2019 was a bumper year for investors, so can we expect more of the same in 2020? Or is a pullback inevitable?
I receive reports almost daily from fund managers and financial institutions. In the last few weeks they’ve tended to focus on the current state of the global economy and what that means for investment markets. So in this episode I’ll be distilling their various insights, and providing my take on a few of them too. I hope you enjoy.
Let’s kick things off with a quick look at what 2019 delivered for us.
There were two key drivers for the year – the United States choosing to embark on a trade war with China, and central banks around the world cutting interest rates.
These two events are certainly linked, with the trade war hurting global economic activity, and causing central bankers to cut interest rates to try and offset the trade wars depressing effect and ward off a recession.
These actions proved successful, especially in the US, where unemployment is now at a very low 3.5%, a long way for the 10% reached during the last recession in 2008.
Low interest rates also drove up investment markets, as low risk investors were forced to hunt for better returning alternatives to generate sufficient income. In Australia this meant traditional term deposit investors moving money into shares for the dividend available.
Here’s some numbers to paint the picture:
In 2019, local Australian shares had a total return of 23.4% – HUGE!
But the US market did even better, up 31.8%
Emerging markets were more subdued at 18.6%
Even bonds had a good year, returning 7.3% in Australia as low interest rates pushed up prices.
Now it is worth pointing out that markets dropped quite sharply in the back end of 2018 and bottomed around Christmas day. So the 12-month measurement for 2019 is starting at a bit of a low point. In fact, if you look over 2 years and take the average, the return comes down to 5.1% per year over the last 2 years, so you can see, last year was to some extent a bounce back off a weak 2018.
It’s a good illustration though of why investing is a long-term game. No one would have foreseen at the start of 2019 that you would get 20%+ investing in shares.
2019 was great, but that’s behind us now. What do we have to look forward to for 2020?
The two big drivers for 2019 were trade tensions and interest rates. So let’s start there. As I put this together, markets are optimistic that whilst not completely resolved, the trade dispute seems to have calmed down quite considerably. There’s a feeling that with an election coming up in the US later in the year, Washington would like to see this matter put to bed.
Markets have therefore kicked off the year positively on an expectation that global economic growth will improve, or at least not deteriorate as had been the worry if things really heated up between the US and China – the two largest economies in the world.
With trade dispute concerns having eased, the need to cut interest rates any further has evaporated. The US Federal Reserve has already indicated that they expect interest rates to remain on hold throughout 2020. Here in Australia, a further interest rate cut remains possible, with unemployment stuck at around 5%, but rates going sideways through 2020 wouldn’t surprise at all.
Investment markets then won’t get the lift provided by falling interest rates again this year, but they might be lifted instead but a stronger global economy leading to increased company profits.
Share markets broadly look expensive in historical terms. On a Price to Earning valuation basis, the Australian market is the most expensive it has been since 1960. That must give pause for thought. What is different now? The answer is low interest rates.
In 1960 Australia’s official interest rate was 5%. Today it’s 0.75%. This suggests shares have plenty of room to increase since the price investors are willing to pay for investments depends on the alternatives available to them. Right now Australian investors can put their money in a bank term deposit and get around 1.5%. Or instead they could buy the ASX200 index and collect a dividend of over 4%, with tax credits on top. Relative to term deposits at least, Australian shares continue to look attractively priced, even whilst they look expensive in historical terms.
What are the key risks we should watch for?
Number one is the US China relationship taking a turn for the worst, mostly likely caused by election posturing.
Geopolitical risk is ever present. It wasn’t so long ago that all the focus was on the collapse of the Greek economy and what that would mean for the European Union. Periodically the world worries about an erratic North Korea. Currently the potential threats look to be an escalation of the conflict in Iran, and Hong Kong protests causing a China crackdown that results in global sanctions and trade disruption.
But who knows what might pop up as the year unfolds?
Inflation is the other potential risk. It has been the missing ingredient in global economies for a long time, but if economic growth does pick up, wage rises should occur, with rising prices to follow. If Central Banks become worried about inflation, interest rates will rise, potentially undoing the gains in investment markets seen in 2019.
From all the commentary I’ve seen, I think the outlook for 2020 can be summed up in two words – Cautiously Optimistic.
Thanks for reading. I hope 2020 proves to be a great year for you.
General Advice Warning