Crystal Wealth Newsroom
Where are we now in 2020?
In our December update, we looked at four potential ‘green shoots’ for this year that could provide a foundation for an improving global economic backdrop, namely:
● Improved monetary policy stability with a return to a positive US yield curve;
● An easing in US-China trade tensions;
● Some form of resolution to Brexit; and
● A stabilisation of the domestic housing market.
During the first few weeks of the year, we saw good progress on all fronts.
However, one and a half months into 2020, we are witnessing a noticeable spike in volatility, following concerns over the economic impact domestically of the bushfire crisis as well as the coronavirus outbreak.
This adds to the list of other ongoing matters such as President Trump’s impeachment side-show, further US military strikes and a reasonable US company reporting season to date (compared to expectations).
The media has also been having a busy time this year with the 24-hour news cycle already punctuated by headlines of strong market rallies here and offshore coupled with reversals and then further rallies. Most of these short-term moves lack any real fundamental cause, but rather represent knee-jerk responses to the latest headline or concern, followed by a reminder that bond yields are so low so there must be somewhere better to invest.
Undoubtedly, the continued low-inflation, low-yield environment has led to a re-rating in asset prices and price/earnings ratios more so than fundamental improvements in underlying earnings growth at this point.
This has been one consistent factor driving market returns over the last 12 months.
With interest rates and bond yields locked into a ‘low rate’ framework for now, equities continue to remain attractive in the medium-term.
Further, any simple comparisons with historical measures which were set based on a higher interest rate backdrop will be inconsistent with current valuations.
Two of the biggest fundamental risks that remain over the next 12 months are the possibility of a global recession, which would impact corporate earnings, and a democratic US presidential victory (as the Republicans are more business friendly and the market has been pricing in a Trump re-election to date).
While neither is currently the base case for markets, they are two items being constantly monitored.
In this environment, with the potential for upside (growth) surprises as well as negative shocks (slower growth, geopolitics, etc) it emphasises the need for suitable portfolio diversification to cover (hedge) these possible scenarios.
What can we expect in 2020?
This year we expect higher volatility and, while it inevitably presents opportunities, it will need patience to implement tactically during the year.
Specifically, maintaining the discipline not to react to market ‘news’ or attempt to chase asset returns. Overall, we expect total returns to be more subdued this year and markets to trade within ranges in response to changing data signals.
We also need to hedge the possibility of further Federal easing against some sort of inflation shock within portfolios. In other words, weighing the short-term potential impact of current issues such as the coronavirus against the potential for global growth to pick-up (i.e. beat current expectations). Domestically, the likelihood of further rate cuts by the RBA remains in play given the expected weak growth numbers.
In short, the low nominal interest rate world means accepting some level of increased investment risk to achieve the same previous level of portfolio income – while managing the downside which is a key focus of our work. Given this, we lower our forecast for income returns over the coming year to the 4-5% range, but with the potential to achieve growth on top through:
• A diversified spread of fixed interest investments to underpin income – reduced sovereign bond exposure at the expense of lifting credit, mortgage and private debt securities and maintaining core hybrid positions.
• Domestic equities still providing an important income role (given the current margin over bonds). The focus is on the quality companies, particularly those with offshore earnings, that can deliver reliable dividend flows.
• Maintaining listed and direct property and other ‘real asset’ backed securities (including infrastructure exposure) for yield.
• Maintaining a well-diversified international exposure but look for the opportunity to diversify out of US-centric equities and consider emerging market opportunities.
• Retaining an exposure to physical commodities (e.g. gold) to balance overall portfolio risk and consider ‘alternatives’ as well to hedge total risk.
Note that the Australian dollar may suffer further weakness in the short-term until further confidence emerges in the outlook for global growth.
On the political front for 2020, the US Presidential election will be the dominant global variable this year, particularly if President Trump is not re-elected. However, don’t rule out an ‘X’ factor from poor Brexit trade negotiations or some other geopolitical event. Markets will remain vulnerable to sell-offs, given the strong gains of last year, but the current poor returns from cash and term deposits continue to provide support for investing on a relative basis.
A note on the impact of the coronavirus outbreak
Markets have been reacting this year to the unexpected outbreak in China of a new strain of coronavirus (2019-nCoV). The two most recent severe outbreaks that provide some insight into the current episode are the 2002-2003 SARS outbreak, which spread from China to 26 other countries but was contained after eight months, and the 2009 H1N1 influenza pandemic, which originated in Mexico and spread globally.
While this outbreak is undoubtedly serious and affecting a large number of people (either directly through contagion or indirectly through quarantine provisions), the flow-on economic impact is still emerging. Uncertainty remains high as the virus appears more contagious than SARS but with a lower mortality rate.
While we do not yet have enough solid evidence to determine the extent of the short versus long-term effect of this outbreak, clearly there has been an initial hit to the tourism and global airline sectors, sectors sensitive to Chinese growth rates and the resources sector given the concern over the prospect for slower global growth.
While past pandemics would suggest that the economic impact of the coronavirus could prove transitory, the potential for a significant economic slowdown still exists due to the large containment actions taken by the Chinese (and many other) governments as well as the uncertainty about current infection rates. If this virus follows the trajectory of the SARS outbreak, then shortly after the World Health Organisation (WHO) issued a global alert, stocks started to perform better. At the end of January, the WHO declared the new outbreak an “international public health emergency”.
It is too early to know whether the number of cases of infection can be contained adequately to prevent a protracted hit to global growth except to note that any short-term economic impact is likely to be followed subsequently by an economic rebound. Logically, the larger the negative impact the greater the potential rebound, with the timing more uncertain.
In the meantime, expect the ‘bond yields down’, ‘bond yields up’ debate to continue in response and market volatility to remain elevated.