John Owen, Portfolio Specialist, MLC, talks about the conditions in the global economy, how Australia performed in 2018 and how investors fared last year.
What were conditions like in the global economy?
While 2018 began with growth synchronised across the globe, the year concluded with marked differences between regions and countries. The US economy was the standout performer, with strong growth and the unemployment rate falling to a near fifty-year low. The US Federal Reserve responded to these buoyant conditions by raising interest rates four times during the year.
Economic conditions in Europe softened as 2018 progressed. Germany’s export oriented economy contracted by 0.2 per cent in the third quarter, the first negative quarter in over three years. As for Brexit, there is diminishing hope an orderly Brexit arrangement will be in place when the 29 March exit date is reached. Brexit has already adversely impacted the UK economy as businesses and consumers anticipate a painful divorce from Europe.
In Asia, Japan’s economy slowed and continues to lag the growth of other economies. In China, economic growth moderated over the year, despite Chinese authorities implementing some targeted fiscal and monetary initiatives to support growth and lessen the impact of US tariffs.
How did Australia’s economy perform?
Our economy improved further in 2018, particularly in the first half of the year. A positive feature was continued improvement in Australia’s labour market, with unemployment falling to a six-year low of 5.1 per cent. Wages growth picked up to a 2.3 per cent annual pace for the September quarter, the highest in three years. However, retail sales growth remains subdued,with many indebted households saving less to maintain consumption. After years of strong price rises, Australian house prices fell 6 per cent in 2018, with bigger falls in Sydney and Melbourne. Inflation remained low, enabling the Reserve Bank to keep the cash rate unchanged at 1.5 per cent, where it has been since August 2016.
How did investors fare in 2018?
After beginning 2018 with considerable optimism, market conditions deteriorated in the final quarter. Asset class returns in 2018 were generally low single digit or negative. Global shares on an Australian dollar hedged basis returned -7.4 per cent for the year. The higher 1.2 per cent unhedged return largely reflected the 10 per cent fall of the Australian dollar against the US dollar. Australia’s market outperformed global despite returning just -2.8 per cent. Individual share market returns in local currency terms were generally negative. For instance, the US S&P500 index returned -4.9 per cent, Japan’s Nikkei index was down by 10.3 per cent and Germany’s share market fell 18.3 per cent. Bond markets delivered low single digit returns, with Australian bonds outperforming global as Australian yields remained stable.
While investors may be disappointed with the returns they see from 2018, it’s important to remember that longer term returns remain pleasing.
Why did markets lose ground?
For much of the year, investors downplayed risks such as rising interest rates, "quantitative tightening" in the US and withdrawal of monetary stimulus in Europe, escalating trade tensions and high valuations in markets.
However, this complacent attitude ended abruptly in the final quarter. Markets became alarmed about the potential impact of further US interest rate rises, the continued withdrawal of monetary stimulus, mixed news on the global economy (notably on Chinese growth), the possible failure of the trade truce between the US and China, rising political risk and the realisation that the economic and earnings growth cycle has passed their peak. The new calendar year begins with considerable uncertainty about the investment outlook.
How is MLC responding to the uncertain environment?
We’ve believed for some time that the appropriate response to the challenging investment environment is to defensively position our multi-asset portfolios. Portfolio decisions we’ve made include holding more cash than normal, being very selective about the types of bonds we invest in, retaining a high exposure to unhedged global shares to increase diversification and using strategies whose returns don’t rely on share markets.
We believe managing risk is the way to generate sustainable returns for our investors. In this unpredictable investment environment, it’s more important than ever.