Kazuki’s, a Japanese restaurant in Melbourne, enjoyed a rush of bookings last October after The Age newspaper’s Good Food Guide gave it two hats.

The bookings burst, however, fizzled out in about a week. In early November, the Reserve Bank of Australia raised the cash rate for the 13th time since mid-2022. The central bank lifted the key rate to its highest in 12 years to crush inflation that reached a 22-year high of 7.8 per cent in 2022.¹

“We got calls for cancellations straight away,” Kazuki’s co-owner Saori Tsuya told the newspaper. “People are switched onto economic changes, and they make decisions accordingly.²

It’s a familiar lament across food services. The Australian Securities and Investments Commission reports the accommodation and food-services sector suffered 1,751 insolvencies in the 11 months through May compared with 1,127 in the same period a year ago and 713 two years earlier. ³

Consumer spending, which accounts for about 60 per cent of economic output, is under pressure due to steeper rents, rising health costs and soaring energy bills as well as higher mortgage repayments. The worrying news for mortgaged households is the Reserve Bank could raise rates again (though we don’t think it will). Inflation in the 12 months to May stood at 4 per cent, which is still above the central bank’s inflation target of 2-3 per cent.⁴

Many companies listed on the ASX are vulnerable to tightfisted consumers, especially those classed as ‘consumer discretionaries’ – a category for companies selling non-essential, often luxury, items. Doubts about the earnings of a significant number of large stocks should hinder the Australian stock market.

Yet, in mid-July, the S&P/ASX 200 Index reached a fresh record high. In the US, where interest rates have also risen to curb inflation, the US market benchmark, the S&P 500 Index, on July 16 set its 38th record close for the year.⁵ How can this be?

The answer is that investors factor in more than present trends for consumer spending into earnings expectations. In the US, hopes that artificial intelligence will boost company productivity and earnings and talk the Federal Reserve will reduce interest rates before year-end have helped propel the US stock market to new heights. In Australia, talk a slowing economy will allow the Reserve Bank to cut the cash rate – or, at least, not increase it again – have helped boost stock prices.

The worry is that stock valuations – the multiples placed on underlying earnings that help set share prices – have surged to heights that many analysts regard as expensive, if not bubbly.⁶ If any of the factors supporting stock prices were to disappoint – say, for instance, interest rates remain at today’s elevated levels for longer than expected, earnings growth falls short of high hopes or another conflict breaks out somewhere – stocks could suddenly drop.

A question that investors might ask is whether there might be a way to mitigate the risk of a slump in stocks.

One answer worth considering is that during turbulent times active-management strategies have the potential to outperform passive ones.

Active managers are those like Atrium who build portfolios with an aim to outperform a benchmark or to achieve positive returns in almost all circumstances. If active managers see trouble ahead, they have the ability to reposition their portfolios to reduce or even avoid relative and absolute losses.

They can protect returns, for instance, by moving more of the portfolio into ‘defensive’ stocks, which are those with earnings only loosely tied to the health of the economy. Or they can hold more cash than previously. Of they could short stocks, if their mandates allow.

Passive managers are those who build portfolio to replicate the performance of a benchmark. During any crash, passive investors must endure the full extent of any stock crash. Less eating out for their investors perhaps come a crunch.

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¹Australian Bureau of Statistics. ‘Consumer price index, Australia.’ 24 April 2024. abs.gov.au/statistics/economy/price-indexes-and-inflation/consumer-price-index-australia/mar-quarter-2024

²‘Groundbreakers can’t survive any more’: Is Australia’s restaurant industry on the brink?’ The Sydney Morning Herald, a sister publication to The Age. 27 February 2024
smh.com.au/goodfood/eating-out/groundbreakers-can-t-survive-any-more-is-australia-s-restaurant-industry-on-the-brink-20240223-p5f795.html

³Bloomberg – As Diners Economize, Sydney’s Top Restaurants Are Shutting Their Doors. 6 June 2024
bloomberg.com/news/articles/2024-06-06/top-australia-restaurants-closing-down-thanks-to-cost-of-living-crisis.Original data can be found at: ‘Insolvency statistics(current).’ Australian Securities and Investments Commission. asic.gov.au/regulatory-resources/find-a-document/statistics/insolvency-statistics/insolvency-statistics-current/

⁴‘RBA August rate hike remains in play, minutes show.’ Bloomberg News. 2 July 2024. bloomberg.com/news/articles/2024-07-02/rba-sees-recent-data-as-insufficient-to-prompt-cash-rate-hike

⁵‘S&P 500’s $18 trillion rally Is ‘broadening out’: Markets wrap.’ Bloomberg News. 16 July 2024. bloomberg.com/news/articles/2024-07-15/stock-market-today-dow-s-p-live-updates

⁶See, ‘Stocks are on an astonishing run. Yet threats lurk.’ The Economist. 16 July 2024. economist.com/finance-and-economics/2024/07/16/stocks-are-on-an-astonishing-run-yet-threats-lurk