Are you kidding yourself about diversification?

For years, the RBA has argued that an economic recovery is “just around the corner” with wages and inflation about to increase.  So far the RBA has been wrong – their preferred trimmed mean inflation has been below target for 3 years and counting. The issue is the penalty for being wrong during a housing boom was that the boom wasn’t as big as expected – but the penalty for being wrong during a housing market correction is that the correction turns into a crash that drags the rest of the economy down with it.

Most Australians are kidding themselves when they think they have a diversified portfolio that will protect them from an Australian housing downturn.

RBA Wage inflation forecasts

The Australian economy is at a crossroads, either (1) RBA is right, something will show up and everything will be fine (2) RBA will continue to be wrong, or there is an international economic shock, and the housing correction will turn into a housing crash.

Forget for a moment the arguments for and against the two paths. Let us assume that both are credible outcomes with a non-zero probability of occurring.

My issue is the upside and downside risks are not equal.

Very few Australian have any diversification against the second option. If you are not diversified, and I mean properly diversified, (not just that you own both bank shares and bank hybrids) then you could be facing dire financial circumstances.

If the RBA is right and you have any of the following characteristics then you will benefit:

  • Own your own home
  • Own an investment property
  • Have superannuation invested in the Australian stock market
  • Own Australian shares
  • Own Australia corporate debt or hybrids
  • Work in a property-related job, whether it be directly with a construction company, as a tradesperson, in a bank or in a range of ancillary occupations relying on the property market like legal, real estate services etc.

However, if these are the only assets you have then you have basically shifted all your chips into the middle of the table betting on a recovery in the housing market. You may be right, but if you are not then you will be in trouble – and if you have a loan against property or shares, or if you are employed in a sector related to the housing market, then your risks are exponentially higher.

Keep in mind also that a likely outcome of a housing crash is a much lower Australian dollar. If you expect to buy imported goods in the future, they will cost more. And with the new structure of the Australian economy, we all buy imported goods – cars, phones, TVs, computers, none of it is made in Australia. Australian’s have even turned electricity into an import – the marginal price of electricity is set by gas, and Australians now pay some of the highest prices in the world for gas as we are now tied to the Asian gas price through exports. So, the Australian dollar falls and your electricity and gas price will also likely rise.

So, even if you don’t think option 2 is a likely outcome, you should be doing something to hedge against it.

In both the investment and superannuation funds that I run, I prefer lower risk hedges: Australian government bonds, cash (both domestic and foreign currency denominated) and international shares, but there are a lot of other ways you can protect yourself from the downside. This most recent stock market bounce has given you one more opportunity to position your portfolio – and I’m not that confident you will get another one.

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Damien Klassen is Head of Investments at the Macrobusiness Fund, which is powered by Nucleus Wealth.

The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. Damien Klassen is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Integrity Private Wealth Pty Ltd, AFSL 436298.

Comments

  1. What are you talking about? Australian investors are diversified…. Their IP’s are in 5 different suburbs! And their super is in 3 different banks!!!!

    • Bingo! Huge numbers of Aussies are exposed to: OO property + IP + ASX200 (30%+ banks), via Super etc.

      The only way you could be more exposed to ‘the bubble’ is have a job in real estate / development plus a SMSF that includes an IP and pure exposure to banks (and their ‘amazing’ dividends) as Damien says. If things go t!ts in a spectacular fashion the financial devastation could be quite epic. This is why money printing on a vast scale is inevitable — the only question is when.

      The China situation shows just how fragile things truly are.

      • boomengineeringMEMBER

        Many years ago my gym client walked in saying he had to give a lecture on diversification. I leaned back on my chair behind the counter and bellowed, “DIVERSIFICATION? diversification is for cowards. He brought up my statement at the lecture and everyone laughed. In my opinion too much diversification and you lose your finger on the pulse.

    • The truth is most people dont have the money to “diversify” and they dont have the time or cognitive capability to look at more than a few investments. They put it instead into things that they have been told aren’t risky (e.g housing and banks)

  2. “The Australian economy is at a crossroads”

    More of a tipping point. Not just Oz – negative stuff happening all over. But too many think that this time it’ll be the same. Sure, there may be choppy waters ahead, even rough seas, but we’ll struggle through, just like we did in the GFC. Cuts & bruises, a few broken bones but not fatal.

    I don’t think so, not this time. The body politic is rotten from the head down and soon the maggots will burst through the decaying skin and even the comatose will awake to reality.

    Then watch out below. When Martin Place is awash in a sea of yellow (or the Oz equiv, shorts & thongs) it’ll be too late to abandon ship: drown in place.

    After a couple of quick cuts by the brave RBA, the smart money will flee (the really smart money has already fled) and queues outside banks will not be orderly as the hoi polio scramble. Digital didn’t make it in time and there’ll be no hero Kev to save the day.

    Then, as gubermint cheques stop, things will get serious.

    Option 3 would be to rip the s*** out of the political system, destroy the welfare state and start over.

    • “destroy the welfare state and start over”

      You do understand that has been the neoliberal project for almost 50 years, where everything is given the market treatment, not that the GFC was a direct result of neoliberal beliefs to begin with.

    • No need to destroy the welfare state. It is destroying itself as we speak.

      “That which is not sustainable will stop”, Herb Stein.

      The next major crisis will be met with unprecedented money printing which will eventually destroy the currency. The currency is all that the Govt has to fund the welfare state. One day, people who rely on transfer payments will wake up to find that any funds they have received from the State will purchase nothing of any substance. That, right there, will be the end of both the monetary system and the welfare state. Those that don’t understand the concept of self-reliance today are, frankly, fvcked.

    • Option 3 would be to rip the s*** out of the political system, destroy the welfare state and start over.

      Neoliberals rejoice, mission accomplished !

    • Just wow … currency is not wealth, even then those that swing towards commodity money, whilst committing categorical error due to false optics on fiat currency, then journey on Musks car in space over devaluation.

      Yet this is the same mob that got everything wrong under Milton and the Monetarist and then the quasi Monetarists afterwards, especially the part about IR w/ a side of government not having a bar of it after abdicating it to the sage economists staffing CB’s …

      But yeah … the welfare state or is that just another term for corporatist state … silly me …

  3. That Wage Price Index curve is rather embarrassing for the RBA. Wonder if it ever comes up over coffee.

  4. Pretty much agree with what Damien has written above. One thing I’m not sure of though is surging generalised inflation in the wake of a falling $AUSD – the Aussie has depreciated a long way since those heady boom days and yet we are struggling to generate inflation. Generalised inflation requires that John and Jane Average have the means to keep on paying more and more for everything at a rapid clip – the traditional mechanisms that allowed that to happen appear to be broken. Centralised wage fixing is gone and unions are emasculated – so we won’t see wage-price spirals – and the capacity to replace that income growth with borrowed money looks just about tapped out. Even if immigration were to be cut back to a sensible level I’m not sure it would be enough.

    Seems to me the most likely outcome is for many domestic businesses to simply have their margins squeezed further and further as the cost of the import components they must pay rise with a falling $AUSD but the average Aussie consumer is simply unable to muster the discretionary spending power to pay more and more. More business failures as they compete harder and harder among themselves to retain a share of a shrinking pie seems most likely to me.

    Which is obviously a bad outcome in itself.

    • Damien KlassenMEMBER

      Sorry for the confusion. In scenario 2, inflation won’t be an issue. The price of imports will increase, but any inflation increase will be short term only.

    • The only people who believe that inflation is a good thing are quack economists. Do yourself a favour and get to grips with proper economics i.e. classical economics. Neo-classical economics is the realm of swivel-eyed loons.

      Economics is not rocket science — all theory should pass the common sense test. Inflation is simply the reduction in purchasing power of the money that everyday people earn. How on earth can that be a good thing? You earn a dollar today and tomorrow it doesn’t buy you as much. The only people who benefit from inflation are people who are up to their necks in debt. Still sound like a good thing?

      Modern Economics – lol

      • In other words as a cad country most Australians be edit from inflation. Better if under reported as well so interest rates dont adjust too harshly to compensate.

      • You mean commodity money preferences and not economics Dominic, not that mainstream neoclassical or its side kicks have operated with a functional model of the monetary or functional financial system all whilst banging on about ex ante ideological philosophical beliefs. You know the ones that enabled all the financialization, wage suppression, enabled loonie C-suite remuneration, wave of privatization of commons and common pool resources, the market is the supreme machine for everything regarding humans and life on this planet ….. Classical economics …. pull the other one …

      • Oh dear skippy ..
        You really are satisfied living in your delusional bubble aren’t you. I’ve never understood incurious people.

      • TOO MUCH inflation is harmful, yes – very little or none at all over an extended period indicates that for some reason, demand is not strong and many capitalists are likely having trouble making a growing profit. In some people’s ideal world there would never be any inflation but ideals seldom reflect reality. Zero or deflating CPI indicates a weak economy and a diminished range of new opportunities for the capitalist to invest in or expand existing capacity – if there is zero inflation it’s probably because consumer demand growth for businesses output of goods and services is stagnant or weak – is this really preferable to a small annual rise in prices?

        It is far too simplistic to say that rising prices must automatically be 100% bad 100% of the time – because there is some level of a symbiotic relationship between the capitalists and the prols. The worker who is a cost of production to one business is the consumer of the next businesses products and one workers wage is the next businesses income – we cannot escape this fundamental reality.

    • With the greatest respect your grasp of economics is derived solely from what you have read in the press. Genuine inflation is little more than a reflection of monetary expansion — there is no such thing as a ‘general price level’ and a target of 2% is as arbitrary as you can get. The clueless morons that constantly bemoan a ‘lack of demand’ as being at the core of economic weakness have zero idea. Demand is potentially infinite — what dampens demand is the price at which goods and services are available. What needs to happen is that supply should adjust to meet the decline in demand, however, what the dweebs at the central banks attempt to do is prop up demand by lowering interest rates and make debt service easier on those who are living beyond their means i.e utterly unsustainable.

      This cannot continue forever. We are in the midst of a gigantic ponzi scheme.

      • I have no formal training but my understanding runs a bit deeper than solely what the tabloids churn out. However, I haven’t been closely involved on a daily basis for years as I am these days self-employed/sole trader so time can sometimes be a bit more of an issue (still prefer working for myself though). So I will probably have forgotten a significant portion of what I learned.

        I fully agree – and always have – that it was a bad idea to prop up demand by making debt ever cheaper and more easily available. Look where that has gotten us. The “wealth” created by this course of action is evaporating as we speak……but the debt and the commitment to servicing it remains.

        And naturally, the 2% – 3% target is arbitrary.
        I’m not sure about markets “clearing” purely as a function of price alone, I would say that what dampens/stokes demand is the price at which goods and services are available……but that this is also relative to the ability of consumers to afford it. If spending power (wages) were to fall in just one or two areas, those businesses might come out in front. But if they fall across the board and workers are not able to borrow to make up the difference, business will as a consequence be required to cut the price of their goods and services in order to remain level-pegging and avoid losing market share – can that really be called a win?

        So HOW a reduction in price is achieved is very important – no business wants to take a reduction in profits so the focus tends to be on cost-cutting. If the costs that are cut are the cost of labour and this were to occur across the economy, then it tends to be a bit self-defeating as the price of the goods and services may have come down but so has consumers ability to afford them – this is the dynamic we call “race to the bottom”.

        I’m acutely aware of the fact that what I produce and sell is very nice to have (if I do say so myself) but it’s not essential for life and falls into the realm of a luxury good. John and Jane Average only buy it after they have paid mortgage/rent, car payments, fuel, put food on the table, shoes on the kids feet etc. And most of my customers are John and Jane Average. I can drop the price so far but eventually the entire operation becomes unviable – upstream costs could only fall so far before the entire supply infrastructure up there would cease to exist.

  5. Serious question for Damien (and anyone else):

    If the banks get into serious trouble, how will we get our cash out of their brokerage accounts when we sell our offshore focused shares and ETFs?

    Don’t fancy have my stocks in a smaller broker given we’ve seen them do naughty things.

    Are we left with going to the bank and exchanging it all into US$, but transferring it where?

    As the global market has its inevitable large and nasty correction on top of Australia’s timely demise, where is the next place to be, if even only for return of your capital?

    • Damien KlassenMEMBER

      Banks have (broadly) 4 types of capital: Retail Depositors, Wholesale lenders, Tier 2 capital (hybrids, convertibles etc) and then Tier 1 (equity holders).
      Losses go from right to left – i.e. Tier 1 are the first to lose money, then when wiped out you go to Tier 2 and so on.

      In the financial crisis, governments around the world bent over backwards to make sure that wholesale lenders didn’t lose money – and so I find it hard to imagine a scenario where the Australian government would decide to let losses wipe out not only every other part of the capital structure but also depositors who are the main “voting” part (by number) of the bank capital structure. The RBA will open the printing press well before that happens.

      There are separate issues about small brokers/banks which might have problems earlier – if you are worried then you need to look at the custodial arrangements where you are investing.

      If you are truly worried that there will be a financial crisis so dire that Australian retail depositors have their money confiscated en masse, then any asset that you buy (including gold) is also likely to be on the list of confiscated assets.

      • Yup, hard to believe that banks won’t get a wholesale bailout in the event of a crisis — maybe even the shareholders given the prevalence of stocks in Super funds. The UK bailout model (GFC) might provide the blueprint.

  6. Many “investors” finding out the hard way the meaning of diversification.
    It is surprising opposition to policies like negative gearing don’t argue more this point that they encourage high risk by discouraging asset diversification. If government concerned about ageing population taking care of themselves they should push for safe investing, not risk.

  7. Diversification : wtf is that
    As a nation our one undeniable talent is that of balancing our bloated a55 on a one legged economic bar stool
    As a consequence we’ve developed cat like reflexes (not) and a sense for economic earthquakes (hardly)….any interference with the “well designed” processes that guarantee balance (lets call them “net capital flow” and its close friend net debt) will guarantee we go splat on the bar floor like some drunken Argentinian.
    However, as for real Diversification, whatever way you look at it it’s to late in the game to make the necessary changes, what’s gunna happen is gunna happen. We need to start planning for what comes after that and in truth the only sensible long term plan is to focus on Education, and I mean real education. Let’s at least regain our lost Pisa rankings, lets hope we can open our eyes (and wallets) to alternatives (hint hint Singapore)
    Our workforce needs to be globally in demand for its skills, that’s the only 21st century labour model that’s likely to yield positive wage growth and resultant class equality.
    We’ve completely missed the boat on Diversifying to maximize the life of our 20th century economy so lets not also miss the boat on real Education for a 21st century Economy.

    • >…We’ve completely missed the boat on Diversifying to maximize the life of our 20th century economy so lets not also miss the boat on real Education for a 21st century Economy.

      Soooo… if I read this correctly – that’s a “Learn To Code™️” with a dollop of “we just have to plan better™️” suggestion you’re making there, mmm? And no, I’m not taking the piss – I’m being serious here. Basically I’m tired of reading all this manure about “future jobs of the future” which no one can tell what the f*ck they are, other than they will have to be “touchy-feely, teamy-worky, open-planny nirvany”.

      It all sounds very much like catholic afterlife, and you have to be good to make it into heaven, but in the mean time, don’t talk with your mouth full of Cardinal.

      • That’s a rather narrow interpretation of what I wrote.
        Educational Excellence goes way beyond supplying code monkeys to program/maintain global “digital” systems.
        That’s just another example of supporting dead/dying 20th century industry.
        Education Excellence is about Aussies inspiring / creating direction in emerging 21st century industry, there are huge opportunities that have absolutely nothing to do with “coding”.
        I have a friend that is working on refining essential oils from a huge variety of Australian plants, these oils are finding application in the Perfume and Pharmaceutical industries…that’s hardly coding.
        I have another good friend that’s exporting Aussie Wines to China (hardly coding)
        I know a third guy working in Aquaculture he’s farming some species of Fish and crustaceans that are uniquely suited to Australian conditions but in high demand for the differentiated sashimi scene (that’s a global trend)
        I know a girl that’s arranges high dollar Caucasian escorts as arm candy for successful Asian businessmen, theses girls earn their money by be very knowledgeable in areas like the arts / humanities, their main job is to complement the often very narrow experience / education base of their “sponsors” Most of these girls spend zero time on their backs (it’s just too easy and cheap to find Thai’s girls that are expert in this aspect of the job)
        All of these people are experts in their respective fields. All are highly educated and could easily get jobs anywhere in the world but I suspect none of them are particularly good at coding.

    • Then mass immigration has to not only stop but reverse up and empty the joint of low-skill migrants who are using our education “system” as a residency doorway. Unless we drastically lift our education standards – which have sunk abysmally since our unis decided to get into selling degrees instead of educating the populace – then we are rooted, totally.

      There is no leadership in the country capable of taking the country forward, let alone at the speed it needs to happen. Now we’re just paving over our institutional strength and covering it in rent seeking and shameless corruption. We’ve sold off the furniture, turned the middle class into the beast of burden for the tax system and let the untaxed elite and their crooked handmaiden politicians get filthy rich off the back of it all. Argentina here we come.

      • From what I’ve seen our Uni’s are continuing to turn out the same number of good highly trained/skilled graduates, however a dramatic expansion has occurred in the numbers of Poorly educated Graduates.
        Don’t get me wrong this is completely unacceptable, however if we can reverse this trend while maintaining our tertiary education throughput than we’ll really be onto a winning strategy.
        At some point we need to address the wage disparity issues but that’s secondary. If all you have to sell is second rate goods than you’ll always have to haggle over the price…Price setters always sell unique goods / services and into today’s world that corresponds closely to highly educated individuals

    • Sorry fisho – but again – your examples have more to do with “living it up” rather than “doing something productive”. Sure – one has to eat to stay alive – but again – you’re talking about niche food products (the “qu’ils mange de la brioche” thing springs to mind for whatever reason)

      So all in all, great: perfumery (more likely than pharmacy), wining, dining and … 21st century pimping. Hurray! We’ve nearly got all senses satisfied here.

      *sigh*

      The point that I’m trying to make here is “what else” – sure there will always be a demand for “luxury/exclusive goods”, and that’s great. But what is your bread and butter?

      In other words – you can’t be exclusive when everyone else is “exclusive”.

      • Huh???
        Surely all real Education strives to produce highly differentiated knowledge and thereby enable the educated individual to pursue unique high value business opportunities.
        I’m not sure I know how to “educate” any population where the result is a narrow “productive” skill set, I have no idea whether high dollar hookers are “productive” or unproductive elements of our economy, absolutely no idea but I suspect it’s a step up educating alter boys in the proclivities of our pastoral priests pariahs./predators.

      • Fisho your problem is it totally dependent on market dynamics, to date and for some decades that has been just he opposite outcome e.g. less quality and longevity for the vast majority – expanding as we speak.

      • No Skippy, I think my problem is that I’m comfortable recognizing that I’m part of the 1% ers
        Most Aussies believe they’re part of the middle yet fail to recognize that they (even the poorest) live lives that can only be afforded by the top 10% globally. They’re wishes for a middle management utopia are completely inconsistent with they’r true protected position. If they’re trying to minimize the loss of position than they need to reduce the dilution of this Aussie wealth (which equals reduced immigration)
        If however they’re comfortable knowing that they’re undoubtedly part of the global elite and they wish to maintain this elite position for themselves and their offspring than they’re probably looking at solutions similar to those that I champion.
        I suspect there’s some law of physics (or at the very least humanity) that prevents one from being simultaneously a part of both groups, and that’s an outcome that most Aussies are uncomfortable with.

  8. Most gentle folk on this blog understand that, with some exceptions, our politicians are a bunch of self- serving hacks who largely look after themselves. Their lies, deceit & GREED are exposed every other day.

    But while most may understand that – and as a result things are going to get ugly – my contention is that only a few realise how dire the circumstances are going to be (esp when linked into the bigger, global picture) As Dominic inferred above, self- reliance will be the new ‘me too’. But on the other side of that coin, when half the population is used to sitting on its fat arse waiting for the gubermint/taxpayer cheque to hit their bank account, don’t expect an orderly line at the soup queue when it doesn’t arrive and the lights go out and the beer/pot runs out. Expect mayhem. Within 2 or 3 years we may have a total societal breakdown a la Strauss & Howe with all the horrific consequences. As bad as that.

    But, in due course, we’ll pull through and it’ll be a totally different Australia we find ourselves in. By then only the most psychotic will want to enter politics, for fear of their lives. There will demand for a new system, away from the political parties, the alliances, the deals, the corruption, the greed, the BLOODY POLITICS & GREED OF IT ALL!

    Well (and this may surprise you) I have the answer:

    DEMOCRACY! RULE BY THE PEOPLE FOR THE PEOPLE!
    • Politicians to be selected, at random, from the electoral roll ( current or former politicians from council level up excluded)
    • 4 year terms, one million dollar salary per year + super, NO expenses, previous jobs/employment guaranteed after service
    • Any person using their power, influence, knowledge to benefit themselves or others while serving or later to go to the slammer for a minimum 8 years.

    We depend on the Jury system to deliver justice. Ordinary people, you & me, decide the fate (and until not that long ago – the life) of those charged with crime. It works. Ordinary people, placed into situations of exceptional responsibility, usually respond magnificently (but of course, one term only…don’t want them to get a taste for power…that’s the slippery slide) Why should this proposal be different?

    What’s wrong with a plumber, a tax accountant, a housewife, an electrician, a doctor, a retiree running the country…that’s who we are! COULD IT BE WORSE THAN THE CURRENT BUNCH OF SHYSTERS?

    Experience? Half the current tribe in Canberra are lawyers… experienced in being clever and bending the truth….what value/experience there?.

    OK more to say but out of time. Many details of course (training, the public servants behind the pollies etc) but I’m a big picture person and let others sort that out. BTW nothing new under the sun ….after putting this together I discovered the concept goes back to Ancient Greece and more recently Italy..