As we approach the Christmas holiday break there is the inevitable analysis and forecasting for the year ahead. Despite some cynics, forecasting is an essential part of the investment process and helps investors to reflect on their portfolio asset allocation, their target expected returns and how much volatility they can tolerate to achieve their financial target.
A key feature of 2018 has been the de-synchronisation of global growth activity. That is, the US economic momentum has been stronger, however, other key economies are growing at a softer pace. Hence the recent IMF downgrades of 2019 global growth to 3.7%, down from 3.9% previously.
The December quarter is obviously very important for retail sales and the period will have a notable impact to economic activity. In the US, the retail holiday season frenzy starts this Friday, the day after Thanksgiving. This is also known as Black Friday. The worlds largest economy has seen some very robust economic growth this year, in part due to the tax cuts a year earlier, and the near full employment. US earnings have also been very strong with the recent US quarterly reporting period confirming the surge in US corporate profits. However, it would be fair to say that US earnings will not grow to the same extent in 2019. The higher US rates and USD will act as a partial brake in the year ahead.
Domestically, there are limited tailwinds for notable acceleration in discretionary retail sales. The well flagged fall in median house prices in the key Melbourne and Sydney markets will impact household wealth effects. The lending credit crunch currently underway post the royal commission imply lower housing finance, therefore lower building approvals. The low unemployment rate is supportive however a key driver for demand for housing, immigration levels, appears to be in line for some cuts in the year(s) ahead.
The contribution of exports and some key infrastructure projects domestically have been the main contributors to economic activity this year. Fortunately, this theme is expected to continue in the year ahead. The challenge will be for the RBA to keep the official interest rate at the historic lows of 1.5%. The slowdown discretionary retail sales, falling median house prices and tighter bank lending conditions all imply the RBA will need to be on hold for the foreseeable future. Raising rates in the next year will amplify the worsening median house prices.
The challenges for the Australian equity market in 2019 will be the higher funding costs globally for companies as the US continues to raise rates, a slowdown in our key trading partners (China) and any worsening of the trade wars which impact a trading economy like Australia.
On balance, maintaining an overweight to equities given the recent market correction, plus some quality diversified property funds, (A-REITs) and non AUD assets for the year ahead is the preferred recommendation given the balance of risks. Remember that equity markets are volatile, and your time horizon needs to be a three year plus outlook. Further, just like most years, investors should anticipate some negative return months in 2019. The recent October market correction has seen valuations become more compelling.
When you get some time to reflect, the holiday break is a great time to thoroughly review your asset allocation. It is an ideal period to spend reviewing your whole portfolio whilst you rest and recharge at the beach. Your asset allocation needs to reflect your expected returns and your tolerance for market volatility over time.
CIO | Atlas Capital
Director | Salter Brothers Asset Management (SBAM)
As seen also in Herald Sun, Tuesday November 27, 2018.