The year 2018 certainly did not go down as one of the uneventful years, as mentioned in the email I wrote to you before Christmas. Now only three weeks into 2019 and we have already seen a continuing shutdown of the U.S. government as a result of continuing disagreement on spending US$5.7 Billion to build a wall on the border of the U.S. and Mexico.
Will “uncertainty” continue to be the theme throughout 2019?
In 2018, Trump’s government rolled out a significant tax reform aimed to reduce the tax burden for US tax payers, and encourage the repatriation of cash held overseas by US corporates. The US enjoys strong economic growth and has the lowest unemployment rate since the 1970s.
This, combined with a relatively well performing Australian economy, had pushed the ASX200 in Australia to its highest level since 2007 and the S&P500 to an all-time high at the end of August. Since September, it has been downhill, which point to the end of the current growth/rising equity cycle. An IMF forecast in October 2018 indicated that the global economic growth is expected to peak in 2018, with a subsequent slowdown in 2019. Additionally, we have a China/US trade war, the UK looking at a “hard Brexit” and other geopolitical tensions.
From a global economy point of view, although US Federal Reserve had rate hikes in 2018 and raised their interest rate to the current level of 2.25%, recent comments by US Federal Reserve chairman Powell in late November appeared to indicate a softening of the expectations regarding near-term economic growth. In turn, this has led to markets pricing one fewer rate hikes in 2019. In addition to this, we witnessed the two digits downfall in stock markets when the China/US trade war intensified, and the recovery of sentiment in after renewed discussions between China and the US came out positive. We are likely to see more ups and downs in 2019 if only we are uncertain about how this trade war will play out.
Domestically, the economy growth in Australia lagged the performance in the US in 2018. And now our economy and inflation are slowing down, too. While unemployment remains very low, the case for rate hikes by RBA is even weaker. I will list down below a few risks that could affect our economy deeply in 2019:
- Housing market: We have seen declines of property prices in major capital cities of Australia and many parts of this world share same concerns over their respective markets. Hong Kong, Vancouver, London and even New York are enduring simultaneous decline in house prices. With the fact that the global properties investors today are generally more highly leveraged, the consumer confidence and consumption capability are significantly discounted. This will certainly affect a consumption driven economy, like Australia.
- Federal election: The chance of having a Labour government after this year’s federal election is high, according to recent polls. Labour’s proposals regarding negative gearings, franking credits and Capital Gain Taxes are not viewed positively by investment markets, given they create uncertainty.
- US/China trade war which has quickly become a “Cold War” given the current approach of the US to try and prevent trading partners to choose between the two.
- China hard landing: A sudden slowdown of the China’s economy would likely have negative effects on the Australian economy. Given China is a major trading partner, along with Japan, there is no discounting the fact that there will be an impact.
At this stage, we view the risk of a global recession as relatively low, but note recession probability indices are currently at their highest levels since 2016.
The only certainty is that there will be continuing uncertainty, which means as an Investor you have to adopt a long term view and look through the “noise”.
Our attitude continues to be one of “risk off” which means, we will only expose our investors to the minimum risk necessary to allow them to achieve their longer term strategic objectives. Unless there is a positive “Risk Return Tradeoff” we will be discerning about whether we invest capital in growth assets.
We also appreciate that money in cash attracts returns which are little better than inflation – 2.7% for term deposits. For this reason we have been increasing our exposure to quality corporate bonds which have been providing significantly higher income returns, without the risk associated with investing in equities (shares). For those growth investments we have in place, we will be recommending that these assets are actively managed. The time of investing cheaply via Index funds and allowing the rising market tide to do the heavy lifting has passed.