2018 Investment Year in Review

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Key Take-outs

  • The comfy armchair ride global share investors experience during 2017 turned into a white-knuckled roller-coaster in 2018.
  • Key global share markets came under significant selling pressure from September on, with the US market falling sharply as the year ended.
  • After starting to fall in late 2017, residential property price falls accelerated in Sydney and Melbourne during 2018, while Hobart rose strongly.
  • Cryptocurrency, the investment mania of 2017, crashed in spectacular fashion, with Bitcoin falling 80% during 2018 .
  • 2018 proved there is no such thing as riskless returns, and that the occasional burst of volatility is the price of admission that all investors have to pay to receive returns better than Cash (i.e. 0% p.a. after inflation and before tax).
  • Low-cost diversification is still the single best way to get your fair share of market returns without flaming out on a single bet (ahem, #CryptoLife).

In our 2018 Financial Year in Review (for the year to 30 June 2018) we spoke about the unusual calm that had dominated markets during 2017, noting that “… 2017 produced a Goldilocks-like investment environment of steadily rising asset valuations.”

Unfortunately, as anyone who is familiar with the fairy tale knows, Goldilocks made herself at home in a stranger’s house, assuming it was a riskless act, only to be surprised by three angry bears unimpressed by her sense of self-entitlement.

As with Goldilocks, many share investors were lulled into a false sense of security during 2018, only to be mauled by a bear of a market.

The Hangover

After a period of near-uninterrupted growth in most major share markets from 2013 onwards, the party hit a sudden bump in February and March of 2018 as concerns in the US over rising official interest rates, coupled with President Trump’s unorthodox policy positions and administrative style, started to rattle markets.

While the middle of 2018 provided some temporary relief, share markets resumed a US-led fall from September over President Trump’s trade war with China, negotiations with North Korea and, towards year-end, the shut-down of certain government departments over funding for President Trump’s border wall with Mexico.

Investment markets were affected less by company or sector-specific issues in the US or elsewhere, with the corporate sector generally being in good health.  

Here in Australia our share market broadly followed the US, however the drivers were more sector-specific.

The financial services sector ended 2018 punch-drunk, having been the subject of many disturbing revelations during the almost year-long sitting of the Royal Commission in Misconduct in the Banking, Superannuation and Financial Services Industry (the Hayne RC).

By contrast our fixed interest (bond) and commercial property markets performed reasonably well, offsetting some of the share market’s losses.

As always, portfolio diversification proved its worth yet again, with these positive sectors helping to buffer our client portfolios from the full force of the late year share market falls.

Clover Portfolio Option Returns for 2018

The table below shows the returns for Clover’s core options for the year to 31 December 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 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 2018 calendar year for each index tracked by our Core portfolios are provided below. 

We have also decided to include a broad measure of the performance of cryptocurrencies in this year’s investment review. This is done for general information only, as Clover currently does not, nor does it have any plans to, invest in cryptocurrencies or any ETFs derived from cryptocurrencies.

We also provide the performance of the residential property market for your interest, despite the fact that Clover does not directly invest in Australian residential property or in any fund or index that may seek to track the Australian residential property market.

Cash: 1.9%

The Reserve Bank of Australia (RBA) elected to keep the official Cash rate at 1.5% through 2018, having assessed that threats to inflation were muted, given the cooling in the major property markets and no sign of wage inflation on the near-term horizon.

For now the RBA appears happy to sit and wait for the current housing downturn to play itself out, while the banking regulator APRA has moved to wind back restrictions to credit growth imposed on the banks in 2017 to make sure that credit supply isn’t overly restricted.

With headline inflation running at 1.9% pa, Cash is delivering an inflation-adjusted pre-tax return of exactly 0% p.a. now. Hence on an after-tax basis Cash is still delivering negative returns for tax-paying investors.

Australian Fixed Interest (Bonds):  4.6%

Australian government bond yields (interest rates) ended 2018 little changed compared to a year earlier, with the bell-weather 10 year government bond yield hovering around 2.28%, a fall of some 0.40% over the year (remember that as bond yields fall, bond prices rise).

Even longer-dated government bonds, such as the 15 year tenure, have been similarly benign, with a yield of 2.53% at present, some 0.38% lower than a year earlier.

To be fair though, the bond market has to some degree been captive to a cautious RBA on the one hand, and skittish share markets on the other.

As volatility flared in global share markets from September on, money poured into bond markets, with nervous institutional investors seeking the relative safety of government bonds. Any port in a storm, as the saying goes.

Corporate bond markets continue to do broadly in line with government bonds, with the balance sheets of large corporations now flush with cash. It appears that conservative gearing levels are the order of the day in many a boardroom around the world at present.

Australian Shares:  -2.8%

The broadly based S&P/ASX 200 Accumulation Index (ie incorporating both price changes and dividend income) finished 2018 down 2.8%, after a very rocky second half.

Concerns about the revelations during, and the future impact of, the Hayne Royal Commission dominated the Australian market during the year.

With the Australian financial sector accounting for some 33% of the S&P/ASX 200,  the Royal Commission revelations resulted in the four major banks, together with wealth managers AMP and IOOF, losing more than $80 billion of their collective market value during the year, as the financial sub-index of the S&P/ASX 200 fell 9.73% during 2018.

Other than financials, the rest of the Australian share market was a bit of a mixed bag, with Information Technology generating a 7.26% return and Consumer Staples a 4.74% return.

The best performing sector during 2018 was Healthcare, which rose 19.25% for the year. By contrast, Communication Services was the worst performing sector, falling an astounding 17.94% in 2018.  Thankfully it accounts for only around 3.5% of the S&P/ASX 200 Index.

International Developed Markets (Currency Unhedged): -0.4%

In earlier investment briefings we had made mention of the unusual (by historic standards) calmness of global share markets in 2017, warning in our 2017 Investment Year in Review that “[d]uring 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.”

True enough that smooth 2017 armchair ride turned into a rollercoaster during 2018, and how! 

The key US S&P 500 index fell 4.4% during the year, with defensive sectors like Healthcare (up 6.5%) and Utilities (up 4.1%) holding up well, while the important Financials sector fell 13%. The worst performing US sector was Energy, with a 18.1% fall over the year.    

Brexit discussions in the UK continue to weigh down the share market there, with the FTSE 100 down some 12% during 2018. The UK is scheduled to leave the EU in March this year, but it remains to be seen whether Brexit will ultimately deliver a Great or Little Britain.   

The manufacturing heavy German DAX index fell some 18% on trade concerns, France’s CAC 40 index finished some 10% lower, fueled by social unrest at the fiscally conservative policies of President Macron, and Japan’s Nikkei 225 index fell some 12% over the course of the year, despite signs of improvement in the Japanese economy.

It should be noted that our clients benefited from being mostly currency unhedged during 2018, with the hedged international developed markets index returning -10.3%.

The large difference between the hedged and unhedged returns for international developed share markets predominantly reflects a falling AUD/USD exchange rate, from 78.03 cents at the start of the year to 70.49 by year’s end.

Global Emerging Market Shares (Currency Unhedged): -7.7%

Global emerging share markets had a torrid 2018, whipsawed by events largely out of their control.

China’s Shanghai Composite index fell around 23% during 2018, as concerns mounted over the trade protections imposed unexpectedly by the US in the early part of the year.  

The dominance of the Chinese market on global developing share markets helped pulled down an otherwise reasonably decent year among some of the other key developing markets.

India’s BSE Sensex share market index rose some 7% during 2018, while a change of government in Brazil saw the key Bovespa index there rise some 12% over the full year, aided by a stunning 20% gain during the second half of 2018.

As with developed markets, the falling Aussie dollar provided some protection for unhedged investors in emerging markets, although the effect was more muted, with the AUD falling only some 5% against the Chinese Yuan and less than 2% against the Indian Rupee.

Australian Commercial Property: 2.9%

Australian listed commercial property funds, such as Australian Real Estate Investment Trusts (A-REITs), had a relatively good year compared to listed companies, delivering a positive return for 2018 on the back of high rental yields across key market segments.   

With robust economic conditions across much of the eastern seaboard, the A-REIT office sector continues to perform well, with solid demand for office space in both Sydney and Melbourne, Australia’s two fastest growing cities.

While yields have ticked up a touch over 2018, there continues to be ample scope for quality property managers to value add through lease management initiatives in both the office and industrial sectors.

Concerns still exist in the retail segment however, with slower growth anticipated for regional, sub-regional and neighbourhood retail property.  

Australian Residential Property*: -3.6%

According to just released results from data analytics firm CoreLogic, Australian residential house prices fell 3.6% in 2018, with the nationwide fall in dwelling prices (incorporating both houses and units/apartments) even steeper at 4.8%.

Sydney experienced the sharpest decline in dwelling prices at -8.9%, while for Melbourne it was -7%. For Perth it was -4.7% and for Darwin it was -1.5%.

Even with these corrections, it is sobering to think that breaking into the Sydney property market now still requires $808,494 (for the average dwelling), or a 20% deposit north of $160,000 (not factoring stamp duty and other associated costs of acquisition).

It’s still far from easy for Australians wishing to own, rather than rent, the roof over their heads.

Brisbane dwelling prices rose (0.2%), as did Adelaide (1.3%) and Canberra (3.3%).  Hobart continues to buck the national trend, with dwelling prices rising a remarkable 8.7% during 2018.

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.

Cryptocurrencies*: -82.7%

What a difference a year makes. This time last year all the talk was about Crypto Bros’, their yellow Lamborghinis and early retirement plans to cruise between Coachella and Burning Man on a never ending hedonistic binge.

Bitcoin (BTC) in particular amongst the various cryptocurrencies, had captured the imagination of younger investors who were disenchanted with and distrustful of ‘traditional’ methods of storing and building wealth.

BTC started 2017 at around US$890, only to streak to an all-time high just under US$20,000 as 2017 ended. It was, with the benefit of hindsight (alas, as is always the case in investing) too good to be true, and since late 2017 began what can only be described as a collapse of mind-boggling proportions.

BTC closed 2018 at around US$3,900, a fall of close to 80% within the space of 12 months.

To put that in perspective, the crypto mania of 2017 has now eclipsed all previous speculative bubbles throughout the ages, and by a comfortable margin, as the below graphic from Bloomberg illustrates:

Source: Bloomberg https://bloom.bg/2GQQoWV  

While we do not denigrate the blockchain, the underlying technology behind all cryptocurrencies, what happened in 2017 was speculation, pure and simple, fed off the belief that you could get crazy rich, crazy fast without any effort or risk.

The sad thing is that many novice investors, envious of seeing their friends get stupid rich, would have been drawn into the world of crypto investing right as the bubble was about to burst in late 2017.  

And how it burst! The chart below shows a comparison between the US S&P 500 share market index and the Bloomberg Galaxy Cryptocurrency Index. While the 8% S&P 500 price drop was not pleasant, the 80+% Crypto index decline was on another scale of pain altogether.

S&P 500 Index Versus Bloomberg Galaxy Cryptocurrency Index 4 Jan 2018 – 3 Jan 2019

The memory of 2018’s crypto losses may haunt some investors for years to come, but there is a valuable lesson here for all; no matter how much of a sure thing it seems at the time, there is no such thing as a riskless return.

* Clover does not invest in cryptocurrencies, index constituted by cryptocurrencies, Initial Coin Offerings backed by cryptocurrencies or ETFs that invest in any of these.  This content is provided for informational purposes only, and should not be construed as a recommendation or offer to buy, sell, or otherwise deal in cryptocurrencies.

Keep Calm and Carry On

The best that we all can do as investors is to diversify intelligently, keep costs constrained and spread the risks between as many different return sources as practicable, knowing that in any one year some will shoot the lights out, others will produce a steady if unspectacular incandescence, and a few may just flame out, perhaps spectacularly.  

Diversification may mean always having something in your portfolio that has underpeformed (as Global Emerging Markets has in Clover portfolios during 2018). But much more importantly, diversification also means never flaming out so spectacularly that there is no way back.

So stay diversified, keep calm and carry on investing. You’ll be far better off in the long-run for having done so.

 

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