In mid-1982, people working in finance were surprised to hear that Japanese life offices and pension funds had quickly bought 7% of all the Australian Government bonds on issue. At a lunch-time discussion on how these unexpected inflows would help our low-saving nation draw on Japan’s abundant savings, I suggested we call it “the Factor-X for the year and a highly positive one at that”.
43 years on, I still enjoy keeping a watch out for the unexpected but powerful influences that impact investment markets - though I readily admit to deriving even greater pleasure when opportunities come up to spread the word on the magic of compound interest.
In 2009, a sub-editor in the Australian re-named my Factor-X the X-Factor, and I moved with the times.
As each year draws to a close, I like to list the main X-Factors of the preceding 12 months. Then I select the X-Factor for that year. My list of the X-Factor in each of the last 43 years is provided at the end of the article.
In financial markets, an X-Factor is a major influence on investment returns that had not been generally expected, predicted or allowed for but comes out of left field and has a powerful impact in financial markets.
To be a fan of the X-Factor, as I am, doesn’t preclude taking a view on where economic conditions, shares, interest rates, property or the exchange rate seem to be heading. Rather, it’s a reminder that investors always need to allow for the many uncertainties and surprises that hit markets from time to time. Investors need to maintain a thoughtful diversification of assets and adopt sensible forms of risk management, such as having enough liquid assets to meet living costs in the early years of retirement, rather than risk having to sell quality assets cheaply in a market panic.
Sometimes, the X-Factor is favourable for investors. Examples of positive X-Factors include, in chronological order:
- the floating of the Australian dollar in 1983
- the collapse of inflation here in 1991
- our economy being little affected during the global financial crisis of 2008 thanks to China’s continuing growth
- the powerful surge in share prices that began in March 2009
- the boost to most commodity prices in each of 2016, 2018 and 2020 as China avoided the hard landing forecast for its economy
- the sharp recoveries in share markets in February 2022, soon after the Covid-induced panic.
At other times, the X-Factor has been unfavourable. Examples include, in chronological order:
- the sharp rise in bond yields in the fake crisis of 1994
- the terrorist attacks in the US in 2001
- the Enron frauds in US markets in 2002
- the near meltdown of the global banking system in 2008
- the powerful disinflation during the 2010s
- the Covid pandemic in 2020
- the sharp increases in inflation during 2022 and 2023, with inflation often turning out to be ‘stickier’ than was initially expected
- the non-delivery by central banks of the four or five cuts in their cash rates that were widely expected in financial markets between 2022 and early 2024.
The finalists for X-Factor 2024
In discussions over the years, I have occasionally made a flippant comment (which I now regret) that, if a year were to come along without an X-Factor, I could call its absence the X-Factor for that year.
The reality is that many years – including 2024, 2022, 2013, 2008, and 2007 – have more than one strong contender for the title. Selection of a single winner each year is not just a challenging task, it also trivialises the challenges that investors face when there are lots of X-Factors to contend with.
The year now ending certainly had an abundant harvest of X-Factors, among them:
- The success of Donald Trump in winning the US presidency while Republicans hold a majority in both houses. Many people are still scratching their heads, wondering what the consequences might be.
- Over the last six years, the US has been by far the world’s best performing economy and the most innovative. In those six years, the US has not experienced a recession, though the National Bureau of Economic Research, which dates US recessions, says it spied a glimmer of one in 2022.
- What makes this clean record of zero recessions so mind-blowing is the many thousands of predictions that an imminent and severe recession was about to hit the US. A conga line of forecasters – many of them people who work in financial markets – has repeatedly claimed that the US economy would soon be upended by a major recession that would also cripple the rest of the world.
- In the early 1980s, Paul Samuelson, a well-known economist and author of the textbook that dominated macroeconomics in my undergraduate years, famously observed that “Wall Street has predicted nine of the past five recessions”. This time around, the gap between “Wall Street predictions made”, and “Wall Street predictions made successfully” is unthinkably wide and lopsided.
- Patient investors holding US shares and who ignored the naysayers have made attractive gains over recent years (and specifically in the last 12 months when average share prices have risen more than 20% and average dividends were increased).
- This year’s positive lead from US shares has also boosted prices in other share markets including the ASX, which reached record highs two weeks ago – something that would not have happened if our share market had been tracking just local factors.
- Another feature of 2024 has been the widely different views on how ‘sticky’ inflation is likely to be. For Australian investors, the two countries that matter for inflation are the US (where tariffs have been increased sharply and the budget deficit is 6% of GDP) and Australia (where wage demands are running at levels well above the rate of inflation and where productivity growth is negligible).
- In my view, underlying inflation in Australia could well be in the troublesome range of 4-5% in 2025 - a couple of notches above both prospective inflation in the US and the medium-term target of the Reserve Bank.
- The price of Commonwealth Bank shares has risen strongly in recent months, perplexing many advisors who had expected banks to suffer increasing losses on their housing loans. In my view, the gains in CBA share price reflect changes in the strategies of many fund managers, particularly among industry superannuation funds, which are now investing more of their clients’ money in exchange-traded funds that track the market and less in actively managed funds run-in house that aim to out-perform market returns through their stock selection. With the record of actively managed funds unimpressive when additional fees are charged, and with the CBA making up an impressive 8.2% of the ASX 200 index, the effect on that bank’s share price has been significant.
- In Australia, economic growth has slowed to near-zero rates over the first three quarters of 2024 despite the massive increases in spending by federal and state governments. The combination of our heavy reliance on variable rate debt when we borrow for housing, and the high levels of mortgages taken on during the extremely low interest rates of the pandemic period, have caused severe financial pain for many mortgagees.
- The Federal Treasurer has made it clear he would like the Reserve Bank to reduce its cash rate to ease theses strains, blaming the Reserve Bank for ‘smashing’ the Australian economy by leaving its cash rate unchanged while other countries have cut their rates. Unsurprisingly, the Reserve Bank Board suggests (my words here) it awaits convincing signs that inflation is on the way down with reasonable prospect of return to the target range over the next year to 18 months.
- The Chinese economy has also slowed, mainly because of the cutback in bank lending and the strains on bank balance sheets after the housing market collapsed from oversupply a couple of years ago. The Government has eased monetary and fiscal policies to stimulate growth, but most commentators say more needs to be done to lift growth to the target rate of 5%. Nonetheless, Chinese share markets have made some useful gains, with the price of FXI, the exchange traded fund made up of large companies listed on the Shanghai Stock Exchange having risen by 33% in the last 11 months, including a one-day move of +9% in the last fortnight.
And this year’s winner of the X-Factor award is …
The US economy is in its sixth year without experiencing recession, despite the many predictions of an imminent and deep economic downturn.
Don Stammer has been involved in investing for more than six decades as an academic, senior official of the Reserve Bank, an investment banker, the chairman of nine companies listed on the ASX, and a columnist for The Australian and Business Review Weekly.
In recent months, Don has joined with Ashley Owen and Shani Jayamanne in setting up the Dr Don Academy, which aims to provide guidance – to young investors particularly –by drawing on the three founders’ combined investment experience of 124 years.
This article is general information only and does not consider the circumstances of any investor.
43 years of the X-Factor file
2024 The US economy is in its sixth year without experiencing recession, despite the many and frequent predictions of a deep and imminent economic downturn
2023 The surge in share prices of US tech stocks, and the better understanding of how they should be valued
2022 High inflation, tighter monetary policies, and sharp rises in interest rates
2021 The fracturing of the long-dominant view low inflation is here to stay
2020 Covid-19
2019 Strong share markets despite repeated predictions of global recession
2018 The impact from the royal commission on financial services
2017 The positive macro influences that, globally, restrained volatility, boosted shares and kept bond yields low
2016 Election of Donald Trump as US president
2015 Widespread experience of negative nominal interest rates
2014 Collapse in oil price during severe tensions in middle east
2013 Confusion on US central bank’s “taper” of bond purchases
2012 The extent of investors’ hunt for yield
2011 The government debt crises in Europe
2010 The government debt crises in Europe
2009 The resilience of our economy despite the GFC
2008 The near-meltdown in banking systems
2007 RBA raises interest rates 17 days pre-election
2006 Big changes to superannuation
2005 Modest impact on economies from high oil prices
2004 Sustained hike in oil prices
2003 Marked fall in US dollar
2002 Extent of US corporate fraud in Enron etc
2001 September 11 terrorist attacks
2000 Overshooting of exchange rates
1999 Powerful cyclical recovery across Asia
1998 Resilience of our economy despite Asian crisis
1997 Asian financial crisis
1996 Global liquidity boom created in Japan
1995 Powerful rally in US markets
1994 Sharp rise in bond yields
1993 Big improvement in Australian competitiveness
1992 Souring of the vision of “Europe 1992”
1991 Sustainable collapse of inflation1990 Iraq invasion of Kuwait
1989 Collapse of communism
1988 Boom in world economy despite Black Monday
1987 Black Monday collapse in shares
1986 “Banana Republic” comment by Paul Keating
1985 Collapse of A$ after MX missile crisis
1984 Measured inflation falls sharply
1983 Free float of Australian dollar
1982 Substantial Japanese buying of Australian bonds