The Megatrends of Now: Uncharted (But Exciting)

In this month’s commentary I want to take you through a series of megatrends that are emerging which you need to consider in your portfolio evaluations. We are entering a world that is different to what we have experienced in recent years. It is uncharted territory, but it is also exciting territory. 

My first megatrend is the looming high inflation rates. This megatrend has an element of controversy because many believe that the current inflation breakouts are only temporary. I disagree – the underlining forces are simply too powerful. 

Costs in China are rising sharply, and they are passing on those costs in their exports of goods to the US, Australia and other parts of the world. Moreover, as we will discuss below, consumers are paying the higher prices. 

China has deep problems and those higher prices for Chinese goods are at least in part helping alleviate its difficulties. But inflation goes further. Whether it be in the US or Australia, the costs of wages are rising. In the US, at the lower levels, wages are up by about a third and around Australia you can see people that have bargaining power using that power to gain much higher pay rates. 

Our second megatrend is interest rates. There are all sorts of warnings that interest rates are set to explode, boosted by inflation. Last night those fears erupted in the US 10-year bond rate surging past 1.6 per cent which is a clear indication of where we are headed. But central banks, whether they be in the US, Europe or Australia, have a vested interest in keeping rates lower. 

Given the inflationary forces, central banks should be already tightening rates but, outside of NZ, they hesitate because their governments have too much debt and in countries like Australia consumers are also highly leveraged.

When you bring together these first two megatrends, you can see we are already in a period where interest rates are negative – i.e. much lower than the inflation rate. So that cash that you have on bank deposit is going to erode in value at a much faster rate while deposit rates are virtually nil and inflation is rising. House prices have gone through the roof and very belatedly APRA is trying to curtail the rises. The only way to do that is change the capital ratios of the banks and they are not prepared to do that. The failure of APRA to act is causing considerable angst amongst younger people who have been priced out of the market, but it is causing a swing to apartments which have not risen by anywhere near the same amount. 

There are many who believe that interest rates will simply have to rise and that will cause a big fall in asset prices. 

I think that is highly likely to happen in due course but be aware that if you go “all cash” in anticipation of big asset price falls then, while you are waiting, negative interest rates will take away the value of your savings. In essence you have to have a good part of your portfolio in some form of equity to protect yourself against the negative interest rate period. 

Megatrend Number Three is that a large portion of Australian consumers are cashed up and spending. We saw that occur in Sydney as soon as the lockdown was curtailed and similar trends will happen in Melbourne later in the month. Retailers who can tap this cash spending will do very well. 

It looks like being an excellent Christmas if retailers can find the stock to supply the demand. Sadly not only are Chinese prices rising but their supply chains are breaking down.

Megatrend Four. China is hurting. Just about everything that could go wrong has gone wrong. President Xi Jinping embarked on an ambitious program of moderating house prices and reducing the role of major technology companies. He also played the carbon game and stopped ordering Australian coal but couldn’t replace it quickly and adequately enough. So, China has had blackouts, COVID-19 lockdowns and now its apartment building industry is in grave jeopardy because it borrowed too much money and couldn’t complete its apartments. 

The Chinese government normally moves quickly and decisively to achieve a rescue but this time they have been indecisive. There is a clear risk that they will take their frustrations out on invading Taiwan. For what it is worth, I think not. The Chinese will enter into a rescue program which will lift demand. 

Megatrend Five. The world’s miners have been underexploring for oil, coal, uranium, lithium and a number of other materials. This means that the required increase in supply from new resources has not taken place and this is underpinning the very sharp rises in oil, gas and coal prices. Clearly the explorations cutbacks to oil, gas and coal are related to carbon emission issues. But I think that while there will be major fluctuations we are entering into a period of higher energy prices and these higher energy prices will contribute to inflationary forces in Megatrend One. Demand for iron ore will depend on how active the Chinese are in their stimulation program. But Vale will be increasing its supply in the next couple of years so the forces we are seeding in other minerals may not apply to iron ore. 

It’s perhaps strange (but understandable in a decarbonising world) that BHP is selling out of a rising price material – oil and gas – to become more dependent on a more sluggish material, iron ore.

Megatrend Six. We are going to electrify on a massive scale including electric cars. This should make the electricity business a highly profitable area. But beware. The benefits will not go to all participants. We have seen 16 small UK electricity retailers collapse in recent months. Electricity retailing is hazardous because the price from generators varies dramatically from negative to positive because of the fluctuations in renewable supply. 

Retailers have to be very skilled in hedge contracts to gain insurance from these wide fluctuations and those that get it wrong find themselves selling at a fixed price at a time when purchase prices have gone through the roof. As those 16 UK small electricity retailers can attest to, electricity retailing has become a dangerous game. 

And, finally: New South Wales and Victoria followed by the rest of Australia have been set to have one of the highest vaccination rates in the world. We are short of skills and will need migration to fill those skills in the short term until we can build up our skills training. We will also need workers to harvest our crops. Students are required for our cafes. Migration and student intakes need to resume.