Investments: We hear the noise, but what are the signals?
Investments | 25/10/2018 |
10 min read
With markets in retreat over recent weeks, it’s clear that investors are starting to take note of some of the concerns that have been highlighted by an increasing number of commentators. The question is: Are they reacting to all the noise, or are there some more fundamental concerns at play in equity markets?
Before we answer this question, we can confirm for Equip members that our investment team, its advisors and external managers have been adjusting our portfolios for some time in anticipation of a market correction after eight years of virtually uninterrupted buoyant returns.
This has included taking some of the risk out of our diversified investment options, which include the Equip MySuper option in which the vast majority of members are invested.
Similarly, we have been working with employers that have more than fully funded retirement schemes, to lock in some of the recent market gains.
Despite these precautions, we maintain a long-term view of investments and are still invested in quality stocks that we believe will help to produce the returns that members will need into the future.
Now to the events of recent days, which have seen more than 5% shaved off US share markets within the week and similar falls in other parts of the world. No one can accurately call the top or bottom of the investment cycle, but this is a correction that we and others have anticipated for some time.
There are a few issues dominating the minds of investors:
- The ‘trade dispute’ between the world’s two largest economies, the USA and China;
- Rising cash rates and bond yields, here and abroad;
- The outlook for emerging economies in Asia, South America and Central Europe; and
- Geo-political influences and events, including our own domestic politics and upcoming federal and state elections.
Equip’s investment specialists spend a lot of time analysing these issues and their potential impact on markets, so let’s take a look at each of them.
The trade stand-off between the USA and China
One cannot underestimate the role of US and Chinese domestic politics in this. President Trump was elected on a nationalist platform of re-energising American industry and offering greater protection for the nation’s workers. So far, this has meant applying tariffs to a range of goods, primarily imported from China. What President Trump is saying on the global stage must also be considered in the context of playing to his home audience with mid-term Congressional elections imminent.
Former Australian Prime Minister Kevin Rudd has warned that the Chinese leadership won’t buckle in the trade clash - one reason being the potential for domestic loss of face associated with ceding ground to the US. He said that the Chinese were struggling with a ‘lack of clarity’ about the US position on trade.
Investment market response to the rhetoric and tariffs was muted, consistent in our view with the fact they have been applied to a relatively small selection of goods, but are now gaining greater attention among skittish investors as the US mid-term elections approach.
Interest rate movements
Interest rate movements here and overseas are likely having a bigger impact on investor sentiment than trade tensions at present. The US Federal Reserve has increased cash rates several times in the last year, with more likely to follow, and President Trump has been openly and directly critical of the Fed’s interest rate settings.
While rising US interest rates are consistent with the US economy’s strong performance (for example, unemployment is at a 50 year low), it increases the cost of capital for companies wanting to invest in people and infrastructure to grow their businesses. In other words, it has its intended dampening effect on the economy, growth in profits and employment.
Rising US rates also strengthened the US Dollar, which is beneficial for Australian investors who hold US assets, as reflected in recent returns from Equip’s International Equities portfolio (which returned more than 18% last financial year).
The Reserve Bank of Australia has been cautious about interest rate increases, and is walking a fine line between low rates fuelling an overheated residential property market and higher rates putting constraints on Australian exporters by strengthening the Australian Dollar.
But the Australian banks are starting to break ranks with the RBA, with some announcing lending rate increases. These increases reflect their higher costs of borrowing money in international money markets.
Even with all this, equity markets have maintained their upward momentum as house prices decline slightly in major capital cities, wage growth remains muted and, as a consequence, consumer confidence and spending come under pressure.
These factors will weigh on investment markets in the future and we do expect returns to be lower the double digits we have experienced over recent years. But this is just a return to more normal conditions for returns from Equip’s investment options.
These markets are so-called because there are usually multiple characteristics that typify them – economic development, incomplete infrastructure, less matured democratic government or other political models, a higher proportion or their population in poorer financial circumstances and, in some instances, an earlier phase of evolution from an agrarian to industrial to a service based economy.
Their development in some or all of these aspects of their communities present risks for investors, with investment returns potentially higher, but usually more volatile than in more mature markets. This has been the case in recent years, but some commentators are now suggesting investors revisit emerging markets as they start to strengthen.
Equip members do not have a large exposure to emerging markets (for example, MySuper exposure is less than 5% of total assets), but we do believe that opportunities will present themselves over the next few years. Accordingly, our external manager list does include specialists in these markets so we can invest as opportunities arise, without exposing members to excessive risk.
We earlier mentioned the imminent US Congressional mid-term elections. The outcome of these will influence President Trump’s ability to gain Congressional support for his political and economic agenda.
In Australia, with its financial sector recently examined under the blowtorch of the robust Hayne Royal Commission into malpractice, the implementation of its recommendations in the sector will be strongly influenced by the Federal Election, which must be held by May 2019.
What and how much will be implemented is the subject of a lot of conjecture, but we are encouraged by the fact that much of what Equip has already implemented in terms of board structure, governance and conflicts management and growth for the benefit of members have positioned the fund extremely well in the context of whatever is implemented.
From an investment perspective, this means less distraction from having to fix what we do, enabling us to continue to focus on achieving the investment strategies that support the best possible retirement outcomes for members.
While investment returns cannot be guaranteed and there will always be events that influence markets, we can control fees and costs. From 1 July 2018, we were able to reduce fees and insurance premiums, which will leave more money from returns in members’ pockets.
Our view is that, while there is a lot of noise in the media about the investment outlook, corporate profits have remained very strong here and around the world. While some of the events we have outlined here might influence corporate profits and investment returns, we think the effect on long-term investment returns will more likely mean a return to the norm rather than the extremely buoyant levels experienced from much of the past decade.
If you would like to talk to us about your Equip investments, you can contact us on 1800 682 626, keep an eye on our website for more information, or make an appointment with an Equip financial planner to arrange an initial discussion about creating a strategy tailored to your needs and goals.
Click here check out our latest investment returns.
This information is provided for general information only. It does not take into account your personal objectives, financial situation or needs and should therefore not be taken as personal advice. You should consider whether it is appropriate for you before acting on it and, if necessary, you should seek professional financial advice. Issued by Equipsuper Pty Ltd ABN 64 006 964 049 AFSL 246383. MySuper Authorisation Number 33813823017672 (‘Equip’, ‘the Fund’ and ‘the Equip Rio Tinto Fund’).