Following a volatile December 2018 quarter the negative returns globally and domestically for risk assets what does the outlook across the various asset classes look like for the year ahead?
The cash rate looks likely to remain on hold at 1.5% for 2019 by the RBA. The ongoing weaker house prices combined with the post royal commission banking landscape will continue to limit housing credit growth. Further, credit conditions have already tightened over the past year for various reasons. Those who require credit are not getting access to it or are pushed towards alternative lending arrangements at much higher rates. Given this backdrop, the prospect for higher cash rates looks very unlikely in 2019. Higher cash rates will simply amplify the negativity already underway within the housing sector.
Fixed income is the essential defensive asset class for investors. They tend to have lower correlations of returns through the cycle vs equities. Exposure to bonds is essential to lower the overall volatility of your portfolio. This includes a blend of low yielding but highly rated and defensive sovereign bond funds, investment grade credit funds and some high yield (sub-investment grade) funds. Note hybrids are not a substitute for fixed income and never will be. They are just too subordinated and exhibit many equity characteristics. Therefore are not contributing to lowering the volatility of your portfolio like traditional fixed income would.
The weakness in equity markets in the previous quarter lead to negative returns for calendar 2018, which included the dividends. This negative return trend across many developed equity markets followed the first half 2018 emerging market equity rout that started in part to the stronger USD over a year ago. Ultimately equity markets are a good indicator of future prices and therefore confidence. Afterall, the earnings have been expanding. In the case with the US the earnings cycle was actually very strong in 2018, peaking in the September quarter.
Equity market valuations are now well below their long-run historical benchmarks and are once again compelling for investors. There will be ongoing elevated equity market volatility and markets continue to adjust to global growth downgrades and the uncertainties from US-China trade wars. Going forward, earnings will be expanding at a lower rate and the elevated market volatility is reflecting this. For the average Aussie investor, they would have at least 50% of their equity exposure in global equites. Over the long-run this is an ideal way to diversify your equity exposure into markets that offer growth in sectors not reflected locally. Home bias tends to work against you over time.
Exposure to some global property and infrastructure via some well established funds will remain part of the asset allocation at much smaller weightings to fixed income and equities. Further, exposure to alternative such and private equity, venture capital and some well credentialed hedge fund managers are appropriate and all help diversify the asset allocation, particularly towards some non-listed exposure.
For the year ahead market volatility is set to remain elevated. Your risk appetite and expected returns are important. This drives your asset allocation weighting across the various asset classes. It is behavioural therefore being aware of changing market conditions and knowing your risk tolerance is important. You need to sleep at night.
CIO | Atlas Capital
Director | Salter Brothers Asset Management (SBAM)
As seen also in Herald Sun, Thursday January 17, 2019.