By Liz Maroney, Westlawn Wealth Adviser (CFP) 9 July 2015
John Owen, MLC Porfolio Specialist, takes a look back at economic and market events over the last 12 months. A must read for global shares and Australian listed property investors.
Despite a range of economic and market “challenges” during the year, markets have delivered good returns (see Table 1), especially for global shares and Australian listed property investors.
Central bank policy helped drive markets (again)
Central bank policy stimulus remained an important influence and source of support for asset prices around the world. Several central banks, including the Bank of Japan and the European Central Bank, were forced to implement or upscale their own versions of quantitative easing (QE) in response to weakness in their respective economies.
In contrast, widespread signs of economic recovery enabled the US Federal Reserve (the Fed) to taper and eventually conclude its own massive QE program in October 2014. Market concerns over the impact of QE withdrawal have been replaced by uncertainty about when the Fed will begin to raise interest rates, which is widely expected to be in the second half of the 2015 calendar year.
Interest rates are providing added stimulus
Interest rates remain at or near historic lows, providing on-going stimulus and much needed support to the global economy. In Australia, below-trend economic growth, higher unemployment and low inflation prompted the Reserve Bank of Australia (RBA) to reduce interest rates on two occasions. China has been responding to weaker than expected economic growth in a similar way with the People’s Bank of China cutting interest rates and implementing bank lending reforms.
In contrast to the increased monetary accommodation trend in much of the world, the Fed has flagged for some time that it will consider raising interest rates, probably in the second half of the current calendar year.
Another strong year for global share markets
Global shares delivered their third consecutive financial year of double-digit returns. The performance of emerging share markets also recovered despite a challenging year economically for many nations.
Chart 1 shows the performance of the major world share markets in local currency terms for the year to June 2015. Most of the major developed markets recorded positive returns. Japan’s share market was the stand-out performer this year with the Nikkei Index reaching an 18 year high. Investors have responded positively to the yen’s weakness which is expected to assist the Japanese economy and exporters. European markets also benefitted from similar weakness in the euro and there are signs that the eurozone’s economic prospects are improving, albeit slowly. However, developments in Greece late in the year create risk for the potential recovery.
Economic and financial conditions in some key emerging economies have been more challenging. Most notably, growth in China has slowed significantly while commodity based economies like Brazil also struggled.
For Australians with overseas investments, returns from global shares were strong on both a hedged basis (that is, when the foreign currency exposure is hedged to the Australian dollar) and an unhedged basis.
Australian shares provided modest returns
While Australia’s share market recorded a modest gain, there were pronounced differences in industry sector performances. Increasing supply coupled with slowing demand in China combined to push iron ore prices lower. Rising shale oil production and a breakdown in the Organisation of Petroleum Exporting Countries (OPEC) cartel weighed heavily on oil prices. As a result, resource and energy companies underperformed other sectors of the Australian market. In an environment of very low term deposit and interest rates, the best performers tended to be sectors and companies with sustainable and attractive dividends, such as listed property trusts and Telstra respectively. Companies with offshore earnings which are likely to benefit from the weakness in the Australian dollar versus the US dollar also performed well.
Valuations are elevated at a time when many companies are experiencing difficult trading conditions. The mid-year profit reporting period confirmed many Australian companies, especially those who are domestically-focused, are relying on cost reduction strategies to boost profits as sales growth remains weak.
Bond investors enjoyed another positive year of returns
High yield and Australian bonds provided the best returns, while hedged global government bonds also performed well.
Interest rates remained at historically low levels around the globe for much of the year as the priority for many countries and regions was to provide much needed economic stimulus, especially in Europe where deflation has been a real risk. The return on cash in Australia was small, forcing many investors reliant on term deposits for income to consider other investments.
Global growth has improved but questions remain
The global economy enjoyed another year of growth but it was uneven.
Growth in the US and UK have been the most resilient of the developed economies. As a result, they are expected to be the first countries to begin lifting interest rates. Elsewhere in the developed world, conditions in the eurozone and Japan are showing early signs of improving but it is occurring slowly, underpinning the ongoing need for their respective QE programs. On-going issues in Greece create risks that the eurozone’s growth recovery will falter. Growth in Asia continues to occur at a reasonable pace, while in China growth has slowed more than expected, requiring policy stimulus measures such as lower interest rates and fewer restrictions on bank lending.
Australia’s economy has needed a ‘helping hand’
Australia’s economy continued to grow but at a pace that the RBA described as below trend. It is clear the economy is experiencing conditions that are far from normal with numerous signs the transition from the ‘mining boom’ is proving to be a complex and lengthy one. Unfortunately, weak capital spending and business investment by the non-mining sector means there has been little or no offset to the significant decline in mining sector investment. Australia’s terms of trade has weakened as prices for our key mining exports (especially iron ore) are lower. In contrast, housing construction enjoyed strong growth while consumer spending, despite low wage growth, also improved.
Faced with economic growth (and inflation) on the weaker side of expectations, the RBA reduced the cash rate on two occasions in the second half of the financial year. While the beneficial impact of these (and possibly other rate cuts ahead) will take time to emerge, lower rates have clearly contributed to the sharp rise in dwelling prices in some of Australia’s major cities.
Overall, the investment environment remains unpredictable
Improvements in both the Australian and world economies and solid investment returns are welcome news for investors. However, many important issues remain unresolved and the investment environment is uncertain. While markets are already anticipating US interest rates will rise at some stage, the impact is difficult to gauge with certainty. There is concern that share market valuations rest on the tenuous foundations of ultra-low interest rates. At the close of the financial year, Greece and the risk of default was back in the headlines. Economic growth in important parts of the world (Europe, Japan) is modest at best and fragile. Slower growth in China as it transitions to a more sustainable, consumer oriented economy has important consequences for Australia, especially as we are now at a point in the commodity price cycle that is less favourable.
All of this is occurring at a time when the valuations of many traditional asset classes and securities are high and return potential is low.
How does MLC deal with this uncertainty?
MLC remains focused on rigorously managing risk and finding even better ways to insulate investors against adverse events.
With future developments in the global environment so uncertain, it’s more important than ever that our clients’ investment portfolios have resilience in a wide range of conditions. Our market-leading investment approach means we constantly consider how a wide range of potential market scenarios – both good and bad – could affect our portfolios. We can then adjust the portfolios to manage possible risks and take advantage of potential return opportunities.
This approach means our portfolios are widely diversified, risk-aware and well positioned for many market environments.
As the market environment continued to evolve this year, we made many changes to our multi-asset portfolios’ exposures to increase their defensive positioning. We’ve been cautious because our assessment is that the reward for taking risk is compressed and the global environment is very uncertain. This is the kind of environment when the things we do at MLC to manage risk have to be at least as important as the things we do to generate returns.
The advice on this site may not be suitable to you because it contains general advice that has not been tailored to your personal circumstances. Please seek personal financial, tax and/or legal advice prior to acting on this information.
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