24 Jun

Diamonds lead markets as EOFY approaches

It’s hard to believe that we are almost half way through 2022, with the end of June and the end of the current financial year hitting next week.

And while there have been some positive signs on the economic front, the most notable of which is a multi-decade low in the unemployment rate, there have also been a range of headwinds, with ballooning inflation rates making cost of living pressures an everyday reality for more and more Australian households.

And while COVID-19 restrictions have by and large been lifted in Australia, the pandemic is still causing issues, particularly in our most important trading partner, China, which has seen parts of the country locked down for large parts of 2022.

Turning to financial markets and it’s fair to say that, so far, 2022 has been a disaster for most investors whose portfolios are concentrated in traditional asset classes.

Stock markets globally have fallen, with the ASX 200 down almost 15% (global markets have done even worse), while cryptocurrencies have been obliterated, culminating in the price of Bitcoin falling below USD $20,000 at one point in the last few trading days, eliminating almost all the gains that date back to the end of 2017.

Pink diamonds are one of the few asset classes that have prospered throughout this period, with our Australian Diamond Portfolio Pink Diamond Index (ADPPDI) suggesting the overall market grew by approximately 15% in the first nine months of the calendar year.

We expect this outperformance will continue, for while we’ve seen some calm return to the markets in the past few trading days, and a short-term bounce wouldn’t be unexpected, there are major warning signs continuing to bubble away.

These warning signs, which we’ll touch on below, only reinforce the reasons why investors may wish to consider looking at hard assets, such as pink diamonds, as we head into the new financial year.

When will the stock market bottom?

As mentioned above, it’s been a tough year so far for equity market investors, with the markets down (as at 21st June):

  • The ASX 200 (Australian stocks) down 14%.
  • The S&P 500 (US equities) down 24%.
  • The NASDAQ (technology stocks) down 32%.
  • The MSCI All World Index (a global equity benchmark) down 22%.

While that means markets aren’t as expensive as they were at the start of the year, it does not mean that they are cheap today, and that now represents a good time to buy.

Indeed, the drop so far also doesn’t mean markets couldn’t still fall further.

Charts like the one below, which show what the price to earnings ratio (which measures the share price of a company, or index of companies, by the earnings per share of a company or companies in an index) was sitting at when markets have bottomed in the past serve as a warning sign.

Price To Earnings Ratio At Prior Bear Market Bottoms

Chat of Price To Earnings Ratio At Prior Bear Market Bottoms

The chart tells us that the average price to earnings ratios at previous market bottoms was 11.7 times, meaning if a company was earning $10 per share, it should be trading at $117 per share (10 x 11.7).

The current price to earnings ratio for the market is 18.5 times, meaning a company earning $10 per share would currently be trading at $185 per share (10 x 18.5).

If the stock market was to revert to the average of 11.7 times, this would suggest it could fall another 35% easily, and that’s before factoring in the potential for earnings themselves to fall, something that would be highly likely should inflation continue to bite, and/or should we head toward a recession.

Given this backdrop, the desire by investors to both protect against a further fall in equity markets by minimising exposure to them, combined with the desire to hold assets that can rise in value even when equities are falling, is a powerful driver for pink diamonds.

We see little reason for this trend to end soon.

Australian housing slowdown gathers pace

For most of this year, the Australian dollar has been under some pressure, having fallen from almost USD $0.73 to below USD $0.70.

It’s not a massive fall, but there is a good chance it will continue to decline, especially as key commodity exports like iron ore begin to exhibit serious price declines.

One factor that should help the dollar fall further (and also limit interest rate hikes) is the very clear signs of weakness emerging in the Australian housing market.

It’s early days yet, but auction clearance rates (which are a good gauge for where house prices are heading) are falling toward 50% in some parts of the country, while in Sydney, prices are already falling at more than 2% in quarterly terms.

The market likely has a lot further to decline, with Chris Joye of Coolabah Capital, whose been one of the best house price forecasters in Australia, recently noting that; “Aussie house prices could fall by more than 30 per cent if the Reserve Bank of Australia fulfils uber-aggressive market expectations for an increase in its cash rate from the post-pandemic nadir of 0.10 per cent all the way to 4.25 per cent.” 

A fall of that magnitude would wipe out some AUD $3 trillion of housing wealth in this nation, equivalent to about one and a half years of total economic output in the nation.

Given this is set to occur against a backdrop of multi-decade highs in inflation, it likely can’t help but fuel demand for hard assets, like pink diamonds, as investors seek shelter from these headwinds.

As always, we hope you’ve enjoyed this week’s edition of “In the Loupe” and we look forward to any questions or comments you may have.


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