NAB 6-month term deposit rate is 2.55% pa while DDH Graham is offering a 6 month rate of 4.05%. Why? The issue is that with interest rates moving up lending is going down. If they can not lend it out it is a cost to the bank.
Silicon Valley Bank collapse was caused by two mistakes:
- They were holding more money than they could lend out.
- They invested the surplus money in bonds and interest rates when up.
Once investors got concerned, there was a run on the bank. As money was held in bonds they did not have access to the cash.
Can this happen in Australia? The short answer is it is unlikely, as Australian banks are highly regulated to ensure that this does not happen here.
What do these events mean for the Australian Stock Market?
If you are nervous, you should be. Those of us who experienced the GFC are well aware of how volatile the markets can be. Now is the time to review your investments and set out a strategy for the years ahead. Recession is expected at this time in the USA and here in Australia. This will provide opportunities to buy good quality companies at discounted prices.
We cannot predict what will happen, but we can look at the past and get a feeling of what to look for, and structure our portfolios according.
Avoid the following:
- Trying to time the market.
- Moving all your investment into cash.
- Listening to the hype in the media. They sell hype not information.
Action you need to take:
- Talk to your adviser and develop a strategy.
- Review your risk profile to ensure that your portfolio matches your risk profile.
- If you live off the income from your investments make sure you have enough to cover 1-2 years of living expenses.
- Be comfortable holding extra cash.
- Do not sell good companies just because the price is falling.
- Buy unvalued companies – best to speak to your adviser on this one.
What to expect over the coming years.
If history is our guide, the market will surge to new highs, before pulling back. This may occur several times prior to the market dropping. Market volatility would start to increase as investors get more concerned.
We will see companies start to downgrade their earnings as people start to pull back their spending. We saw a bit of this in the February reporting season.
At this stage there is no reason to panic. Now is a good time to review your portfolio and speak with your adviser for those how hold direct equities. If you are invested in a managed fund or index fund you may want to make sure your investments are in line with your risk profile.
Please contact us if you would like more information.