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The best time to worry? When no-one else is

There’s a really great way to earn yourself notoriety and gain a following in business and investment circles: make a prediction of doom.

You know the ones: that house prices will crash (Steve Keen, repeatedly), that you should ‘sell everything’ (thanks RBS) or that a Trump presidency would cause a huge fall in world stock markets (almost everyone, until the day after the election). They have been, of course, spectacularly wrong.

The real rock stars, though, are the ones who were right. Think economist Nouriel Roubini, given the moniker Dr. Doom, or the lesser known (but in small circles, deeply venerated) ex-fund manager, Michael Burry. These gentlemen were bearish in the lead-up to the Global Financial Crisis, and have been lionised since.

Those who were wrong press on regardless, and find favour among fellow-travellers who buy the story, even if the predictions were wrong. And those who were right only have to be right once — the ability to distinguish between skill and luck remaining elusive based on a single event — to be feted in the media and followed by devotees.

Everything, of course, being obvious in hindsight.

The far more useful approach, of course, is not to predict, but to prepare. Which brings me to the events of the past couple of weeks.

If you’ve paid even a passing interest to the business news recently, you couldn’t help but be struck by the number of large corporate deals being proposed, and done.

Frank Lowy and family have ceded the Westfield empire to European giant Unibail Rodamco. Management (and private equity firm Bain) have lobbed a bid for Sukin skincare owner BWX. Local and overseas bidders are lobbing bids for private healthcare operator Healthscope, and Santos has only recently rejected an almost-$15 billion offer from self-described ‘energy investment vehicle’ Harbour Energy. Even pipe-and-plumbing outfit Reliance Worldwide is in on the game, offering $1.2 billion for a UK business.

These deals come at the end of an interesting decade following the GFC. In the immediate aftermath, companies were shell-shocked, hoarding cash, lest the banks again become unfriendly. No-one wanted to be caught short, and fortifying the balance sheet was the first order of business. Once it became clear that the present threat had passed (and aided by short memories, management incentives, or both), companies decided to use some of that cash, but slowly, at first, and usually on share buybacks. That approach was even more pronounced in the US, where shareholders don’t benefit from franking credits on dividends, but also held sway here.

Now, if the recent past is any guide, we’ve moved into the third stage: deals and acquisitions. Risk appetites have increased significantly, with growth on companies’ minds.

Again, I’m sure this has nothing to do with CEO incentives or short memories.

But the very presence of such an approach tells us a lot. It says that CEOs are looking to buy growth. That boards are convinced that such deals make sense. And it tells us that shareholders are supportive of those sorts of deals.

If a week is a long time in politics, a decade seems to be an epoch on the markets.

A few people reading this might be in charge of those deals, but I’m not talking to them (though, sidebar: be careful about those deals… the odds aren’t in your favour). Instead, I’m talking to the rest of us. Because the surge in so-called ‘corporate activity’ might well tell us something about the state of stock markets. And, possibly, about the economy.

Markets and economies are cyclical. They boom and bust. It’s ever been thus, and, despite today’s 45 year-old having never facing a recession in their working lives, will ever be thus. And we can look for signs as indications of where we are in those cycles.

Like, for example, a significant increase in corporate risk-taking. Things like billion dollar mergers, and increased deal-making.

There’s a parallel in the economy, too. 25 years of unbroken growth. House prices that, a little off their highs, are still in nosebleed territory. Interest rates that are far more likely to rise than fall (or that, if they fall, are likely to do so because the RBA sees storms on the horizon).

Maybe we get to 30 years of growth. Maybe unemployment goes to 4%. I hope so.

Foolish takeaway

I’m a contrarian, by nature. I’m happiest investing when others are nervous, because it’s likely I’m being offered a good deal by the seller. But when ‘animal spirits’ are in the ascendancy, when optimism reigns and everyone is bullish? Well, that tends, historically at least, to suggest that we’re entering choppy waters. Perhaps the wind dies down and it’s again smooth sailing. Or not.

I’m not arrogant — or silly — enough to make predictions. But I’m smart enough to be mentally prepared. It’s a time for winding in risk. For paying down debt. For making sure I’m ready to ride the storm, should it come. That doesn’t get me headlines, but hopefully saves you at least a little pain, if the worst does come to pass.

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