As the global economy slows, the sharemarket should be viewed with increasing caution, says Mark Rider.
Sharemarkets have rebounded from their sharp drop in December, but investors shouldn’t be lulled into complacency by this upswing: the volatility we saw in 2018 is expected to continue this year.
Rising market values in January have made up for about half of the 20 per cent loss we saw late last year. It’s a nice start to the year, but ANZ’s chief investment office wants to be clear: we believe this will be a challenging year for investors.
Expect volatile sharemarkets
There’s plenty of risk in the sharemarket because economic growth is slowing while pressure is increasing on wages and prices rise, especially in the US. This may in turn see the US Federal Reserve raise interest rates, which would further slow global economic growth.
(Not to mention other matters such as the US-China trade war, Brexit, China’s debt-laden slowing economy, and so on, which are already making investors nervous and markets twitchy.)
Sharemarkets are clearly quite sensitive to all these issues, and can respond with volatile swings to positive or negative news in these areas. This is what we have been seeing.
Slower, but still solid growth
In response, governments and central banks are making effort to maintain growing economies.
- The US Federal Reserve will likely pause rate hikes for all or much of this year, which would support momentum in the world’s most important economy.
- China is easing monetary policy, through such measures as boosting lending to small businesses.
- Investors should note these efforts are likely only to stabilise growth rather than lead to a genuine reacceleration in 2019.
It’s a similar story for Australia. Growth will likely slow but remain solid. Public spending, business investment and net exports should all contribute to keep growth around trend. However, wages growth is expected to remain weak with falling house prices in both Sydney and Melbourne adding to concerns. Despite these risks the government budget is in good shape. The Reserve Bank of Australia’s cash rate is likely to remain at 1.5 per cent for at least another year.
Investment returns 2017 v 2018
Index information: International shares hedged - MSCI World ex Australia Net Index (hedged to AUD) | International shares unhedged - MSCI World ex Aust (Net) | US shares – US S&P 500 | European shares – MSCI Europe | Emerging market shares - MSCI Emerging Markets (Net) in AUD | Australian Shares - S&P / ASX 300 Accumulation | International ¬fixed interest – Bloomberg Barclays Capital Global Aggregate (hedged to AUD) | Australian ¬fixed interest - Bloomberg AusBond Composite 0+ Yr Index | International property – FTSE EPRA/NAREIT Developed Rental Index ex Australia (hedged) | Infrastructure - FTSE Developed Core infrastructure 50/50 Net Hedged to AUD | Cash - Bloomberg Barclays Bank Bill Index.
Source: JP Morgan
It’s not a case of ‘the end is nigh’
To be clear, while slowing, Australia and the global economy still has a solid outlook. The recent correction means it’s just returning to a ‘trend’ level after a couple of years of above-trend growth.
This also means the value of shares have literally been corrected – they are now fairly valued, not over valued, putting sharemarkets on a more sustainable footing, and giving investors more reasonable expectations of what returns can be expected this year.
This is all nicely balanced but the risks on the outlook are partly downward as we are now late in the investment cycle. We’ve been in an upward growth phase for about 10 years, and that is something that simply cannot last. There is always a cycle to investment market performance, and we’re due for a downswing. The question is, what form will it take?
US investment-cycle clock
Gradual slowdown, lower returns most likely
We predict three main forms that a downswing could take this year. While our base case suggests a market downturn, our two risk scenarios are not so rosy.
1. The most likely scenario is what ANZ’s chief investment office is focused on – a gradual slowdown. We see the investment and economic cycle continuing to slow with inflation only gradually lifting. Central banks will balance attempts to dampen any financial market ‘exuberance’ while working against recessionary forces.This isn’t a bad outcome.
2. In terms of risks, while a relatively low probability, a sharper lift in inflation would be very concerning because it would make it harder for the US Federal Reserve to pause rate rises. Such a situation could lead to negative returns for investors and sharp loss of sharemarket value.
3. A mild recession is a little more likely than this. This will occur if US rates stay on hold and the economy slows. Company earnings would be negative due to higher costs and lower growth. Tariff escalation due to the US-China trade war would compound this situation.
In summary, our view is cautious towards growth assets such as shares for the coming year. While share valuations have improved, our analysis shows that the global economy has slowed. All up, we expect returns to be below the average of recent years.
- Read the Chief Investment Office’s Spotlight summary of its 2019 outlook (PDF).