Investment Update - December 2019

The final quarter of 2019 capped off a stellar calendar year across all asset classes, with renewed central bank support catapulting a number of global equities indices to record highs and, in Australia, driving bond yields to record lows. Greater Brexit certainty and the announcement of a Phase 1 trade deal between the US and China also provided investors with greater comfort. Nonetheless, concerns about the health of the global economy linger, with consensus forecasts suggesting a slowdown in growth in 2020.

Among asset classes, hedged developed overseas and emerging markets equities were the strongest performers over the quarter, returning 7.5% and 7.3%, respectively. The détente in Sino-US trade tensions is considered likely to benefit global trade, pushing up both emerging market equities and their currencies. Unhedged exposure to developed overseas equities lagged performance somewhat as the Australian dollar appreciated overall, supported by a tempering in dovish domestic rates outlook and softening trade tensions. Nonetheless, unhedged developed overseas equities were the strongest performers over the year, returning 28.0%, while their hedged counterpart (26.8%) and emerging markets (18.6%) were also materially up on their levels as at 31 December 2018 – although it must be noted, these returns are skewed by the late-2018 nadir equities markets had reached amid concerns about central bank over-tightening.

The S&P 500 Index, which covers US equities, trended upward over the quarter, breaching the 3,200 mark to end 2019 at a record high. The Nasdaq Composite Index, which has a skew toward US technology stocks, similarly reached record highs at year-end, briefly exceeding 9,000 points. The S&P/ASX 200 Index, a leading Australian equities gauge, also hit a record high in late November to reach 6,893 points.

The dissipation of investor concerns was accompanied by a sell down of ‘safe harbour’ assets such as government bonds, driving up yields over the quarter, especially in December. Both Australian and overseas fixed interest accordingly posted negative returns during the period, recording -1.3% and -0.8%, respectively. The 10-year US Treasury bond yield increased from 1.66% to 1.92%, while the Australian equivalent similarly increased from 1.02% to 1.37%. After being inverted for a period of time, the US Treasury yield curve also reverted to its usual upward-sloping trajectory, helping assuage concerns about an economic downturn (a persistently-inverted US Treasury yield curve is considered a harbinger of looming recession). Nonetheless, government bond yields are generally much lower than they were at the start of 2019, with renewed central bank stimulus driving up bond prices. For example, the Australian 10-year Commonwealth Government bond yield fell from 2.30% to a record low of 0.85% during the year.

Australia

Australian macroeconomic data released over the quarter was relatively muted. Third quarter GDP disappointed, with year-on-year growth coming in at 1.7%. Tellingly, private demand was underwhelming, with household consumption barely improving despite an uptick in disposable income. The higher savings rate suggests households are, contrary to RBA expectations, using lower rates to reduce indebtedness rather than spending to stimulate the economy.

Recent RBA rate cuts helped propel a recovery in Australia’s housing market, with prices surging throughout the quarter; indeed, the November price increase in Sydney was the highest monthly rise since 1988. The increase in housing prices is likely to further stretch household indebtedness and could constrain discretionary spending.

In late November, the RBA provided clarity around its potential use of unconventional policy tools. The RBA’s governor, Philip Lowe, noted that quantitative easing would not commence until the official cash rate fell to 0.25%, with asset purchases likely limited to government bonds.

In other economic news, Australia’s trade surplus narrowed from record levels following reduced export demand, while capital expenditure data disappointed, with a 0.2% quarterly decline on a seasonally-adjusted basis.

Consumer sentiment, however, continued to struggle, with the Westpac-Melbourne Institute gauge spending the entire quarter in contractionary territory. Weak sentiment, coupled with the potential economic impact of major bushfires which ravaged Australia at the end of 2019 and into 2020, led to an increased likelihood of the RBA cutting its policy rate at its February 2020 meeting. In its December minutes, the RBA noted that it would pay closer-than-usual attention to data over the next two months in deciding whether to change rates at its first meeting in 2020.

United States

In the United States, economic data continued to be positive overall, with unemployment declining to an equal 50-year low of 3.5%, while average hourly earnings growth came in at a robust 3.1%.

Trade tensions with China continued to weigh on sentiment, with the ISM manufacturing PMI reading falling steadily over the quarter and ending 2019 at 47.2; the lowest since June 2009.

On the political front, articles of impeachment against US President Donald Trump were announced in early December by House Democrats, and by mid-month the President became only the third US leader in history to be impeached. That said, his removal from office is predicated on the approval of a supermajority of the US Senate, which is controlled by his Republican Party. Accordingly, it is highly likely Trump will remain President to contest the 2020 election.

In monetary policy news, the US Federal Reserve reiterated that rates would remain on hold for the time being, with Chair Jay Powell noting that the US economic glass was ‘much more than half full.’ The language has led markets to anticipate just a single rate cut in 2020.

Europe

European economic data continued to be subdued, although there was an upside surprise for inflation, and employment remained robust.

Both headline and core inflation for the Eurozone edged upwards – although the latter figure of 1.3% year-on-year still remains well below the ECB’s target of around 2.0%. The first speech from the ECB’s new President, Christine Lagarde, reiterated the need for increased fiscal support in addition to the central bank’s renewed asset purchase programme and record-low interest rates.

In political news, Spain’s first governing coalition government in 80 years was formed by investiture vote in early January. The outcome comes after two Spanish general elections in 2019 proved inconclusive. The coalition between the centre-left PSOE party and anti-austerity, hard-left Unidas Podemos is nonetheless somewhat precarious; there remains considerable uncertainty around how easily consensus will be reached given the overall fragmented nature of the contemporary Spanish political landscape. Meanwhile, in France, protests and strikes continued against President Macron’s proposed pension reforms.

In an interesting monetary policy development, Sweden’s Riksbank raised its policy rate from -0.25% to 0% and indicated it is unlikely to change over the near-term. The hike comes despite inflation remaining below the target rate, and reflected the bank’s view that negative rates have failed to stimulate the economy. Whether other central banks with negative policy rates follow suit, however, remains to be seen.

United Kingdom

In the United Kingdom, Boris Johnson led the Conservative Party to a decisive victory in the general election on 12 December. Up against a very left-leaning Labour candidate in Jeremy Corbyn, Johnson emerged with a majority of 80 seats and, with it, a clear mandate from the public to proceed with his Brexit plan. The result increases the chances that the 31 January 2020 Brexit deadline extension could indeed be the last one before the UK leaves the EU.

China

In positive news for the global economy, a ‘Phase 1’ trade deal between the US and Chinese governments was announced in mid-December after over two years of ongoing talks. The deal is likely to see a US$200 billion increase in Chinese purchases of US products and services over the next two years, plus exemptions for a number of US imports. The US, meanwhile, suspended planned tariffs on US$160 billion of Chinese imports, plus also halving previously-implemented tariffs from 15% to 7.5%. The formal signing of the deal is expected to occur in mid-January.

Nonetheless, trade tensions have started to take their toll on the Chinese economy, with Chinese third quarter GDP growth declining from 6.2% to 6.0%; the weakest rate since 1992.

You can download the full report here.