Introduction

After the poor returns for investors in 2018, 2019 turned out surprisingly well with average balanced growth superannuation funds looking like they have returned around 15%.

But can it continue this year? Particularly with an intensification of the US/Iran conflict adding to global uncertainty and the drought and horrendous bushfires further weighing on the Australian economy. Here is a summary of key insights and views on the investment outlook in simple point form.

Five reasons 2019 turned out well for investors

2019 saw slowing growth and weak profits amidst an escalating US/China trade war and tensions with Iran and yet it turned out well for investors. Here are five reasons why:

• Easy money – central banks eased monetary policy in response to the growth slowdown and various threats to growth reversing the tightening seen in 2018.
• Cheap starting point for assets – after the falls of 2018 shares started 2019 cheap and they and other assets were made relatively cheaper as interest rates & bond yields fell.
• The crowd was very gloomy at the start of 2019 with much fear about the outlook – when this is the case it’s always easier for assets to rise in value.
• While geopolitical threats remained high there was some relief by year end – with the US & China reaching a Phase 1 trade deal; Iran tensions not seeing a major or lasting disruption to oil supplies; and a hard Brexit avoided for now.
• Global growth was not as bad as feared – despite a mid-year recession obsession as yield curves inverted. In fact, global growth indicators looked to be stabilising by year end.

Seven lessons from 2019

• Don’t fight the Fed, ECB, PBOC or RBA – as long as recession is avoided monetary easing is positive for investment returns from growth assets.
• The starting point matters – when assets are cheap, and the crowd is negative as they were at the start of 2019 it’s relatively easier to get good returns.
• Post GFC caution remains but can be both negative and positive – yes it periodically weighs on growth, but it is keeping economies from overheating and thereby is helping to extend the economic and investment cycle.
• Geopolitics remains a significant driver of markets and economic conditions – but it can be positive whenever there is any relief and things don’t turn out as bad as feared.
• Just because Australian housing is expensive & household debt is high does not mean house prices are going to crash.
• Stick to an investment strategy – 2019 started in gloom and had its share of distractions but investors would have done well if they just stuck to a well-diversified portfolio.
• Remember that while shares can be volatile and unlisted assets also come with risks, the income stream from a well-diversified mix of such assets can be relatively stable and higher than the income from bank deposits.

Five big picture themes for 2020

• A pause in the trade war, but geopolitical risk to remain high. President Trump is likely to want to keep the US/China trade war on the backburner but it could still flare up again and other issues include the escalation seen so far this year in the Iran conflict, a return to worries about a “hard Brexit” at year end if UK/EU free trade talks don’t go well and the US election if a hard left Democrat candidate gets up.
• Global growth to stabilise & turn up thanks to policy stimulus with business surveys recently showing stabilisation.
• Continuing low inflation and low interest rates. Growth won’t be strong enough to push underlying inflation up much and some central banks will still be easing (including the RBA).
• The US dollar is expected to peak and head down as global uncertainty declines a bit and non-US growth picks up.
• Australian growth is expected to remain weak given the housing construction downturn, weak consumer spending and the drought with bushfires not helping.

Key views on markets for 2020

Improving global growth & still easy monetary conditions should drive reasonable investment returns this year but they are likely to be more modest than the double-digit gains of 2019 as the starting point of higher valuations for shares & geopolitical risks are likely to constrain gains and create some volatility:

• Global shares are expected to see total returns around 9.5% in 2020 helped by better growth and easy monetary policy.
• Cyclical, non-US and emerging market shares are likely to outperform, if the US dollar declines as we expect.
• Australian shares are likely to do okay this year but with total returns also constrained to around 9% given sub-par economic & profit growth.
• Low starting point yields and a slight rise in yields through the year are likely to result in low returns from bonds.
• Unlisted commercial property and infrastructure are likely to continue benefitting from the search for yield but the decline in retail property values will still weigh on property returns.
• National capital city house prices are expected to see continued strong gains into early 2020. However, poor affordability, the weak economy and still tight lending standards are expected to see the pace of gains slow leaving property prices up 10% for the year as a whole.
• Cash & bank deposits are likely to provide very poor returns, with the RBA expected to cut the cash rate to 0.25%.
• The $A is likely to fall to $US0.65 as the RBA eases further, then drift up as global growth improves to end little changed.

Seven things to watch

• The US trade wars – we are assuming the Phase 1 trade deal de-escalates the trade war, but Trump is Trump and often can’t help but throw grenades.
• US politics: the Senate is unlikely to remove Trump from office if the House votes to impeach and another shutdown is also unlikely but both could cause volatility as could the US election if a hard-left Democrat gets up (albeit unlikely).
• The US/Iran conflict – which could escalate further with Iran unlikely to negotiate and Trump wanting to sound tough, potentially disrupting oil supplies.
• A hard Brexit looks like being avoided but watch UK/EU free trade negotiations through the year.
• Global growth indicators (PMIs).
• Chinese growth – a continued slowing in China would be a major concern for global growth.
• Monetary v fiscal stimulus in Australia – significant fiscal stimulus could head off further RBA easing.

Four reasons global growth is likely to improve a bit

• Global monetary conditions have eased significantly over the last year. China has also seen significant fiscal stimulus.
• The stabilisation seen in business conditions PMIs in recent months suggests monetary easing is getting some traction.
• We still have not seen the excesses – massive debt growth, overinvestment, capacity constraints or excessive inflation – that normally precede recessions.
• The de-escalation of the US/China trade war should help reduce a drag on business confidence (at least for a while).

Five reasons Australia is likely to avoid a recession

The bushfires are estimated to knock around 0.4% mainly from March quarter GDP mainly due to the impact on agriculture, tourism and consumer confidence and spending. Coming at a time when Australian growth is already weak it risks knocking March quarter growth to near zero or below. However, while the risk of recession has increased, it remains unlikely:

• Infrastructure spending is strong.
• Mining investment is starting to rise again.
• The bushfires will be followed by a boost to spending from the June quarter as rebuilding kicks in.
• Already weak growth, made worse by the bushfires in the short term will likely force further fiscal stimulus.
• The $A is likely to remain weak providing a boost to growth.

Three reasons why the RBA will cut rates this year

• Growth is likely to disappoint RBA expectations for 2.8% growth this year.
• This will keep underemployment high, wages growth weak and inflation lower for longer.
• Fiscal stimulus is unlikely to come early enough.

We expect the RBA to cut the cash rate to 0.5% in February & to 0.25% in March, with quantitative easing likely from mid-year.

Three reasons why a deep bear market is unlikely

Shares are vulnerable to a correction after the strong gains seen over the last year, but a deep bear market (where shares fall 20% and a year after are a lot lower again) is unlikely:

• Global recession remains unlikely. Most deep bear markets are associated with recession.
• Measures of investor sentiment suggest investors are cautious, which is positive from a contrarian perspective.
• The liquidity backdrop for shares is still positive. For example, bank term deposit rates in Australia are around 1.3% (and likely to fall) compared to a grossed-up dividend yield of around 5.7% making shares relatively attractive.

Nine things investors should remember

• Make the most of the power of compound interest. Saving regularly in growth assets can grow wealth substantially over long periods. Using the “rule of 72”, it will take 48 years to double an asset’s value if it returns 1.5% pa (ie 72/1.5) but only 9 years if the asset returns 8% pa.
• Don’t get thrown off by the cycle. Falls in asset markets can throw investors out of a well thought out strategy at the wrong time – as some were at the end of 2018.
• Invest for the long term. Given the difficulty in getting short term market moves right, for most it’s best to get a long-term plan that suits your wealth, age & risk tolerance & stick to it.
• Diversify. Don’t put all your eggs in one basket.
• Turn down the noise. Increasing social media and the competition for your eyes and ears is creating a lot of noise around investing that is really just a distraction.
• Buy low, sell high. The cheaper you buy an asset, the higher its prospective return will likely be and vice versa.
• Beware the crowd at extremes. Don’t get sucked into the euphoria or doom and gloom around an asset.
• Focus on investments that you understand and that offer sustainable cash flow. If it looks dodgy, hard to understand or has to be based on odd valuation measures or lots of debt to stack up then it’s best to stay away.
• Accept that it’s a low nominal return world – when inflation is 1.5%, a 15% superannuation return is very pretty good (and not sustainable at that rate).

Introduction

After sharp share market falls when headlines scream about the billions wiped off the market the usual questions are: what caused the fall? what’s the outlook? and what does it mean for superannuation? The correct answer to the latter should be something like “nothing really, as super is a long-term investment and share market volatility is normal.” But that often sounds like marketing spin. However, the reality is that – except for those who are into trading or are at, or close to, retirement – shares and super really are long-term investments. Here’s why.

Super funds and shares

Superannuation is aimed (within reason) at providing maximum (risk-adjusted) funds for use in retirement. So typical Australian super funds have a bias towards shares and other growth assets, particularly for younger members, and some exposure to defensive assets like bonds and cash in order to avoid excessive short-term volatility in returns.

The power of compound interest

These approaches seek to take maximum advantage of the power of compound interest. The next chart shows the value of a $100 investment in each of Australian cash, bonds, shares, and residential property from 1926 assuming any interest, dividends and rents are reinvested along the way. As return series for commercial property and infrastructure only go back a few decades I have used residential property as a proxy.

Because shares and property provide higher returns over long periods the value of an investment in them compounds to a much higher amount over long periods. So, it makes sense to have a decent exposure to them when saving for retirement. The higher return from shares and growth assets reflects compensation for the greater risk in investing in them – in terms of capital loss, volatility and illiquidity – relative to cash & bonds.

But investors don’t have 90 years?

Of course, we don’t have ninety odd years to save for retirement. In fact, our natural tendency is to think very short term. And this is where the problem starts. On a day to day basis shares are down almost as much as they are up. See the next chart. So, day to day, it’s pretty much a coin toss as to whether you will get good news or bad. So, it’s understandable that many are skeptical of them. But if you just look monthly and allow for dividends, the historical experience tells us you will only get bad news around a third of the time. If you go out to once a decade, positive returns have been seen 100% of the time for Australian shares and 82% for US shares.

This can also be demonstrated in the following charts. On a rolling 12 month ended basis the returns from shares bounce around all over the place relative to cash and bonds.

However, over rolling ten-year periods, shares have invariably done better, although there have been some periods where returns from bonds and cash have done better, albeit briefly.

Pushing the horizon out to rolling 20-year returns has almost always seen shares do even better, although a surge in cash and bond returns from the 1970s/1980s (after high inflation pushed interest rates up) has seen the gap narrow.

Over rolling 40-year periods – the working years of a typical person – shares have always done better.

This is all consistent with the basic proposition that higher short-term volatility from shares (often reflecting exposure to periods of falling profits and a risk that companies go bust) is rewarded over the long term with higher returns.

But why not try and time short-term market moves?

The temptation to do this is immense. With the benefit of hindsight many swings in markets like the tech boom and bust and the GFC look inevitable and hence forecastable and so it’s natural to think “why not give it a go?” by switching between say cash and shares within your super to anticipate market moves. Fair enough if you have a process and put the effort in. But without a tried and tested market timing process, trying to time the market is difficult. A good way to demonstrate this is with a comparison of returns if an investor is fully invested in shares versus missing out on the best (or worst) days. The next chart shows that if you were fully invested in Australian shares from January 1995, you would have returned 9.7% pa (with dividends but not allowing for franking credits, tax and fees).

If by trying to time the market you avoided the 10 worst days (yellow bars), you would have boosted your return to 12.4% pa. And if you avoided the 40 worst days, it would have been boosted to 17.3% pa! But this is very hard, and many investors only get out after the bad returns have occurred, just in time to miss some of the best days. For example, if by trying to time the market you miss the 10 best days (blue bars), the return falls to 7.6% pa. If you miss the 40 best days, it drops to just 3.6% pa.

The following chart shows the difficulties of short-term timing in another way. It shows the cumulative return of two portfolios.

• A fixed balanced mix of 70 per cent Australian equities, 25 per cent bonds and five per cent cash;
• A “switching portfolio” which starts off with the above but moves 100 per cent into cash after any negative calendar year in the balanced portfolio and doesn’t move back until after the balanced portfolio has a calendar year of positive returns. We have assumed a two-month lag.

Over the long run the switching portfolio produces an average return of 8.8% pa versus 10.2% pa for the balanced mix. From a $100 investment in 1928 the switching portfolio would have grown to $218,040 compared to $705,497 for the constant mix.

Key messages

First, while shares and other growth assets go through periods of short-term underperformance relative to bonds and cash they provide superior returns over the long term. As such it makes sense that superannuation has a high exposure to them.

Second, switching to cash after a bad patch is not the best strategy for maximising wealth over time.

Third, the less you look at your investments the less you will be disappointed. This reduces the chance of selling at the wrong time or adopting an overly cautious stance.

The best approach is to simply recognise that super and investing in shares is a long-term investment. The exceptions to this are if you are really into putting in the effort to getting short-term trading right and/or you are close to, or in, retirement.

SOURCE: https://www.ampcapital.com/au/en/insights-hub/articles/2019/november/why-super-and-growth-assets-like-shares-really-are-long-term-investments