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Daniel Needham – CIO Morningstar Investment (Demo)

Our time with Daniel was well spent confirming Morningstar’s views that the levels of risk associated with potential loss of investment capital are at their highest levels in seven years. For this reason, Morningstar are holding significant cash reserves across their portfolios and have reduced their allocation to growth. The US perspective has obvious impacts on Australia. There economy has grown faster, run harder and their share market has increased significantly as a result of the Trump tax and pump priming initiatives. With a hostile Congress and a Federal Reserve seeking to continue to raise interest rates, the risks are increasing from a risk return perspective.

In Australia we have settings for credit and accessing loans swinging from “too loose” only recently, to now “too tight” as a result of the knee jerk reactions to the Hayne Commission of enquiry and APRA’s tightening of lending, including the restrictions on interest only lending.

Tie this together with an already cooling housing market, an increased absence of foreign buyers, a Royal Commission that has the banks running scared and a Labour government proposing significant housing tax policy reforms and poised to win the next election, then it is reasonable to deduce that the risks have markedly increased in our economy. The increased uncertainty means we are seeing auction clearance rates falling to their lowest level in seven years.

From a behavioural finance perspective, when the houses we pay for fail to increase in value, the Australian consumer has a tendency to tighten their belts. Uncertainty leads households to reduce spending on renovation and interior decoration. Sustained decreases in house prices weakens construction activity as developers put off new construction, which has a knock on effect for associated businesses and business activity.

Politically, rather than taking action and discussing the “elephant in the room,” the economy and financial system have been kicked around as a political football by all parties. While there is no business case in Australia for interest rates to rise, we import circa 60% of our credit funds from offshore economies (USA is one) where interest rates are rising. This means that the RBA in Australia has a weakened tool (monetary policy) to assist is matters take a turn for the worse.

For these reasons, we are “Risk off” hand having over the last nine months, been reducing client exposure to growth assets. We have also been introducing Corporate Bonds into our client’s holdings along with continued Term deposit strategies. Why are we doing this?

When we see a portfolio of investment grade corporate bonds providing a trailing return of circa 5.5% with a two to three year duration, with very limited risk, it raises a red flag as to the question of risk and return in equity markets. Our key message is prudence and while we appreciate that investment has to occur, it needs to be done in a measured way using an averaging approach with a cautious eye to how much risk you need and should be taking.

Protection of your capital remains utmost in our minds and our work.

I apologise if this article has come across as a little too technical, but I have attempted to explain our thoughts in these uncertain times as we continue to provide you with ongoing advice. Always happy to discuss.