Economic & Market Briefing December 2018

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While diversified investment portfolios were resilient in 2018; the absolute performance was overall quite subdued for the 12 months ending 28 December 2018. This outcome was further magnified as the period begun at market highs following Trumps tax cuts and ended on the back of a significant correction. Irrespective of this, portfolios have held up well when compared to individual equity markets; highlighting the benefits of diversification and a dynamic asset allocation.

To better understand the economic and market influences over the 2018 calendar year, as well as gain further insights into the next 12 months, 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 in Australia and overseas.

Calendar Year 19: A Review

Economic Summary

2018 begun with developed countries achieving market highs in January on the back of a continued ‘Trump-fuelled’ tax cut rally. Our earlier correspondence last year signalled two messages for investors; ‘fasten your seatbelt’s’ and ‘volatility is back’, both of which remain relevant. At the time of our last update; we were in an environment of growing political and economic uncertainty, yet growth markets demonstrated a marked dissonance. That changed in Q4 2018; as equity markets jittered and investor confidence was repeatedly battered. As the global economy enters its tenth year of expansion, talk of a recession is becoming prominent. However, current indicators primarily show strong ‘above-trend’ data, with predictions that economic growth may shift down, but not out; from great to good. The risk factors of late 2018 remain, including; dwindling workforce capacity, trade uncertainties and monetary policy normalisation.


Australian Economy

In Australia the repercussions from the Hayne royal commission have been felt well before February’s final report is written. Credit policies of all banks have been tightened significantly in addition to macroprudential measures taken to cool the housing market. The fallout has been a sharp decline in credit growth, mostly affecting economically sensitive housing credit. Housing price weakness is affecting the psychological household wealth effect, with a knock-on effect on consumer spending. The data released in late December shows that Australia looks on track for further economic growth of around 2.75% to 3%. Although positive data, the pressure on household consumption is expected to feed into GDP growth and the intensity is likely to increase.

2019 is expected to continue the recent shift seen in Australia, with the economic outlook more cautious than previous. Leading predictions include; unemployment to reverse and start moving back up, inflation to remain weak, consumer spending to remain constrained and GDP growth to subside. Australia’s 27-year unbroken record of GDP growth is unlikely to be disturbed in 2019, yet a negative quarter is an outside chance. This scenario could result from a combination of reduced consumer confidence and increasing saving ratios. A lower $AUD could absorb some effects, however, this will unlikely be able to completely offset the headwinds. Against this backdrop, it is increasingly expected that the Reserve Bank will not lift interest rates, while whispers of a possible cut are becoming louder.

The Economic Cycle

The typical business cycle is characterised by an economy moving through a series of states: early cycle, when growth recovers strongly after a recession; mid-cycle, as an economy approaches and then exceeds full capacity and growth peaks; and late cycle, as the economy slows down and tips into recession (highlighted below). The increasing conversations regarding an impending global recession often rest on the assumption that U.S. expansion, as the world’s largest economy, is at the final stage of the cycle. However, leading economic experts at the IMF predict that the U.S. is only just approaching the later stages of expansion. Global recession risks are further reduced as numerous major economies (i.e. Europe and Japan) are behind the U.S. cycle and still undergoing significant expansion.


A Labor Government
What will it mean for investors?

The Federal Election itself is not expected to be a surprise, with the Labor Government strong favourites to win. As a result, there is also little to prevent the Labor party from implementing the policies they have highlighted over the past months. These include the mediation of negative gearing, abolishment of franking credit cash refunds for SMSF’s and the reduction of the 50% capital gains tax discount to 25%. These policies will impact investors. Australia would welcome serious discussion over true taxation reform, however, we anticipate that a piecemeal approach will result in several unintended consequences. We will be closely following these developments and will be formulating strategies to ensure we maximise your opportunities.


Market Summary

Australian Equities

The S&P/ASX 200 Accumulation Index has had a volatile year, recovering strongly from its March lows, but then suffering a large dislocation again in the final quarter. Returns for the 12 months are down; -2.84% for the period, although signs of recovery continue to show in January. The chart below highlights this performance;

ASX/S&P ASX 200 Accumulation Index – 12 months to 28 December 2018

2019 Outlook

Australian Equities were not immune to those concerns affecting global markets over the past quarter, consuming the positive returns from the first half of 2018. However, following the recent valuation correction, the outlook appears brighter, with investment managers expecting a returning focus on high-quality businesses with strong cash flows and high certainty of earnings.

The sectors predicted to be best positioned in 2019 are consumer staples and healthcare. However, companies that can deliver growth in this environment are also likely to be chased by the market as earnings growth proves a rare attribute in these conditions. The sectors with more mixed prospects include; banks and financial services, resources and residential property. Such sectors are likely to be impacted by the two major events already prominent on the Australian Market calendar; Royal Commission Findings and the Federal Election.

2019 is shaping up as a better year for investment returns in the Australian share market. More attractive valuations, solid dividend yields, strong balance sheets and a returned focus to quality, cash flows and fundamentals should provide investors with the potential to reap good rewards.

Global Equities

Global equities have experienced a substandard final quarter of 2019, leaving growth market returns down for the calendar year. The slide began in October, as increasing trade tensions eventually became too much for even the most stubborn investors. November seemingly stabilised but what followed was the worst December for U.S. markets since the Great Depression; exacerbated by rising rates from a persistent Fed. Despite an astonishing bounce up of 5% the day after Christmas, the U.S. market finished the year below where it started. The rest of the developed markets followed suit in Q4 and the calendar year returns can be found below;

2019 opened trading with a wobble, following Apple’s revenue downgrade, which was attributed to a few key slowing economies. However leading professionals do not expect the recent market slide to be long-lived, although consensus is also reached on another volatile year. The late-2018 correction has been flagged as the third intra-cycle equity reset (following mid-2011 and late-2015) providing some relief to those anxious over the current cycle length. Fundamentals remain healthy, as far as earnings, investment spending, corporate balance sheets and leverage are concerned. Markets still possess an optimism that is all to absent late cycle; although key recession indicators and risks must be continually scrutinised.


The importance of diversification is regularly discussed as a risk reduction tool. However, the current example is too valuable not to highlight. When evaluating the above index returns it is evident that diversified portfolio returns have held up well, relative to growth markets. This is the result of allocating your capital across a range of assets, markets, managers and strategies. By coupling diversification with a dynamic asset allocation to active managers, this reduces the risk of significant loss, improves capital preservation and broadens access to on-going income streams.


What the world can learn from Australia

It is perhaps the most successful developed economy.
An Economist Perspective

What is the biggest problem facing America? Or Japan? Or Britain? Or France? Opinions vary, naturally, but persistent concerns continue to recur. Some economist’s point to decades of slow growth in median incomes, which has bred disillusion and anger among working people. Fiscal hawks decry huge public debts, destined to grow even faster as ageing populations rack up ever bigger bills for health care and pensions. Then there is immigration, which has prompted a furious populist backlash in the United States and all over Europe. That hints at what, for many, is the most alarming trend of all: the lack of any semblance of a consistent political consensus about how to handle these swelling crises.

Rising incomes, low public debt, an affordable welfare state, popular support for mass immigration and a broad consensus on the policies underpinning these things—that is a distant dream in most developed countries. But Western politicians sometimes acknowledge that Australia has had the best track record of any country across these areas.

Australia’s economy is arguably the most successful in the developed world. It has been growing for 27 years without a recession—a record for a developed country. Its cumulative growth over that period is almost three times what Germany has managed. The median income has risen four times faster than in America. Public debt, at 41% of GDP, is less than half Britain’s.

Luck has had a hand in these feats, to be sure. Australia is blessed with lots of iron ore and natural gas, and is relatively close to China, which hoovers up these raw materials. But sound long-term policymaking has helped, too. After the last recession, in 1991, the government of the day reformed the health-care and pensions systems, requiring the middle class to pay more of its own way and a superannuation contribution system which has the envy of most countries. The result is that Australia’s government spends just half the OECD average on pensions as a share of GDP—and the gap will only widen in the years ahead.

Even more remarkable is Australia’s enthusiasm for immigration. 29% of its inhabitants were born in another country—twice the proportion in the United States. Half of Australians are either immigrants themselves or children of immigrants. And the biggest source of immigrants is Asia, which is fast changing the country’s racial mix. Compare that with America or Britain or Italy, where far smaller inflows have generated hostility among a big portion of the electorate—or Japan, where allowing foreigners to settle in any numbers is a political taboo. In Australia both main parties argue that admitting lots of skilled migrants is essential to the health of the economy.

These achievements are not without their flaws. There are also reforms that Australia should be undertaking and is not. Nonetheless, Australia’s example shows that reforms considered impossible elsewhere are perfectly achievable. Democrats in America assail most proposals to restrain the rising costs of public pensions or health care as tantamount to throwing grannies off a cliff; in Australia it was the left that pioneered such policies. The Labor Party sold obligatory private pensions to unions as an increase in benefits, since it is technically employers who are required to make regular payments into investment funds on their workers’ behalf. The party also made sure to retain a basic public pension, which is paid to those who have not managed to build up adequate personal savings.

By the same token, it is quite possible to maintain popular support for mass immigration, even from culturally dissimilar places. But it is essential to give voters the sense that their borders are properly policed and that there is no free-for-all. Again, bipartisanship is important. It was a right-wing government that first allowed immigration from Asia on a big scale, admitting a lot of refugees from Vietnam in the 1970s.

Australia’s political system rewards centrism. All eligible citizens must vote, by law, and those who might not bother to turn out otherwise tend to plump for mainstream parties. There is no need to rally supporters to the polls by pandering to their prejudices. Since everyone has to show up, politicians focus instead on winning over the wavering middle. The system of preferential voting, whereby Australians rank candidates in order of choice, rather than picking just one, also exerts a moderating influence.

Killing the goose?

The irony is that, just as the benefits of this set-up are becoming so obvious, Australians appear to be growing disenchanted with it. Voters express growing doubts about the effectiveness of government. It has not cost the two main parties many seats, thanks to the electoral system, but their vote-share has fallen by 20 percentage points since the 1980s. Politicians, conscious of voters’ disgruntlement, have also become increasingly febrile. They are constantly turfing out prime ministers, in the hope that a new face will boost their party’s standing with the electorate. Some in the ruling Liberal Party, although not the current prime minister, have begun to call for a reduction in immigration, undermining decades of consensus. Ambitious reforms have become rare. The rest of the world could learn a lot from Australia—and Australians could do with a refresher course, too.


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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


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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