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Investing

A Review Of Current Risks

I had hoped to hold onto my NZX and ASX listed stocks for years to come and ride out any dips in the markets, with the view that my stocks were of such quality and a good balance that I could just get a nice dividend return to cover my retirement.

Also, the planned exit from one of my private equity holdings would be significant enough to cover any losses and secure my position. However as inflation unfolds around the world, with some countries experiencing hyper inflation and comments from the BoE saying that they’re not going to shy away from generating a recession to curb inflation, I had a moment of panic yesterday and sold some stocks. Specifically my panic was that as my private equity exit isn’t happening as early as planned (and I might end up holding for more years to come), if the RBNZ were to put rates up this could mean that I am unable to service my mortgage in future and my stocks could become so undervalued that I would be bankrupt with a negative equity situation on my home.

As I’m feeling a bit calmer today, I decided to reconsider things with a goal of holding on to as many of my stocks as possible, particularly the more resilient ones, while diminishing the possibility of bankruptcy from my future.

The first thing to consider is a summary of what’s currently going on that might affect me, so I made a list:

  • Inflation for all goods due to monetary policy and COVID related supply issues
  • Inflation of food and fuel throughout the world due to war related supply issues
  • Inflation of wages in NZ due to lack of labour supply
  • Wealth destruction from NZ housing policy
  • Wealth destruction from falling share market due to all of the above
  • … and it’s going to be a contentious one, but I’m going to add an incompetent NZ government to this list, too.

Looking at how this might play out, it seems that COVID is here to stay for a few more years; and while the war in the Ukraine is a bit of a wild card, from my research into Russia’s military losses vs stock, when considering the time it takes to resupply their losses, it seems that Russia can keep up their invasion indefinitely if they choose to do so. This means that consumer price inflation is likely to stay for a while – certainly at least as long as the war and sanctions persist.

From what I can see (with the limited research I’ve done), the media’s reporting of house price falls lags significantly (about a month). The superior data that I’m fortunate enough to have access to suggests that things might be a lot worse than reported, with houses similar to mine having fallen by 23% where I live (based on a limited dataset – I should probably do more research on the other data). What’s worrying about this, is that it’s likely common consensus that the housing market is in a downward trend, which becomes a self fulfilling prophecy, pushing prices down further. The same can be said for losses in the stock market, though this is forward looking in a different way.

Wage inflation is in my opinion, the only thing that’s allaying a recession. Here’s why I say that and why I was panicked yesterday.

Inflation results in high interest rates (aimed to reduce spending) which results in less spending by consumers. This results in less company revenue and then poor company outlook, which results in less company investment. When companies invest less money, they hire fewer people, resulting in less demand for labour and fewer jobs. This results in less money in the hands of the public, which results in less spending by consumers (which loops back to the start, causing a downward economic spiral that is difficult to manage. Even if this is managed well by our current government (I say government rather than RBNZ because there are problems in supply that cannot be fixed by monetary policy alone), this difficult challenge will have to be handled well by more than most governments of the world to avoid global contagion of financial issues.

To compound the problem, the above also results in lower house prices, due to less buyer capacity. Lower house prices are a particular problem for NZ because a lot of wealth is held in houses. The loss of the wealth effect from people having value in their houses looks like this:

House prices go down, which means that people have less borrowing power (think: LVR). This results in less spending which is the cause for the downward economic spiral I mentioned in the former paragraph.

As I mentioned before, wage inflation is the only thing that can allay a recession because it enables people to keep spending, and gives them enough money to pay more for goods and services, which means that companies can pass on their costs, keep their profits up and therefore keep investing, which means more people hired… etc. In other words, it breaks the downward spiral.

Because of this, I am keeping a sharp eye on retail stats which I believe are a bellwether for wage inflation. Unfortunately, even though I have things like Paymark stats that can give indicators, I can’t tell if costs are being fully passed on to consumers until retail stocks publish their NPAT figures. I believe that a fall in consumer spend reported by Paymark is an early recession indicator, but a flatline or below CPI increase is an indicator of a possible recession.

In terms of my strategy (without discussing the specifics), I will:

  • Assume my exit from the private equity will not eventuate
  • Assume that my 6 figure shareholder loan will be paid back at the start of next year
  • Use that money and other money from yesterday’s fire sale to reduce my mortgage as terms allow
  • Consider locking in a multi year term for my mortgages that come off fixed rates
  • Continue to hold onto my high quality stocks for the long term – which includes a retail stock that will likely struggle, but has a history of always paying a dividend
  • Not bother selling the remaining handful of lower quality stocks whose value is sufficiently low that it’s wouldn’t change my financial position to sell anyway (The value of which is about $4,000)

In the event that I lose my job during a particularly bleak recession, I will use the value in my listed stocks, savings and hopefully shareholder loan, to try to outlast the recession.

Risks to my strategy are:

  • I lose my job AND (the shareholder loan defaults OR stocks drop in value by >60% from their current position and I can’t get another job for 6 months)
  • Interest rates go crazy after next year when my largest mortgage expires and I don’t get pay rises. The level of “crazy” depends on what other failures happen in my investments that prevent me from paying down my mortgage.

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