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Economic & Market Briefing September 2018

Wealth Creation = Advice + Management

Introduction

Diversified Investment portfolios continued to show strong positive performance for the 12 months ending 27 September 2018. Although political tensions remained prominent throughout the quarter growth markets were resilient. As a result, the majority of asset classes have moved upwards year on year, given the positive and relatively synchronised macroeconomic environment.

To better understand the economic and market influences over the year so far, as well as gain further insight into the remainder of 2018, we have summarised a selection of commentaries from market leaders. The following provides an overview as to the current positioning of both economies and markets both in Australia and overseas.

Fiscal Year 19: The Beginnings

Economic Summary

It has been an interesting period for global economies. 2018 has affirmed its position as a return to more challenging conditions following on from the ‘Goldilocks period’ that was 2017. Escalation of trade tariff tensions has dominated investor sentiment in recent months, while confirmation of the continued upward path for interest rates in the United States has stoked the fire. European, U.K. and, most recently, Japanese Central Banks have also signalled a progressive return to a more normal interest rate policy. Political uncertainty regarding the ongoing Brexit negotiations and the outlook for the European Union remains, while the ebb and flow of the United States’ relationship with North Korea, Iran and China ensure that there is no shortage of uncertainty. Against this backdrop, growth markets have nonetheless managed to post impressive returns, with most delivering double-digit gains over the last twelve months.

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Australian Economy

The Australian Central Bank met last week, and while it held rates steady and suggested increases were unlikely for quite some time, it also acknowledged the recent strengthening in economic growth. Indeed, recently released data showed that real GDP rose 3.4% year-over-year in quarter-two. That represents the strongest annual growth rate since 2012, but with inflation stuck near the bottom of the central bank’s target range, there seems to be no urgency to raise interest rates anytime soon. Positive indicators like these have seen businesses become more optimistic. The NAB business survey has shown confidence strengthening, helped by improved business conditions. However, not all industries are benefitting from the better times, with retail businesses suffering from sluggish spending growth.

Global Economy

The Fed raised interest rates by 25 bps last week in a widely-expected move. Previous moves have been accompanied by a statement with the following wording; “monetary policy remains accommodative.” However, that language disappeared this week, meaning the committee is implicitly signalling that the Fed rate has moved into neutral territory. That said, the neutral rate estimate is not precise and could take on a broad range. The consensus expectation is that the Fed will look for another 25 bps rate hike before year-end and 75 bps of tightening next year. The consumer confidence index neared an all-time high in September, while personal income and spending data released generally supports consumers’ upbeat sentiment surrounding the near-term outlook.

The Trade War continues to escalate, with a further ratcheting up of trade tensions between America and China. From September 24th, imports of products worth as much as $189bn, including furniture, computers and car parts, will be hit with duties of 10%. The Chinese have promised to retaliate on the same day with duties on $60bn of American exports. The tit for tat shows no signs of easement, signalling that America and China are in a full-blown trade war. Consequential drops in exports in June and July will likely lead to a reversal of trade’s second-quarter boost to overall GDP growth. Meanwhile, markets remain on edge around global trade tensions, with concerns Japan may be the next target for U.S. tariffs. On the policy front, Brexit negotiations showed tentative signs of making progress, although a preliminary deal remains elusive for now. Fears around emerging market contagion eased this week, allowing the focus to shift back to global central bank developments and economic data releases,

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Lehman: Ten Years On
More has changed than meets the eye.

Ten years ago, last month, Lehman Brothers, the fourth-largest US investment bank, filed for bankruptcy protection. The fall of Lehman was not the beginning of the global financial crisis, nor the moment when risks were highest: but it was the point at which the previously unthinkable became real. The world’s credit markets froze with fear. A complete collapse of the financial system seemed plausible and with it a global depression much deeper than the parlous recession which actually followed. The epicentre of the crisis was a wave of US subprime mortgage failures that hit the housing and financial sectors and then spilt over into the broader global economy.

Thankfully, the financial system is in a much better place right now than a decade ago. The global economy has been expanding - the US is in its ninth year of expansion, which is the second-longest on record (behind Australia), and most developed economies are at or near full employment. Further, inflation remains modest despite unprecedented monetary stimulus. However, the GFC set in motion or accelerated some deep shifts in the global economy that leave us still short of 'pre-crisis normal’. A number of these ‘enduring scars’ include;

  1. Slower global growth as a result of less international trade.
  2. Persistently low interest rates.
  3. Stagnating wages.

Yet the contrast between the economy and the markets couldn't be starker. While most economic variables showed subpar performance, stocks and bonds have delivered very solid returns over the ten years that have followed.

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Market Summary

Australian Equities

Although a near flat quarter for the ASX/S&P ASX 200 Accumulation Index, year to date returns have been strong; 14.2% for the period. The chart below highlights this performance;

ASX/S&P ASX 200 Accumulation Index – 12 months to 27 September 2018

Reporting Season Wrap

As corporate reporting season comes to an end, we look back at how the Australian equity market performed: dissecting the key themes that emerged.

Overall, a solid reporting season helped drive the S&P/ASX 300 Accumulation Index to gains of 1.4% last month. However, as always there were hits and misses aplenty, many of which were met with explosive price moves. Unsurprisingly, the difference between the best and worst performing companies was particularly high towards the end of the month, when small-cap names traditionally tend to release results.

The five pivotal trends we saw materialise in the recent reporting season are;

  1. The reappearance of cost inflation
  2. The resilience of consumers and retailers
  3. Capital management policies
  4. Merger and acquisition activity
  5. Small-cap tech performance

The persistence and endurance of these trends will be significant in determining the potential returns of stocks and asset sectors going forward. Domestic economic conditions remain supportive and the Australian equity market continues to offer opportunities for investors, noting an increasing divergence in valuation between segments of the market.

Global Equities

Global equity markets followed suit and managed to post impressive returns against a difficult backdrop. Global markets established all-time highs in August, driven by another strong earnings season in the US and hopes that the US administration is prepared to negotiate to avoid an all-out global trade war. The MSCI World ex Australia index returned 20.8% for the year to 30 September 2018, further supported by the weaker Australian dollar, which fell to a 20-month low against the US dollar. Investors remain optimistic based on rising corporate earnings and reasonable valuations in numerous sectors; despite slowing momentum and less synchronisation in global growth.

The S&P 500 Index has had another strong year, returning 17.91% to 30 September 2018, simultaneously marking a record for the longest ever bull run. US equities have seen earnings growth of around 25% over the last two quarters. Encouragingly, revenue growth also rose to 10% in the second quarter, suggesting the rally might have further to run. The impact of Trade Tensions remains a key risk and is being closely monitored.

The Eurozone economic recovery has continued, however, market performance has been adversely impacted by political uncertainty, with the MSCI Europe Ex UK returning -1.49%. The region's outlook remains clouded with continuing Italian political developments and the pending approval of the new budget may add another source of volatility over the coming quarter. Across the channel, the energy of the hard-core Brexiteers strengthened during the Conservative Party conference, however, negotiations continue. The FTSE 100 TR index has returned 6.08% over the period.

The Japanese equity market (Nikkei 225 Average PR) has had a strong year, posting double-digit returns of 18.49% over the period. In Japan, there are now more jobs available per applicant than at any point since 1974. Banks also continue to expand credit, in stark contrast to the deflationary period in the early 2000s. The relative strength of the US dollar against the Japanese yen, helped by rising interest rate differentials, has been supportive of Japanese equities over the quarter.

The MSCI Emerging Markets Index returned 7.56% to 30 September 2018. Emerging economies have had an eventful quarter, starting with Turkey’s Central Bank decision to not raise rates; plummeting the lira. Following this, a political spat with the US exacerbated the vulnerabilities in Turkey’s already fragile economy. The spotlight then shifted to Argentina; struggling with an impending recession and the peso under pressure. Although EM equities were down for the quarter currencies bore the brunt of the sector’s stress.

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The Royal Commission

The Big Four
An investigation into Australia’s Financial Services finds a litany of abuses.

BANKS often face conflicts of interest when it comes to advising their customers. The regulators who are supposed to stop these abuses are not always up to the job. But when wrongdoing does finally come to light, the penalties can be vast. Financial institutions in Britain have had to lay aside £40bn ($74bn) to compensate customers mis-sold payment protection insurance. Wells Fargo was fined $1.4bn by American regulators and ordered to reimburse the people to whom it had sold useless insurance or mortgages with inflated fees. Now it appears to be the turn of Australian banks to face a reckoning.

A royal commission has exposed a litany of abuses. Its interim report, published on September 28th, paints the country’s large financial institutions as consumer-crushing oligopolies. Lenders charged hidden fees long after providing services, and for some services they never provided at all, on occasion to people who were dead. They siphoned off at least $1bn of compulsory pension savings in excessive charges. And they offered mortgages that they should have known were far too expensive to afford. Their behaviour, said Kenneth Hayne, the head of the inquiry, was not just immoral, but criminal.

The banks have tried to pin the blame on a few rogue staff. In fact the wrongdoing was pervasive - and turbo-charged by government policy. Until relatively recently few Australians sought financial advice. But the introduction of compulsory private pensions in the 1990s gave them savings to invest. At $2.6trn, Australia’s superannuation pot is now one of the world’s largest. It has sustained a swelling wealth-management industry.

The inquiry levelled sharp criticisms at outsized commissions. ‘Commissions’ were banned via FOFA legislation introduced in 2014 but a number of large institutions side-stepped this minor inconvenience by renaming them. It found these ‘incentives’ had encouraged financial advisers to direct customers’ savings towards high-cost, poorly performing funds and insurance providers to sell policies that would never pay out. They also boosted risky mortgage lending, since brokers’ earnings were linked to the size of the loans they sold. Financial regulators were lax, negotiating minimal fines for those who broke the rules rather than taking them to court. Sanctions were often “immaterial”, the report stated. In the decade to June, the infringement notices (a kind of fine) issued to large banks by the Australian Securities and Investments Commission, the conduct regulator, came to less than $1.3m.

The institution hit hardest by scandal has been AMP, a wealth manager, which not only charged for non-existent services but then lied to the regulators about it. It has since lost its chief executive, chairman and half its board. AMP and the four biggest banks have agreed to repay $216m charged for services they never provided but this may only ‘scratch the surface’ of the actual wrongdoings.

Financial institutions are now scrambling to prepare for the inquiry’s final recommendations, due in February. They have tightened home-loan assessments, and some have said they will sell their wealth-management businesses. More than that may be needed. The commission may call for statutory separation of lending and financial advice, and for an overhaul of bonuses.

It seems likely to demand better enforcement, rather than new laws (there are plenty already). The conservative coalition government, which had at first opposed the inquiry, has allocated more money to the regulators. It says a recently appointed counsel will improve the chance that misconduct will be punished in court. Yet the regulators’ reputation has been damaged. Allan Fels, the former chairman of the Australian Competition and Consumer Commission, thinks his old employer should be given greater power to step in. Others call for an entirely new regulator.

The commission looks unlikely to be able to finalise everything that is needed before the final report is due. Mr Fels suggests that unfinished business could be turned over to other review boards. Or the inquiry could be extended—an idea favoured by the Labour Party, which is on course to win an election due next year. Either way, the banks stand exposed to potentially huge regulatory penalties and to consumer lawsuits. The days since the interim report was published have seen billions of dollars wiped from their market capitalisation.

Personal Message from Ross
Ross Rickard - CEO

While I was shocked by the impact of the recent Royal Commission, I was not surprised by their findings. The stories of client exploitation have been disgraceful. These institutions have for too long been operating to their own agenda and without fear of legal repercussions. The Royal Commission has taken the concerns industry insiders have had for years, directly into the living rooms of ordinary Australians. That is a good result!

While I have confidence that all my clients know what clearly separates Financial Professionals from these shocking revelations, I would still like to take this opportunity to restate the key differences that keep Financial Professionals at the ethical forefront of our profession;

  1. We do not have any conflicts of interests when selecting investment products. We select investments we believe are best suited for your specifically tailored portfolio. This is done by detailed analysis of a wide variety of independent research, countless portfolio manager meetings, conferences, presentations and the knowledge acquired over 25 years of experience.
  2. We charge a transparent and fair fee for our Investment Management Service, which aligns your success with ours. It is a ‘sliding-scale’ fee to reflect true value and cost-effectiveness; it is charged on successful completion of the task and is not product related.
  3. We research a myriad of funds, constantly and consistently, whether held in client portfolios or not, to ensure we understand the key options and remain up to date.
  4. We have remained ‘off-platform’, particularly while this space was dominated by product providers which introduced inherent conflicts, and an additional layer of fees and limited choice.
  5. We spend the time to understand your individual needs, goals and objectives to be able to tailor a portfolio suited to you; we do not use a cookie cutter portfolio approach where everyone fits into a few ‘boxes’.

Today, we see three of the four major banks throwing in the towel, and our nation's institutional advice network retreating, as numbers decline and are threatened with a slew of criminal charges. The interim report, although without reference to recommendations, showed glimpses that those spearheading the Hayne inquiry do ‘get it’.

I am very proud of my profession, I know the real benefits it can have to people’s lives and am lucky to be able to experience this daily. There are a majority of others in the industry doing good and honest work. It is therefore unfortunate to see those good advisers being tarred with the same brush as those ‘greed driven’ institutions with no regard for ‘client first’ principles.

We are committed to always providing the best service to each and every client, to maintain the strong trust and loyalty you have in us. If you know someone who has been caught up in the ongoing Bank sponsored corruption and needs real financial advice or wealth management services; we would love to take their call as we know we can help.

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Contact Us

(07) 5555 5400

advice@finprof.com.au

Ground Floor 140 Bundall Rd, Bundall QLD 4217

https://www.financialprofessionals.com.au/

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Sources

Reserve Bank of Australia, OECD, Franklin Templeton Investments Australia, BT Investment Management, Yahoo Finance, Visual Capitalist, JP Morgan, Colonial First State, Market Index, Schroder Asset Management, The Economist

Disclaimer

All care has been taken in preparing this report. However, please note we base our financial product research on current information provided to us by third parties (including financial product issuers) which we cannot necessarily verify. While we use all reasonable efforts to obtain information from reliable sources, we do not guarantee the data or content contained herein to be accurate, complete or timely. To the extent that our research is based on information received from other parties, no liability is accepted by Investment Professionals, its affiliates nor their content providers for errors contained in the report or omissions from the report. Past performance is no guarantee of future performance. Index returns are based on the country of domicile.

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