Is it time to be conservative?
I’ve been saying for some time that we are living in a period of unusually high economic risks. How you plan around those risks will determine how you come out the other side when we go through the next big market correction.
Let’s start with the statement that a market correction is inevitable. It is simply a matter of when. We have had recent market collapses in 1987, 1998, 2008 and most punters are guessing the next one will be around 2017. There’s no science around that date. It could be as early as tomorrow. Hopefully not! When the next correction happens, Governments and Reserve Banks around the world will not have the balance sheets to fight it. Money printing and borrowing our way out of trouble wont work.
The next correction is going to deal out some serious pain as Governments are forced to cut costs and increase taxes. In reality no one knows what will happen. We have kicked the can so far down the road that, no matter what this correction looks like, it will be ugly. The next correction will likely start with the financial system and the share market then push into commercial property and finally residential property. Commodities for the most part have already corrected. Any recovery in commodity prices will arguably be short-lived and wishful thinking.
What do you do? What risks or vulnerabilities do you face?
If you lose your job will you get another one, or will you have to hobble to 65 like many in my father’s generation after 1987. How do you protect your assets? When and how do you make the most of the opportunities that fall out of a correction? Most of us can’t go off grid, so we have to work with what we have in front of us. Maybe you’re looking to expand your business, take on extra staff. Whatever it is, everyone has plans and ambition.
At Squirrel, we are investing in new businesses and opening new branches. Our business is more exposed to the market than most and we’re still investing. So what are we doing differently? We’ve sold our property investment portfolio and will be debt-free in 20 weeks when the last one settles. I’m not for a moment suggesting you should sell up. In my world, Squirrel leaves me with such a big exposure to the property market I don’t want that exposure amplified by debt. We are also raising private capital for Squirrel to strengthen its balance sheet and to fund investment rather than using our cash flow. When it comes to cash flow we are constantly planning and running different scenarios. It’s a weekly and slightly neurotic process. The point is we are still making investments, it’s just more considered.
When the next correction hits, the issue will be liquidity. An important lesson from the Great Depression was that as the market kept falling there simply were no investors left capable of buying. When businesses are going under (or not paying rent) then owners face a cash flow crisis and are forced to sell. If there are no buyers and prices fall, then other properties are forced to sell. It’s a vicious cycle. The fundamental mistake is fourfold (1) assuming you can sell when you need to (2) that prices won't fall (3) the bank won't take all of the proceeds of the sale and (4) that you can always borrow money. Make sure you have your risks covered and have a plan for your worst case scenario. Get real around the risks of liquidity and test your assumptions. This is not the time to sit there with your head in the sand.