2018 Financial year in review

financial markets

 

The 2017/18 financial year just ended could best be characterised as a story in two parts. The first half was one of unbridled optimism in investment markets, as a steady stream of positive economic news buoyed asset prices both in Australia and abroad.

Strong US economic growth pushed the unemployment rate there to 4% p.a by year’s end, a level not seen since January 2001, while here employment grew by a net 393,000 jobs during calendar 2017.  The US sharemarket received a further boost as 2017 came to a close, when Congress passed a raft of tax reform measures in December.

Both developed (broadly North America, Europe, Japan and Australia) and emerging share markets performed  strongly, as did most major asset classes. As a result, 2017 produced a Goldilocks-like investment environment of steadily rising asset valuations.

The first half of 2018 has been considerably less Zen for investment markets, as concerns about the potential impact of rising US interest rates rattled sharemarkets in early February. More recently growing alarm at President Trump’s decision to impose tariffs on a range of imported goods and commodities, has raised the spectre of a trade war between the world’s two largest economies, the US and China.

Conditions for Australian investors have also moderated in 2018, with a tightening of lending standards imposed by the bank regulator, APRA, in March 2017 finally taking the heat out of the east coast residential property market, particularly Sydney, from around September onwards.

The commencement of hearings by the Royal Commission into banking, superannuation and financial services has also surfaced some questionable banking, lending and financial advice practices, dampening the valuations of some of the largest companies on the Australian sharemarket.

While the financial sector has struggled so far in 2018, other sectors, including healthcare and consumer staples, have performed strongly.

Clover Portfolio Option Returns for FY 2018

Clover’s portfolios performed broadly above expectations during the financial year, mainly due to the strong run up in equity markets as 2017 came to a close.

The table below shows the returns for Clover’s core options for the year to 30 June 2018. The second column indicates what each Clover option generated on an after-fee basis*, while the third 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.

Asset Class Returns for FY 2018

Clover portfolios are created from building blocks at the asset class level, with each Exchange- Traded Fund (ETF) deployed in client portfolios aiming to track as closely as possible the performance of a particular asset class index.

The returns for the 2017/18 financial year for each index tracked by our Core portfolios are provided below. We also provide an index of house prices (the average of five major capital cities) as well as the most widely quoted measure of consumer price inflation, the consumer price index (CPI).

Cash: 1.8%

The last time the Reserve Bank of Australia (RBA) changed the official cash rate was almost two years ago in August 2016, when the rate was reduced from 1.75% p.a to its current 1.5% p.a. This is now the longest consecutive period without a change in the official cash rate since at least 1990, highlighting the fact that domestic economic conditions continue to remain subdued.

Recent RBA comments suggest that the Bank is increasingly concerned about the effect of any rate rise on household consumption, given that incomes have been growing more modestly than anticipated while household debt remains high. The prospect of a rate rise before 2019 has receded somewhat as a consequence, with some market commentators even raising the possibility that the next rate movement may be down rather than up.

With headline inflation currently running at 1.9% pa, Cash is delivering an inflation-adjusted pre-tax return of -0.1% p.a. at present.

Australian Fixed Interest (Bonds):  3.1%

Australian government bond yields (interest rates) ended the financial year broadly in line with where they were a year earlier, with the 10 year government bond rate hovering around 2.58% as the financial year came to a close.

After drifting up during the first half of the financial year, government bond yields reversed as a bout of sharemarket volatility during February and March this year saw bonds in demand for their defensive qualities.

Corporate bond markets have performed broadly in line with government bonds, with very little movement in the spread (the difference in yields between government bonds and those issues by companies).

Australian Shares:  13.0%

The broadly-based S&P/ASX 200 Index had a lacklustre start to the financial year, essentially trading sideways from July to October 2017.

The Australian sharemarket then took its lead from Wall Street, as US equity markets rose through the back end of 2017 on the prospect of President Trump’s package of corporate tax reforms being enacted.  The final package passed through the US Congress in late December.

Investors were however given a short, sharp reminded in early February that markets can fall as well as rise, when US equity markets fell sharply on fears the gains had been overdone, with Australian markets similarly impacted.

As the largest sector of the S&P/ASX 200 Index (at approximately 33%), the financials sector has been impacted by revelations of improper practices that have surfaced at the banking, superannuation and financial services Royal Commission since public hearings commenced in mid March.

While financials have been a drag on the S&P/ASX 200 index so far this year, healthcare and consumer staples, together accounting for some 16% of the index, have performed strongly, with the healthcare and consumer staples sectors generating a price return (i.e. not incorporating any income) of 24.5% and 12.3% respectively for the year to date.

International Shares (Currency Unhedged):  15.7%

Developed international sharemarkets have delivered a much bumpier ride so far in 2018 compared to calendar 2017.  In many ways 2018 is providing a more typical investing experience, with its mix of market spurts, lulls and occasional dips.  In contrast, 2017’s escalator-like upward ride for many developed sharemarkets was an enjoyable, yet ultimately unsustainable, aberration.

The US S&P500 index rocketed into 2018 off the back of strong economic growth numbers and the passing of significant tax cuts into law. The euphoria was short-lived however, as February saw a short, sharp downturn in markets, with a 12% pullback occurring in the space of less than two weeks. Since then US markets have trended upwards but have yet to recover their 2017 year-end levels.

International markets have also been impacted by growing concerns around the political stability of countries such as Spain, Italy and Austria.

Matters have not been helped by the Trump administration’s June announcement of tariffs (i.e. punitive taxes) on a range of imports such as steel and aluminium, applying equally to close allies Canada, Mexico and the European Union as they do to China.

Much of the nervousness in developed sharemarkets so far this year has been due to rising political tensions rather than deteriorating economic fundamentals, with corporate profitability still robust across the major global economies.

Global Emerging Market Shares: 9.9%

As with the more developed markets, emerging sharemarkets have given back some of the exceptional performance of 2017, for much the same reasons.

China’s Shanghai Composite index is down around 12% for the year to date, in part on rising concerns over debt levels now held both on corporate balance sheets and amongst households.

A recent emerging market darling, Turkey’s main sharemarket index is down around 17% for the year, due in large part to global investor nervousness at announcements made by the recently re-elected Erdogan government. Political tensions in other emerging economies, including Brazil and Argentina, have also dampened investor appetite, and returns there.

Not all emerging markets have had a tough time during 2018, with India’s Sensex sharemarket index up almost 10%, on the back of strong economic growth that is currently running at over 7% per annum.

As many emerging economies are highly dependant on exports to large developed countries like the United States to foster growth, the escalation in global trade tensions is not a welcome development for these countries.

Australian Commercial Property: 13.0%

After a robust performance during 2017, Australian Listed Real Estate Investment Trusts (A-REITs) have had a more sombre start to 2018.

The A-REIT sector has slightly underperformed the broader Australian sharemarket so far this calendar year, rising 2.99% against the S&P/ASX 200 gain of 4.29% on a price basis.

The impact of rising funding costs have taken some of the lustre off commercial real estate, while the continued expansion of online shopping continues to impact traditional brick and mortar retailers and the malls and shopping centres in which they operate. Offsetting this is the continued strong performance of both the office and industrial property sub-sectors.

Australian Residential Property*: -2.5%

The slowing in Sydney and Melbourne residential property prices, first evident late last year, has definitely taken the upwards momentum out of the residential property market.

The market took some time to adjust to tighter lending standards imposed on the banks in early 2017, with these policy adjustments not showing up in a softening of house prices on the east coast until September.

The scrutiny of bank lending practices has also been significantly amplified by the recent Royal Commission hearings into lending practices, with banks responding by adjusting loan assessment procedures and tightening lending standards.

These changes are likely to disadvantage property investors, who will find it harder to finance property acquisitions, but could equally disadvantage first home buyers who may find themselves having to save a larger deposit as banks adjust their loan-to-valuation ratios downward.

According to data from CoreLogic, Sydney dwelling values have fallen some 4.5% over the past year, while Melbourne values have softened by 1.8% since the start of the year.

Among the other capital cities it’s a case of a north/south divide, with Darwin prices falling 7.7% over the past year, while Hobart prices have risen an astonishing 12.7%, albeit off a relatively low base.

 

Index used: CoreLogic
* 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.


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