Interesting times in the world of finance – 2019
Reflections on 2019 and some thoughts on the investment landscape in 2020.
The Share Market
After the roller coaster share market last year (ie. shares were up strongly early on and then fell in a heap, ending down by around 2-3%), 2019 saw a significant bounce back. At the time of writing, the Australian share market is on track to deliver a return of more than 25% and international markets, such as the US, are fairing even better.
Despite all of the negative press in the US (the impeachment hearing, the trade war with China, the constant barrage of Trump tweets etc. etc) the US economy continues to perform well. Unemployment remains at a 50-year low and wages are rising at the fastest rate since the Global Financial Crisis. The residential property market is also gathering steam. Paradoxically, the US Federal Reserve reduced interests in 2019. This was largely due to fears of a slowdown induced by the Trump/China trade war. I will talk about this more below. But considering the healthy state of their economy and rising wages, I expect we will see interest rate rises back on the agenda next year. If that happens, get ready for some volatility in 2020. However, over the medium to long-term, a strong economy in the United States is a positive for the rest of the world.
I won’t sugar coat this – I think the Reserve Bank of Australia are making a big mistake. This year they reduced the key benchmark rate three times to a record low of just 0.75%. That is lower than at any time in Australia’s history. They argue that wages growth is sluggish and the economy is muddling along at rate which is lower than it could be.
But surely these interest rate settings should be kept in a glass case, which is only broken in case of emergency. Certainly not when property prices are rising and unemployment is at a relatively low level of around 5%. For those who don’t trust the unemployment figures, the Australian Bureau of Statistics tracks workforce participation and it is currently the highest level on record. These are hardly the economic indicators one would associate with an economic emergency.
With nothing left up their sleeve, what will they do if we suddenly experience a financial crisis or head into a recession? I worry about this.
I also question the benefit of these low interest rates on the economy. Low interest rates cause many retirees to reign in their spending, meanwhile young mortgage holders appear to be building their savings and paying off their mortgages rate than spending (a strategy I certainly endorse by the way!).
I’ve attended a few conferences and professional development sessions throughout the year, and I have put this question to a couple of senior economists. They acknowledge the hurt experienced by older Australians, but they still seem to believe that, on balance, lower interest rates produce a net benefit to the economy. What the economy loses with retirees, they gain more from mortgage holders and borrowers. As one economist from a major institution told me back in August, ‘its about 60/40’ in favour of reductions. This seems to be the way economists and the RBA think about these matters. As long as the net result achieves the desired outcome, who cares about the casualties? Too bad if you are part of the 40% I guess.
For the moment, there seems to be a consensus that interest rates are likely to remain low for a long time, and some are even predicting more cuts in 2020.
This will continue to make low risk investing very challenging. There are options, but much caution is warranted, with mortgage funds and riskier forms of investments, disguised as low-risk bank accounts, starting to be promoted to investors hungry for higher yields.
I won’t go into this in great detail, as I generally avoid recommending unlisted and alternative investments, such as commercial property trusts, private equity and infrastructure. But it is worth noting that many prominent super funds have loaded up on these assets to the tune of about 25% to 30% of balanced portfolios. They like these investments, because they are valued intermittently and they can smooth out investment returns when the share market drops. They know investors are more likely to jump ship when the markets are down, so are they more worried about losing members than targeting the best returns for members over the long-term? What other reason could they have for allocating such huge allocations to these assets? Especially now, with interest rates at record lows.
This is the worst possible time to own such investments. The process of valuing unlisted investments, means they get a boost from interest rate reductions. What we have seen over the last 25 years, is an almost uninterrupted period of interest rate declines. By parking some of their defensive exposure (I would argue that these investments should be in the growth part of the portfolio by the way) into these investments, they have been able to produce some surprisingly good returns. However, as interest rates bottom out and eventually start to rise, their members will be in for a rude shock. If interest rates suddenly jump back up to levels seen just a few years ago, these investments could fall in value by as much as 25% to 30%. And this is in the defensive part of the portfolio! Ouch!
Trump v’s China
When I wrote about the Trump versus China tariff/trade standoff 12 months ago, I expected a deal to be struck within 6-9 months. I was wrong. Although a partial deal has been agreed between China and the USA a few days ago. This is certainly a welcome sign and it is good news for the world economy. But what is now becoming clear, is that there are many issues on which China and the US will never agree. This looks like the beginning of what is likely to be a long, uneasy, on-again/off-again relationship between these two financial and geopolitical super powers. I’m afraid we will probably have to get used to it. I was at a conference recently, where a highly regarded fund manager was talking about this issue. Someone from the audience asked the question – ‘will this eventually lead to a war?’ to which the fund manager replied ‘they are already at war and they have been for some time. This is the way wars are fought these days’ (ie. cyber, trade, media & politics). It was a sobering observation. But I should add, that this same fund manager was also very upbeat on the world economy and the share market in general, and they are currently holding overweight positions in both the US and China.
Australian Property Market
At this time last year, the housing market was in decline and there were genuine fears that the drop in prices (about 11% here in Melbourne and 15% in Sydney), which started towards the end of 2016, could morph into a crash. The shock defeat of Bill Shorten, who promised to increase capital gains tax and end negative gearing, gave a boost to investor sentiment, with clearance rates immediately bouncing back to boom time levels and price growth now starting to accelerate.
At the same time, finance is still quite challenging to obtain, as anyone who has recently applied for a loan will testify. My advice, for anyone looking to re-finance or buy a new place, is to use an experienced mortgage broker. It is also more important than ever, to make sure you have a pre-approval and only make offers subject to finance, unless you are absolutely sure you can settle on a property. Don’t rely on your past experience or assurances given to you by the bank years ago (or even months ago), as the game has changed quite significantly.
While the short-term outlook for property looks very good, I would urge caution. House prices have historically grown in-line with wages over the long-term both in Australia and abroad. But for the last 23 years, house prices have outpaced wages quite significantly. As a result, the ratio between house prices and income, has blown out to levels never before seen in Australia, with Sydney and Melbourne ranking as two of the most expensive cities in the world. You can read a good article about this via the below link.
Despite the high cost, I continue to recommend young people save for a deposit and buy as soon as they are comfortably able to do so. Owning a home still makes sense as a hedge against paying a lifetime of rent.
For those looking to invest, caution is warranted. Don’t expect the incredible price growth, which we have seen over the last 50 years, to be repeated. In the 70s and 80s, we saw rampant inflation and wage growth, averaging around 10% per year. So while property prices grew at the same rate, people’s capacity to buy and pay off a home remained relatively in check. Since the mid-90s, we have seen the great divergence of incomes and house prices, which has lead to our world beating housing ‘unafordability’. With house prices so high relative to income, investors need to be aware of the high risks they are taking on. The high growth of the past is unlikely to continue, and the risk of falls has never been greater. But for the moment at least, positive sentiment is carrying the market forward and I’m expecting continued growth through 2020.
Considering the headwinds to growth I described above, my general advice to those who wish to buy an investment property, is to borrow no more than you can comfortably afford to repay before retirement. That way, even if you don’t see a lot of price growth, you will still own the asset and have free cashflow from the rent to supplement your retirement income. Another strategy (everyone seems to know someone who has made a fortune out of this approach) is to use the rising equity from their first investment property to borrow more and then more again, and continue to buy properties with no prospect of ever repaying the loans. This strategy is more likely to lead to destitution than riches in the decades ahead. When considering the two options, think about the Hare and the Tortoise.
With Boris Johnson wining the election in the UK, it appears Great Britain’s exit from the European Union may actually happen in 2020. Although it’s hard to believe the referendum was all the way back in 2016! Brexit is likely to be a messy affair. If the UK does manage to withdraw from the EU, there is speculation that Scotland may withdraw from the United Kingdom; and what will it mean for Northern Ireland, since Ireland will happily remain in the EU?
Fortunately, for most of us, this torrid affair means very little. On the world stage, this once great super power has little financial influence. Shares listed on the London Stock Exchange represent less than 6% of a typical international shares fund. If you have a quick scan through the largest companies, you may be familiar with some of the names like Vodafone, HSBC, Unilever, GlaxoSmithKline, BP, Royal Dutch Shell and AstraZeneca. Even Australian companies like BHP and RioTinto, which are dual listed in Australia and the UK, are in the top 15. What all of these companies have in common, is their multinational footprint. With operations across the world, does it really matter that their head office is based in the UK? If it suits them to do so, they will shift parts of their business to Zurich or Paris with the stroke of a pen. This would be bad for UK employment, but good for employment elsewhere. As foreign investors, it matters little to us here in Australia.
Benchmark Financial Planning
In 2020 you may read about changes to financial adviser standards. I want to assure you that I am committed to the profession and I remain as passionate as ever about the value of financial advice.
Sadly, not everyone feels the same way and it appears there is a large exodus unfolding which will continue into 2020. The main reasons are the banks, which are closing down their financial planning divisions in response to the Royal Commission, the requirement to pass a compulsory exam and upgrading adviser qualifications to a minimum degree standard. In my case, I have passed the exam and the Masters Degree I completed many years ago, has been approved by the standards board. So despite what you may hear or read in the media next year, it will be business as usual for us.
The information contained above is general advice only and was current as at the time of writing (ie. 20 December 2019). It was written by Ben Marshall and does not reflect the views or opinions of the Australian Financial Services License holder Capstone Financial Planning. The content was been prepared without taking into account the investment objectives, financial situation or needs of any particular person. Therefore, before acting on any information you should consider its appropriateness, having regard to your personal objectives, financial situation and needs. You should also obtain a copy of the relevant Product Disclosure Statement before investing in any product. This information is given in good faith and has been derived from sources believed to be accurate at its issue date. However, it should not be considered a comprehensive statement on any matter nor relied upon as such.
We suggest you contact us, or another suitably qualified financial adviser, to obtain personal financial advice prior to making any investment decisions.