This Quarterly edition from Snowgum Financial Services provides you with an eight minute summary of matters to do with the economy, investing and markets.
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Key Stats
The RBA cash rate sits at 1.5%p.a. Most forecasters expect the cash rate to remain unchanged through 2019.
Australian GDP growth ended the year at 2.8%p.a.
Increased consumption was the largest contributor to GDP growth
Public sector demand was the second largest
Inflation remained at 1.9%p.a.
Wage growth improved slightly to 2.3%p.a.
US Economic growth was 3.4%p.a (to Quarter 3 2018)
The US unemployment rate ticked up 0.2% to 3.9% in December, mirroring a 0.2% increase in the participation rate. Still near record lows.
Global economic growth rate was 3.9% for 2018. Robust.
The fastest growing economy for 2018 was Libya with 55% growth. The global laggard was Venezuela at -16.6%, making it two wooden spoons in a row for the perennial global beauty pageant winners.
2018 in review
A late correction in equity markets was the key event for investors in 2018. Most equities, particularly those trading at higher price to earnings ratios, saw a material retraction in their share price.
Media and market noise aside, major economic drivers continued at a more sedentary pace, with most indicators generally flat or positive.
Globally
Globally, labour conditions remained positive. Wage growth saw a modest uptick in the latter half of 2018. Graph below left.
Longer term US labour participation rate data (graph below right) suggests that amidst the positive headline employment data, a large segment of the US labour force has been permanently shut-out from the job market since 2000.
Underlying forward indicator data appears to be stabilising in China. Inventory levels, purchasing managers index and fixed asset investment have all stabilised from earlier declines in 2018.
Trade tensions between the US and China have severely impacted Asian equity market sentiment.
In 2018 the US had a 344 billion (USD) trade deficit with China. Therefore China may have limited economic bargaining power in a prolonged trade war.
EU economic growth was sedate at 1.8% (based on year to Q3 2018 data).
BREXIT continues to dominate EU sentiment.
Domestically
Economic growth in Australia was driven by increasing consumption and public spending.
NSW and VIC were the engine rooms of the Australian economy.
Australia’s continuing infrastructure boom (part of the public spending component propping up GDP growth) is increasingly important in sustaining growth against a backdrop of credit tightening from lenders.
This tightening up of credit was the catalyst that brought the end of the east coast housing boom.
A generation of current and former Australian ‘blue-chip’ businesses struggled in 2018 (Telstra, the big four banks, AMP and Myer).
(Data from: United States census bureau, ECB, RBA, US BEA, CEIC Data, ABS, CoreLogic)
Investment outlook for 2019
Investing remains simple in principle – buy into good businesses at reasonable prices and be patient.
Interest rates, as a de-facto opportunity cost for not investing, govern what is considered a ‘reasonable’ price.
International Equities
The US Fed Reserve is continuing to raise interest rates.
As US rates normalise, further market volatility is expected.
For investors with an Asian appetite, valuations remain more attractive than for companies in developed markets.
However, with the shadow of a trade war looming, the Chinese market remains somewhat depressed.
Investment takeaway
Passive exposures remain exposed to large sentiment movements, given their proportional weighting to ‘growth’ businesses, making them susceptible to volatility.
Investment opportunity is best pursued, from a risk-adjusted perspective, via targeted exposures. Our preference remains for businesses trading at reasonable values with industry/sectorial tail winds.
Investors in Chinese businesses are having their patience tested and although the fundamentals look favourable, a conservative exposure seems prudent.
It is helpful to remind ourselves that “markets can remain irrational longer than you can remain solvent” – John Maynard Keynes
Domestic Equities
The drivers of current Australian GDP growth, consumption and public spending, are difficult to sustain over the long term.
Domestically focused mature businesses are facing more international competition, and some are ill-prepared for this competition.
Globally focused Australian based businesses (like RIO, CSL, BHP, COH and MQG) are better positioned to withstand competition, having exposure to broader market segments and more experience at adjusting to dynamic business conditions.
Fixed interest
The fixed interest paradigm has not greatly changed in the last few years.
Rates remain low and will probably remain so for some time. Therefore, shorter term contracts and/or with floating rate positions are more attractive.
Credit spreads remain tight, not providing investors much compensation for additional risk. Higher rated exposures are preferable in this environment, especially when fixed interest is held as a capital protection component within the portfolio.
Diversification remains, as it has always been, far more important across credit exposures than counterpart equity exposures. For most investors, a suitable fund manager is required.
Property
We don’t advise directly on property, so cannot comment with authority. Most properties are acquired with a large amount of credit. As the flow of credit finance has tightened, we expect demand for properties to continue to weaken through the first half of 2019.
A very small but less likely glimmer of hope is that after the final report from the Royal Commission, lenders again may become more confident to lend more funds for housing and construction.
On the supply side, holding property prices down, a record number of apartment completions are predicted for Sydney and Melbourne in 2019 and into early 2020.
The combination of increased supply and diminished demand points to further housing weakness. Investment property returns over the last few years, due to the high capital value of property, have been poor.
However, property is a large asset class and as with any investment sector, there will be good investments for anyone prepared to look hard enough.
Royal Commission Fallout
2018 was a turbulent year for the financial services industry, not least financial planning. The following section discusses our views and shares some of the changes taking place across the industry. From 1 January 2019, any new financial adviser will be required to hold a relevant degree and two years’ professional experience prior to becoming licensed… You’d be forgiven for thinking that this seems like common sense. However, prior to this, a four-week course was all that stood between finance novice and finance expert - a recipe for disaster. Existing advisers licensed before 1 January 2019 will have until 2024 to satisfy these new education requirements.
The Financial Services and Banking Royal Commission has proven a catalyst for overdue reform. 2018 saw major banks announce or follow through with their plans to demerge/divest their wealth management and insurance business divisions. We have consistently held the view that large institutions should not be both financial product and financial advice providers. This move, although positive, does not overcome some inherent conflicts within large wealth institutions that employ financial advisers to make recommendations on in-house financial products – (this article we wrote for Money Management in 2016 further discusses this belief).
Grandfathers everywhere were given a bad name when, through the Royal Commission process, it emerged that grandfathered commissions/payments remained a large component of some major institutions business models. Future of Financial Advice (FOFA) reforms, introduced in 2013, were intended to force businesses away from conflicted remuneration. The Royal Commission has resulted in a much quicker transition of businesses away from such remuneration.
Financial services industry consumer sentiment is at an all-time low. However the demand for compliance, risk and governance staff in the industry is at an all-time high (more here). The many changes within the financial services industry has challenged the profitability of many retail financial advice businesses.
As a result the regulatory cost and business infrastructure required (compliance, legal, licensing, remediation and operational personnel) to revamp financial advice businesses, let alone the public relations risk, has seen multiple bank CEO’s question the value of advice businesses.
Brian Hartzer, CEO of Westpac “Investing inevitably has a level of subjectivity around it which can mean that with the best will in the world results don’t necessarily come out the way you expect them to. The standards of documentation and proof that we’re now, as a general industry, expected to meet are very, very high, and so the cost of training, hind sighting, storing documents, auditing and the like is very, very high relative to the revenue associated with providing that advice.”
Shane Elliot, CEO of ANZ on Financial Advice “A service for the wealthy”
All major banks (except Westpac) have divested themselves, or are in the process of divesting themselves, of their advice, insurance and wealth management businesses. As the above quote would indicate, Westpac may soon also exit the wealth space entirely. AMP and IOOF are in disarray with a a significant share market bruising (and potentially more to come) and Macquarie Bank has flagged it has given up on retail advice completely.
Adding to the challenge for institutions, the supply of competent advisers will become constrained with new education standards expected to contribute to a reduced flow of new adviser entrants and an exodus of existing unqualified financial advisers from the industry. We have consistently advocated for higher education standards as one critical step, amongst several reforms, required to professionalise the industry. The steps towards professionalisation are discussed more broadly in this article from 2016.
It is not all doom and gloom for the financial advice industry, and the consumers using it. The upside for the consumer in the future will be a higher standard and more professional service from financial advisers. We expect to see advice fees rise with changes due to a combination of changing business models reduced adviser supply and higher consumer expectations. In addition, direct to consumer low-cost technology services will step in to meet the needs of less complicated consumer services.
By Matt Vickers
Principal Adviser at Snowgum Financial Services
Disclaimer
Any advice contained in this update is of a general nature only and does not take into account your circumstances or needs. You must decide if this information is suitable to your personal situation or seek advice. Prior to investing in any particular product, you should read the Product Disclosure Statement.
Snowgum Financial Services Pty Ltd (ACN 603 703 859 is a Corporate Authorised Representative (Corporate ASIC AR number 001001581 ) of Peter Vickers Insurance Brokers Pty Ltd (Australian Financial Services Licensee (AFSL) No 229302 & Credit Licensee (ACL) No 229302 ǀ ABN 68 074 294 081)..