In this article we consider the year that was, along with analysis on likely themes in the year ahead, finished off with some practical thinking around portfolio management.
2015 was a tough year for investing, with the stand out exception being property in Australia.
Share markets globally struggled. The main Australian index, the ASX 200, ended down 2% after trading down as much as 18% from its peak. The main US index, the S&P 500, traded down as much as 12% before finishing little changed, while the UK market ended down about 4% after falls as much as 16%. The worst of all was China’s main index, the Shanghai composite, which was down as much as 43% from its peak, but still up 9% for the year.
Defensive assets like cash and fixed interest also struggled due to the low interest rate environment globally, meaning income yields remain very low and it was difficult to achieve reliable returns from these traditional safe havens.
The bright spot has been Property Markets. Residential property in Australia grew by about 10%, driven largely by exceptional performances from Sydney and Melbourne respectively and this excludes rent. Australian Property trusts also did very well at over 14%. Property has been supported by historically low interest rates and strong demand from local and international investors.
One of the key themes that caused market anxiety in 2015 was waiting for the US Federal Reserve to raise interest rates. The US economy makes up 22.4% of the worlds Gross Domestic Product currently (GDP – put simply, what the world produces), with the Euro region 17.1%. China is the second biggest economy by country at 13.3% and then Japan at 6.2%. It drops off quickly from there. This data demonstrates just how important the US economy is to global growth.
The official US interest rate was increased at the last meeting of the year and while it was only a lift from 0% to 0.25%, it is significant, given it is the first move up in nearly a decade and symbolises the fed’s belief that the US recovery is sustainable. The move however took a lot longer than was initially anticipated by markets, which in turn resulted in volatility.
Another cause for volatility has been a slowing of the Chinese economy. China was one of the few bright spots throughout the GFC growing strongly, while most of the remainder of the developed world was hit hard. Their pre GFC growth rates were 10%, owing in part to an unprecedented property boom, which caused a lot of oversupply in the Chinese market.
The world’s largest Index Fund manager ‘Vanguard’ in fact estimates as much as 75% of the slowdown in China’s growth rates can be attributed to them absorbing the property overhang and expects China’s growth in 2016 to drop below 7%. The World Bank estimates China to grow by only 6.7% in the coming year.
A slowdown in China impacts the entire world, given it is the second largest economy, however the most significant impact is felt by Asia and this is a big part of why the Australian share market has performed worse than other developed countries, even considering Australia has continued to grow as an economy.
Other reasons for market volatility include geopolitical issues that sent short term shocks through the market, but nothing sustained. Events like the Paris bombings, war in Syria, and tensions in the South China Sea also contributed to short term volatility.
So where to for 2016?
2016 has started the year in abysmal fashion for share markets, with investors reacting savagely to news that China has again reduced its currency manually against the US dollar. Concerns that it implies their economy is not growing at the rates initially thought is driving the current fear.
While this current market down turn may translate into something more long term, an economist we like and think has a great way of explaining his thoughts on the direction of markets is AMP Chief Economist Shane Oliver. Asked for his views of the year ahead in December he says:
“No doubt those who were looking for economic mayhem to break out in 2015, will simply roll their expectations for disaster into 2016. However, there are good reasons to believe we will simply see a continuation of the constrained uneven global growth that we have been seeing over the last few years.
Major economic downturns are invariably preceded by either economic or financial overheating and there are no signs of that. There has been no major global bubble in real estate or business investment, inflation remains low, share markets are not unambiguously overvalued and global monetary conditions are easy. In terms of the latter while the Fed is likely to raise rates the process is likely to be gradual reflecting constrained US growth and still low inflation. And monetary easing is set to continue elsewhere, which in turn will also limit the extent of Fed tightening to the extent it puts upwards pressure on the value of the $US. As such, apart from a left field shock, it is hard to see what will drive a major global economic downturn at present.
At the same time, it is hard to see what will drive a sharp acceleration in economic growth either. Rather, the structural combination of slower population growth, a more cautious approach to debt and structural problems in the emerging world will keep a lid on global growth. Consistent with this leading growth indicators point to steady growth. Not collapsing, but not booming either.”
Interestingly, his predictions for Global shares is the stand out best performer, estimating 9% growth or 15%, when factoring in their view for the Australian dollar falling to $0.60 against the greenback. A view supported by Vanguard, predicting 7 – 10% growth in global shares and in an article published in The Age on 11th January, they say it is the consensus on Wall Street that the S&P 500 will rise 7 percent for all of 2016. AMP also predict a reasonable year for Australian shares at 7% and 7% for listed Property Trusts.
A review of several economist’s and fund manager predictions for 2016 reflects a consensus view that 2016 is set to be another challenging year, with a typical observation being that the world markets are going to have to get used to lower global growth for some years yet.
Like last year, the key concerns of markets this year are likely to continue to be China and the US. That is, China managing its reducing growth rates and the US raising interest rates.
The US Fed has indicated there could be around four increases, so the market will be watching the Fed’s moves closely and as a separate but related point, the likelihood is that the Australian dollar will continue to reduce against the greenback, as their economy strengthens and in turn their interest rates are increased. On the point of how China manages their economy, there is an expectation that China will provide stimulus to its economy to manage its growth.
The other almost inevitable eventuality will be geo political issues arising that affect markets.
Back at home, we are entering our 25th year of uninterrupted growth. In fact quite incredibly, we have only had three quarters of negative growth in this period and one of them was as a result of the Queensland floods.
Considering the challenges Australia has faced, we are transitioning quite well at the moment from being so heavily dependent on mining. New growth and employment opportunities have been arising in health, hospitality and agriculture, that have helped offset the reduction in Mining revenues and employment.
Economists expect interest rates are likely to remain low for the foreseeable future and a further rate cut or two may still be a possibility.
The big question then is where to put your hard earned savings?
Firstly, an important point: Nothing written here should be construed as advice. In order to advise you, we must first make an assessment on your personal situation and objectives and this is 100% essential.
In an environment that is expected to be challenging and likely remain challenging as the world adjusts to a lower growth environment, some people may feel their money is safest under their bed, but as always this is ill advised.
The generally lower risk options continue to be bank accounts or if you have a home mortgage, simply reducing debt. With interest rates so low, there is certainly an argument that can be mounted for this and in fact, the greatest opportunity people have to make serious in roads into their debt is when interest rates are low.
Whether you have existing debt or are looking to get into debt to buy a home one savings tip we’d suggest is to work out what your cost would be if interest rates were at a more normal level of say 7% and make payments equivalent of this. If you can do more, then great, but by doing this as a minimum, you are achieving two things. The first is that you are reducing your debt more rapidly than simply making minimum repayments, but the second is that you are setting a savings pattern that sees you prepared for the eventuality of increasing interest rates.
If you are in retirement or do not have any debt, it will continue to be very difficult to make a reasonable return from cash and fixed interest so it is wise weighing up all of the options against your individual objectives. In this current environment, it is likely that if it looks too good to be true it probably is, so while some options exist that look attractive, it is essential to weigh up the risk and return.
Direct property at a national level is likely to level from here and this is a view shared by several Economists. Interest rates dropping may support a small further run in valuations, however with interest rates so low and investment lending regulations from banks tightening, it is likely there will be a cap on price growth. This is not to say that a long term investment into property will not yield growth, but does suggest that investment selection will be extremely important.
As noted above, the likes of AMP’s Shane Oliver believes that listed property trusts are likely to continue to be sought after and provide return, as investors chase yield and could be considered as part of a balanced portfolio.
Australian and Global shares are tipped by some for growth, but as always will be the most volatile of all investments, given they are traded and priced daily. If the Australian dollar falls as is broadly tipped, this will enhance potential returns for Global Shares and Australian Shares will continue to benefit from the sizable dividend yield that is typical of Australia. For these share based investments, the same metrics as always should apply, being a long term view in a well diversified portfolio.
We believe our clients portfolios are well positioned in the current climate. With a tilt to global shares, we hold a largely unhedged position to currency, meaning if the Aussie dollar falls as is expected, our clients portfolios will benefit.
We currently have primarily active fund managers, which albeit are more expensive, have flexibility to pick the eyes out of the market to a point, to invest in the stocks they see are best positioned for growth and give them an opportunity for outperformance.
We also hold some alternatives, which provide diversification and hedges our portfolio’s somewhat to market shocks.
For clients with SMSF’s, we are looking at direct share and direct fixed interest exposure, which gives the opportunity to be highly selective in sectors of the market and stocks. Further to this, for retirees in particular, we are looking at a range of vehicles to create visible income ‘pots’ to meet ongoing retirement needs.
Please contact us if it is of interest to discuss your financial and investment planning needs.
By James McFall - Founder Yield Financial Planning
"GOOD FORTUNE NEEDS GREAT PLANNING"
The content of this presentation is intended to be general information only and has been prepared without taking into account any person’s objectives, financial situation or needs. Each person should consider its appropriateness having regard to these matters or obtain relevant professional financial advice before making any financial decisions. Examples are illustrative only. Each person should obtain any relevant professional financial, taxation and social security advice before making any financial decisions.