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How to diversify when investing in bonds no longer works

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Bonds have traditionally helped diversify the risk of shares because bond and share prices tend to move in opposite directions. But what if both bond and share prices fall at the same time, so that this diversification no longer works? MLC provides some insights about how they manage this challenge in their portfolios.

Why does diversification matter?

In an investment portfolio, diversification, or investing across many types of assets, is essential. The prices of different assets tend to rise and fall at different times, so investing in a mix of assets means risk is spread out and the portfolio is less exposed to the ups and downs of returns of individual assets.


Bonds, the traditional diversifier, aren’t working

Over the long term, the highest returns tend to come from shares. Shares do particularly well when economic growth is strong. If economic growth and therefore company earnings are lower than expected, share prices tend to decline. Bonds tend to do well when the economy is weak, so when share prices fall, they should reduce the negative impact on a portfolio.

Bonds have traditionally been used to diversify the risk of investing in shares because bond and share prices tend to move in opposite directions. But what if both bond and share prices fall at the same time, so that this diversification doesn’t work? In today’s market, there’s a much higher risk of this than usual. That’s because bond yields are unusually low, which means bond prices are unusually high (bond yields and prices move in opposite directions). Any asset which is expensive is vulnerable to a fall – for example, bond prices are vulnerable to higher than expected inflation and interest rates.

 

But why are bond yields so low, and bond prices so high?

After the global financial crisis struck, central banks took extraordinary steps to support the financial system. This included drastically lowering interest rates and buying bonds to increase liquidity. This reduced the supply of bonds, which raised their prices and lowered their yields. Investors hunting for returns were forced into more risky assets, making everything expensive at the same time.

This has been great for investors, who have received strong returns. But it also means that almost all assets are potentially vulnerable to rising interest rates as central banks move back to more normal policies. The normalisation process has begun and this is a key reason for more volatility in both bond and share markets. Since the prices of bonds and shares may fall together, bonds may not play their normal diversifying role.

Because of this risk and unusually low bond yields, we’ve had very little or no exposure to conventional bonds in our MLC Inflation Plus portfolios, and have been significantly underweight in the MLC Horizon and MLC Index Plus portfolios, for some time. This means it’s been important to find other ways of diversifying share market risk. A key strategy has been using foreign currency exposure.

 

How can foreign currency exposure help solve the diversification problem?

Australia’s economy relies heavily on exporting natural resources, such as iron ore. This means our dollar tends to rise when the global economy is growing strongly. Global share markets also tend to perform well in these circumstances.

When global share markets weaken due to concerns about economic growth, the Australian dollar tends to decline. So reducing our exposure to the Australian dollar, by holding more of other currencies, can help to insulate our portfolios against losses when global share markets fall.

In recent years we’ve increased the exposure to foreign currencies such as the US dollar in our portfolios, allowing us to benefit from the returns of global share markets while helping to manage the risk of those markets falling. This diversification strategy has been very successful, both for making returns and reducing risk. This is particularly so for the MLC Inflation Plus portfolios, where we’ve used derivatives to manage the exposure at zero cost. By using derivatives, we’ve benefited more from rising share markets, while helping manage their risks.

Our dollar has fallen against the US dollar over the last couple of years. This makes foreign currency exposure less powerful as a diversifier, so we’ve reduced our exposure over time. However, the investment environment has very few diversification opportunities and exposure to foreign currency – including the yen, the British pound and the euro – is still a helpful strategy for controlling risk in our portfolios.

In unpredictable and constantly changing markets, we’ll continue to look for new ways to help provide returns and manage risk for our investors.

SOURCE: https://www.mlc.com.au/personal/blog/2019/01/how_to_diversifywhe

Newsletter – 18th Dec 2018

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Dear Emma ,

 

Christmas is nearly upon us and we have been very busy catching up with clients.

Today, we received a gift from one of clients, Bob, who made our new reindeer decorations for the office.  They have taken pride of place on the front desk for everyone to see!

The Australian economy in 2019 – house prices, growth and interest rates

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Key points

  • Australian growth has slowed again. The housing cycle downturn and its impact on the economy will likely see growth constrained to around 2.5-3%.
  • As a result, spare capacity is likely to remain significant, keeping wages growth and inflation low.
  • The RBA is likely to cut rates in 2019 and the housing downturn will likely see Australian shares continue to underperform global shares.

Introduction

2019 is likely to be an interesting year for the Australian economy. Some of the big drags of recent years are receding but housing is turning down, uncertainty is high around the global outlook and it’s an election year, which will add to uncertainty. This note looks at the main issues around the housing downturn and what it means for the economy and investors.

Australian growth has slowed again

September quarter GDP growth was just 0.3% quarter on quarter or 2.8% year on year and was well below expectations.

Australian real GDP growth
Source: ABS, AMP Capital

It was concerning for two reasons. Firstly, it suggests that the pickup in growth seen in the first half of the year was an aberration. And secondly it highlighted that the fears around consumer spending as housing slows may be starting to be realised as consumer spending was the big downside surprise.

Housing downturn…

For years we have felt that the combination of surging household debt and surging house prices was Australia’s Achilles heel in that it posed the greatest domestic threat to Australian growth should it all unravel. But we also felt that in the absence of a trigger it was hard to see it causing a major problem. However, over the last year a combination of factors have come together to turn the housing cycle down and create a perfect storm for house prices in Sydney and Melbourne.

These include: poor affordability; tight credit conditions; a surge in the supply of units; a collapse in foreign demand; borrowers switching from interest only to principle and interest loans; fears by investors now that changes to negative gearing and capital gains tax if there is a change of government (assuming Labor can get it through the Senate) will reduce future demand for their property investment; all of this is seeing the positive feedback loop of recent years (of rising prices > rising demand > rising prices etc) give way to a negative feedback loop (of falling prices > falling demand > falling prices etc). This could all be made worse if immigration levels are cut sharply.

Auction clearance rates have fallen to record lows (in terms of my records!) – which for Sydney and Melbourne are consistent with further price falls running around 8-10% pa – and housing credit continues to slow.

Sydney action clearance rate and home price growth
Source: Domain; AMP Capital

House prices in Sydney and Melbourne will likely have a top to bottom fall of around 20% (10% in 2019) and national average prices will likely have a top to bottom fall of around 10%.

…leading to a drag on growth

While not on the scale of the property crashes seen during the Global Financial Crisis (GFC) in the US and parts of Europe, the Australian property downturn will have a significant negative economic impact. The main impacts are expected to be:

  • a direct detraction from growth as the housing construction cycle turns down. This is likely to amount to around 0.4 percentage points per annum (which was what it added on average during the construction boom).
Building approvals are pointing to a fall in home building
Source: ABS, AMP Capital
  • reduced demand for household equipment retail sales as dwelling completions top out and decline.
  • a negative wealth effect on consumer spending of around 1% pa. Rising housing wealth helped drive decent growth in consumer spending in NSW and Victoria as households reduced the amount they saved as their housing wealth rose. This is now likely to go in reverse detracting around 0.6 percentage points from GDP growth.
  • there could also be a feedback loop into further bank credit tightening if non-performing loans and defaults rise.

Taken together these could detract 1-1.2 percentage points from growth over the next year.

No recession, but constrained growth

Clearly a deeper slump in national property prices – say a 25% top to bottom fall rather than the 10% we are expecting – would cause severe economic damage but in the absence of much higher interest rates or unemployment causing mass defaults this is unlikely. Australia hasn’t seen the sort of deterioration in lending standards seen in the US prior to the GFC that saw people with “no income, no job, no assets (NINJA’s)” get loans and where the Fed raised rates 17 times over two years! And unlike in the US, Australian mortgages are full recourse loans so there is no “jingle mail”. So, a US GFC style surge in defaults adding to downwards pressure on prices is unlikely.
Barring a deeper property slump, a recession is unlikely:

  • The drag on growth from slumping mining investment (which was averaging around 1.5 percentage points per annum) is fading as mining investment is getting close to the bottom.
  • Surveys point to a recovery in non-mining investment. Business investment plans for this financial year are pointing to a 4% gain and 7% for non-mining investment.
Actual and expected capital expenditure
Source: ABS, AMP Capital
  • Public infrastructure spending is rising and has further to go.
  • Net exports are likely to continue adding to growth, although the US/China trade war is a threat here.
  • And there are even a couple of positives for consumer spending in the form of lower petrol prices (saving around $10 a week for a typical household) and likely pre-election tax cuts or handouts although these may not kick in until July 2019. Under a Labor Government this looks likely to be more skewed to low and middle income earners with high income earners facing tax hikes.

Given the cross currents, our assessment is that growth is likely to be around 2.5-3% going forward. This is not the recession some fear but it’s well down from the 3.5% pace the RBA expects.

Inflation to stay lower for longer

Growth around 2.5-3% won’t be enough to further eat into spare labour market capacity so the decline in unemployment is likely to stall (job vacancies appear to be slowing) and underemployment is likely to remain high at 8.3%. This in turn points to wages growth remaining weak. Meanwhile, it’s hard to see much uptick in other sources of inflationary pressure: competition and pressure for price discounting remains intense and commodity prices have fallen this year with the oil price falling over 30% from its recent high feeding through to lower petrol prices and the link between moves in the $A and inflation has been weak for years now. The latest Melbourne Institute Inflation Gauge points to a further fall in inflation into this quarter with its trimmed mean measure of underlying inflation up just 1.3% year on year in November.

MI inflation gauge points to lower inflation
Source: ABS, Melbourne Institute, AMP Capital

RBA to cut in 2019

Against the backdrop of falling house prices, tight credit conditions and constrained growth, which will keep wages growth weak and inflation below target for longer we see the next move by the RBA being a rate cut. However, it will take a while to change the RBA’s thinking, so we don’t see rates being cut until second half next year but won’t rule out an earlier move if things are weaker earlier than we are expecting. By end 2019 the cash rate is likely to have fallen to 1%.

Rate cuts won’t be aimed at reinflating the property market but supporting households with a mortgage to offset the negative wealth impact on spending. A 0.25% rate cut roughly saves a household with a $400,000 mortgage $1000 a year in interest costs. And banks will likely have no choice to pass the cuts on given the bad publicity not passing them on will generate.

Implications for investors

There are several implications for Australian investors.

First, bank deposits rates will remain poor.

Second, with the RBA likely to cut rates and the Fed hiking (albeit slowing) the $A is likely to fall into the high $US0.60s.

Third, Australian bonds are likely to outperform global bonds.

Finally, while Australian shares are still great for income, global shares are likely to remain outperformers for capital growth. The housing downturn will weigh on retailers, retail property, banks and building material stocks.

Should you borrow to invest in shares or property?

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Experts discuss the pros and cons of borrowing to invest in property or shares

At a recent NAB webinar, prominent finance commentator Noel Whittaker, REA Group Chief Economist Nerida Conisbee and NAB Equity Lending Head of Sales Craig Saunders discussed the principles and options of borrowing to invest.

Why borrow to invest?

Borrowing money to invest in property or shares could help you move forward financially.

You may not have the cash to buy an investment property outright so investing in shares can create new opportunities for accumulating assets.

There may also be tax benefits if you’re on a high marginal tax rate.

Have a long-term approach

However, borrowing money has its risks. And, as Noel Whittaker pointed out, borrowing to invest in shares and property is not a short-term strategy. “You need a seven- to 10-year time frame,” he said. “Property’s going to have long flat times and shares will be volatile.”

Shares vs Property

Every investment decision has good and bad points. “If you borrow to buy property, it’s tangible, you get rental income, you’ve got the potential of capital gain and it doesn’t have the volatility of shares,” Conisbee said.

If you borrow for shares, you can start with $1,000 and very low entry and exit costs. “Shares are liquid, the income can have franking credits to make it highly effective for tax purposes, and you can diversify easily,” Whittaker said.

Both agreed that when weighing up what will suit you best, you have to factor in set-up costs, regular fees and any costs associated, as well as loan interest rates and the capital gains tax you’ll pay.

Include all these factors into your calculations and Whittaker believes “long term, shares have greater potential capital gain than property.”

Shares: How to borrow

Margin loans allow you to use your shares or managed funds as security against the money you borrow. However, if the value of your investment falls below a certain point, the lender can issue a margin call – a demand that you top up your investment or repay some of the loan. You could be forced to sell off some of your shares for a lower price than you paid. “If you don’t understand the risk of a margin loan you shouldn’t use the instrument,” Saunders said.

Pros

Shares require a smaller investment than property. “You can get started with as little as $1,000,” Saunders said, adding: “Entry and exit costs are also very low.”

Whittaker explained that income can have franking credits, which makes it highly effective for tax purposes. “In the long term, shares have better potential capital gain than property,” he said.

Cons

Shares are volatile and, if you have all your eggs in one basket, the risks are high. “If you pick the wrong company, you can lose all your money,” Whittaker warned.

Diversifying across different asset classes, industry sectors and geographic regions minimises this risk.

Property: How to borrow

Investment property loans can be fixed interest, variable interest or interest-only.

“Interest-only has been very popular but you need to be very careful as the repayment amount can jump significantly at the end of the interest-only period,” Conisbee explained.

Pros

Many people like property because it’s an investment they can see and touch.

“You get income from the rents, you’ve got potential capital gain and you can renovate it,” Whittaker said.

“Of course, the key to property success is to buy well and add value.”

Conisbee described Australia as possibly one of the most property-obsessed countries in the world.

“The main reason is probably that capital growth has been so amazing,” she said. “If you bought here in Sydney five years ago, for example, your home value would have increased by, on average, 50 per cent.”

Cons

Property is an illiquid asset. “If you need money, you can’t sell a back bedroom,” Whittaker pointed out.

It also has high entry/exit costs and you’ll need mortgage insurance if you borrow more than 80 per cent of the value of the property.

“One of the biggest risks is that you’ll be without a tenant for a length of time,” Conisbee said. “This can result in quite a significant loss of income.”

Just remember

There are great opportunities in both asset classes. The important thing is to have a clearly thought-through strategy, based on independent advice along with a long-term objective.

SOURCE: https://www.mlc.com.au/personal/blog/2018/11/should_you_borrowto

Dealing with a serious health issue

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Planning carefully and working through the issues can help if you or your partner experiences serious illness or injury later in life

A major health issue can throw life into disarray and put paid to the best laid plans for travelling, relaxing and enjoying all that your retirement years have to offer. Planning carefully and working through the issues can help you cope if you or your partner has the misfortune to experience serious illness or injury later in life.

We tend to think of serious illness or injury as something that will only affect others. Preparing for it isn’t high on the agenda for most people, despite the fact that some 134,000 Australians are diagnosed with new cases of cancer each year, according to the Cancer Council .

Unfortunately, financial worries can come immediately after a diagnosis in many households. Sensible planning can see you better placed to cope, both financially and emotionally, should you or your partner experience a major health issue.

Safeguard yourself

Making sure you have appropriate insurance for your age and life stage is critical to minimise the financial impact of serious illness or injury.

If you’re still in the workforce, income protection insurance can safeguard a percentage of your salary or wages should you be out of action for an extended period or forced to retire earlier than planned. If you don’t have cover, you may find a long break or premature departure from the workforce has a significant impact on your retirement planning. It might make it much harder for you to pay down debt before you down tools, for example, or to accumulate the superannuation balance you’d hoped to achieve to meet your income needs in retirement.

Alternatively, total and permanent disability insurance (TPD) can see you receive a lump sum payout if you’re left unable to work, while trauma insurance covers you for a lump sum payout in the event you’re diagnosed with one of a range of serious illnesses and conditions, such as heart attack, stroke or cancer.

Many Australians hold some or all of these policies within their super funds but aren’t familiar with their terms and conditions, or have inadequate cover for their circumstances. That’s why it’s sensible to review your policies periodically. You may decide to increase your cover if it’s necessary (and affordable) to do so or, conversely, save money by cancelling a policy that’s no longer required.

Keeping on top of your insurance requirements will give you peace of mind and the protection you need to cushion you from the financial impact of an adverse health event. If you’re unsure of the level of cover you require, a financial adviser will be able to provide you with that advice.

Evaluate your budget

When a serious health issue strikes, reviewing your budget can be very useful when you’ve had time to come to terms with the bad news. It’s possible you’ll be up for a range of additional expenses, including treatment or surgery, medication, travel and parking costs, home modifications and help around the home. You may also be able to identify areas where your spending can be reduced, if it seems likely your resources will come under strain.

If you have private health insurance and plan to access it, it’s wise to contact your doctors and health fund to get an idea of the gap fees you’re likely to be charged. If you’re still working, your doctor should also be able to advise whether you can carry on working while having treatment, or how much time off you’ll need for recovery. You’ll also need to check what your policies cover you for if you have personal insurance.

Get help with hardship

Seeking access to hardship assistance may be necessary if you’re not covered by personal insurance and injury or illness leaves you in financial difficulty. Utility providers and other creditors may be prepared to assist with extended terms or payment plans, for example, should you experience finding it hard paying household bills. If you still have a mortgage, your financial institution may be willing to grant a repayment holiday until you’re back on your feet.

It may also be possible to have a proportion of your superannuation released early, if you’ve yet to reach retirement age and your circumstances satisfy the Department of Human Services , grounds for early release.

Talking your situation through with a financial adviser or counsellor can help you clarify your position and determine the best way to move forward.

Seek support to stay strong

Dealing with serious illness can be draining emotionally, as well as financially. Accepting offers of help from family and friends, as well as making the most of community and online support networks, can make a real difference during what can be one of life’s most challenging times.

SOURCE: https://www.mlc.com.au/personal/blog/2018/11/dealing_with_a_serio

Eight ways to boost your fitness in retirement

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It’s time to put physical fitness at the top of your priority list and start enjoying the next phase of your life

If you’ve said goodbye to full-time work and hello to retirement, it’s time to put physical fitness at the top of your priority list and start enjoying the next phase of your life. What’s your fitness regime?

People tend to give plenty of thought to ensuring their finances are in good shape at retirement but what about the health and fitness of the body carrying you through that time of life?

The statistics are a little alarming. According to the Victorian Government’s Better Health research, only about one in 10 Australians1 aged over 50 exercise enough to gain any cardiovascular benefit. Plus, there’s evidence that about half of the physical decline associated with ageing may be due to a lack of exercise, from reduced muscle mass and balance issues to joint problems, high blood pressure and disease.

The message is that, as you age, it’s more important than ever to be physically fit. For people aged 65 and over, at least 30 minutes of moderate intensity exercise a day, combining aerobic and muscle strengthening exercises, is the advice from the government’s HealthDirect site2. Your brain will thank you, too, with a recent study3 from the University of Melbourne highlighting the importance of exercise in keeping your grey matter healthy.

No matter what your fitness level, there are ways to get (and keep) moving to reap the benefits of exercise – from building a healthier, stronger body to boosting your mood and brain function.

There’s plenty of support available if you need ideas to get more active and have fun at the same time. Remember, the best exercise is the one you enjoy doing. We’ve put together a list of our top eight suggestions. Just make sure you take care and consult your doctor before embarking on any new exercise program.

1. Stairway to fitness

Got some stairs at your local park or at home? Several studies4 have revealed the benefits of including the simple act of walking up and down stairs for fitness and well-being – from boosting cardiac health and bone density to warding off diabetes. Start off with 10 minutes a day and work your way up and down to 30 minutes.

2. Walking your best friend

Having a dog when you retire can be one of the best things to do for yourself. As well as encouraging you to exercise, studies show that just having a dog around helps people relax, reduces stress, speeds up recovery after illness, and reduces blood pressure and cholesterol levels. Don’t (or can’t) have a dog? Perhaps consider walking someone else’s. Of course, if you can’t access a furry friend just walking is one of the most accessible ways to boost your fitness. Just make sure it’s at a brisk pace to get the benefits!

3. Dance your way

Dancing is a great way to keep active, offering many physical and mental benefits. There’s a style for everyone, from ballroom and line dancing to salsa and even belly dancing. Not only can you burn up the calories while you’re burning up the dance floor, it’s beneficial for the joints and balance, as well as helping keep your grey matter in shape5.

4. Mow like you mean it

There’s a workout just waiting for you in your own back yard. Mowing the lawn with gusto with any type of push mower will soon raise a sweat and counts towards the total activity you should get each week. If you’d like a more peaceful experience, opt for an electric mower over a fuel one, and for a more vigorous session (that’s also environmentally friendly) you could even go old-school with a manual reel mower.

5. Lifting weights

More and more weight training benefits for older people continue to emerge – from keeping muscles strong to improving brain function6  – and there are many ways to incorporate this strengthening activity into your life, whether at home or at your nearest gym. According to the experts, you should do specific strength exercises two or three times a week.

6. Row your boat

Getting out on the water can be exhilarating and an effective way to get your body working. Whether it’s dragon boats or rowing boats, kayaks or stand-up paddle boards, older Australians are flocking to maritime activities. The Australian Dragon Boat Federation says it has 5,750 registered adult participants, with the 50-plus age group making up more than half that. Many local paddling clubs offer ‘come and try’ sessions so you can test the waters first.

7. HIIT: Not just for the young

HIIT, or high-intensity interval training, is a form of exercise that’s been getting lots of attention, with researchers uncovering big benefits for older adults particularly. Mayo Clinic researchers studied the effects of HIIT on people over the age of 65, for example, and discovered some age-related deterioration of muscle cells had actually been reversed7. A HIIT workout involves alternating between a high and low level of exercise. The best news is the experts say just a few short periods of this style of session a week will get results.

8. The water’s fine

Swimming is great for people of all ages but especially older adults. It can be as physically challenging as you want to make it and is easy on the joints. It’s also been shown to help increase balance8, thus reducing the chance of falls. Swimming works many muscle groups at once and you can even specifically target different groups of muscles by using different strokes. A dip in the pool could also include water aerobics and water resistance exercises to take advantage of water’s ability to reduce joint pain while also increasing muscle strength. It’s also good for the soul – just lie back and have a float.

Go well on your journey to getting your body moving more, increasing your fitness and hopefully having some fun at the same time, but remember that you should get your doctor’s or health care professional’s advice before starting on any new physical activity program to make sure it’s right for you and your needs.

SOURCE: https://www.mlc.com.au/personal/blog/2018/11/eight_ways_to_boost


1. https://www.betterhealth.vic.gov.au/health/healthyliving/physical-activity-for-seniors
2. https://www.healthdirect.gov.au/physical-activity-guidelines-for-older-adults
3. https://pursuit.unimelb.edu.au/articles/how-much-exercise-keeps-our-brains-healthy-as-we-age
4. https://www.thenational.ae/lifestyle/wellbeing/a-look-at-the-many-benefits-of-stair-climbing-1.609166
5. https://www.frontiersin.org/articles/10.3389/fnagi.2017.00059/full
6. https://sydney.edu.au/news-opinion/news/2016/10/25/increasing-muscle-strength-can-improve-brain-function–study.html
7. https://www.mayoclinic.org/why-interval-training-may-be-the-best-workout-at-any-age/art-20342125
8. https://academic.oup.com/aje/article/180/8/830/2739186
9. https://www.cancer.org.au/about-cancer/faq.html
10.https://www.humanservices.gov.au/

What does the recent market volatility mean for investors?

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Portfolio Specialist John Owen discusses what’s causing the current market volatility and how MLC is managing their portfolios for customers

What’s causing the market volatility?

There are a number of factors worth noting. Very low interest rates and central banks injecting cash into economies has contributed significantly to the strong market returns we’ve seen in recent years. However, for some time central banks have been either suspending or winding back their stimulus programs. One way of winding back stimulus is by raising interest rates again – the US Federal Reserve has lifted interest rates eight times over the past three years.

It has been an ongoing concern for us that when this artificial stimulus comes to an end, markets would suffer.

Also playing into sentiment is uncertainty created by President Trump’s trade war and the impact on global economic growth, particularly China’s growth. Lending (credit) growth around the world is also showing signs of weakness.

Even though global growth continues and the US economy remains strong, there are fears the company earnings cycle may have peaked and company profitability from here could be under pressure.

The Australian share market has felt the brunt of the recent falls. The weakness of the big 4 banks in the wake of revelations at the Hayne Royal Commission hasn’t helped.

It’s highly uncertain how all these factors will affect financial markets and the economy over the next few years; and this uncertainty has contributed to the share price volatility in recent days.

Putting the market weakness into some perspective, at the time of writing the S&P 500 Index, after falling 5% so far this month, is now back at the level it was early in July.

You may also recall we experienced a significant bout of share market weakness in February this year, only to have the market recover over following months.
How does the recent market volatility impact the funds I invest in?

If your funds are invested in shares, movements in the value of share markets will affect your investment value.

Share markets have risen strongly in recent years, helping deliver solid returns to investors. For example, the Australian share market (measured by the S&P/ASX200 Accumulation Index) returned 11.3% pa in the seven years to 30 September 2018 while the global share market return (measured by the MSCI All Countries World Index, hedged to Australian dollars) was 15.4% pa in the same period. It’s quite normal for share markets to ease back after a period of such substantial growth.

In all periods of volatility, markets act irrationally and our active managers are doing exactly what we expect of them, looking to take advantage and buy good investments at cheaper prices than they could prior to the volatility, which helps lay the foundations for long-term growth.

If possible, you should continue to focus on how you’re progressing towards your longer-term goals. If you were invested during the period of strong returns in recent years you may be pleased with your longer-term returns despite the recent volatility. It’s also realistic to expect that often investments that produce higher returns and growth in value over long periods tend to be more volatile in the short term.


Should I be selling my investments now?

While market downturns are generally unpleasant, they are to be expected as uncertainty will never disappear from investment markets.

As you can see in the following chart, Australian and global share markets have eventually bounced back from numerous down times, including the GFC in 2008. Clearly there’s truth in the adage: “Stocks take an escalator up, and an elevator down” – gradually rising over many months and years but only take a few days to fall.

By selling your investments immediately after a significant fall you’re not only taking losses, you’re reducing your chances of making your money back should markets recover.

The reality of investing in share markets is that we need to accept some risk when seeking returns that will outpace inflation in the long run.

Source: FactSet, Global Shares (unhedged): MSCI All Countries World (Gross, $A) Index, Australian Shares: S&P/ASX 200 Total Return Index. Returns are total returns with dividends reinvested. Past performance is not a reliable indicator of future performance.

I’m retired or close to retirement, what should I do?

It’s not always easy to ignore what’s happening to your investments when there is negative news and markets are volatile. While history has shown us the share market does bounce back, it may be swift or it may take years.

If possible, you should continue to focus on how you’re progressing towards your longer-term goals. However, if the recent market volatility has unsettled you to the point where you would prefer to reduce your exposure to riskier assets or protect some or all of your capital, there are some solutions available. We recommend you discuss solutions with your financial adviser.


What is MLC doing to protect its customers from the impact of the market volatility?

The market has been overlooking the potential risks of rising interest rates and reduced central bank stimulus for some time, so risk management has been uppermost in our mind. We’ve believed for some time that where possible, it’s appropriate to ‘defensively’ position our multi-asset portfolios – MLC Inflation Plus, MLC Horizon and MLC Index Plus portfolios. For example we’ve been holding more cash than normal, carefully selecting derivatives for the portfolios to improve risk control and provide diversification, and investing in alternative assets and strategies that provide returns that are not reliant on share markets.

Our focus on managing risk and searching for ways to help reduce the impact of significant negative returns on our multi-asset portfolios may not prevent negative returns in weak share market conditions but our caution should provide some insulation.

SOURCE: https://www.mlc.com.au/personal/blog/2018/11/what_does_the_recent

How to transition to retirement

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Find out how to transition into retirement easily

We’ve given you a few tips to help you towards the next stage in your life – retirement.

As you get closer to retirement, you will start to wind down and want to work less without compromising your lifestyle. That’s where a Transition to Retirement Pension (TRP) could work for you. It could help you through the next stage of life when you’re not quite ready to give up working yet.

Work less for the same income

If you want to ease into retirement by reducing your hours and working part-time, you can maintain your lifestyle by using some of your super to top up your income through a Transition to Retirement Pension (TRP). The key benefit of the strategy is to draw income from the TRP to replace the employment income. The taxable portion of pension payments you draw from your super (between preservation age and 59) is taxed at your marginal tax rate with a 15% rebate. If you’re 60 or over, the pension payments you receive will be tax free (if paid from a taxed fund).

Another strategy is to retain your current employment arrangement (e.g. continue working full-time) while maximising the amount you can concessionally contribute to your super account. Similarly, income payments drawn from the TRP can replace the income contributed to your super.

You should seek advice from your financial adviser or a tax agent if you are considering a TRP, to make sure it works for you.

When can you start a TRP?

You can start a transition to retirement pension as soon as you reach your preservation age:

Your date of birth Preservation age
Before 1 July 1960 55
1 July 1960 – 30 June 1961 56
1 July 1961 – 30 June 1962 57
1 July 1962 – 30 June 1963 58
1 July 1963 – 30 June 1964 59
After 30 June 1964 60


How much you can withdraw and how payments work

You’ll need to draw a minimum amount of 4% a year from your TRP (increasing to 5% when you reach age 65). You’ll be limited to taking a maximum of 10% a year of your account balance in pension payments until you meet a full condition of release. This could be either permanently retiring, reaching age 65, or ending an employment arrangement after age 60.

From 1 July 2017, any income earned on investments in your TRP account is taxed at up to 15% (including capital gains). Once you meet a full condition of release, you’ll need to notify your fund. The earnings in your pension will become tax free once you meet one of the full conditions of release.


Is a TRP right for you?

If you’re under 60, the pension income may affect payments like Family Tax Benefit or Child Support.

Understanding what’s best for you and keeping up with regulations can be complex, so it’s important to seek advice from your financial adviser or a tax professional to find out if the TRP is right for you.

SOURCE: https://www.mlc.com.au/personal/blog/2018/11/how_to_transitionto

Review of 2018, outlook for 2019 – another cycle extension

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Key points

  • 2018 saw reasonable global economic and profit growth and still low interest rates but it has been a rough year for investors with worries about the Fed, trade wars and global growth causing volatility and poor returns.
  • 2019 is unlikely to see the plunge into recession many fear with growth likely to stabilise supporting profit growth, the Fed is likely to undertake a pause in rate hikes and global monetary policy is likely to remain easy. The RBA is expected to cut interest rates.
  • Against this backdrop, share market volatility will likely remain high but markets should start to improve through the year.
  • The main things to keep an eye on are: the risks around the Fed, US/China tensions, global growth, Chinese growth and the property price downturn in Australia.

2018 – a lot weaker than expected

After the relatively low volatility and solid returns of 2017, the past year has seen almost the complete opposite with high volatility and poor returns. It started strongly in January but started to get messy from February. At a big picture level things were fine: global growth looks to have held solid at around 3.7%, inflation rose in the US but only to target and it remained low elsewhere, the Fed raised interest rates but rates generally remain low and profits rose solidly. But it was the risks below the surface that came together to give a rough ride. There were five big negatives:

  • Fear of the Fed. The Fed provided no real surprises and nor did US inflation, but investors became increasingly nervous that Fed hikes would crush US growth and profits.
  • US dollar strength. While the US dollar did not rise above its 2016 high it caused problems in the emerging world where US dollar denominated debt is high.
  • President Trump’s trade war. This was always a high risk for 2018 and once it got underway it weighed on share markets. While the initial focus seemed to be the US versus everyone it morphed into fears of a new Cold War with China adding to fears about growth and profits.
  • China slowdown. This was as expected to around 6.5% as a result of credit tightening but fears that it will combine with the trade war and get worse added to global growth angst.
  • Global desynchronisation. US growth was strong, but it slowed in Europe, Japan, China and the emerging world.

Australia saw growth around trend and made it through 27 years without a recession, as infrastructure spending, improving business investment and strong exports helped support growth and this in turn drove strong employment growth, a fall in unemployment and the Federal budget closer to a surplus. Against this though credit conditions tightened significantly with the Royal Commission adding to regulatory pressure on the banks, house prices fell, wages growth edged up but remained weak and inflation remained below target, all of which saw the RBA leave rates on hold.

Overall this drove a volatile and messy investment environment.

Investment returns for major asset classes

Investment returns for major asset classes
* Yr to date to Nov. Source: Thomson Reuters, Morningstar, REIA, AMP Capital
  • Global shares saw weak returns in local currency terms with significant corrections around February and October. But this masked positive returns from US shares but weakness elsewhere. Global share returns were boosted on and unhedged basis because the $A fell.
  • Asian and emerging market shares paid the price for being star performers in 2017 with losses thanks to a rising $US causing debt servicing fears, the US trade war posing a threat to growth and political problems in some countries.
  • Australian shares were hit by worries about the banks, consumer spending in the face of falling house prices and weakness in yield-sensitive telcos and utilities offsetting okay profit growth and low interest rates.
  • Government bonds yet again had mediocre returns reflecting low yields and capital losses from rising yields in the US as the Fed hiked. Australian bonds outperformed.
  • Real estate investment trusts remained constrained on the back of Fed tightening and higher bond yields.
  • Unlisted commercial property and infrastructure continued to do well as investors sought their still relatively high yields.
  • Commodity prices were weak on global growth worries and the oil price had a roller coaster ride, first surging ahead of US sanctions on Iran then crashing as demand fell.
  • Australian house prices fell led by Sydney and Melbourne.
  • Cash and bank term deposit returns were poor reflecting record low RBA interest rates.
  • Reflecting US dollar strength, the $A fell not helped by a falling interest rate differential and lower commodity prices.
  • Reflecting soft returns from most assets, balanced superannuation fund returns were soft.

2019 – better, but volatility to remain high

In a big picture sense, the global economy looks to be going through a mini slowdown like we saw around 2011-12 and 2015-16. This is most evident in business conditions indicators that have slowed but remain okay. See the next chart.

Global business conditions PMIs have slowed, but still strong
Source: Bloomberg, IMF, AMP Capital

Like then, this has not been good for listed risk assets like shares but it’s unlikely to be signalling the start of a recession, baring a major external shock. Monetary conditions have tightened globally but they are far from tight unlike prior to the GFC and the normal excesses in the form of high inflation, rapid growth in debt or excessive investment that precede recessions in the US or globally are absent. In fact, to the extent that the softening in growth now underway takes pressure off inflation and results in easier monetary conditions than would otherwise have been the case it’s likely to extend the cycle, ie delay the next recession. The slump in oil prices is a key example of this in that it will take some pressure off inflation and provide a boost to consumer spending. Against this background the key global themes for the year ahead are likely to be:

  • Global growth to stabilise and then resynchronise. Global growth is likely to average around 3.5% which is down from 2018 but this is likely to mask slower growth in the first half of the year ahead of some improvement in the second half as China provides a bit more policy stimulus, the Fed pauses in raising interest rates, the fall in currencies against the $US dollar provides a boost to growth outside the US and trade war fears settle down (hopefully). Overall, this should support reasonable global profit growth.
  • Global inflation to remain low. With growth dipping back to around or just below trend in the short term and commodity prices down inflation is likely to remain low. The US remains most at risk of higher inflation due to its tight labour market, but various business surveys suggest that US inflation may have peaked for now at around 2%.
  • Monetary policy to remain relatively easy. The Fed is likely to have a pause on rate hikes during the first half and maybe hike only twice in 2019 as it gets into the zone that it regards a neutral. Rate hikes from other central banks are a long way away. In fact, further monetary easing is likely in China and the European Central Bank may provide more cheap funding to its banks.
  • Geopolitical risk will remain high causing bouts of volatility. The main focus is likely to remain on the US/China relationship and trade will likely be the big one. While Trump is likely to want to find a solution on the trade front before tariffs impact the US economy significantly & threaten his re-election in 2020, it’s not clear that this will occur before the March 1 deadline from the Trump/Xi meeting in Buenos Aires so expect more volatility on this issue. Wider issues including the South China Sea could also flare up along with negotiations around Italy’s budget.

In Australia, strength in infrastructure spending, business investment and export values will help keep the economy growing but it’s likely to be constrained to around 2.5-3% by the housing downturn and a negative wealth effect on consumer spending from falling house prices. This in turn will keep wages growth slow and inflation below target for longer. Against this backdrop the RBA is expected to cut the official cash rate to 1% with two cuts in the second half of 2019.

Implications for investors

With uncertainty likely to remain high around US interest rates, trade and growth, volatility is likely to remain high in 2019 but ultimately reasonable global growth & still easy global monetary policy should drive stronger overall returns than in 2018:

  • Global shares could still make new lows early in 2019 (much as occurred in 2016) and volatility is likely to remain high but valuations are now improved and reasonable growth and profits should see a recovery through 2019.
  • Emerging markets are likely to outperform if the $US is more constrained as we expect.
  • Australian shares are likely to do okay but with returns constrained to around 8% with moderate earnings growth. Expect the ASX 200 to reach around 6000 by end 2019.
  • Low yields are likely to see low returns from bonds.
  • Unlisted commercial property and infrastructure are likely to continue benefitting from the search for yield but it’s slowing.
  • National capital city house prices are expected to fall another 5% led again by 10% or so price falls in Sydney and Melbourne as tighter credit, rising supply, reduced foreign demand and potential tax changes under a Labor Government impact.
  • Cash and bank deposits are likely to provide poor returns.
  • The $A is likely to see more downside into the high $US0.60s, as the gap between the RBA’s cash rate and the Fed Funds rate goes further into negative.

What to watch?

After the turmoil of 2018, the outlook for 2019 comes with greater than normal uncertainty. The main things to keep an eye on in 2019 are as follows:

  • US inflation and the Fed – our base case is that US inflation stabilises around 2% enabling the Fed to pause/go slower, but if it accelerates then it will mean more aggressive tightening, a sharp rebound in bond yields and a much stronger $US which would be bad for emerging markets.
  • The US trade war – while it may now be on hold thanks to negotiations with China, Europe and Japan these could go wrong and see it flare up again. US/China tensions generally pose a significant risk for markets.
  • Global growth indicators – if we are right growth indicators like the PMI shown in the chart above need to stabilise in the next six months.
  • Chinese growth – a continued slowing in China would be a major concern for global growth and commodity prices.
  • The property price downturn in Australia – how deep it gets and whether non-mining investment, infrastructure spending and export earnings are able to offset the drag from housing construction and consumer spending.

SOURCE: https://www.ampcapital.com/au/en/insights-hub/articles/2018/December/Review-of-2018-outlook-for-2019-another-cycle-extension

Corrections, gummy bears and grizzly bears in shares

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Key points

  • The pullback in shares could still have further to go but a deep (grizzly) bear market is unlikely as US, global or Australian recession are unlikely.
  • Increasing US Federal Reserve openness to a pause in raising rates, the likelihood of a US/China trade deal sometime in the next six months and the plunge in oil prices all add to confidence that a grizzly bear market is unlikely.

Introduction

While global and Australian shares had a nice bounce from their late October lows – rallying about 5%, partly reversing their 10% or so top to bottom fall, they have since fallen back to their lows as the worries about US rates, bond yields, trade, tech stocks, etc, have morphed into broader concerns about global growth and profits. Fears of a credit crunch and falling home prices are probably not helping Australian shares either, which this week dipped below their October low. Our assessment remains that it’s too early to say we have seen the lows, but we remain of the view that it’s not the start of major bear market.

The three bears – correction, gummy & grizzly

Very simply there are 3 types of significant share market falls:

  • corrections with falls around 10% (of course these aren’t really bear markets – but some might feel that they are!);
  • “gummy” bear markets with falls around 20% meeting the technical definition many apply for a bear market but where a year after falling 20% the market is up (like in 1998 in the US, 2011 and 2015-16 for Australian & global shares); and
  • “grizzly” bear markets where falls are a lot deeper and usually longer lived (like in 1973-74, US and global shares through the tech wreck or the GFC).

I can’t claim the terms “gummy bear” and “grizzly bear” as I first saw them applied by stockbroker Credit Suisse a few years ago. But they are a good way to conceptualise them. Grizzly bears maul investors but gummy bears eventually leave a nicer taste (like the lollies). Corrections are quite normal and healthy as they enable the sharemarket to let off steam and not get too overheated. As can be seen in the next chart, excluding the present episode since 2012 there have been four corrections and one gummy bear market (2015-16) in global and Australian shares. Bear markets generally are a lot less common, but arguably what we saw in 2015-16 was a gummy bear market.

Source: Bloomberg, AMP Capital
Source: Bloomberg, AMP Capital

The next table shows conventionally defined bear markets in Australian shares since 1900 – where a bear market is a 20% decline that is not fully reversed within 12 months. The first column shows bear markets, the second shows the duration of their falls and the third shows the size of the falls. The fourth shows the percentage change in share prices 12 months after the initial 20% decline. The final column shows whether they are associated with a recession in the US, Australia or both.

Bear markets in Australian shares since 1900 

Based on the All Ords, excepting the ASX 200 for 2015-16. I have defined a bear market as a 20% or greater fall in shares that is not fully reversed within 12 months. Source: Global Financial Data, Bloomberg, AMP Capital
Based on the All Ords, excepting the ASX 200 for 2015-16. I have defined a bear market as a 20% or greater fall in shares that is not fully reversed within 12 months. Source: Global Financial Data, Bloomberg, AMP Capital

If a gummy bear market is defined by a 20% decline after which the market is higher 12 months later whereas as grizzly bear market sees a continuing decline over the subsequent 12 months after the first 20% decline, then since 1900 there have been 12 gummy bear markets (these are highlighted in black) and there have been six grizzly bear markets (highlighted in red). Several points stand out. First, the gummy bear markets tend to be a bit shorter and see much smaller declines averaging 26% compared to 46% for the grizzly bear markets.

Second, the average rally over 12 months after the initial 20% fall is 15% for the gummy bear markets but it’s a 23% decline for the grizzly bear markets.

Finally, and perhaps most importantly the deeper grizzly bear markets are invariably associated with recession, whereas the milder gummy bear markets including the 1987 share market crash tend not to be. Five of the six grizzly bear markets saw either a US or Australian recession or both whereas less than half of the gummy bear markets saw recession.

It’s also the case that US share market falls are much deeper and longer when there is a US recession.

What’s it likely to be this time?
Our view remains that a grizzly bear market is unlikely because, short of some unforeseeable external shock, a US, global or Australian recession is not imminent. In relation to the US:

  • Business and consumer confidence are very high.
  • While US monetary conditions have tightened they are not tight and they are still very easy globally and in Australia (with monetary tightening still a fair way off in Europe, Japan and Australia). We are a long way from the sort of monetary tightening that leads into recession.
  • Fiscal stimulus is continuing to boost US growth.
  • We have not seen the excesses – in terms of debt growth, overinvestment, capacity constraints and inflation – that normally precede recessions in the US, globally or Australia.

Reflecting this, global earnings growth is likely to remain reasonable – albeit slower than it has been – providing underlying support for shares. In relation to Australia – yes housing is turning down and this will weigh on consumer spending, but it will be offset by a lessening drag from mining investment, strengthening non-mining investment, booming infrastructure spending and solid growth in export earnings. Growth is unlikely to be as strong as the RBA is assuming but it’s unlikely to slide into recession either.

So, for all these reasons it’s unlikely the current pull back in shares is the start of a grizzly bear market. However, we have already had a correction in mainstream global shares and Australian shares (with circa 10% falls) and with markets falling again it could turn into gummy bear market, where markets have another 10% or so leg down – a lot of technical damage was done by the October fall that has left investors nervous, the rebound from late October was not particularly convincing and many of the drivers of the October fall are yet to be resolved.

Some positives

However, there are three developments that help add to our conviction that we are not going into a grizzly bear market. First, recent comments by Fed Chair Powell and Vice Chair Clarida indicate that the Fed remains upbeat on the US economy and a December hike looks assured (for now), but it is aware of the risks to US growth from slowing global growth, declining fiscal stimulus next year, the lagged impact of eight interest rate hikes and stock market volatility and appears open to slowing the pace of interest rate hikes or pausing at some point next year. The stabilisation in core inflation around 2% seen lately may support this. Past gummy bear markets (1987, 1998, 2011, 2015-16) all saw some pause or relaxation by the Fed.

Second, while it’s messy after the US/China standoff at the recent APEC forum there have been some positive signs on trade. Talks between the US and China on trade have reportedly resumed ahead of a meeting between President Trump and President Xi at the G20 summit next week and President Trump has repeated that he is optimistic of a trade deal with China and that the US might put any further tariff increases on China on hold if there is progress. The US/China trade dispute is unlikely to be resolved quickly when Trump and Xi meet. Perhaps the best that can be hoped for is agreement to have formal trade talks with the aim of resolving the issues and the US agreeing to delay any further tariff increases. With Trump wanting to get re-elected I remain of the view that some sort of deal will be agreed before the tariffs cause too much damage to the US economy. Rising unemployment (as fiscal stimulus will turn to contraction next year if current and proposed tariffs/taxes on China go ahead) and higher prices at Walmart will sink Trump’s re-election prospects in 2020. Of course, investors are now highly sceptical of any progress on the trade front. So any breakthrough in the next six months could be a big positive.

Finally, while the 30% plunge in the oil price since its October high is a short-term negative for share markets via energy producers, it has the potential to extend the economic cycle as the 2014-16 oil price plunge did. The main drivers of the fall in the oil price are slower global demand growth, US waivers on Iranian sanctions allowing various countries to continue importing Iranian oil, rising US inventories, the rising $US and the cutting of long oil positions. While oil prices are unlikely to fall as much as in 2014-16 when they fell 75% (as OPEC spare capacity is less now) they may stay lower for longer. This is bad for energy companies but maybe not as bad for shale producers as in 2015 as they are now less indebted and their break-even oil price has already been pushed down to $50/barrel or less. It will depress headline inflation (monthly US inflation could be zero in November and December) and if oil stays down long enough it could dampen underlying inflation. All of which may keep rates lower for longer. And its good news for motorists who see rising spending power. For example, Australian petrol prices have plunged from over $1.60 a litre a few weeks ago to below $1.30 in some cities. That’s a saving in the average weekly household petrol bill of around $10.

Source: Bloomberg, MotorMouth, AMP Capital
Source: Bloomberg, MotorMouth, AMP Capital

SOURCE: https://www.ampcapital.com/au/en/insights-hub/articles/2018/November/Corrections-gummy-bears-and-grizzly-bears-in-shares