With the trade deal wrapped up and signed, investors piled into risk assets with equities ending 2019 and starting 2020 with big gains. The S&P/ASX 200 rose 3.7% in the past four weeks. The main characters saw big moves as well, with the U.S. S&P 500 up 3.6% and China’s CSI 300 index up 4.8%. Other major markets lagged, with the Euro Stoxx 50 up 1.2% and Nikkei 225 down 0.5% in the same period.
Commodities were relatively flat over the four weeks but gold and oil did have a short-lived spike on the escalation of U.S.-Iran tensions following the assassination of Irainian General Soleimani.
Bonds were mixed, with U.S. and Japanese yields roughly flat. A hint of a recovery in Europe plus comments indicating a shift in opinion away from negative interest rates led to a rise in yields in Europe. On the other hand, the bush fire crisis has driven Australian long-term yields marginally lower.
The Australian Dollar rose slightly to 69 U.S. cents.
Trade tensions eased as the U.S. and China to signed a ‘phase one’ deal on 15 January and the U.S. removed China from its list of currency manipulators. However, there was little in terms of addressing structural differences.
Domestic data for November was encouraging. Employment data rebounded from a disappointing October, with the unemployment rate falling to 5.2%. Retail sales and a rebound in building approvals was also indicative of a nascent recovery but the severity of the bushfires is tempers optimism, with estimated impact of 0.25% of GDP per quarter.
U.S. economic data remains mixed, with manufacturing activity remaining weak over the last few months but services activity remaining strong. Employment in the U.S. continues to improve despite the latest figures coming in slightly below estimates combined with core inflation of 2.3% for 2019 providing little reason for the Federal Reserve to hike.
On the other hand, China’s easing policies seem to be taking hold as activity indicators look to be rebounding with manufacturing remaining above the key level of 50 for the second month in a row. The Chinese government remains in easing mode as they look to maintain the rebound momentum by cutting the Reserve Requirement Ratio by 0.5% to 12.5%, which effectively releases liquidity supply to the economy. Trade also rebounded in December, with both imports and exports surpassing expectations as trade tensions eased.
European data was also optimistic as manufacturing and services activity indicators both beat expectations though manufacturing remains mired in a slowdown.
In the near term, all eyes will be on the global earnings season but the spotlight will likely be on the U.S. elections this year as we outline in our outlook below.
Outlook for 2020
- Investors should expect more subdued portfolio returns in 2020 given high valuations across multiple asset classes
- Expect increased volatility given U.S. Presidential election uncertainty
- Emerging market equities should outperform in 2020 anchored by China
- Australian equities should continue to underperform international peers
At face level, it’s easy to start 2020 with a sense of optimism. ‘Phase one’ of the U.S./China trade deal has been signed, Chinese economic data seems to be stabilizing and major central banks in the U.S. and Europe are back expanding the monetary base.
As President Trump often touts, U.S. employment is as strong as it’s been since the late 1960’s. Unsurprisingly, U.S. Consumer Confidence remains within a whisker of its record high.
In China, small business confidence is improving (see below), manufacturing sentiment is again positive and we feel confident that Chinese authorities will do everything in their power to ensure a strong and vibrant economy (and sharemarket) for the heavily anticipated 100 year anniversary of the founding of the Chinese Communist Party in 2021.
Contrast this upbeat mood now with how we started 2019 and the change in mood couldn’t be more pronounced, but looking into 2020 investors should be asking, ‘are we still travelling, or have we already arrived?’
In knowing where we’re going, it helps to know where we’ve been, and with that in mind its worth acknowledging the following few facts:
- the 2019 ASX200 Accumulation return of +23.4% was the best in a decade
- The Australian bond index benchmark returned a generous +7.8% despite the RBA Cash rate starting the year at an already miserly 1.5%
- The ASX200 and S&P500 now sit on their highest forward equity valuations since the tech-boom 20 years ago
- Australian nominal and real interest rates sit at record lows
Undeniably, we start 2020 from a higher vantage point and with higher stakes at risk. The risk/reward available to investors from traditional listed assets is far less attractive than it has been in some time and, importantly, investment outcomes remain highly dependent upon the continued monetary benevolence of central banks such as the Fed and ECB.
Mathematically, it becomes very difficult to envisage a scenario in which balanced investors achieve a sustained return much beyond 5% unless the underlying economy improves and with it do corporate earnings.
U.S Election uncertainty a likely theme
Whilst optimistic that China is bottoming, it’s difficult to get more excited about the United States economy.
Afterall, economic stimulus has been prodigious via the Federal Reserve and through the Trump tax cuts, and because of that, employment, residential house construction and consumer confidence already stand at multi-decade highs.
But this comes with a cost. The U.S budget deficit will approach 5% of GDP in 2020 – a level seen only 3x in the last 50 years and always at the depth of recession.
Arguably of greater concern should be the uncertainty felt by small businesses in the lead up to the U.S Presidential Election in November, and the massive gap between currently low-touch policies of Trump’s presidency and the bigger government favoured by left-leaning Democrat candidates such as Bernie Sanders and Elizabeth Warren with the prospect of increased regulation across all manner of industries.
We think this uncertainty will make it difficult for investors to expect another strong year of equity returns in the U.S without feeling sure that President Trump will win another 4-year term.
Australia’s economy spluttering
Where we had endeavoured to hope that rebounding house prices would provide a cushion to household consumption in 2020, we now feel like the summer bushfire crisis has cancelled out much of that hope.
Tourism and agriculture are the sectors most obviously impacted, but the bushfires will likely have a deeper and wider impact on Australia’s already fragile consumer economy.
Australia’s consumer confidence ended 2019 just off of a 4-year low (see below) despite record low interest rates, a rebounding housing market and with confidence restored amongst the superannuant-class that franking credits would remain a source of retirement income.
Business confidence is worse and is at a 6-year low and, concerningly for consumption, Australian job advertisement volumes are down -19% year on year and at their lowest absolute number since early 2016.
Though we feel the economy is in dire need of fresh stimulus, it seems likely that the Federal Government will wait until the May Budget announcement before offering up new infrastructure investment or personal tax relief.
We fear 2020 is at risk of being lost to local policy intransigence.
We hope not, but with equity valuations at 20-year highs and corporate earnings under pressure, having already gone backwards in 2019, it feels responsible to be cautious. See the chart below to witness the divergence between Australian share prices and underlying earnings per share.
Though we feel reason to commence the year with some caution, we still feel confident in the risk/reward offered to us by a number of investments.
Within the international equity portfolio we believe emerging market equities should outperform, buoyed by a stabilization in China and the prospect of ongoing policy support in the lead up to next year’s Chinese Communist Party 100-year anniversary.
Emerging market equities start 2020 on a multiple of 13x which sits well within their historical range and compares favourably to the high multiples on which U.S and Australian equities trade.
We continue to favour the attractive returns available in domestic property-backed debt made possible by the continued retreat from this lending by major Australian banks.
We expect to see a more volatile year in 2020 and aim to have the cash on hand at appropriate times with which to profit from.
As in any year there are multiple variables that could influence or upset our base case, which is for a likely modest single-digit return year. However, we think investors will do well to observe the U.S Presidential Election campaign and upcoming Federal Reserve policy in relation to recent liquidity injections. Any sign the U.S Federal Reserve intend to create more permanence with their recent monetary injections and asset markets globally could again temporarily surprise on the upside.
For those of you seeking greater detail on investments please contact your advisor directly.
Want more information?
This month’s perspective highlights that market sentiment on all asset classes is constantly changing. It is important for us to quickly recognise any threats, to preserve your investment capital or to identify early investment opportunities to maximise any return advantages. At Partners Wealth Group we don’t get complacent with the current state of play and constantly monitor investments and your portfolios.
If this article has raised questions regarding your personal situation, please contact your Partners Wealth Group advisor directly or on 1800 333 143.