It’s been another positive week on the coronavirus front, with rates of infection in Australia continuing to slow, whilst financial markets (apart from oil) have been calm, at least relative to the extreme volatility seen in March of this year.
Given this backdrop, we thought it appropriate to use this week’s “In the Loupe” to touch on three key areas of relevance to our readers at Australian Diamond Portfolio.
- The shocks to the Australian economy that continue to build.
- Why household frugality is the new normal.
- Why high levels of equity market concentration are a growing risk for investors.
These developments are all linked, and combined will continue to encourage investors to allocate part of their portfolio to tangible assets like pink diamonds.
So far this year, pink diamonds have again shown their ability to hold their value, despite the unprecedented challenges we face. As you’ll see below, we don’t expect that to change anytime soon, with the role they can play both protecting and enhancing wealth becoming clearer by the day.
Australian Economic Shock to Build
Whilst the news regarding the slowing spread of coronavirus continues to get better, with some restrictions on movement and socialising lifted in certain states, the news about the economy only continues to deteriorate.
Modelling by Ernst and Young suggests the lockdown we are currently in could cost up to $400bn over a six-month period should most restrictions remain in place, a number that is closer to 20% of our total economic output.
The pain is already being felt in our banking sector, with NAB, one of the big 4, cutting its dividend AND announcing a capital raising, after cash earnings fell by 24.6%.
Expect the rest of the big 4 to follow suit in due course, with the dividend cuts likely to further compress discretionary spending, given how popular these stocks are with self-directed investors.
Unemployment is likely to rise significantly in the months ahead too, with many economists forecasting a rise toward 10%. Note that even that horrible figure masks the truth, as employees on ‘Jobkeeper’ payments won’t be classified as unemployed, even if they aren’t going to work.
Given this, total hours worked by employees might be the better gauge, with the Reserve Bank expecting this to drop by 20% in Q2 2020.
Overlaying all of this is the huge slowdown in the Australian property market, with the latest commentary suggesting a fall of 10-15% in residential property prices may be seen across the rest of 2020.
Whilst that doesn’t sound disastrous, remember the Australian property market is valued at over AUD $7 trillion, so we are talking $700bn to $1 trillion in wealth evaporating.
Given this backdrop, it’s no surprise to us that we are seeing more investors contact Australian Diamond Portfolio looking to invest in pink diamonds, rather than invest in residential property.
Austerity Will Last
Whilst most market commentary (including some of the points we’ve made above) focuses on the time that it will take for the world to get COVID-19 under control, how deep the recession we suffer will be, and whether we get a V, U or L shaped recovery, there has been little quality analysis on how consumers and households will change their behaviours in a ‘post’ COVID world.
This week we came across a great article that does detail how household spending may change. Titled; “Fire the epidemiologist, hire a shrink” the article looks at which parts of the economy may never return to ‘pre’ COVID normal, noting that in China, even though most restrictions have been lifted, restaurant dining remains well down.
This is an indicator not only of extra frugality amongst consumers, but also the fact that many of us won’t immediately revert to ‘normal’ behaviours even once the government gives us the all clear.
The article also touches on the fact that the decisions being taken by central banks and governments the world over are likely to lead to higher inflation in the years to come.
This frugality at household level, which is a headwind to company earnings and stock markets, coupled with the potential for higher inflation, are both tailwinds for pink diamond investment, as investors rotate part of their portfolios into assets that will not only protect wealth, but thrive in the current environment.
Market concentration is one risk that investors don’t often pay attention too. In simple terms, concentration risk looks at what percentage of an overall market is made up of just one stock, or one sector.
In Australia for example, many investors are worried (rightly in our view), that banks, financial services and mining companies make up 50% of the entire Australian equity market, as this is much higher than most developed markets, leaving us exposed should there be a downturn in resource investment or Australian house prices.
Right now, the concentration risk in equity markets is flashing a big warning sign, with the top five companies in the S&P 500 making up more than 21% of the market, as the below chart highlights.
S&P 500 now more concentrated in the largest stocks than ever
As you can see, this is substantially higher than levels seen almost 20 years ago, just before markets had a huge crash, and pink diamonds begun their impressive, multi-year rally that continues to this day.
Should history repeat, as it so often does, then this market concentration risk is yet another factor which will drive astute investors away from expensive and overly concentrated financial markets toward hard tangible assets like pink diamonds instead.
Those making the move into this asset class now stand to benefit most, as once reality kicks in for most investors, the rush of money into these assets, coupled with the supply shutdown from the closure of the Argyle Diamond Mine, will be seen through continued strong price appreciation.
As always, we hope you’ve enjoyed this week’s edition of “In the Loupe” and look forward to any questions or comments you may have.