2018 was another interesting year for investors with particularly volatile markets since October! So how does 2019 bode for investors?
No more ‘easy money’
The market significantly shifted its thinking on interest rates and monetary policy during 2018.
Since the GFC 10 years ago, global central banks busily stimulated their economies and this included buying US$18 trillion of Government bonds in ‘Quantitative Easing’ (QE). Interest rates fell to their lowest ever and that ‘easy money’ pushed up the price of growth assets (shares and property). That accommodative policy also subdued normal market volatility.
Interest rates fell so much that returns from cash and deposits became unappealing compared with share dividends and property/infrastructure rents. Consequently, the price of those growth assets was pushed up – but the reverse can now be true as interest rates rise. So the global unwinding of Central Bank stimulus that started with rising US interest rates, will remove a key tailwind supporting equity and growth markets generally.
We expect easy money will keep unwinding in 2019 as US interest rates rise and it’s likely to dampen returns on growth assets, especially in the overpriced US stock market. In addition, the one-off effect of Trump’s huge tax cuts will fade, as will the effect of his spending plans. The now high US dollar is another encumbrance for US markets.
However, some stocks could benefit from rising US interest rates and a strong USD: possibly Computershare (CPU), BHP Billiton (BHP), Rio Tinto Limited (RIO) and QBE Insurance (QBE).
Since October 2018, more market volatility has become evident. This increased price fluctuation was largely caused by the paradigm shift in market thinking about interest rates – and also Trump’s disruptive influence.
Equity valuations improved significantly in late 2018, making opportunities to judiciously add international equities (ex US) more appealing again. For our Australian shares, better prices must be balanced against political and house market uncertainties – so, a neutral outlook. In the prolonged expectation of very gradual rising interest rates, non-residential property also has appeal.
Uncertainty and geopolitical risks are always present – but now particularly, such issues are key market drivers. It’s because sound reasoning can be interrupted at any time by a late-night tweet from an ego-centric, unpredictable leader with disturbing access to power.
Some stocks that might hold up better than most amid market volatility: Newcrest Mining (NCM), Evolution Mining (EVN) for gold to soothe uncertainty, and perhaps reliable staples like Woolworths (WOW), Wesfarmers (WES), Coles Group Ltd (COL) and AGL Energy Limited (AGL).
The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry heavily influenced Australian financial stocks in 2018. Its revelations wiped billions off the market values of Australia’s largest banks. Our blog, Misconduct amid Poor Governance discussed related issues that needed to be addressed. Royal Commission revelations had a significant impact for Australian share investors returns in 2018.
In energy markets, the debate around unresolved policies like the National Energy Guarantee (NEG) caused significant impact for related companies.
Abroad, the Trump Trade Wars and trade tariffs to dissuade China’s theft of the west’s intellectual property added further uncertainty. It may have played well in evening political coverage but also caused collateral US exporter damage within the US.
In 2019, these lingering issues create continued concern for markets. Here, Labor’s proposed tax changes might yet cause further market turbulence for investors.
If Labor wins the looming Federal election, they aim to stop refunding cash for unused franking tax credits arising from Australian share dividends. So for some, ‘Franking Credits are on the Chopping Block’.
Labor also plans to phase out negative gearing and halve capital gains tax concessions, bringing Australia closer to tax rules used elsewhere in the world. Such changes would cool enthusiasm about borrowing to invest, and further cool Australian property prices. As tax incentives move away from property, might we hope for more incentives to invest in broadening our export base?
Some stocks with strong prospects that don’t rely on franking credits are: Amcor (AMC), CSL Limited (CSL) and ResMed Inc (RMD).
House prices will keep falling
Residential property prices will remain an important factor in Australia in 2019. Though prices have fallen by 9.5% from their peak in Sydney and 5.8% in Melbourne, these adjustments follow cumulative increases in Sydney (40%) and Melbourne (32%) over the previous four years. So the fall is not yet significant, though affordability is still stretched in both cities. For Adelaide neither the boom nor the likely fall is as significant.
In our November 2016 ‘Time to re-think property’ blog we noted that “the natural growth limit for property is our ability to pay for it”.
Interest rates have been falling since the last recession 28 years ago and our booming property market was driven more by this than by negative gearing. As rates fell, banks loaned more and that money found its way into higher property prices. This loose credit allowed property buyers to pay ever-increasing prices.
As credit becomes tighter, the Property Bell Tolls.
Our Reserve Bank (RBA) is unlikely to raise rates till 2020 but the major banks have lifted loan interest rates out of cycle as their offshore funding costs increased. More importantly for 2019, credit is being tightened by those banks – we flagged this in our Australian Property Price Outlook blog of April this year.
It’s a regulator-induced (APRA) crackdown on business and residential property lending, especially for investment loans – reinforced by the critical gaze of the Royal Commission. Our banks needed to tighten up their lending criteria and to change interest-only loans on investment properties to principal and interest loans. This means there’s now less borrowed money in the property market to sustain high prices.
Unlike previous cycles where affordability was boosted by sharp reductions in interest rates and strong income/wages growth, the necessary restoration of affordability in this cycle will need to come from reduced house prices. It is unfortunate that this sense of declining wealth can have the effect of reducing consumer spending, thus tending to contract Australia’s economic growth.
As easy money unwinds around the world, the US is leading the way and it’s now in the latter stages of its economic cycle. Meanwhile, as the Australian and Chinese economies slow, we can expect more divergent returns between regions, sectors and asset classes in 2019.
Most investors seek to ‘balance’ risk with complementary asset classes – though there’s confusion on what a ‘balanced portfolio really is. Host Plus Super’s ‘Balanced’ Fund has 90% in growth assets (shares, property and infrastructure) while Australian Super has 80% and Vanguard’s has a more careful 50% in its Balanced Fund. Host Plus treats half its infrastructure as defensive rather than ‘growth’ and 75% of its property. Interesting… when recalling that after the GFC, listed property fell in value more than the main stock market.
All that aside, the Schroders fund manager chart below, shows asset class returns in the last three years of low-interest rates and low volatility helped all asset classes rise. Until recently diversification was less important:
But during market distress, prudent diversification between assets tends to be more important. The chart below shows the range of asset class returns amid extreme distress in the 2008 GFC. Repeating the GFC seems unlikely and though Trump’s economic skills may yet disappoint us, you can see that diversification is important.
For many months we’ve said US assets prices were too high and so we chose a gradually more conservative asset allocation than usual. Our client exposure to US markets is already significantly less, which may create buying opportunities in other markets as they fall in sympathy without themselves being overpriced.
What can an investor do?
Overall, we expect slower growth and lower returns for 2019, with the US still to the fore but exerting less influence. Trade wars will hopefully be resolved and while US interest rates will rise, ours probably won’t until 2020. Ours and other global stocks are fair value though US stocks are still overpriced – but no US recession is expected just yet. China may face weaker growth but it’s unlikely to be diverted from its path, so our exports should muddle through.
“Today, it’s harder to predict how things will unfold in the world that at any time in the last 40+ years. It is a riskier environment than I can ever remember.” – John Hewson.
So, what’s an investor to do? Three important steps you should follow are:
- Be clear about your goals and risk tolerance.
- Have a strategy.
- Once 1 + 2 are clear, stick to it!
At Wotherspoon Wealth, we help our clients create an investment strategy tailored to their own goals and risk appetite. It ensures they can stay the journey and have the patience to ride the market’s ups and downs, while always meeting their income needs. One way we articulate this is in our ‘Three-tier approach to retirement’.
We believe in a higher standard of financial advice, free from product bias and conflicts of interest.
Disclaimer: All information in this article is intended to be general in nature for discussion purposes only. So you should not rely on it and seek personalised professional advice before making any decision.