Navigating Higher Interest Rates, The Teele Way

This week I want to highlight the views of investment strategy legend Bruce Teele to help you navigate higher interest rates plus those of Michael Hawker to raise the alert on the insurance implications of climate change. I suspect relatively few Eureka Report readers would have heard of either man. So let me introduce them and you will see why their views are fascinating.

Bruce Teele joined the old JB Were stock-broking business aged 22 and moved around on callipers because of a polio infection in his youth. He ended up running Were for around 20 years, retiring in 1997, and was a source of inspiration and values to countless people within the securities industry.

Long-term Investors

Teele believed it was very hard to pick economic trends and not all that valuable for long-term investors to join the fashion of short-term profit forecasts. Rather, long-term investment portfolios should concentrate on investing in good businesses that were being run well.

He often calculated how much it would cost to start a similar business from scratch and that helped him calculate the long-term worth of a particular enterprise.

Bruce is now retired, although after JB Were he became chairman of the Australian Foundation and his beliefs still reverberate around the AFIC boardroom.

I highlight the Teele beliefs today because all the indications are that the Reserve Bank is fearful that the current 7.8 per cent inflation rate will boost wages and embed them into the economy, creating a nasty inflationary cycle.

To stop such an event, they aim to slow the Australian economy down via higher interest rates, boost unemployment and make life difficult for many enterprises and people.

Invest in Good Businesses

This greatly endangers asset values which are closely related to interest rates but under the Teele philosophy you ride through the slump, provided you are invested in good businesses.

Against this background let's look at what we might expect during the rest of 2023.

In broad terms there are about 15 – 20 per cent of the population that are affluent and are really not affected by the problems of those in the mortgage belt and others in difficulty. They keep spending. 

Then there is 15 – 20 per cent of the population at the bottom end, many of whom have difficulties in renting and/or keeping up with their mortgage.

Then there are about 60 – 70 per cent of the population that are just making ends meet but are not saving. They will be in trouble if they lose an income or interest rates rise too high. But at this stage they are managing.

The key to marketing in that environment is to know the economic status of your customers and pitch your marketing and strategies accordingly. Not every company will do this. 

Recession Unlikely

If the Australian economy was simply made up of the above population structure, then the nation could easily have a recession. But our booming mining and agricultural industries make a recession highly unlikely. 

Indeed, we are set for a budgetary surplus because of the profit bonanza in the mining industry. That profit bonanza will not only boost tax revenues but also dividend payments with the people at the top end being the biggest beneficiaries.

There is now an easing in the retail sector which is partly as a result of interest rates but a larger factor is the bad weather we have seen in Queensland and New South Wales which has depressed spending in areas way beyond those directly impacted.

These forces will set trends in 2023, along with the transfer of vast numbers on low fixed mortgage rates to current rates.

Hidden Danger

But the hidden danger facing Australia is that the US Federal Reserve will become increasingly alarmed that wages rises have become embedded into the US system, creating an inflationary cycle. The Federal Reserve is now alerting people of the danger.

If inflation does not come down with current measures, then the Federal Reserve will almost certainly hit the American economy hard with much higher interest rates.

Australians need to be aware of this danger because we will have no choice but to follow because unless we do, our currency will be trashed with massive short-selling. In turn, that will destroy any impact of our interest rate rises on inflation.

The Reserve Bank will have to act irrespective of the mortgage belt consequences. Under the Bruce Teele scenario, if you are invested in a good business, sit tight through whatever crisis or boom that may impact the nation. 

Cyclones Omen

Just after the turn of the century I was yarning with Michael Hawker who had only recently become chief executive of Insurance Australia Group (IAG). At that time climate change and carbon were on the horizon but on a relatively minor scale.

I asked Michael if there was a test to determine whether there was a change coming in the climate. He gave a simple answer and said that the best indication would be an increase in storms but, in particular, cyclones would tend to come south.

If that took place, it would greatly damage buildings and infrastructure in Queensland and New South Wales in areas where previously there had not been a cyclone danger so buildings and infrastructure were not built to resist cyclones.

This would be a major hazard for insurance companies. I filed the information somewhere in the back of my mind and then as the cyclone hit Norfolk Island this week the news broadcasts pointed out that it was rare for cyclones to come as far south as Cyclone Gabrielle and linked the event to the incredible amount of rain we have seen in so many parts of Australia.

The insurance damage so created has been a major blow to insurance companies and they will attempt to recoup that with higher premiums in the years ahead.

The danger for insurance companies is that there is a limit as to how much the reinsurance market can handle at an economic price. We will see an increasing number of buildings where the cost of insuring is simply too high. And insurance companies that take risks could endanger their solvency.

We are not anywhere near that stage at present, but the Hawker remark more than 20 years ago has an increased relevance in today’s world.