With the 2019 calendar year quickly drawing to a close, I thought it would be good to have a look at what next year might bring in terms of investment risks and opportunities.
Over the years, I found that its best to form opinions on the economy by reading analysis/insights and attending economic briefings, whilst being careful to not overindulge. Too many opinions and viewpoints can confuse and sometimes send you down a rabbit hole. This should be complimented with real-world observation such as taking notice of retail traffic conditions, anecdotal discussions with business people and so on. This approach has served me pretty well over the past few decades.
The economy and the risk of recession
There has been a bit of press lately about the risk of Australia and other developed economies (including the US) slipping into a recession.
Australia is now in its 28th year of uninterrupted economic expansion – which is a world record for a developed economy. But all records must end someday. That said, population growth and raw-material (iron ore) exports have been big contributors to our economy over recent decades. I don’t see that changing anytime soon. However, some sectors of the economy have been really struggling. For example, retail trade has been flat in the year to September 2019. Retail weakness has mainly manifested in household goods (probably impacted by the property market slowdown) and department store sales (thanks to online competition). Wage inflation has also been low with the Wage Price Index recently coming in at 2.2%. Prior to early 2013, the index used to always be above 3% (and peaked at 4% just prior to the GFC). But this phenomenon isn’t unique to Australia – all developed economies around the world are struggling to generate wage inflation.
In terms of globally, the US deserves the most attention because it’s the largest developed economy by far. The Fed Reserve has been cutting rates to keep the economy growing. President Trump has called for more rate cuts (even negative rates) and for them to recommence quantitative easing. Lower rates in the US are expected to depreciate the US dollar which should add some more fuel for the economy.
On the whole, I think a recession in Australia or in the US is unlikely in 2020. Of course, both economies are getting closer to an economic slowdown as each month passes. Barring any unforeseen circumstances, I think these economies will keep ticking along albeit at a slower rate.
Interestingly, in a speech on Tuesday night (26/11/19), the Reserve Bank Governor suggested that it would prefer to cut rates two more times before implementing quantitative easing, which I was personally pleased to hear.
I normally defer to Westpac’s chief economist Bill Evens for interest rate forecasts, as I have found he’s been consistently the most accurate over the years. Bill is forecasting only one more rate cut which is predicted to occur in the first quarter of 2020. But the big question is how much will the banks pass on? I suspect that they will continue with what they have done the last few times i.e. pass on circa 0.15% of the cut onto most borrowers but the full 0.25% for interest only investment loans.
After the interest rate cutting has finished, it will then be up to the government to loosen fiscal policy and increase its spending to further stimulate growth. Thankfully, Australia’s low debt levels relative to other developed countries and high commodity prices means the government has plenty of fuel in the tank.
I shared my thoughts on the property market in this blog in September here. I said that I believe price growth would be good but is unlikely to get out of control due to the relatively tight credit (borrowing) market. However, the market has certainly improved over recent weeks and months and Vendors are starting to gain confidence (resulting in increased listings and sales). I expect this to continue into 2020 and we should enjoy some relatively good growth, particularly in blue-chip locations.
Over the past decade, equity markets have benefited greatly from low interest rates and loose monetary policy (quantitative easing), as well as some economic expansion in the US in particular. However, valuations seem high, particularly in the US and to a much lesser extent here in Australia. Two markets/asset-classes that represent the best value at the moment are the UK and emerging markets, which I discussed last week. I posted the below table last week on social media. It sets out predicted returns over the next decade using various measures including the CAPE ratio.
I don’t know what equity markets will do next year and I’m not even going to try and guess. But I do know that studies have shown that starting market valuations is a reliable predictor of long-term returns. Invest when markets represent value and you will likely enjoy good returns. Invest when they are expensive, and you won’t.
Equity markets have their headwinds including economic slowdown and high valuations, as discussed above. Government and treasury bond yields are sub 1% and corporate bond yields are circa 3.5%. So, where do you find growth and income (other than direct residential property)?
The answer could be in commercial real estate (listed and/or unlisted real estate investment trust or REIT) or infrastructure. Although, be careful (i.e. chose investments wisely), as everyone is thinking the same thing and the demand for these investments are driving up prices. For example, the real estate (S&P/ASX 300 A-REIT) and infrastructure (FTSE Developed Core Infrastructure Index) indexes have both returned over 12% p.a. over the past 5 years.
What to do?
So, what do you do with this information? In simple terms my advice is to play the long game. Stick to your investment strategy and keep investing (i.e. invest regularly and spend what’s left over). However, don’t be blind to the risks and opportunities discussed above.
If you’re investing in a market or asset class that seems overvalued or risky, consider under-weighting your allocation and use valued-based investment strategies to protect yourself. Otherwise, look for markets that appear to represent the best value. Stick to time-tested, rules-based, well-diversified, evidenced-based investments strategies – no throwing darts at a dartboard! In the long run, this approach will pay handsome dividends. And if you need help, don’t hesitate to reach out to us.