Economic Overview

On Friday we witnessed a significant event and its real time impact on financial markets. Britain voting to leave the European Union.

21 January 2016

Ten years ago, in another country, a man we’ll call Bill, died at 75. He left his wife, a lady we’ll call Betty, $50,000 and a house worth $350,000. Betty was 65, living on a government pension and no longer wanted the hassle of the house. So she sold it, but before leaving she asked her next-door neighbour for advice on investing the proceeds.

Her neighbour pointed Betty towards his financial advisor. Soon Betty was set up with a portfolio that paid her rent and offered her income in addition to her pension.

Then 2008 happened.

Betty’s portfolio fell by 25%. Despite her funds still doing what they were designed for – paying rent and offering additional income, Betty panicked, ignored her advisor and sold at the bottom. She dumped the remaining cash into a savings account as the country’s central bank was slashing interest rates. Within a year the central bank had cut interest rates to almost zero.

Over the next few years Betty’s money sat in the bank earning next to nothing. The funds she cashed in recovered their losses and continued to pay distributions. Betty continued to make regular withdrawals from her cash, only they were smaller as she attempted to conserve her cash. Interest rates never recovered and now Betty’s withdrawals have nearly eaten away all her cash.

We tell this story because we’re all human and can be easily frightened. Markets have had an extremely poor start to the year and the media has piled on. The biggest headline recently came with the Royal Bank of Scotland telling investors to “sell everything”.

The strategist behind the call was Andrew Roberts. Roberts suggested we were in for a global deflationary crisis and warned investors to brace for a cataclysmic year. We’re not saying Roberts and RBS are wrong, because we don’t know what comes next, but few in the media offered any perspective to the call.

In 2010, after a rough start to the year, the same Andrew Roberts was quoted in UK’s The Telegraph:

“Andrew Roberts, head of European rates strategy at RBS, said “Great Depression II” could now be approaching” and “This is a global deflation scare.”

You may recall the sequel to the Great Depression never happened in 2010.

What to do about the current turmoil? It’s unknown if the share market will go down further before it goes up again, so the hardest thing to do is also the best thing to do – nothing.

Andrew Roberts’ appeal to base emotions will resonate with many people, just like 2008 spooked Betty. They’ll believe this time is different and it’s time to bury their cash in a vegemite jar. The reality is this isn’t anything new; declines like we’ve seen in 2016 are an annual occurrence. Over the past 30 years the average intra-year decline on the ASX is 12%, and in 23 of those 30 years the market still finished the year positive.

If your portfolio is well diversified then you can weather these declines. Investors drawing income can do this from cash and defensive assets and rebalance their portfolios when share markets improve.

We ensure most of our clients in drawdown phase have at least 5 years of defensive assets available so that growth assets don’t need to be sold in a downward market. For clients in the accumulation phase of their lives, it is an opportunity to buy equity assets at cheaper prices.

Accumulators and investors with longer term investment strategies can accrue additional assets at lower prices or they can simply allow some time for their asset prices to recover.

As always still feel free to contact us if you have and questions on this or any other issue.

_{This represents general information only. Before making any financial or investment decisions, we recommend you consult a financial planner to take into account your personal investment objectives, financial situation and individual needs.}

 2015 September Quarter Review

Economic Overview

The scale of China’s economic slowdown and the policy response to it were among themes that preoccupied global markets in the September quarter.

On August 11, China devalued its currency by nearly 2%, a move that fuelled concerned about the success of China’s efforts in rebalancing its economy from investments and exports to domestic consumption.

Given China’s substantial demand for iron ore, coal and other raw materials, concern about its slowdown was cited as one possible factor – alongside supply issues – in driving down commodity prices, resource stocks and related currencies like the Australian dollar.

In the US, China’s slowdown was cited by the Federal Reserve as they delayed an anticipated increase in interest rates. Despite this, Fed governor Janet Yellen said she still anticipated an increase before the end of the year. Central banks elsewhere also maintained accommodative interest rate policies for similar reasons.

Across the Atlantic, data showed a recovery in European business sentiment. In August, Greece, secured a third bailout from its creditors in return for promising to carry out economic reforms.

Late in the quarter, the emergence of the Volkswagen emissions scandal raised concerns at the impact on the German economy. The car marker, whose CEO quit over the rigged emissions tests, is one of Germany’s largest employers.

In Australia, the commodity downturn hit resource companies and resource rich regions like Western Australia. With the economy slowing and inflation contained, the Reserve Bank kept the cash rate at 2%, where it had been since May.

Market Overview

Asset Class Returns

The following outlines the returns across the various asset classes to the 30^th September 2015.

Global equity markets in the September quarter posted their worst quarterly performance in four years, led by emerging markets and more specifically commodity and energy related shares.

Exxon Mobil Chevron, Glencore and BP were among the biggest drags on global equity markets, though there were positive contributions from some technology and consumer names such as Amazon, Google, Facebook, Nestle and Nike.

Unsurprisingly the weakness spilled over into commodity related currencies, with the Brazilian Real, South African Rand and Australian Dollar among the worst performers against the US dollar.

Fading expectations for inflation made for good bond returns, with longer-dated government bonds posting their biggest quarterly gain of 2015, while the search for yield in a low interest environment helped to lift listed real estate. Again, more evidence of the benefit of diversification – as local shares sunk, other asset classes behaved in a completely different fashion.

On the Australian share market, energy companies like Santos and Origin were among the worst performers, though merger activity boosted some industrials like Asciano and Treasury Wine Estates. Qantas, continuing its turnaround and benefiting from low oil prices, posted strong gains.

In New Zealand, it was a similar story to Australia, as the local share market also posted its worst quarterly performance in several years, but NZ bonds posted strong quarterly gains.

Was there a time without volatility?

It’s been a volatile year, apparently.

The market has moved around quite substantially and the media has been on the scene to remind us about it. If there’s one constant that keeps the media in business it’s retelling an old story and trying to tell us it’s fresh and relevant – curse our short memories!

If we could remind ourselves how common and ultimately uneventful market volatility and most corrections are, we’d endure a lot less stress when investing. With that in mind, to highlight how the worst periods during a year are often markedly different from the whole year, we’ve put together a 30 year chart of the ASX highlighting intra-year declines vs. full year returns.

The message? Corrections happen regularly – but they’re rarely fatal.

This chart underlines the danger of reading too much into a temporary correction and taking action based upon it. Significant drops happen at least once on a yearly basis and if we take the worst declines (those included for this this chart), they average 12% down before the market forms any type of recovery.

There are a few things to note. Firstly, on three occasions the yearly return was worse than the worst intra-year decline measured. A 10% fall can happen in a short period of time; from there the market may form a small recovery or trade sideways over a number of months. From that point if it starts another fall it will inevitably drag the yearly return lower. Thankfully the fall/reprieve/fall scenario has only occurred three times in the last 30 years.

Secondly, even good years will suffer rough declines. 2012 and 2013 produced solid double digit returns, but at one stage during both of those years they suffered double digit peak to trough falls before recovery. And take 2009, as the world reeled from the financial crisis. The ASX had hit a double digit decline by early March, something that would have most investors questioning their strategy to stay the course, but from that point the market staged a remarkable recovery and finished the year 33% ahead.

If you’re a long term investor it’s just another reminder that there’s nothing to be feared from a correction.

Now the following chart isn’t the art work of an indecisive snail that fell into an ink pot, it’s just further evidence volatility is nothing new. The combined lines are three ASX charts from 2013, 2014 & 2015. They are through till mid-October and the charts are deliberately untagged and in no particular order.

Despite the media playing on the idea that “volatility is back in 2015” it appears hard to identify any real difference in volatility between the three charts. Volatility has neither remerged, nor has it been absent in any of the charts. There are roaring ups and downs, with little smooth sailing to be found.

Has it really been a volatile year or just a normal one? In truth it’s been both – markets are always volatile and that’s normal.

With thanks to DFA Australia.

This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.

Economic Overview

The global economic backdrop remained mixed in the June quarter. Continued recovery in the US and modest gains in Europe and Japan were offset by a continuing slowdown in China, weak commodity prices and Greece’s recurring debt woes.

Globally, monetary policy remains highly accommodative. However, the US Federal reserve has declared its intention to raise interest rates sometime this year if key indicators continue to strengthen.

Across the Atlantic, despite an easing of deflation fears and small signs of an economic recovery, the European Central Bank kept rates at record lows and continued its quantitative easing program.

In Asia, the economic news was also mixed. In Japan, business sentiment improved as the economy emerged from a recession trigged by last year’s hike in sales taxes. Meanwhile China grappled with slowing exports, manufacturing and its property market. In late June, China’s Central bank cut interest rates for the fourth time since November.

For Australia, the falling terms of trade and low growth in labour costs depressed incomes. The fall in mining investment, as major projects have come online, has yet to be replaced by new growth. Central banks in Australia and New Zealand were both torn between heated housing sectors and falling commodity prices, yet opted to cut interest rates to offset weakening overall demand.

Late in the quarter, Greece’s five-year-long debt crisis came to a head after the breakdown of marathon talks with its international creditors. The prospect of a Greek default unnerved markets and raised concerns of a break-up of the 19-nation Euro currency block.

Market Overview

Asset Class Returns

The following outlines the returns across the various asset classes to the 30^th  June 2015.

A strong start to 2015 for equity markets gave way to a more mixed picture late in the second quarter as attention moved to the prospect of higher US interest rates and the future of Greece in the Eurozone.

Despite the late June dip that dragged quarterly returns down, over the full financial year most asset classes delivered solid returns.

Currencies boosted unhedged global equity returns through the year as the $USD rose in anticipation of a US rate hike, though this effect waned in the June quarter.

Global indices ended largely flat for the quarter as the Greek debt crisis eroded gains towards the end of June. The UK was the top developed market in Australian dollar terms, while the US market was mostly unchanged.

Emerging markets were flat over the quarter, with small companies beating large and value companies beating growth. China was the standout market across the financial year, even with a heavy fall in June, the Shanghai Composite Index was still up over 150% for the year.

The Australian market lagged those offshore, dropping 6.5% for the quarter to reduce its full year return to 5.6%. Again, most of that damage was done in the last weeks of June as the market reacted to Greek debt, China’s share market tumbling and the RBA talking down interest rate relief.

That was a bad few weeks… or was it?

Q:  I am concerned at all the turbulence in the markets and wonder if I should move my share-based investments inside super to cash until things calm down.

That question was put to financial advice columnist Noel Whittaker on July 14. Noel offered an uninspiring one sentence response; so we thought we’d go into a little more detail and analyse the timeframe that inspired this question.

Due to Greek debt and Chinese gamblers, world markets suffered significant volatility across June & July. If you were just reading the headlines or heard general news reports when the media decided the sharemarket’s falls were big enough to warrant reporting on, you’d likely think it was a horrible span of a few weeks and investors were left significantly in the red.

You’d be wrong.

While the market falls came at exactly the wrong time for anyone using the end of the financial year as a measuring stick, 14 days into the new financial year and the market was actually higher than it was a month earlier – a time of relative calm when no one was yet talking about Greece!

While Greek’s debt saga could drag on further and China’s stock market gamblers could sell up when restrictions are lifted or get a second wind, this past month serves as an important lesson in how to handle volatility.

We’ve compiled a chart of the ASX All Ords from June 15 to July 15, we’ve then superimposed some headlines taken from the Australian Financial Review that highlight how quickly the media whips between light and dark stories, some amusingly timed. The chart also highlights the volatility a sharemarket can endure during a one month period (with some significantly down days); yet still end that month higher than it started.

If you expand the chart, you’ll note the warnings on Greece started 15 days before the deadline and become more apocalyptic as the 30th of June grew closer, aligning with the market declines. At the absolute bottom we were told “Greek saga set for a catastrophic turn” only to see the market race higher. At the next peak the headlines said “The Panic Has Gone – For Now” only to see the market take a large drop.

Many of the headlines appear to have awkward timing to them – seemingly relentless market declines are followed by headlines of more horror to come and at that moment the market sharply turns upwards. Or just when the headlines say “don’t panic” the market moves sharply downward.

If you truly want to get something out of this chart, we’d ask you to imagine yourself looking at the ASX close on June 15 at just under 5,500 points. Then imagine you went on holiday for a month to Tropical Island with no communications, meaning you had no idea what the market was doing. Then imagine you arrive home on July 15 to find the ASX close at just over 5,600 points.

Would anything that happened between those two dates have really mattered to you? And if you wanted to exit, when would be the right point to wait for calm to re-enter? As investors we need to remember short term sharemarket charts often appear as disconcerting as the period between June 15 and July 15, meaning there’s no chance of correctly picking “when things will calm down”.

With thanks to DFA Australia.

This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person or entity. Accordingly, to the extent that this material may constitute general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.

Is being able to withdraw Super for first home buyers a good idea?

Last year the independent senator from South Australia, Nick Xenophon raised a loopy idea that has long been an obsession of the real estate industry. Let first home buyers raid their superannuation to buy a house.

It didn’t grab a great deal of attention and it attracted mostly criticism. Given Xenophon enjoys an occasional populist thought bubble and lacks the ability to carry such a proposal through to legislation, it soon died off – until recently.

With the federal Liberal government struggling in the polls there have been some notable backflips and populist ideas emerging. Xenophon’s superannuation raid for homes was recently reheated by Treasurer Joe Hockey. Given Hockey’s position in the government it attracted significantly more attention and unfortunately somehow legitimised the idea as being worthy of debate.

A similar idea was introduced in Canada back in 1992. Called the Home Buyers Plan, it was suggested to the then Canadian government by the Canadian Real Estate Association during a real estate downturn! First home buyers in Canada are allowed to dip into their Registered Retirement Savings Plan (RRSP) up to $25,000 (increased from $20,000 in 2009) for a deposit on a first home.

The money is meant to be repaid to the RRSP over 15 years, but in 2011 and after $28 billion in withdrawals, the Canada Revenue Agency reported 47% of the people who borrowed the money had never paid back a cent.

When the money is not repaid, a tax deduction previously given for those RRSP contributions is then whacked back onto the individual’s taxable income. So the first home buyer then has an empty retirement account and a larger tax bill! So why would these first home buyers increase their tax bill rather than replenish their retirement account?

Probably because they don’t have the money.

Looking at Canada’s housing market we might be able to understand why. According to the real estate boards of Vancouver and Toronto it now takes over $1 million to buy a house in either city. A situation even worse than Melbourne or Sydney.

And as the graph above shows, Canadian national house prices (the red line) have continued to power upwards becoming more unaffordable since 2009 when the Home Buyers Plan withdrawal limit was increased. Meanwhile in the 3^rd quarter of 2014 Statistics Canada announced Canadian household debt had reached an all-time high.

It seems ridiculous for governments to encourage raiding retirement savings to bid up home prices and further indebt ourselves, but let’s look at how it affects a retirement scenario.

Assume two 30 year olds with a 35 year superannuation timeframe. They both have $25,000 in their superannuation account and they’re both currently earning $50,000 per annum, meaning a $4750 yearly super contribution. Over 35 years we’ll assume continuing employment and an annual pay rise of 2%, compulsory employer contributions stay at 9.5% and they make no additional contributions.

The first 30 year old does not take the$25,000 out of their superannuation to buy a house. If we assume a 7.5% average annual market return, their superannuation balance grows to $1,226,997 over 35 years. The second 30 year old does take the $25,000 out of their superannuation to buy a house. Assuming the same market return, their superannuation balance grows to $912,775.

So there’s an over $300,000 or 25.6% difference in final returns.

Pandering to the current angst of first home buyers over rising house prices in some cities may be a popular move in some circles, but it appears extremely short sighted.

Firstly, it hurts the retirement incomes of those who raid their superannuation and may mean they’re drawing a government pension when they previously wouldn’t. Secondly, you never make anything more affordable by throwing money at it. Like with the first home owners’ grants, sellers will see first home buyers coming and adjust their prices upward accordingly.

After all, ask yourself why the program in Canada was suggested by the Canadian Real Estate Association during a market downturn and why it was increased during the financial crisis in 2009 – it certainly wasn’t to push prices down.

_{This represents general information only. Before making any financial or investment decisions, we recommend you consult a financial planner to take into account your personal investment objectives, financial situation and individual needs}

The world’s in a mess! Oil’s tanked. Greece and the European Union are fighting over debt (again). Australia has a Prime Minister hanging on by the fingernails (again). The Australian dollar has cratered against the US. Madmen are running riot through the Middle East (again). Interest rates have been slashed in Australia and all over the world because economies are shaky.

In summary, things have never seemed so uncertain – as usual.

If you’re worried about this mess, remember, despite the endless headlines, those with a balanced and liquid portfolio continue to do quite well.

Some investment rules to remember for the year ahead (and always).

1. Prepare to be surprised. Rarely do we make it through a year without a calamity that will have an effect on markets somewhere. So don’t exit an asset class. This year, like last year (and the last hundred or so), was meant to be end of days, but the recent interest rate cut put a fire under local shares.

The dollar drop also improved returns on unwedge international shares. Who knows what comes next? The point of having a well-constructed portfolio is having various asset classes weighted in line with your risk profile because the future is a guess and you prepare your portfolio for it now.

2. Don’t try to time the market. For the past few years experts have told us why various markets and asset classes will crumble. If you listened, you left those freely available gains on the table for someone else. It’s better to be invested for the long term than paralyzed each day by the latest headline.

Markets will eventually take some time off, but no one knows when. And even when they do, most asset classes will continue to pay you to hold them with ongoing distributions.

3. Don’t buy individual shares. While the local market has raged upwards to its highest point in years, anyone who had filled their portfolio with individual energy or commodity companies was still licking their wounds. It’s an amateur mistake.

Looking for hot tips is time consuming and haphazard. And waiting for great news on one company to fire up your portfolio is true risk. Especially if the market leaves you behind as you twiddle your thumbs waiting for a big announcement.

4. Understand what good returns are. Red hot real estate has been a media go to. Stories of baby boomers piling in with their SMSFs and Chinese buyers flooding auctions are regularly reported in the media as the market heated up, but how hot is the real estate market?

Real estate stats firm RP Data released Australian real estate returns from the beginning of 2009 until the end of 2014 and they ranged from impressive – Sydney up 57% and Melbourne up 50% to more pedestrian – Brisbane up 9% and to Hobart, where prices haven’t moved in six years.

Yet the return on Australian shares over the same period was 90%. Australian listed property returned 93% and unhedged global shares returned 79%. As listed assets experience a minute by minute test of their valuation we get to read headlines like “$50 billion wiped off the market” twenty times a year. This spooks some investors and you’ll find them swearing their investment property can’t be beaten for growth.

5. The economy isn’t the share market. Interest rate cuts signal things aren’t so rosy. When it comes to private debt – a real drag on consumer spending, only in Canada and that other bastion of great financial management, Greece, do households carry more debt than Australia. Yet studies have shown a low correlation between GDP growth and market performance.

Quality companies will make money in good times and bad. And many companies listed on the ASX conduct their business overseas or are US dollar exposed. A falling dollar is better for their returns. There are winners and losers from every economic reality. And the true winners stay diversified and liquid.

_{This represents general information only. Before making any financial or investment decisions, we recommend you consult a financial planner to take into account your personal investment objectives, financial situation and individual needs.}