What A 12 Months – Tickets Please ….

So you’ve paid your money and you hand over your tickets before taking your seat on the ‘investor rollercoaster’.

Pre Covid-19

From July 2019 up until late February 2020, all seemed fun with things looking relatively ‘rosy’ as we rode the investor rollercoaster to all time highs (around 7500 on the All Ordinaries here in Australia and around 29500 on the Dow Jones in the USA).

This period saw strong gains across much of the global share markets – company earnings were healthy, central banks were reducing interest rates, discussions on the final Brexit details were moving forward and there was an easing in the USA / China trade war all helping to push fears of a recession to the background.  The biggest thing, looking forward, was whether President Trump might win another term.

It seems like an age ago now but here in Australia, we battled intense and devastating bushfires and floods (what a country) and the share market still pushed ahead.

There was a thought though tickling the back of investor’s minds that maybe the rollercoaster was just nearing the peak of the initial climb with company share prices potentially a little ‘top heavy’ and that some sort of drop was possible.

Well those musings were correct but not for the reasons thought … hello Covid-19.

Free fall (hands in the air)!

Post Covid-19

News of some sort of Covid outbreak in China started in January but it wasn’t until late February that the world really started to fathom the monumental impact that Covid-19 would have for the globe as cases in Europe, Australia, USA and emerging markets swiftly increased.

This fear then led to share markets quickly falling in late February by around 35%, commodity prices fell too and the US dollar strengthened (the Australian dollar hit a low of US$0.55) as investors factored in ‘worse case’ scenarios.

It was only around 4 weeks after the Covid-19 news hit the airwaves, in late March, that the All Ordinaries hit a (then) low of around 4400 here in Australia and the Dow Jones hit around 18600.  There was no way to know then that this was a turning point as the investor rollercoaster headed back up again on the back of monumental Government stimulus and dreams of a vaccine.

And Now

Since that late March point, the markets have rallied to a point now where the All Ordinaries is now around 6250 and the Dow Jones is around 26700 – still 17% and 9% respectively below the Pre-Covid highs but over a 40% jump from the March depths.  The Australian dollar is around US$0.70 (a 27% increase from the bottom) and commodity prices have firmed (especially iron ore as China’s demand has rebounded and South America (Australia’s largest iron ore export competitor) is in the grips of seemingly ever-increasing Covid-19 numbers).

A Slightly Longer Term View

So, despite this wild ride of recent times, the financial year just ended saw global shares return around 5.2% in Australian dollar terms thanks largely to the tech and healthcare heavy USA share market.  Australian shares were down 7.7% for the financial year.  With the Reserve Bank of Australia (RBA) anchoring cash rates at 0.25%, returns here were hard to find but bonds provided reasonable returns as plunging yields saw capital gains in this space.  Listed property was hit with double-digit losses resulting from a slump in economic activity pushing up vacancies and depressed rents in retail and office properties.

Source: Thomson Reuters, AMP Capital

This last period has again reinforced key investment principles being (i) diversification is key and (ii) timing the market is hard (nigh, impossible).  We might also throw in (iii) beware the crowd mentally (especially at times of heightened emotions) as Warren Buffet has been quoted as saying, “be greedy when others are fearful and fearful when others are greedy”.

So What’s Coming

Covid-19 will continue to be the biggest influence on investment markets for the foreseeable future with the number of cases continuing to grow (both here in Australia and especially overseas).  The obvious threat to economic activity is clear with some estimating that even this current 6 week lock-down in Melbourne will reduce Australia’s GDP by 1% this quarter alone.  Some businesses, many even, will not survive and unemployment will remain high with property prices likely to fall.

But there is increasing optimism for a vaccine and global governments remain committed to providing fiscal stimulus in a low interest rate environment.

The US Presidential Elections in November may provide a positive push to the investment markets if President Trump secures a second term (especially in the USA) but a question mark remains over USA / China tensions and what may be said or done by President Trump if it becomes obvious that he will lose (which betting agencies currently suggest is a real possibility).

This all leads to heightened uncertainty and increased investment volatility so, the investment rollercoaster rolls on (“please remain seated and hold on”).

Save more and retire sooner!

‘Cash is King’ is an oft used term and in the context of a wealth creation strategy no truer words have been spoken.  You can have all the objectives you like but if you don’t have the free cash flow to achieve them they will remain objectives only and never a reality.

So, the journey to helping a client achieve their important personal goals will almost always start with their cash flow.  This case study deals with this most important component of any wealth creation strategy.

Please feel free to share it with someone you care about if you think they may benefit from reading about how improving free cash flow can help them!

What is the objective?

Generally, APC would want to increase ‘free cash flow’ or a client’s savings capacity.  If we can do this then we can propose a strategy to use this free cash flow to generate capital growth and income generation and help them achieve their goals sooner.

Pay yourself first

The most powerful concept for improving ‘free cash flow’ is the idea of paying yourself first which works like this;

1. Understand your NET income AFTER TAX
2. Detail your expenses, broken down by the following categories;
   1. Not Negotiable Expenses – must pay expenses
   2. Nice to Have spending – doing things that bring a smile to your face
   3. Luxurious spending – absolute indulgence!
3. Subtract 2 from 1 and you have your savings capacity or free cash flow

Now, when you know the answer to step 3, this figure is the amount you ‘pay yourself first’ by committing it to a savings or wealth creation strategy before you do anything else.  This is a powerful yet simple strategy which can make a material difference.

The Clients – Professional couple with three pre-teen children

After providing our online budget tool, an initial analysis of their cash flow yielded the following information;

Whilst positive this free cash flow was not enough to achieve the personal goals of our clients.  So the following activities were undertaken;

Review of their debt repayments

Many people actually have mortgages and loans that are not market competitive.  Banks do not automatically re-set all variable loans to the current market rate.  They change your existing loan rate by whatever margin is being increased or decreased.  So if person A started a loan at 5% and person B started it a year later at 4% and the bank decreases their loan book by say 0.25% then person A’s rate goes to 4.75% and person B’s rate to 3.75%.  Person A doesn’t automatically get B’s market competitive rate!

In this case study, the clients have two loans, a home mortgage and an investment property loan, both on principal and interest (P&I) repayments which together are $83,712 per annum. APC recommended re-writing the loans and using a mixture of fixed and variable loan structures and achieved a significant reduction of their annual repayments to $61,932.  This generated an increase in free cash flow of $21,240 per annum.

If you have friends or family members who have a mortgage or investment loan, APC has an appraisal service to check if the rates they have are market competitive.  In addition we can also provide some guidance with regard to the structure of their loan(s) – fixed versus variable.  This appraisal is at no charge and is exclusively part of your Private Client Service.

If you are interested just ask any member of the APC advice team.

Other Expenses

In addition to creating free cash flow from lowering the servicing cost of their debt, we also reviewed their general expenditure and highlighted some areas that they could, together, consider if further areas of savings could be found.

After reviewing this together they found an additional $15,060 of savings by re-calibrating expenditure and placing a higher priority on the achievement of their longer term goals over some of the shorter term spending decisions they had been making.

In total, once the exercise was complete a total of $36,300 of extra free cash flow was generated or just over $3,000 per month!  To put this another way, for this couple it was like receiving a $74,000 pay rise!

Now, with a new free cash flow of $73,950 the strategy has the oxygen it needs and the clients can see a path way to achieving the goals that are personally important to them and their family.

Give yourself a pay rise!

If you would like a fresh review of your overall cash flow to see if you can increase free cash flow and give yourself a pay rise, please feel free to make contact with any member of the APC advice team

We’ll be happy to help!

Luke and Amy welcome Theo into the world!

 Welcome Theodore Phillip Price to the APC Family. Born at a healthy 3.63Kg at 4:14AM on the 4^th of May, Theo is thriving in his new world. Although much sleep deprived, Amy and Luke are thoroughly enjoying their new journey as parents!

Calypso receives a promotion

Congratulations to Calypso who has been officially promoted to Para Planning Team Leader effective from July 1^st.  Over the past four years Calypso, who joined APC in September of 2016, has been a member of the para planning team under the leadership of Luke.   It became apparent early that Calypso is a detail person who willingly takes on challenges and, like all of the APC team, is very client focused!

In July of 2019 it was decided to transition Calypso over a twelve month period into her new role. Luke, who commenced his transition to the APC advice team in July of 2018 has now completed this and we congratulate Luke also as he takes on a permanent position as an APC Adviser.  Luke has been a valued member of our team since November 2012!

Just as APC strives to help our clients achieve their important personal goals, we also pride ourselves in helping bright young professionals achieve their professional and personal objectives as well.  We welcome and celebrate Calypso’s and Luke’s success!

APC’s new website

You may have noticed that our website has had a facelift.  After approximately ten years without any change of significance we thought it was time for a fresh look.  We would encourage you to take a look and let us know what you think.  Importantly, your Client Portal is in a familiar place at the top right hand corner of our home page.

https://australianprivatecapital.com.au/

APC’s Values

Since our establishment in 1988, APC has always had a ‘Client First’ philosophy.  As our business has grown we have adopted other guiding principles and recently we came together as a team to formalise the following six values which epitomise Australian Private Capital:

1. Placing our client’s interests always ahead of our own
2. Being honest with our clients and ourselves while operating with integrity
3. Always being willing to help our fellow team members
4. Supporting diversity in our team
5. Having an inclusive approach
6. As we prosper we give back to society

APC’s Partners

APC has long held the view that where we can we should take the opportunity to be a good corporate citizen.  This behaviour lead to our Value #6 – As we prosper we give back to society.  In the early days, as we replaced computer equipment every three years, we donated this equipment to indigenous communities.

However over the years we have developed a more formal approach to APC’s Partnership Program and it is now an important feature of our strategy.  Please take the time to review our program and our partners on our website;

https://australianprivatecapital.com.au/apcs-value-and-partners/

APC’s 2020 Annual Client briefing

It will be of no surprise to you that this year’s briefing, held annually at the NGV, is not possible due to the ongoing COVID-19 health crisis.  APC is currently considering how we may provide you an Economic Briefing, Market and Portfolio update and some NGV content for your enjoyment and we will share this with you over the coming month or so.

NGV’s virtual conversation – Destiny Deacon

On a similar topic, as part of the NGV Corporate Sponsor program, APC was able to provide our clients access to the virtual conversation on the work of Destiny Deacon.  We have received a great deal of positive feedback form you on this and hope to be able to do so again when the NGV release more virtual content exclusively for their corporate sponsors.

Every two years, Australian Private Capital surveys our clients to measure how you think of our service.  APC uses an external consultant (Business Health) to conduct the survey so that it is completely at arm’s length from APC.  The survey is anonymous which ensures the integrity of the results as our clients can express their views honestly.  Business Health tell us that only the better advice firms actually take the time to do this survey.

It is with great pride for our entire team that this year’s survey provided our best ever overall score of 4.75 out 5.00!

APC Values

In large part this result is a measurement of APC being true to our values. These guiding principles provide us with a framework by which all decisions within APC are made.  Whilst our overarching goal is to delight our clients with exceptional service, our firm’s objective of helping all our clients achieve Clarity, Control and Confidence in relation to their financial strategy is achievable by our commitment to live up the following values.

1. Placing our client’s interests always ahead of our own
2. Being honest with our clients and ourselves while operating with integrity
3. Always being willing to help our fellow team members
4. Supporting diversity in our team
5. Having an inclusive approach
6. As we prosper we give back to society

So, to the survey results.

This graph, provided by Business Health, has the most recent result (2020) at the left with each bar moving right reflecting scores of previous survey years.  The trend of the graph shows a steady improvement over time.

Business Health say “Our (Business Health) benchmark average score is 4.23. Your (APC) average score across all categories was 4.75 which puts you at the very top of the of the businesses in our national benchmarking group”.

The graph below measures various Key Performance Indicators (KPIs) of the survey.

Business Health say “your clients scored you most highly for Standard of Support Staff and Business Relationship (which both achieved an average score of 4.85)”.

This score is a wonderful affirmation that APC is delivering on our desire to develop personal relationships with our clients and provide them with excellent service.  It makes a particular comment about how our clients feel about the service that Petra, Calypso, Blake and Loan are providing and we commend them all on a great achievement!

Here are some client comments from the survey;

• The small business approach enables the team to interact face to face with each client every six months which inspires confidence that APC has the interests of each client at the forefront.

• There are two main strengths: the first is the knowledge and data-driven advice related to my personal circumstances; and the second is the APC culture of being very client-focussed so that one really does feel like an individual rather than just a cipher

• APC opted for independence and rejected commissions for the recommendation of products long before this was mandated. This is key to me

• A professional caring group who go the extra mile to meet our needs

• Independent advisor free of conflicts and commission driven sales incentives brought us to APC. Great staff and service have kept us there

• Made to feel inclusive and respected, despite being one of the less wealthy clients of the company

• I have never felt that they didn’t have my best interests at heart.

• I am very happy with the level of service and advice I receive from APC. I feel valued and respected by the staff who are friendly and professional.

What is APC’s KAIZEN?

KAIZEN is the Japanese word for ‘improvement’ and even though our survey this year resulted in our best ever score, our lowest rated score from your perspective, was our ‘Range of Financial Services’.  So in the coming month or so we will be back in touch with you to better understand where we can improve in this area.

Our clients are great referrers!

Over many years, APC has grown almost exclusively from our clients referring family and friends to us.  It is the greatest accolade a client can bestow on APC and in this survey 96% of you said you are willing to do so!

APC has recently launched our new website and we have enhanced our Financial Health Check survey.  As the name suggests, this is a survey that provides the opportunity for someone to self-assess on key aspects of their financial health.  The survey takes about 10 minutes and at the conclusion the person receives a report which outlines their areas of strength and also their areas where improvement is required.

There is no charge for the report and it is a great way you can help a friend or family member start the journey to potentially achieving a greater degree of financial health.

https://australianprivatecapital.com.au/financial-health-check/

Finally, thank you for being our client.  It is a privilege APC has never taken for granted as we strive to deliver the best outcome for you, always.

Warm regards,

The APC Team.

Please click on the link below to download the Standard Classic Portfolio Performance (Classic 30 to Classic 100) as at December 31st 2020.

2020_DEC_CP_Performance

Please click on the link below to download the Specialist Classic Portfolio Performance (Classic 50 Income Fund, Classic Thematic 70 Portfolio and the Classic Ex Pat Australian Share portfolio) as at December 31st 2020.

2020_DEC_CP_Performance – Specialist

Please click on the link below to download the APC Satellite Investment Strategy Performance (Targeted, Low Correlation and Opportunistic) as at December 31st 2020.

2020_DEC_CP_Performance – Satellite

Time investments made early can bring great financial rewards down the track.

Most of us recognise the benefit of being financially organised and the great reward that can come about when this starts early.  This is – in part – because of the value of time when it comes to investing and the so-called ‘magic of compounding’.  Getting started early can also create a great sense of accomplishment, setting up a foundation for a confident and active approach to money management as a young adult. 

Many of our clients have shared with us that if they had started the journey with APC earlier, they would have felt in a stronger position today.  They wanted to make sure their children benefited from this realisation.  This led to the establishment of APC’s Foundation Client Service designed to assist the children of our clients in the beginnings of their own financial journey.

While their needs and goals may differ from Mum and Dad’s, there are a number of financial ducks that can be lined up which can put one on a great footing.  If the New Year inspires some motivation to get started, here are some items which may be worth considering if getting financially sorted is part of this year’s resolution.  

The benefit of time

While a hunt for higher returns almost certainly requires acceptance of a higher level of risk, time is a force to be reckoned with.  The importance of making a conscious choice about superannuation investments is a decision that can make a marked difference to the investment value and trajectory over time.  In practical terms, this might be the difference between choosing a ‘balanced’ investment option rather than a ‘high growth’ option.  The longer you have to invest, the greater the impact – and 1 or 2 per cent higher average return per annum might make a greater difference than you think. Looking at the effect of an early savings strategy, the chart below is a simple illustration of the amount of monthly saving required for one to save $1m at age 65.  It might have many of us wishing we could turn back the clock!

(source: https://www.businessinsider.com.au/amazing-power-of-compound-interest-2014-7)

Income protection insurance

Most of us tend not to think about the possible health issues that can unfortunately happen, especially when relatively young, fit and healthy. But if you had a machine at home that spat out the equivalent of your income every year, you probably would insure it – right?

When the unplanned occurs, parent’s often step in to help their children if they are not covered or simply need financial assistance – which can in turn impact their own retirement plan.

You can typically cover up to 75 per cent of your income with payments until you are aged 65 (if an illness/injury means you cannot work). Getting the cover locked down in your early 30s – or before – can be a good idea.  It often means you have yet to experience major health issues that the insurance company might otherwise specifically exclude or attach an additional cost to cover. 

Health insurance premium loading

Lifetime Health Cover is a government initiative, which was introduced with the aim of encouraging younger people to get and maintain hospital cover.  In summary, an extra cost applies to hospital cover unless you have it in place by the July 1 following your 31st birthday – 2 per cent for every year over 30.

So, one could end up paying, for example, a 20% loading by age 40 and so on – up to a cap. If there is no other impediment to taking action on health cover, these provisions make it worth getting the ball rolling.  

Automation

The act of automation simply makes for an intelligent approach to money management.  It is just as much about making it all easier as it is about consistent action – which can be the key (see chart above!)   We probably don’t need to tell most young people that technology is their friend. When it comes to saving, investing and budgeting there has been fantastic innovation with a myriad of online tools and apps available. When it comes to ‘paying yourself first’, making it automatic can be most effective at reaching important goals and staying on track.

In our E-News article of November 2018 entitled ‘Do Industry super fund investors know what they’re investing in?’, we highlighted the dubious practice by many Industry Super funds of mis-characterising the ‘Defensive’ and ‘Growth’ characteristics of the assets held within their portfolios.

The widespread practice of calling a Growth asset Defensive seeks to lower the perceived risk associated with a portfolio while enhancing the overall return.  This allows funds that do this to ‘game’ the league tables of returns for use as a slick marketing tool.

In our article we highlighted the Hostplus Balanced fund (among others) as being the most impacted by such a practice.  Whilst Hostplus market this fund as ‘Balanced’ it is in fact a ‘High Growth’ fund.

The banking and superannuation regulator APRA (Australian Prudential Regulatory Authority) recently (though quite belatedly in APC’s opinion) exposed Industry Super for exactly this practice and held out Hostplus as the most egregious.

APRA’s ‘Heatmap’ assessed Hotplus’ flagship Balanced MySuper product as having a staggering 93% allocation to Growth assets!  As our article in November 2018 suggested it is very doubtful indeed that many of the investors in such a product would have truly understood the risk profile of the investment.   

It is clear that for anybody to assess superannuation (or any investment for that matter) they cannot just look at returns in isolation. Given APRA still have not provided a strict guideline on what a Defensive and Growth asset actually is, funds will continue to apply inconsistent and often misleading characterisations of their own.

In our E-News article of February 2019 entitled “Industry Super Funds – illiquid asset valuations called into question”, we highlighted the conflicted arrangement of how Industry Super funds value their own unlisted assets.  APRA has now also called into question how these assets are characterised by Industry Super.  These assets are almost always Direct Property.

Industry Super’s argument seems to be that if a property is owned by a listed entity (for example a Real Estate Investment Trust – REIT- listed on a stock exchange) then it should be characterised largely as ‘Growth’ whereas if it is owned by an unlisted entity (for example the ISPT – Industry Super Fund Property Trust) then it should be largely considered a Defensive asset.  However the asset itself, in both cases a direct property, would be identical.

It simply does not make sense for the characteristic of an asset to be determined by how it is owned and not by the asset itself.  Yet this is the central defence by Industry Super of how it makes these asset characterisation decisions.

As we demonstrated in our E-News article of November 2018 entitled ‘Do Industry super fund investors know what they’re investing in?’, when correctly characterised, the Hostplus fund does not outperform.  APRA’s ‘Heatmap’ showed infact that the Hostplus MySuper product underperformed APRA’s own ‘simple reference portfolio’. APC continues to be of the view that until such time that APRA and ASIC (Australian Securities and Investment Commission) publish a set of guidelines that all industry participants MUST adhere to, the issue of asset mis-characterisation and therefore a lack of consumer protection will continue to be a problem.

Introduction

Our high-level investment view for this year is that a combination of improving global growth boosting profits and still easy monetary conditions will help drive reasonable investment returns, albeit more modest than the very strong gains of 2019. This note revisits five charts we see as critical to the outlook.

Chart #1 – Global business conditions PMIs

Global Purchasing Managers Indexes (PMIs) – surveys of purchasing managers at businesses in most major countries – are an excellent and timely guide to the state of the global economy. Although services sector PMIs held up better than for manufacturers – which tend to be more cyclical – both softened through 2018 and into mid-2019. Since then they have shown signs of improvement suggesting that the global monetary easing seen through 2019 with interest rate cuts and renewed quantitative easing is working. Going forward they will need to improve further to be consistent with our view that growth will pick up this year.

But so far, the 2018-19 slowdown in business conditions PMIs (and hence global growth) looks like the slowdowns around 2012 and 2015-16 as opposed to the recession associated with the global financial crisis (GFC).

Chart 2 – Global inflation

Major economic downturns are invariably preceded by a rise in inflation to above central bank targets causing central banks to slam the brakes on. At present, core inflation – ie inflation excluding the volatile items of food and energy – in major global economies remains benign. In the US, the Eurozone and Japan core inflation is well below their central bank targets of 2%. Inflation in China spiked to 4.5% through last year, but core inflation has been falling to 1.4% and is well below the Government’s 3% target/forecast. A clear upswing in core inflation would be a warning sign that spare capacity has been used up, that monetary easing has gone too far, and that the next move will be aggressive monetary tightening. But at present we are a long way from that.

Chart 3 – The US yield curve

The yield curve is a guide to the stance of monetary policy. When short-term interest rates are low relative to long-term rates businesses can borrow short and lend (or invest) long and this grows the economy. But it’s not so good when short rates are above long rates. An inverted US yield curve has preceded past US recessions. So, when this happened last year there was much concern that a US recession was on the way. However, in recent months various versions of the yield curve – with the gap between the US 10 year bond yield and the Fed Funds rate and the US 10 year bond yield and the 2 year bond yield shown in the next chart – have uninverted as the Fed cut rates and hence short-term yields fell, good economic data provided confidence that recession will be avoided and the US/China trade war de-escalated reducing the threat posed by the trade war.

While the US yield curve has uninverted in the past and yet a recession has still come along, the uninversion seen in recent months coming after such a shallow and short-lived inversion provides confidence that the inversion seen last year gave a false signal as occurred in the mid to late 1990s (as circled).  In addition, it’s also worth noting that other indicators suggest that US monetary policy was far from tight – the real Fed Fund rate was barely positive, and the nominal Fed Funds rate was well below nominal GDP growth and both are far from levels that in the past have preceded US recessions.  So it’s a good sign that the US yield curve has been steepening in recent months. A return to yield curve inversion – which became deeper than seen last year – would be a concern of course.

Chart 4 – The US dollar

Moves in the value of the US dollar against a range of currencies are of broad global significance. This is for two reasons. First, because of the relatively low exposure of the US economy to cyclical sectors like manufacturing and materials the $US tends to be a “risk-off” currency, ie it goes up when there are worries about global growth. Second, because of its reserve currency status and that a lot of global debt is denominated in US dollars particularly in emerging countries, when the $US goes up it makes it tough for emerging countries.

So when global uncertainty is rising this pushes the $US up which in turn makes it hard for emerging countries with $US denominated debt. If we are right though and global growth picks up a bit, trade war risk remains in abeyance and the Iran conflict does not become big enough to derail things then the $US is likely to decline further which would be positive for emerging countries.

Chart 5 – World trade growth

It’s reasonable to expect growth in world trade to slow over time as services become an ever-greater share of economic activity and manufacturing becomes less labour dependent. However, President Trump’s trade wars since 2018 combined with slower global growth saw global trade fall last year. This year should see some reversal if the trade wars remain in abeyance as Trump focuses on keeping the US economy strong to aid his re-election and global growth picks up a bit.

US recession still a way away

In recent years there has been much debate about whether a new major bear market in shares is approaching. Such concerns usually reach fever pitch after share markets have already fallen 20% or so (as they did into 2011, 2016 and 2018). The historical experience tells us that what happens in the US is critical to how deep share market falls get. Deep (“grizzly”) bear markets like the 50% plus fall seen in the GFC are invariably associated with US recession. So, whether a recession is imminent in the US, and more broadly globally, is critically important in terms of whether a major bear market is on the way. The next table summarises the key indicators we are still watching in this regard.

US recession signposts

Indicator	Recession Yes/No
Yield curve inverted	?
Fed Funds rate well above growth	No
Cyclical spending, % of GDP	No
Private debt growth	No
US leading indicator	No
Inflation well above target	No

Source: AMP Capital

These indicators are still not foreshadowing an imminent recession in the US. The yield curve is most at risk if it inverts again. But other measures of monetary policy in the US are not tight and we have not seen the sort of excesses that normally precede recessions – discretionary or cyclical spending as a share of GDP is low, private debt growth has not been excessive, the US leading indicator is far from recessionary levels and inflation is benign.

Concluding comments

At present, most of these charts or indicators are moving in the right direction, with the PMIs improving a bit, inflation remaining low, the yield curve steepening, the $US showing signs of topping and the US/China trade truce auguring well for some pick up in world trade growth. But to be consistent with our view that this year will see good returns from shares we need to see further improvement and so these charts are worth keeping an eye on.

Dr Shane Oliver

Head of Investment Strategy and Chief Economist

AMP Capital

2019 – Growth Down, Returns Up

Christmas 2018 was not a great one for many investors with an almost 20% slump in US shares from their high in September to their low on Christmas Eve, capping off a year of bad returns from share markets and leading to much trepidation as to what 2019 would hold. But 2019 has turned out to be a good year for investors, defying the gloom of a year ago. In fact, some might see it as perverse – given all the bad news around and the hand wringing about recession, high debt levels, inequality and the rise of populist leaders. Then again that’s often the way markets work – bottoming when everyone is gloomy then climbing a wall of worry. The big global negatives of 2019 were:

• The trade war and escalating US-China tensions generally. A trade truce and talks collapsed several times leading to a new ratcheting up of tariffs before new talks into year end.
• Middle East tensions flared periodically but without a lasting global impact & the Brexit saga dragged on although a near-term hard Brexit looks to have been avoided.
• Slowing growth in China to 6%. This largely reflected an earlier credit tightening, but the trade war also impacted.
• Slowing global growth as the trade war depressed investment & combined with an inventory downturn and tougher auto emissions to weigh on manufacturing & profits.
• Recession obsession with “inverted yield curves” – many saw the growth slowdown as turning into a recession.

But it wasn’t all negative as the growth slowdown & low inflation saw central banks ease, with the Fed cutting three times and the ECB reinstating quantitative easing. This was the big difference with 2018 which saw monetary tightening.

Australia also saw growth slow – to below 2% – as the housing construction downturn, weak consumer spending and investment and the drought all weighed. This in turn saw unemployment and underemployment drift up, wages growth remain weak and inflation remain below target. As a result, the RBA was forced to change course and cut interest rates three times from June and to contemplate quantitative easing. The two big surprises in Australia were the re-election of the Coalition Government which provided policy continuity and the rebound in the housing market from mid-year. While much of the news was bad, monetary easing and the prospect it provided for stronger growth ahead combined with the low starting point resulted in strong returns for investors. 

• Global shares saw strong gains as markets recovered from their 2018 slump, bond yields fell making shares very cheap and monetary conditions eased. This was despite several trade related setbacks along the way. Global share returns were boosted on an unhedged basis because the $A fell.
• Emerging market shares did well but lagged given their greater exposure to trade and manufacturing and a still rising $US along with political problems in some countries.
• Australian share prices finally surpassed their 2007 record high thanks to the strong global lead, monetary easing and support for yield sensitive sectors from low bond yields.
• Government bonds had strong returns as bond yields fell as inflation and growth slowed, central banks cut rates and quantitative easing returned. • Real estate investment trusts were strong on the back of lower bonds yields and monetary easing.
• Unlisted commercial property and infrastructure continued to do well as investors sought their still relatively high yields. However, Australian retail property suffered a correction.
• Commodity prices rose with oil & iron up but metals down.
• Australian house prices fell further into mid-year before rebounding as the Federal election removed the threat to negative gearing & the capital gains tax discount, the RBA cut interest rates and the 7% mortgage test was relaxed.
• Cash and bank term deposit returns were poor reflecting new record low RBA interest rates.
• The $A fell with a lower interest rates and a strong $US.
• Reflecting strong gains in most assets, balanced superannuation funds look to have seen strong returns.

2020 Vision – Growth Up, returns still good

The global slowdown still looks like the mini slowdowns around 2012 and 2015-16. Business conditions indicators have slowed but remain far from GFC levels. See next chart.

While the slowdown has persisted for longer than we expected – mostly due to President Trump’s escalating trade wars – a global recession remains unlikely, barring a major external shock. The normal excesses that precede recessions like high inflation, rapid growth in debt or excessive investment have not been present in the US and globally. While global monetary conditions tightened in 2018, they remained far from tight and the associated “inversion” in yield curves has been very shallow and brief. And monetary conditions have now turned very easy again with a significant proportion of central banks easing this year. See chart. The big global themes for 2020 are likely to be:

• A pause in the trade war but geopolitical risk to remain high. The risks remain high on the trade front – with President Trump still ramping up mini tariffs on various countries to sound tough to his base and uncertainty about a deal with China, but he is likely to tone it down through much of 2020 to reduce the risk to the US economy knowing that if he lets it slide into recession and/or unemployment rise he likely won’t get re-elected. A “hard Brexit” is also unlikely albeit risks remain. That said geopolitical risks will remain high given the rise of populism and continuing tensions between the US & China. In particular, the US election will be an increasing focus if a hard-left candidate wins the Democrat nomination.
• Global growth to stabilise and turn up. Global business conditions PMIs have actually increased over the last few months suggesting that monetary easing may be getting traction. Global growth is likely to average around 3.3% in 2020, up from around 3% in 2019. Overall, this should support reasonable global profit growth.
• Continuing low inflation and low interest rates. While global growth is likely to pick up it won’t be overly strong and so spare capacity will remain. Which means that inflationary pressure will remain low. In turn this points to continuing easy monetary conditions globally, with some risk that the Fed may have a fourth rate cut.
• The US dollar is expected to peak and head down. During times of uncertainty and slowing global growth like over the last two years the $US tends to strengthen partly reflecting the lower exposure of the US economy to cyclical sectors like manufacturing and materials. This is likely to reverse in the year ahead as cyclical sectors improve.

In Australia, strength in infrastructure spending and exports will help keep the economy growing but it’s likely to remain constrained to around 2% by the housing construction downturn, subdued consumer spending and the drought. This is likely to see unemployment drift up, wages growth remain weak and underlying inflation remain below 2%. With the economy remaining well below full employment and the inflation target, the RBA is expected to cut the official cash rate to 0.25% by March, & undertake quantitative easing by mid-year, unless the May budget sees significant fiscal stimulus. Some uptick in growth is likely later in the year as housing construction bottoms, stimulus impacts and stronger global growth helps.

Implications for Investors

Improved global growth and still easy monetary conditions should drive reasonable investment returns through 2020 but they are likely to be more modest than the double-digit gains of 2019 as the starting point of higher valuations and geopolitical risks are likely to constrain gains & create some volatility: •

• Global shares are expected to see returns around 9.5% helped by better growth and easy monetary policy.
• Cyclical, non-US and emerging market shares are likely to outperform, particularly if the US dollar declines and trade threat recedes as we expect.
• Australian shares are likely to do okay but with returns also constrained to around 9% given sub-par economic & profit growth. Expect the ASX 200 to reach 7000 by end 2019.
• Low starting point yields and a slight rise in yields through the year are likely to result in low returns from bonds.
• Unlisted commercial property and infrastructure are likely to continue benefitting from the search for yield but the decline in retail property values will still weigh on property returns.
• National capital city house prices are expected to see continued strong gains into early 2020 on the back of pent up demand, rate cuts and the fear of missing out. However, poor affordability, the weak economy and still tight lending standards are expected to see the pace of gains slow leaving property prices up 10% for the year as a whole.
• Cash & bank deposits are likely to provide very poor returns.
• The $A is likely to fall to around $US0.65 as the RBA eases further but then drift up a bit as global growth improves to end 2019 little changed.

What to Watch?

The main things to keep an eye on in 2020 are as follows:

• The US trade wars – we are assuming some sort of de- escalation in the run up to the presidential election, but Trump is Trump and often can’t help but throw grenades.
• US politics: the Senate is unlikely to remove Trump from office if the House votes to impeach and another shutdown is also unlikely but both could cause volatility as could the US election if a hard-left Democrat gets up (albeit unlikely).
• A hard Brexit looks like being avoided but watch UK/EU free trade negotiations through the year.
• Global growth indicators – like the PMI shown in the chart above need to keep rising.
• Chinese growth – a continued slowing in China would be a major concern for global growth.
• Monetary v fiscal stimulus in Australia – significant fiscal stimulus could head off further RBA rate cuts and quantitative easing.

Written by Dr Shane Oliver Chief Economist at AMP Capital

Investing can be seen as difficult and there are many schools of thought as to the best approach.  The APC Investment Philosophy taps into academic research which incorporates a number of guiding principles, such as investing is not speculating.  Another of which is the relationship between risk and return, which results in a methodical and disciplined ‘tilting’ of share investments towards ‘small cap stocks’ as well as ‘value stocks’.

At the APC Annual Client Briefing held in August (link here) we took a closer look at the performance of these ‘tilts’ with a key finding that the ‘value premium’ sought had deserted us in recent history, impacting short term returns.  Taking a deeper dive, this is however not an uncommon occurrence when we look at a longer period.  History has shown us that ‘value’ stocks underperformed the broader market 13% of the time in Australian markets and 17% in international markets in the 10 years up until December 2018. 

If we were to look further back, ‘value’ stocks had underperformed ‘growth’ stocks by an average of nearly 6% per year for the 10 years ending 31 March 2000 leading to some at the time questioning whether the ‘value premium’ was a reliable source of excess returns and if it would be possible to recover this lost ground.  Fast forward to the beginning of March 2001 (only 12 months later) and the recovery of ‘value’ stocks was such that the 10 year number had reverted from a negative to a positive with ‘value’ outperforming ‘growth’ by nearly 40% from April 2000 to February 2001.

While the value premium will seemingly ‘disappear’ from time to time it’s important to keep a long term view.  While the above demonstrates the extremes, the tilt to ‘value’ stocks in portfolios has in the fullness of time, historically, resulted in an average outperformance as evidenced in our presentation. 

As it happened, there has been a recent swing in the fortunes of ‘value’ stocks with the three months following the APC Annual Client Briefing showing ‘value’ stocks outperforming ‘growth’ stocks by over 2% globally.

Not for one instance are we suggesting a recurrence of the numbers leading up to February 2001 is on the cards but maybe Santa is a ‘value’ investor.  Investment markets can move quickly and trying to chase the best returns can often lead to investment misery – sticking to the plan and long term fundamentals is by far the better strategy.