A Comment on the April decline and some suggestions for what to do

April was a poor month for equities. Global Market capitalisation based benchmarks declined 8%+ in US$ terms and approximately 3% in A$ terms as the A$ declined in a "risk-off" environment, as it usually does. Most countries and sectors declined.

The global diversified trust declined a very small amount and the Global 30 high conviction strategy declined 1% in A$ terms. The former return was aided by a reasonable inflow of subscription $ which we invested slowly thereby holding significant cash weightings during the most severe falls. The monthly active return of 3%+ is unusually strong.

Value beat Growth by a wide margin which makes sense to us. Finally some sanity prevails and the benefits of dividends and justifiable valuations are showing their mettle. It's not too late to make a switch to investing in stocks which meet 'needs' rather than 'wants'. There are many tailwinds which suggest this could be a multi-year theme - National Industrial Policy, the benefits to investors of dividend reinvestment / a low turnover strategy which is less exposed to capital gains and thus less harmed by the fiscal tax drag from inflation, historically low levels of capital investment in the capital stock of many countries.


Everyone now knows that inflation is not transitory. Defence food and energy security are probably important. Rolling back years of poor monetary policy and years of neglect of the capital stock of a nation is not going to be an overnight event; but that is what makes it an investable proposition. That realisation will come slowly to many investors, slightly less quickly to central bankers (encumbered by academic arrogance) and probably very slowly to all politicians.

It seems pointless to give much space here to statistics which illustrate the rampant price inflation that was incubated by poor monetary policy and artificially suppressed by manipulating the calculation of the inflation basket. If it hadn't been the Russian invasion of The Ukraine, it would have been catalysed by something else.

Evidence of rampant price inflation, suffered as usual by those least able to deal with it, are in almost every financial media article. We are surprised that they're surprised. It was all so obvious. Our frustration is we didn't perform even better having turned down the chance to drink the 'transitory' Kool Aid.

What happens now? So where should we invest?

In the long run nominal bond yields tend to equate to nominal GDP. Thus we are still some way off equilibrium with global government bond yields at 2-3% and nominal GDP much higher, thanks to inflation. At some point we'll get a tipping point with either more interest rate increases at the long (and short?) end, and/or a decline in nominal GDP.

It's also clear that within GDP the share going to profits is very high relative to that going to labour. This can only swing back to labour, and for capitalism to continue, we hope it does. This is perhaps what the RBA mean when they stated that interest rates will only rise as and when wages rise? We can't believe they want wages AND the general price level to rise...? That simply creates more inflation.

Even some fund managers understand the concept of d/k-g so lower growth of profits and higher discount rates are not conducive to investing in long duration assets especially the highly rated growth stocks. Many fund managers will make the switch so flows will be in favour of defensive stocks.

8% p.a. might be as good as it gets from equities while we squeeze out inflation, and inflation expectations, and play catch up on capital investment? This might take a couple of years, because we don't believe policy makers can change their minds even though they should when it becomes clear that what has been done hasn't worked. (Was it Keynes or Churchill who first suggested that when the facts change they change their minds? Where are their equals now?)

Bonds in the last couple of years haven't been safe and have declined (US10 year note) in the order of about a 20% loss of capital since the bottom of the yield in mid-2020 of about 0.6%. Modified duration x yield change = approximate capital price change, ignoring convexity. At a yield of 0.6% these were highly explosive toxic instruments, as we suggested.

Almost as bad as stocks like LYFT, NFLX and all those SPACs that were so heavily promoted by Wall St?

With so much debt to be serviced our guess on the level of rates is that at 4% on governments and thus 6% on mortgages, that will be painful enough and we'll start to see a decline in the rate of inflation. It's therefore getting close to where bonds will be safe but only in so far as they are more stable in price and will therefore still lose you money in real terms.

A note on the Euro sovereign bonds:- Sovereign spreads between Germany and France and France and Italy are widening again as the ECB hints they will be tightening as the Germans have had enough of the "Inflation passagere' nonsense from Mme Lagarde at the ECB. If anyone is caught between a rock and a hard place it's the ECB - tighten as they must to squeeze inflation, and they risk a spread crisis; don't tighten and they get more inflation and a crisis anyway. We still avoid Euro banks. They have also been walloped by Russian write-offs. We hope/expect/need to see an increased focus on capital investment and the provision of food energy and defence security. Technology is also on the agenda somewhere. We're not suggesting that all countries will 'go it alone' and it's the end of the era of global trade and capital flows, but we are positing that more 'plan Bs' will be developed.

Thus for equities: bias to Value, favour dividends as part of the 8% target, favour beneficiaries of capital investment, look at balance sheets because refinancing of debt at ludicrously low levels is yesterday's story and will not now be possible, and ditch the idea of FANG and remember to QUAKE.


Union Pacific




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Delft Partners May 2022

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