2017: The Investment Year in Review

financial markets

Another year is behind us. 2017 was a year where politics, both global and domestic, seemed to dominate the news, from the ongoing turmoil in the White House, to the Parliamentary citizenship debacle here, and the historic passing of the same sex marriage legislation just as the year drew to a close.  

On the investment front, most markets and asset classes delivered returns significantly above the forecasts of a year ago. 2017 was a year in which risk was amply rewarded, with global sharemarkets in general, and emerging markets in particular, producing outsized returns for investors.  

Clover portfolio options benefited from the strong run up in global sharemarkets during 2017, in being constructed to provide more exposure to international shares relative to Australian shares, a positioning that added to relative returns during the year.

Clover Portfolio Option Returns* for 2017

Clover Portfolio Option 1 Year to 31 December 2017 (%) (After Fees*, Pre-Tax) 1 Year to 31 December 2017 (%) (After Fees* & Inflation, Pre-Tax)
Conservative 4.7 2.9
Moderate 6.4 4.6
Balanced 8.1 6.3
Growth 10.1 8.3
Aggressive 11.9 10.1

* The returns in the table have been calculated based on a notional $50,000 portfolio invested for the entire period without any additional contributions or withdrawals.   

The table above shows the returns for Clover’s core options for calendar 2017. The first column indicates what each Clover option generated on an after-fee basis, while the second column adjusts the returns for the effects of inflation, giving a more insightful view into the growth in purchasing power generated by each option’s returns.

By any measure 2017 was a buoyant year from an investment perspective. Not only did most share markets deliver returns significantly above their long-run averages, many did so with a level of risk (as measured by the volatility of price changes) lower than the historical average.  

As an example, the Dow Jones Industrial Average (“the Dow”), the US index of 30 of the largest companies listed on the New York Stock Exchange, returned 25.08% in 2017, ending the year at a new all-time high of 24,719 points.

During the year the Dow reached more new highs (71) than any other year in its 121 year history, while daily volatility was lower than at any point since 1964. Astute investors would do well not to assume 2017’s benign market conditions are a ‘new normal’ in investment markets. 

Asset Class Returns for 2017

Asset Class Benchmark % Return (Year to 31 December 2017)
Cash Bloomberg AusBond Bank Bill Index 1.7
Australian Fixed Interest (Bonds) Bloomberg Composite Aust Bond Index 0+ Years 3.7
Australian Shares S&P/ASX 200 Index 11.8
International Shares (currency unhedged) MSCI World (excluding Australia) Index 13.8
International Shares (currency hedged) MSCI World (exc. Australia) AUD hedged Index 20.1
Global Emerging Markets MSCI Emerging Markets Index 27.1
Australian Commercial Property S&P/ASX 200 A-REIT Index 5.7
Australian Residential Property (Houses – combined capitals average) CoreLogic 4.0
Inflation (latest quarter) CPI 1.8

Cash: 1.7%

With the official cash rate held by the Reserve Bank of Australia at 1.5% p.a.for the sixteenth month in a row, the return from holding Cash continues to be muted. Seen from an after-inflation perspective, and with headline inflation currently running at 1.8% pa, Cash is delivering a real return of -0.1% p.a. at present. And that’s before taking tax into account.   

While there is a possibility that Cash rates here might start to rise during 2018 in response to rising rates in the US and elsewhere, the RBA will be concerned about the impact that lifting rates could have on Australia’s heavily indebted households.

Australian Fixed Interest (Bonds):  3.7%

Australian government bonds yields eased during the second half of 2017, as did corporate bonds yields. As a result, returns from Australian bonds lifted from being flat halfway through 2017 to finish the year modestly positive.

Financial market pundits have been talking down the prospects of bonds for several years now, expecting bond prices to fall as the US unwinds its decade-long quantitative easing program. So far bond returns have instead been steadily, if modestly, positive.   

Australian Shares:  11.8%

The broadly-based S&P/ASX 200 rebounded from a mid-year lull to end the year 11.8% higher, up from the 9.3% financial year to 30 June 2017 return.  

Much of the return in the Australian sharemarket was generated by companies outside the top 50 by market size, with the S&P/ASX Midcap 50 returning 22.06% for the year.

Financials (incorporating the big four banks) constitute the largest sector, at over 35% of the S&P/ASX 200 index. 2017 was not a stellar year for financials, with most of this sector’s 5.04% return coming in the last three months of the year.

The best performing sector for 2017 was healthcare, with a return of 26.35% (but accounting for less than 8% of the overall index). Telecommunications services was the poorest performing sector, falling 21.3%. Thankfully its weighting in the broader index is a modest 3%.

The almost 48% difference between the best and worst performing sectors of the Australian sharemarket during 2017 is a stark reminder about the importance of investment diversification in portfolio construction, both within an asset class (such as Aussie shares) and across different asset classes, to prudent investing.

International Shares (Currency Unhedged):  20.1%

As the aforementioned 25.08% return on the Dow indicated, 2017 turned out to be a stellar year for US sharemarkets. The US accounts for some 56% of the world’s sharemarket, and so a buoyant US market generally results in strong international share returns for developed markets (exchange rate effects notwithstanding).

Two key sectors drove the US sharemarket during 2017; Information Technology and Financials.

Information Technology dominates the US sharemarket in much the same way Financials dominate Australia’s. It accounts for some 24% of the broader S&P 500 index, with Apple, Microsoft, Facebook, and Alphabet (Google’s parent entity), together with Amazon (which falls instead in the Consumer Discretionary segment) now comprising 5 of the 10 largest companies in the S&P 500 index.

Collectively the US Information Technology sector returned in excess of 30% during 2017 (based on the return of the S&P Technology Select Sector index).

US Financials struggled through much of 2017, however finished strongly, on the back of significant tax reforms initiated towards the end of the year by the Trump administration, including a measure to reduce the US corporate tax rate from 35% to 21%.

Overall the financial sector generated a return of some 19.43% (based on the return of the S&P Financial Select Sector index).

Other developed international sharemarkets also performed strongly, with both Germany and France delivering returns in excess of 25%, while Japan delivered a 21.8% gain.

Global Emerging Market Shares: 27.1%

Global emerging sharemarkets were the strongest performing asset class in Clover portfolios for 2017. Companies in rapidly developing economies such as China, India, Brazil, Turkey, Russia and Indonesia are included in global emerging market indices, and many benefited from strengthening export markets as trade liberalisation initiatives continued apace.    

As with the US sharemarket, the emerging market story during 2017 was very much dominated by the Information Technology sector, with Chinese tech companies in particular, including entities such as Tencent Holdings, Alibaba and Baidu, benefiting from strong investor appetite.

While the Chinese sharemarket was the standout performer (with the China A 50 index rising 46.9%), India (36.8%) and Brazil (21%) also made strong contributions. Russia, in contrast, had a less than stellar year, with its sharemarket return only just positive, at 0.27%.

Australian Commercial Property: 5.7%

The Australian commercial property sector performed steadily during 2017, as investor sentiment was tempered somewhat in the retail sector, where the prospects of growth in rental yields remain muted amidst the continued growth in online retailing.

The office and industrial sectors were better supported, with investors more confident about the outlook for both capital growth and rental yields in these areas.

Australian Residential Property*: 4.0%

After a stellar run during the previous three years, the Australian residential property market finally showed signs of cooling as 2017 drew to a close, particularly in the two largest markets of Sydney and Melbourne.  

The slowing in house price growth can be largely attributed to initiatives by the lending regulator APRA during 2017 to curb the amount of interest-only and low quality, low deposit financing being provided by banks and other mortgage financiers.

The tighter lending standards have transmitted to a lower level investment related activity in the Sydney property market, with data from property research provider CoreLogic indicating that Sydney house prices actually fell 2.9% in the final three month of 2017, with prices only rising 2.1% for the entire year.

Among the other major markets Melbourne house prices rose 9.1% for the year (but did record a fall of 0.4% during December), Brisbane and Adelaide rose 3.1% and 3.3% respectively, while Perth house prices fell by 2.6% and Darwin by 5.3%.

* Clover does not invest in direct Australian residential property. Depending on their Clover option, investors may however have some exposure to the Australian residential property market via exposure to certain A-REIT companies that may be involved in residential property development and/or land banking.

Outlook for 2018: Peering into the Crystal Ball

We’re not great fans of investment forecasting, given that precious little evidence exists to indicate that anyone can consistently predict the state of future financial markets.

The inability to devine future market movements is the reason savvy investors don’t place too many eggs in too few baskets. By being appropriately diversified you’re less likely to miss out on the outperformers, and it’s hard to be more diversified at a lower cost than through the use of passive investment strategies.

That said, astute investors need to be alive to the investment threats and opportunities surrounding them, to minimise the possibility of being impacted by risks that could reasonably have been identified in advance. So below are some of the key issues and factors that we think could impact on investment markets during 2018.

International outlook

As we move into 2018 geo-political risks continue to be a source of concern, including the rising tensions over North Korea’s continued development of its intercontinental ballistic missile (ICBM) capabilities, the progress of Brexit negotiations in the lead up to the planned separation date of 29 March 2019, and potential fallout in the US from the investigation into Russia’s alleged involvement in the November 2016 Presidential election.

Financial markets will also be fixated on the appointment of a replacement for US Federal Reserve Chair Janet Yellen, with the President’s nominee, Jerome Powell, a strong candidate to replace Yellen when her term ends in February.

Bond markets in particular will be looking for signs as to whether the new Chair will continue Yellen’s unwinding of the low interest rate policy first implemented during the Global Financial Crisis. Under Yellen the US Fed Funds Rate has lifted from near zero in late 2015 to now sit at around 1.4% p.a.

The U.S. share market enjoyed a year-end rally as the prospect of a cut in the corporate tax rate lifted the outlook for corporate profitability for the year ahead, and as recent jobs data indicates that US economic activity continues to expand.

Australian outlook

The Australian economy hasn’t enjoyed the same level of expansionary activity as the US, and while some 400,000 jobs were added during 2017, income growth remains worrying low. This, combined with concerns over high household indebtedness, could constrain consumption as households deal with the prospects of higher energy costs and higher mortgage rates (if continued rate rises in the US transmit to higher funding costs for lenders here).

With the banking sector such a key driver of the Australian sharemarket, this year’s banking Royal Commission will be an unwelcome distraction for not just the banks, but for superannuation funds and other financial services entities that have been included in the Commissioner’s scope of enquiry.

That said, and according to recent survey results, business confidence is currently well above the long-term average (with the exception of the retail sector), so it would be premature to confine the Australian sharemarket to ‘also ran’ status for 2018.

And so to the million-dollar (literally, in many cases) question; what will happen to Australian residential property prices during 2018? First home buyers would welcome some relief from the brutal run up in average house prices experienced over the past five years. Property investors, however, would be impacted if it were to happen, particularly where low deposit, interest-only loan facilities are in place.

In reality is that there is no one housing market in Australia. Each city has its own characteristics in terms of land availability, jobs growth, net annual migration, mix of property types and development regulation that dictate supply/demand dynamics. So while the average Sydney and Melbourne first home buyer has all but been priced out of inner-ring (less than 10 kms from CBD) freestanding properties, the Perth property market has delivered a very different experience recently.

As to whether the cooling now evident in pockets of Sydney and Melbourne will accelerate, much will depend on how much investor demand is crimped by the tighter standards imposed on investment loans. The early signs are that investor activity is waning, while first home buyer activity is rebounding.

Disclaimer


Also published on Medium.