Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist
Movements on the global and domestic stage in 2019 have driven home some tried-and-tested lessons in investing, markets, and keeping your cool.
Each year, we see new leaders, new policies, and new conflicts which impact markets. At the ground level, it can be tempting to get caught up – or overwhelmed – by the micro.
However, if we take a look at some key themes and events from the year that was, we see that some evergreen investment principles have yet again applied to 2019, and likely will for 2020.
2019 in hindsight
1. Highs and lows
Seasoned investors will be familiar with Warren Buffett’s much-used quote: “Be fearful when others are greedy, and greedy when others are fearful.” A retro look at the last 12 months tells us, yet again, that expression rings true.
This time a year ago, there was a lot of negative sentiment about share markets. At home and overseas, shares fell sharply until about Christmas last year. By Christmas eve, the US share market had fallen 20 per cent from its high in September.
By the start of this year, markets had promptly turned around, and this year turned out to be a reasonably good year for share markets. It was a classic case of the market bottoming out when negative sentiment had reached fever pitch.
2. Negative noise
Throughout 2019, there have been several significant negatives that we could point to. Global debt is high and unemployment is rising. Those factors are contributing to heightened social tensions, which are seeing a rise in populist leaders, and a backlash against what many would consider ‘sensible’ economic policies.
Without doubt, as a result, there are events happening globally that are rattling markets. The trade war with the US and China is a fitting example of that – two global superpowers swinging between stalemate and vitriol has directly impacted markets and confidence.
Despite the backdrop of major events like the trade war, there are several other factors which counter the negative. For example, inflation is still low, and interest rates the world over are still low. We know that these conditions make for good investment returns. We are also seeing an unprecedent spike in technological innovation globally. Also, there is rapid growth in middle class populations throughout Asia. All of these things contribute to market opportunities, and should be considered just as much as the black spots.
3. Begin with the end in mind
The hunt for yield this year has been a hunt indeed. There is a lot of anxiety about the implications of the lower-for-longer environment on retirees.
The key question here is: what is most important to you? Is it the absolute security of your investment? In that case, you have to wear the low yields for now, and get the guarantee of a cash holding.
Many investors have realised though that they’re not getting much out of their bank deposits, and shifted their money to shares or real and unlisted assets. I sense a preparedness on the part of these investors to recognise that while share values can move around, and there are risks in markets like commercial property and infrastructure, the income flow is relatively stable.
In short, to me, the most important thing for self-funded retirees to consider in this environment is whether their priority is absolute security or steady income, and then to work backwards from that.
4. Housing hype
If 2019 taught us anything about residential property in Australia, it’s that just because housing is expensive and household debt levels are high, doesn’t mean house prices are going to crash.
The market turnaround, which kicked off around the middle of the year, also reminds us that there is strong underlying demand in our housing system. It took a few tweaks – like the election outcome and resultant confirmation that the tax system will remain unchanged for property investors and rate cuts – to spark confidence.
We continue to see an unmet underlying demand for housing in Australia. There is often talk of huge supply coming onto the market, and a jump in vacancy rates. This may be the case in some instances, but the key considerations include whether that supply is meeting demand in areas people want to live in, and if the supply is intended for everyday life (for example, it’s not a holiday home.) And most importantly, whether the supply is enough to match strong population growth.
5. Don’t discount the US
At this point in history, despite the growing global force of China, the US continues to dominate in terms of influence on global markets.
We could point to some hard examples of this, such as during the tech wreck in the early 2000s. The US went into recession at that time, and although Australia did not experience recession, our share market still got hit.
A perhaps more relatable example is in day-to-day life. I would venture a guess that even the most seasoned investors would be more in tune with the movements of the US share market on a daily basis than the Chinese share market. If the US share market has a bad day, we brace for it in Australia – it’s in the news, futures will have come down, and awareness is raised. If Chinese shares have a bad day, it might get a mention, but it’s nowhere near as big of an issue.
So, even though in relative terms the US economy has declined, this year has again proven it continues to punch above its weight.
For the year ahead, there’s a few themes market watchers should keep an eye on. Here’s a few for you to consider.
1. The global economic cycle
For me, the key issue next year will be the global economic cycle. As it stands, we expect that global economic growth will pick up again, in response to monetary easing that we’ve seen this year, therefore avoiding a recession at home and abroad. Should that materialise, it will likely result in decent market gains.
2. Pressure at home
In Australia, growth is sluggish, and the economy is running below its potential. This creates an argument for further policy stimulus. We have already seen the government introduce staged tax cuts from early next decade – it’s likely that these could be brought forward.
But assuming this does not occur quickly enough, we also expect to see two more cash rate cuts between now and February, bringing the official cash rate down to 0.25 per cent, which we believe will be its bottom. Any further cuts would unlikely have the desired impact, as banks have already not been passing on the recent drops in full.
The scope for extra stimulus is one of a mix of reasons we don’t foresee a recession next year. There are still measures up the government and Reserve Bank’s sleeve to prevent it.
3. The US and China trade war
The race for the US presidency next year could prompt a short-term turnaround from Trump in this long and drawn-out trade war with China.
History tells us that presidents aren’t re-elected if they let the economy slide into recession, or if unemployment spikes in the run up to the election. Trump wants to get re-elected, and he will be under pressure to put the trade war on hold for a year at least, which he could claim as a win for his leadership and hopefully, the US economy. Further, any good news Trump can announce during the presidential race represents a win for his campaign.
In addition, there is reason for China to want the trade war to settle. The Chinese economy has slowed down, and trade battles don’t help in that context. Also, there’s a risk for the Chinese government that they will be negotiating with a tougher Trump if he is re-elected, into what would be his second and final term.
In the long-term, the ongoing battle between these superpowers is unlikely to dissipate. In short, it has tell-tale signs of the so-called Thucydides Trap, in which a rising power and an incumbent power go to war (of sorts) where there is threat of displacement. This has its origins in the fear felt and acted on by Sparta during the rise of Athens. Fortunately, given both China and the US are nuclear powers a hot war is thankfully unlikely, but some sort of cold war is a high risk.
4. Local politics in the US
The US election is next year, marking the end of Donald Trump’s first term in office. He is now fighting for a second and final term, and has history on his side along with current betting market odds. Often with share markets, it’s a case of better the devil you know. A Trump re-election shouldn’t rattle share markets too much, nor should a victory from a more centrist candidate, like Joe Biden. However, if victory goes to the left, the share market would get nervous.
At the same time, there are impeachment proceedings against Trump. In public, this is amplifying significantly against Trump. Recently US speaker of the house, Nancy Pelosi, has implied Trump’s actions were worse than those of Richard Nixon, who resigned amidst the scandal of Watergate. Still, at this stage it appears unlikely that the upper house would vote to remove Trump from office (as 20 Republican senators would need to desert him), but the whole saga has the potential to rattle markets.
5. Brexit and Boris Johnson
October 31 this year was supposed to be the UK’s “do or die” Brexit Day. Instead, the UK’s Prime Minister Boris Johnson has successfully called a general election in an attempt to break the Brexit stalemate.
All major parties look to be entering the election supporting a soft Brexit or none at all, meaning the risks of a hard Brexit are diminished. Nonetheless, markets will be watching this closely in the months to come. And even if a short-term soft Brexit is agreed to, it could still return as an issue if the UK and EU fail to negotiate a long-term free trade deal by the end of a transition period
The biggest risk for the UK is if the UK leaves with no agreement in place. If this occurs, the UK will break all trade ties overnight and likely revert to World Trade Organisation rules while independent trade agreements are negotiated. This could be disastrous for the US in the short term as 46% of UK exports go to the EU (against 6% of EU exports which go to the UK).
Keep calm and carry on
I have been working in and around investment markets for 35 years now. A lot has happened over that time in Australia and overseas. A few things that come to mind include the 1987 crash, the recession Australia had to have, the Asian crisis, the tech boom/tech wreck, the mining boom, the Global Financial Crisis and the Eurozone crisis. There was also the end of the cold war, a long period of US domination and now the rise of Asia and China.
As the saying goes, the more things change, the more they stay the same. This will remain true of investment markets going into 2020. It’s important to see through the noise, hold a steady hand, and remember that the crowd can panic and get things horribly wrong.
I recently wrote about the nine most important things I’ve learned in my career, which you can read more about here. I expect these golden rules to apply for the years to come.
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