Here’s my forecast: “The global economy is going to have a significant downturn and record levels of debt are going to make it worse.”

It seems there is constant hand-wringing about the risks around the Chinese economy with the common concerns being around unbalanced growth, debt, the property market, the exchange rate and capital flows and a “hard landing”. This angst is understandable to some degree.

While the populists did not fare as well as many predicted in Europe last year the populist left-leaning Five Star Movement (5SM) and populist far-right Northern League (NL) were the big winners in the Italian elections in March.

“Financial peace isn’t the acquisition of stuff. It’s learning to live on less than you make, so you can give money back and have money to invest. You can’t win until you do this.” Dave Ramsey

Thanks to an improvement in the budget position since the Mid-Year review, of around $7bn per annum, this has been made relatively easy. A modest fiscal stimulus will help households, but the main risk is that the revenue boost proves temporary.

While the global economy is seeing its fastest growth in years and the US Federal Reserve has increased rates five times since December 2015 and is on track for more hikes this year, the Reserve Bank of Australia (RBA) has now left interest rates on hold for a record 21 months in a row.

Much has been written about the trade dispute between the US and China and the risk of a global trade war. Much of it has been hyperbole but financial markets have had to price in the risks of a full-blown trade war zapping global growth. This has been difficult given almost daily developments on the issue since early March. This note takes a simple Q & A approach to the key issues.

After the calm of 2017, 2018 is proving to be anything but with shares falling in February on worries about US inflation, only to rebound and then fall again with markets back to or below their February low, notwithstanding a nice US bounce overnight.

For the last few years the Australian economy has been meandering between 2-3% growth. This remained the case through last year with December quarter GDP up just 0.4%, and annual growth of 2.4% as a bounce a year ago dropped out.

The period since the Global Financial Crisis (GFC) has seemed unusual in the sense that periodic crises and post GFC caution prevented the global economy from overheating and excesses building, in turn preventing the return of the conventional economic cycle.

If Australia has an Achille’s heal it’s the high and still rising level of household debt that has gone hand in hand with the surge in house prices relative to incomes. Whereas several comparable countries have seen their household debt to income ratios pull back a bit since the Global Financial Crisis (GFC), this has not been the case in Australia.

From their highs to their recent lows, US and Japanese shares have fallen 10%, Eurozone shares have fallen 8%, Chinese shares have fallen 9% and Australian shares have lost 6%. This note looks at the issues for investors and puts the falls into context.

2017 was unusual for US shares. While Japanese, European and Australian shares had decent corrections throughout the year of around 5 to 7%, the US share market as measured by the S&P 500 saw only very mild pullbacks of less than 3%. This was against the backdrop of a strongly rising trend thanks to very positive economic conditions and President Trump’s business friendly policies.

Higher global inflation and higher bond yields – what’s the risk and implications for other assets?

Although 2017 saw the usual worry list – around President Trump, elections in Europe, China, North Korea and Australian property – it was good for investors.

Two years after it first started raising interest rates in this cycle in December 2015, the Fed has increased rates for the fifth time, raising the Fed Funds rate another 0.25% to a target range of 1.25-1.5%.

2017 – a relatively smooth year

At the start of last year, with global and Australian shares down around 20% from their April/May 2015 highs, the big worry was that the global economy was going back into recession and that there will be another Global Financial Crisis (GFC). Now, with share markets having had a strong run higher, it seems to have been replaced by worries that a crash is around the corner and this will give us the global recession and new GFC that we missed last year!

Australians seem particularly vulnerable to worries these days. On the weekend I read that Australians are suffering from an “epidemic of anxiety” and that out of a survey of 24 nations Australians ranked in the upper half in terms of worries about a health epidemic (9^th highest), a terrorist attack (8^th highest) and a nuclear attack (5^th highest) – way above South Korea in terms of the latter despite Kim Jong-un’s new found nuclear capability just across the border! And a Roy Morgan survey has found that only 31% of surveyed Australians expect next year to be a better year than 2017, which is the lowest on record and only just above the 30% who expect next year to be worse. See the next chart.

Introduction

The surge in bitcoin has attracted much interest. Over the last five years, it has soared from $US12 to over $US8000; this year it’s up 760%. Its enthusiasts see it as the currency of the future and increasingly as a way to instant riches with rapid price gains only reinforcing this view. An alternative view is that it is just another in a long string of bubbles in investment markets.

The last five years have seen strong returns for diversified investors thanks to double digit gains in shares (after a rebound from a mini bear market around the Eurozone crisis) and solid returns from unlisted commercial property and infrastructure.

The low interest rates of recent times along with periodic turmoil in investment markets has provided us with a reminder of the importance of the income (cash) flow or yield an investment provides.

Where are we in the global investment cycle and what’s the risk of a 1987 style crash?

A common narrative on the Australian housing market is that it’s in a giant speculative bubble propelled by tax breaks, low interest rates and “liar loans” that have led to massive mortgage stress and that it’s all about to go bust, bringing down the banks and the economy with it. Recent signs of price falls – notably in Sydney – have added interest to such a view.

The US Federal Reserve provided few surprises following its September meeting. While it left interest rates on hold, it confirmed that it will begin what it calls “balance sheet normalisation” next month and continued to signal its expectation that it will raise interest rates again in December and in the years ahead. While projected interest rates increases were lowered slightly for 2019, the Fed was more confident in another rate hike this year than markets had expected. So while US shares were little changed overnight, bond yields and the US dollar rose slightly.

For some time now, the investment world has been characterised by a search for decent yield paying investments. This “search for yield” actually started last decade but was interrupted by the Global Financial Crisis (GFC) and the Eurozone debt crisis before resuming again in earnest. 

As Warren Buffett once said: “There seems to be a perverse human characteristic that makes easy things difficult.” This has particularly been the case with investing where complexity has multiplied with new products, new ways to access various investments, tax changes and new regulations, all with social media adding to the noise. But it’s really quite simple and this can be demonstrated in charts.

Growth bounces back (again)

The June half earnings reporting season in Australia is now done. The good news is that profits and dividends are up with 67% of companies reporting higher profits than a year ago (see the first chart below) and 64% increasing dividends from a year ago which is a good sign regarding the quality of earnings.

The Global Financial Crisis 10 years on – Lessons learned and can it happen again?

The Threat Of War With North Korea – Implications For Investors

Inequality- is it increasing? What’s driving it? And what it means for economic growth and investors

Investing is often seen as complicated. And this has been made worse over the years by the increasing complexity in terms of investment products and choices, regulations and rules around investing, the role of the information revolution and social media in amplifying the noise around investment markets and the expanding ways available to access various investments.

2016-17 saw strong returns for investors – 5 reasons why returns are likely to be solid in 2017-18

From goldilocks to taper tantrum 2.0 – a bit of turbulence hits markets. 3 reasons not to be fussed.

It’s now 12 months since the British voted to leave the European Union, an event that some saw as setting off a domino effect of other European countries looking to do the same.

Growth slows again

The perils of forecasting and the need for a disciplined investment process

The Trump bump and shares – short-term risks, but five reasons for optimism