Investment market update - January 2019

10 Jan 2019

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2018 in (not so pretty) pictures

Line graph showing key events during the 2018 calendar year against movements in the ASX200. First quarter: US tax cuts come into force; global equities sell-off post surge in US 10-year yield; AUS outperforms major markets; NAB conditions hit record high. Second quarter: Fed hikes 25bp; Trump announces tariffs on steel and aluminium; PBOC cuts RRR by 100 bps. Third quarter: Trump releases final list of tariffs on Chinese imports; OPEC meeting, oil producers end compliance with productin curbs; Fed hikes 25bp; Trump announces an additional $200bn tariff list; China unveils stimulus package. Third quarter: Scot Morrison becomes Australian PM; Fed hikes 25bp. Fourth quarter: AUD drops to lowest level since January 2016; US midterm elections; China and US declare temporary trade truce at the G20 summit; major oil producers agree to cut production; Brent hits one year lows.

After hitting a peak of nearly 6,400 in September, the ASX200 (an index of the largest 200 companies in Australia) followed the swoon in global markets, finishing at 5,646. Despite the -6.9% fall over the year, most UniSuper members will see their account balances flat or slightly up in 2018. Our Balanced investment option—the default option for our accumulation members—eked out a small positive return of 0.9%.

As is typically the case over any 12 month period in financial markets, there were many twists and turns—although, generally speaking, the negative forces held sway. Here we attempt to capture the main drivers of market performance over the last year.

The US Central Bank (‘the Fed’) continued to increase its target rate

Arguably, the most important factor driving global financial markets over the past few years has been the rise in US interest rates from about zero to 2.50% at a time when other central banks were holding rates steady, or even cutting them (as was the case with the Australian Reserve Bank). This trend continued in 2018.

Line graph comparing US interest rates (‘Fed Funds Rate’) and RBA Cash Rate. Graph shows the RBA Cash Rate declining from 2.5% in January 2015 to 1.5% in July 2016 and remaining at 1.5% until January 2019. Graph also shows Fed Funds Rate increasing from around 0.01% in January 2015 to 2.5% in January 2019.

Source: UniSuper

The Fed has also transitioned from quantitative easing (QE) to quantitative tightening (QT)

In addition to increasing the cost of US dollars (by raising rates), the Fed is also reducing the quantity of US dollars available. Quantitative tightening is a technical process whereby the Fed effectively transitions from being a buyer of bonds to a seller of bonds, putting upward pressure on interest rates. (As bond prices go down, bond rates go up).

Bar graph showing the monthly purchases of bonds by the US Federal Reserve since 2009. Graph shows the substantial amount of bonds bought during the first (November 2008 – March 2010), second (November 2010 – June 2011) and third (September 2012 – October 2014) rounds of Quantitative Easing. However, beginning in October 2017 the Federal Reserve has effectively sold increasing amounts of bonds.

Source: UniSuper

Tightening of US dollar liquidity has resulted in a stronger US dollar relative to other currencies

Changes in exchange rates are a key way in which changes in US interest rates are transmitted to the rest of the world. The impact is particularly large on countries with significant US dollar borrowings and weak fundamentals, such as Argentina and Turkey.

Bar graph showing nominal exchange rate vs US dollar as a percentage, for the period December 2017 until January 2019. Europe area: about -5; Japan: 0; United Kingdom: about -7; Argentina: more than -50; Brazil: about -15; Australia: about -6; China: about -5; India: about -11; Mexico: under -5; Russia: about -15; South Africa: about -14; Thailand: about -1; Turkey: about -30.

Source: IMF staff calculations

Tightening US dollar liquidity usually hurts asset prices and 2018 was no exception

All global share markets were down in 2018. The US share market was actually in positive territory until December when it recorded a 9.4% decline. This was the worst December on record for the US since the Great Depression!

The graph is expressed in US dollar terms for consistent comparisons. Not surprisingly, Argentina and Turkey were two of the worst performers.

2018 calendar year returns (USD)

Bar graph showing 2018 calendar year returns as a percentage in US dollars. USA: about -5%; Australia: about -14%; Europe: about -15%; Japan: about -15%; UK: about -15%; China: about -25%; Argentina: about -47%; Turkey: about 39%.

Source: UniSuper
Past performance is not an indicator of future performance

Trump’s trade wars didn’t help

Despite higher rates, share markets were generally holding up OK until it became clear that Trump was going through with his threat to start a trade war. This immediately hit confidence, and industrial production and trade volumes have noticeably declined. Forecasts for global growth in 2019 have been revised down to about 3% from about 3.75%.

Line graph showing industrial production and world trade volumes. The graph shows a declining trend between February 2015 and February 2016 which grows again between February 2016 and August 2017, before dropping between November 207 and November 2018.

Sources: CPB Netherlands Bureau for Economic Policy Analysis; Haver Analytics; and Markit Economics

Australia has had its own problems, particularly falling house prices

House prices in Australia have been caught in a perfect storm. Starting from an overvalued position (particularly in Sydney and Melbourne), they have succumbed to lower foreign buying and tighter lending conditions arising from the fallout from the Royal Commission and APRA restrictions.

Line graph showing property price growth in Brisbane, Melbourne, Sydney and Perth as a percentage, QoQ. The graph shows a steady trend for all cities between 2013 and mid-2014. Prices in Perth and Brisbane remain steady but spike in Sydney and Melbourne between mid-2014 and 2015. Sydney and Melbourne then experience a drop mid-way through 2015 and growth during 2016. Prices decrease for Melbourne and Sydney from 2017 to the end of 2018 but remain steady in Brisbane and Perth.

Source: Corelogic, Morgan Stanley

Impact on investment returns

A poor year for higher-risk assets caused an almost 180 degree turnaround in the relative performance of UniSuper’s investment options. Whereas global strategies were our best performers in 2017, in 2018 they were our worst—with the notable exception of Global Companies in Asia (which had negligibile exposure to companies listed in the underperforming emerging market countries). Conversely, the Australian Bond option climbed to the top of the ladder in 2018 after being the second worst performer in 2017. The Cash option (1.8%) outperformed the Balanced option (0.9%) in 2018, representing the first time that has happened since 2011.

2017 (%) 2018 (%)
Best performing
Global Environmental Opportunities 20.12 Australian Bond 4.08
Global Companies in Asia 19.26 Global Companies in Asia 3.41
International Shares 17.24 Listed Property 2.65
Worst performing
Diversified Credit Income 3.55 High Growth -1.26
Australian Bond 2.86 Global Environmental Opportunities -2.94
Cash 1.71 International Shares -3.76

Past performance isn’t an indictor of future performance. The information in this article is of a general nature and doesn’t take into account your individual objectives, financial situation or needs. You should consider the appropriateness of the information for your personal circumstances and consider consulting a licensed financial adviser before making an investment decision based on the information contained in this article.

Is there light at the end of the tunnel?

Given that most share markets around the world have experienced their worst year since the global financial crisis, investors are generally engulfed in gloom. With a number of markets having fallen 20% from their peaks, we now hear talk of being in a ‘secular bear’ market. We feel there shouldn’t be too much attention paid to such predictions. Markets could indeed fall further but there’s nothing particularly special about a 20% fall as distinct from, say, a 15% or 25% fall. In fact, if an investor bought every time a market fell 20%, they would far more often than not be in front within 12 months.

In terms of catalysts of a more positive tone to markets, top of the list are:

  1. A clear indication from the Federal Reserve that they’re close to the end of this tightening cycle. In this regard, the latest comments from Fed officials have been encouraging and January is off to a more positive start. The firm market consensus is that we’re closer to the end than the beginning of the cycle, and some commentators are even suggesting the possibility that the next move in official rates will be down.
  2. Resolution to the China/US trade war. In global finance, there are really only two countries that matter—the US and China—so it’s absolutely essential that they arrive at a workable truce. How this plays out is anyone’s guess, although we can take some heart from Trump’s recent tweets that talks are progressing well. Let’s hope it’s not fake news.
  3. For Australian investors, it’s hard to see a broad market rally without support for the banks. Assuming that the bad news from the Royal Commission has already been factored in, we now need stabilising house prices, particularly in Sydney and Melbourne. Unfortunately, given political uncertainty and tighter lending conditions, it’s hard to see this happening any time soon. But it will happen… housing cycles never die.

This is not intended to be an endorsement of any of the listed securities named above for inclusion in personal portfolios. The above material reflects UniSuper’s view at a particular point in time having regard to factors specific to UniSuper and its overall investment objectives and strategies.

Past performance is not an indicator of future performance. This information is of a general nature only and may include general advice. It has been prepared without taking into account your individual objectives, financial situation or needs. UniSuper’s investment strategies will not necessarily be appropriate for other investors. Before making any decision in relation to your UniSuper membership, you should consider your personal circumstances, the relevant product disclosure statement for your membership category and whether to consult a licensed financial adviser. This information is current as at 9 January 2019.

Return objectives are not promises or predictions of any particular rate of return. Returns specified relate to our Accumulation (not Pension) investment options and are published after fund taxes and investment expenses, other than account-based fees.