Investments to Avoid in 2022

The current investment environment feels a lot like 1999 just before the dotcom bubble burst, with a hint of 1994.

Investors would probably need to be over 40 to remember the fallen angels of 1999 when the dotcom bubble popped.  Back then the new paradigm was that price to earnings ratio’s were irrelevant and it was price to revenue that mattered.  Sound familiar?

One of the most high profile busts in 1999 was One Tel.  At it’s peak, One Tel had a market capitalisation of $5.3bn in November 1999 making it one of Australia’s largest companies at the time.  It reported a record operating loss in August 2000 of $291m, before entering receivership in May 2001.  

1994 saw the Australian 10 year bond rate rise from around 6.3% in January 1994 to over 10% by the end of 1994.  Long term interest rates are important as valuations of shares and property are anchored to them and generally speaking as rates rise, property and share valuations fall.

Fast forward to 2022 and investors could be forgiven for thinking they have been cryogenically frozen from the periods of 1994 and 1999.  Long term interest rates have doubled in the last 6 months, and share markets are laden with many companies trading at lofty valuations, making little or no profit today.

While history doesn’t exactly repeat itself, the lessons from these two time periods can help investors today avoid repeating the mistakes of the past.

Hugh Dive, the Chief Investment Officer at Atlas Funds Management believes that investors should look to avoid tech stocks and growth stocks on high price earnings multiples as rising interest rates will be unkind to them.  The companies Dive refers to have minimal to no earnings today but the promise of large profits in the distant future.  Asset valuation models are sensitive to interest rates, and higher rates result in lower valuations.

Dive says that rising interest rates make the “boring” profits and dividends of companies such as Amcor, Ampol and Transurban look more attractive than a tech company promising large “blue sky” cash flow in 20 years time.  This occurs as the present value of profits delivered today are worth more when rates rise than profits that may or may not be generated in 10 to 20 years time.

Matt Williams, portfolio manager at Airlie Funds Management is wary of loss making tech companies but acknowledges that there will be some winners amongst them and nominates Spotify and AirBnB as looking interesting.  Williams says crypto and NFT’s are obviously impossible to value making them speculative.

Williams adds that investors should be careful of some of the reopening beneficiaries which are now priced for perfection.  Qantas and Flight Centre for example now have enterprise values higher than what they were pre-COVID which means that investors are already factoring in a strong travel recovery.  Ultimately we will revert back to pre-COVID travel levels at some point but it’s taking longer than what was previously envisaged.

Another high profile casualty of rising interest rates is Government Bonds.  Dive is of the view that investors should stay away from bonds.  He says that bonds have enjoyed a 40 year bull market as 10 year rates have fallen from 16% in 1982 to 2% today.  The capital value of bonds increase as rates fall, but as long term rates rise, the capital value of bonds fall.  As a rule of thumb, for every 1% rise in long term rates, investors can expect the capital value of a 10 year bond to fall by around 9%.  Superannuation investors in Balanced, Conservative or Fixed Interest funds are likely to have a large allocation to Government Bonds and would be wise to review these funds.

Williams sums up the current environment by saying that the market dynamics will change as central banks slowly but surely wind back monetary settings from “ridiculously easy” to just “easy”.  Volatility will create headlines and headlines build psychological pressure in investors minds to “do something”.  That “something” should be to think 5 – 10 years ahead and look to buy great companies that are being sold cheaply by the market.

 

Mark Draper writes monthly for the Australian Financial Review - this article was published in February 2022