Each year in January, a lot of investors take a fresh look at the investment outlook.
Their usual starting point is to fully understand just what had happened to investment returns in the preceding 12 months — followed by a look at whether these recent experiences are likely to continue in the new year. Not so easy this time around, as 2018 has left such a complex legacy.
Returns on the main asset classes over the full year to December 31 were, on average, mixed and mostly fairly small. However, sharemarkets fell sharply just before year’s end — by almost 20 per cent in the US — and many share investors and commentators were predicting the return of a deep and prolonged bear market.
Since then sentiment has turned positive again — and spectacularly so for shares like Australia’s CSL and Netflix (NASDAQ:NFLX) in the US.
Investors need to consider whether the pervasive gloom that came to dominate market sentiment in much of the December quarter is likely to be the forerunner of a lengthy period of negative returns for share investors (such as 2008) — or should be seen as yet another of the overreactions in markets that give investors opportunity to buy quality shares cheaply (such as 2015-16)?
As usual, US shares have set the direction most other sharemarkets followed. But within the last 12 months, and particularly in February and December, US share prices moved up and down much more than shares in most other rich economies, including Australia.
That reflected worries that the US economic recovery (now almost 10 years old) could soon die of old age. Also, there has been big swings in the outlook for US monetary policies; and major revisions to the earnings outlook for some US tech stocks.
In my view, the plunge in share prices in late 2018 will come to be seen as another case of markets overreacting to a false crisis.
Investors are right to worry about the trade wars, the pace of tightening in US monetary policy, and the slowing in China’s growth — and should expect further bouts of negative market reaction as “bad” economic news is announced or perceived. That said, market sentiment seems to have become too pessimistic in December and could become too gloomy again.
It’s less a case of exiting the market; more a time to consider the many shades of grey and look for opportunities to buy on extreme weakness. Let’s focus on some of those shades of grey.
Certainly, the global economic outlook is not as comfortable or predictable as it was when all major economies enjoyed good rates of growth from mid-2016 to early 2018. Of course, much will depend on whether the US and China can make peace in the trade war.
Either way, the risks of an early recession in the US are being exaggerated: there, consumer spending is buoyant and the Fed is clearly willing to pause its monetary tightening while it assesses whether recent financial market volatility is harming the US economy.
The concerns that China will soon experience its much-predicted hard-landing are also exaggerated. China’s economy is slowing both in trend terms and cyclically; but China has already begun easing its economic policies. And the Chinese authorities are better at economic management than they’re usually given credit for by commentators in the West.
There’s some good news for investors — thanks to the December sell-off in shares and to some upward revisions to earnings — in that sharemarket valuations are no longer so overstretched.
For example, price-to-earnings ratios for shares in the US and in other rich economies — including Australia — are again at or a little below their average levels of the past five or six years. Of course, earnings announcements to be released in the next few weeks (for the December quarter in the US and for the half-year here) will be all-important.
In most countries, inflation stayed low through 2018. Even in the US, where jobs growth is strong, the uptrend in inflation has, to date, been mild and drawn out. Around the world, disciplined rates of inflation and heightened fears of a global economic slowdown have pushed bond yields down to what seems to be unsustainably low levels.
In 2018, Australia achieved stronger growth in GDP and in job numbers than had generally been expected. This year, export volumes and infrastructure spending will probably remain buoyant. But consumer spending could soften, particularly if house prices were to fall sharply. To date, the decline in house prices has been reasonably orderly — and is helping to improve housing affordability. My guess is the cash rate will be left unchanged this year.
In recent months, market expectations on the outlook for the prices of the bulk commodities that dominate Australia’s exports perhaps also seem to have turned too pessimistic. Some investors and commentators in the US and Asia, when considering the outlook for our commodity exports, put too much weight on the Commodity Research Bureau index of US commodity prices — using an index that excludes all four of our major exports (coking coal, steaming coal, iron ore and LNG).
In the six months to the end of December, the RBA’s index of our commodity prices in US dollars has risen 2.7 per cent. While the CRB index of commodity prices fell 13 per cent, the RBA’s index of commodity prices rose 2.7 per cent.
Don Stammer is an adviser to Altius Asset Management and Stanford Brown Financial Advisers. The views expressed are his alone.