The S&P/ASX 200 Index (ASX: XJO) looks likely to head to a loss today – down 1.23% to 5,420 points at the time of writing. Although this is a level Elon Musk might approve of on today of all days, it will be worrying for ASX investors who might have gotten used to an ASX in the… green after 4 weeks of consecutive gains.
Whilst I hope the ASX brings all investors prosperity in 2020, I also see some problems ahead. I don't discuss these 2 problems as a doomsayer, but rather as an investor who thinks that long-term success on the markets comes from a mindset of being 'ready for anything'.
Problem 1 – Inflation
Inflation is not a concern right now, but it's a problem I see as potentially possible down the road, whether that be in 2020 or 2022.
Right now, the Australian and American governments are attempting to mitigate the impacts of the coronavirus by spending a lot of money. Whilst I absolutely do not have a problem with this, I also think it's an action that could lead to inflationary pressures down the road.
The US government, in particular, is printing money through Quantitative Easing programs at an unprecedented rate – using that money to buy government and corporate bonds. Our own Reserve Bank of Australia (RBA) has also been buying bonds for the first time ever (although not nearly as much as the Fed).
History tells us that at some point, money creation generally leads to inflation. This may or may not occur, but I think investors shouldn't be too surprised if it does.
Problem 2 – Earnings
At the end of the day, shares on the ASX are valued on two metrics: how much a company earns and what investors are willing to pay for each dollar of earnings.
Australia (like the global economy) is on track to go through one of the worst recessions in history this year. In this recession, many ASX companies will find themselves earning far less in profits than they were in 2019 and in prior years.
Once these new earnings are built into the share market, investors will have a nasty choice of paying a price-to-earnings (P/E) ratio far higher than what we are used to or sharply devaluing ASX shares.
Foolish takeaway
Regardless of whether either (or both) of these problems eventuate, I still think sticking with a Foolish investment strategy of buying good quality companies at good prices will continue to be a winner. But again, be ready for anything that comes our way!
