Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 510

‘Prepare for war’ with hostile markets

An ancient Latin adage advises 'if you want peace, prepare for war'. This is useful advice for current market conditions.

This may seem a surprising comment considering the recent performance of global equities. After all, indexes are up, and volatility is down. Never mind that a handful of tech giants like Apple and Microsoft are driving the headline positive numbers while most shares are having a harder time.

And there has been good news. It has gone quiet in the global banking sector after the debacles in US regional banks and the demise of Credit Suisse. This offers comfort to anyone who has been in markets long enough to know that stress in the financial sector is often the first sign of real trouble.

But even if they are not ringing as loudly as they were, we still hear alarm bells warning of potential difficulties on a broader front. While the banking sector has so far avoided systemic problems, at the very least these events should inhibit economic activity.

Already cautious loan officers have further tightened their standards. Consumers are also likely to adjust their behaviour increasing saving and cutting spending. Corporates too will inevitably look more closely at their liquidity and raise the required return of any potential investments.

Regardless of recent performance, our view is that we are in the ‘risk averse’ stage of the current equity market cycle. Therefore, the balance of probabilities is heavily weighted towards falling indices and negative returns, and we believe this will continue to play out through to mid-2024.

There are several data points that we believe support our concerns, including:

1. Government deficit and corporate profitability

Around the world, the COVID-19 pandemic triggered increases in government deficits. While the resultant growth in the stock of debt remains huge, deficit spending itself will provide no further sugar rush to business profits. For example, in the US, the deficit is currently set to remain at between 5-6% of US gross domestic product (GDP) rather than ballooning as it did during the pandemic.

Furthermore, business profits should no longer benefit from consumers spending their way out of lockdowns. In the US the savings rate has fallen to 4.7%, from the extraordinary 33.8% during the beginning of the pandemic. If anything, savings rates may well rise from here.

2. Labour costs

According to the US Bureau of Labor’s statistics, there are currently twice as many job openings as there are people to fill them. This is as high as it has been at any time since the GFC (Global Financial Crisis). The consequences of worker shortages are showing up in median wage growth which has accelerated since the start of 2021.


Source: US Bureau of Labour Statistics
 


Source: Federal Reserve Bank of Atlanta 

3. Interest rates

Up until 2022, the falling cost of corporate debt helped boost businesses’ margins. But since central banks started increasing rates, interest costs have grown and compressed margins. Meanwhile, it is difficult to envisage a situation where interest rates will meaningfully fall.

4. Taxation rates

In the US, the government is considering raising the marginal tax rate on US-derived profits which will turn what has been a tailwind in recent years into a headwind.

5. Earnings per share (EPS)

According to Bloomberg, current year S&P 500 EPS estimates peaked in June last year at $248 with the latest at $220. Looking at leading indicators, EPS could easily fall to below $200, perhaps materially below. If that seems unlikely, do not forget that the 2019 pre-pandemic high was just $164. Reversion to that level would put an S&P 500 index at 4000 on an eyewatering PE (Price Earnings) of 24 times.

Considering this, three areas for investors to look at to help manage risk are:

  • Valuation – while the debate around value versus growth is perennial, what is inarguable is that buying a dollar for 80 cents means there is 25% upside available to a value investor that a growth investor often misses. This is not to say that value investing is like shelling peas, but that it does offer an added source of potential return.
  • Income – remember the importance of income. In terms of the two components of total return, the bull market that ran throughout the last decade trained global equity investors to focus on capital growth more than income. But income always plays a positive part, while the same cannot be said of capital growth.
  • Discipline – take steps to avoid behavioural biases that are repeatedly the cause of investment errors. Examples are recency bias (favouring what has just happened) or confirmation bias (sifting for data that support an already formed view). Swerving such pitfalls is difficult, but a disciplined process that is aware of the dangers helps.

We live in a probabilistic world, which can include rolling hills and caressing breezes, so there is always a chance that our caution proves to be unwarranted. But our advice is to protect capital, because what matters is losing as little as possible when times are bad to have as much working for you when things get better.

To this end, investors should prize income, excellent value, short duration, and rapid payback periods. They should avoid high beta shares, those with prices that can be largely or more than fully explained by overall market moves, and they should avoid financial leverage. We believe this remains a time to play defence. 

 

Hugh Selby-Smith is Co-Chief Investment Officer of Talaria Capital. Talaria’s listed funds are Global Equity (TLRA) and Global Equity Currency Hedged (TLRH). This article is general information and does not consider the circumstances of any investor.

 

RELATED ARTICLES

Recession surprise may be in store for the US stock market

Clime time: why this time really is different

Global recession looms as debt balloons

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

The 2025 Australian Federal election – implications for investors

With an election due by 17 May, we are effectively in campaign mode with the Government announcing numerous spending promises since January and the Coalition often matching them. Here's what the election means for investors.

Latest Updates

World's largest asset manager wants to revolutionise your portfolio

Larry Fink is one of the smartest people in the finance industry. In his latest shareholder letter, the Blackrock CEO outlines his quest to become the biggest player in private assets and upend investor portfolios.

Economy

Australia's economic report card heading into the polls

Our economy grew by a nominal rate of 7% per annum from 2017 to 2024, but it benefited from the largesse of fiscal and monetary policies, both of which are now fading. We need a new, credible economic growth agenda.

Preference votes matter

If the recent polls are anything to go by, we are headed for a hung parliament at the upcoming federal election. So more than ever, Australians need to give serious consideration to their preference votes.

SMSF strategies

Meg on SMSFs: Tips for the last member standing

It’s common for people as they age to seek more help in running their SMSF if their capacity declines. An alternate director may be a great solution for someone just planning for short-term help in the meantime.

Wilson Asset Management on markets and its new income fund

In this interview, Matthew Haupt from Wilson Asset Management discusses his outloook for the ASX, sectors such as REITs that he likes, and his firm's launch of a new income-oriented listed investment company.  

Planning

‘Life expectancy’ – and why I don’t like the expression

Life expectancy isn't just a number - it's a concept that changes with survival rates over time. This article breaks down how age, survival, and societal factors shape our understanding of life expectancy, especially post-Covid. 

The shine is back on gold, and gold miners

Gold mining stocks outperformed in 2024 and are expected to do well in 2025. At this point in the rally, it's worth considering what has driven gold prices higher and why miners could still have some catching up to do.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.