December 2018 vs. December 2019: Then versus Now.

Despite the bumps felt along the way, the past year proved to be markedly positive for investors.

Strong returns were generated despite economic slowdowns in many parts of the world propelled by the US-China trade dispute, the protracted manoeuvring surrounding the United Kingdom’s exit from the European Union, and political flashpoints such as the civil unrest in Hong Kong. The escalating use of “tit for tat” trade measures by the US and China dampened global trade and led to a drop in business confidence.

What proved to be a strong counter to these negative influences was the monetary policy “U-turn” by the US Federal Reserve and other central banks. A total of 20 central banks have cut interest rates over the past 12 months - some to record lows - while some also renewed or increased asset purchases. This had the effect of pushing bond yields down (again) - at one stage over $17 trillion bonds trading with a negative yield. This also fuelled a steady rise in sharemarkets, with higher yielding companies proving particularly attractive to investors. Similarly, in New Zealand, the Reserve Bank of New Zealand lowered the Official Cash Rate in two steps to 1.0%, which included a surprising 0.5% reduction in August. This buoyed both the housing market and the share market, with the latter posting its strongest annual return in nearly twenty years. The NZ sharemarket’s higher dividend yield proved irresistible to international investors and it was once again one of the highest performing markets in the world.

Diversified portfolios benefitted from the strong returns found in the majority of asset classes, with 12-month returns sitting comfortably higher than both their 5-year averages and the returns of 2018.

Late 2018 saw trade tensions between the United States and China escalate, leading many investors to sell their investments, fearing a global economic slowdown. In response, central banks around the world took on more accommodating stances, with many keeping interest rates on hold. The United States Federal Reserve led the pack, pivoting their monetary policy away from tightening interest rates to adopting a more cautious approach in light of a slowing US economy (which was partly the result of rising interest rates during 2018).

As the year progressed there were many twists and turns in the trade disputes, not only between the US and China, but also involving other American trade partners such as Europe, Canada and Mexico.

The early part of 2019 saw some apparent progress in meetings between the US and China. Consequently, global markets rebounded in the first and second quarters, with most asset classes eclipsing the falls suffered in late 2018. The month of May was a notable exception to this momentum, where markets fell as the United States re-imposed tariffs on China and the resignation of former British Prime Minister Theresa May added to Brexit ambiguity. June managed to reverse these losses, with trade tensions easing and central banks reaffirming their commitments to lower interest rates, allowing markets to regain momentum to finish the second quarter on a high.

Market optimism continued into the third quarter, with the United States and China making progress on delayed tariff implementation and central banks lowering interest rates to offset slowing growth. Despite this, risks remained. Fears of a global recession came to the fore after further signs of a broad economic slowdown in the United States, Europe and China; unpredictability in the markets took hold when United States and Chinese trade talks lost momentum; while a number of political crises escalated, notably in Hong Kong, Argentina and the United Kingdom. Markets experienced mixed and volatile returns as the quarter came to a close, showcasing the apparent fragility of global markets going into the final quarter of the year.

Nevertheless, progress was made on a number of fronts and the final quarter saw encouraging returns. News of an apparent “phase-one” trade deal in December between the United States and China lifted markets to new highs, with market returns further supported by a slight improvement in some economic indicators. In spite of the economic risks being tilted to the downside and notable political threats remaining, the year turned out better than most had predicted for global markets. Higher growth portfolios, such as those with greater exposure to shares, were ultimately rewarded with higher returns, although bond markets also generated attractive returns.

Looking ahead to 2020, we continue to believe the world is in the late stages of the economic cycle. However, while the global economy is currently growing at its slowest rate since the financial crisis, the actions of central banks during 2019 and the likelihood of some increased government spending emerging in 2020 has reduced the likelihood of a recession and will likely prolong the cycle. Of course geopolitical risks remain elevated in light of the impeachment of President Trump, the American Presidential Election in November and the implementation of the negotiated trade truce, where the devil is usually in the detail. Similarly in the UK, despite an increased majority, the government still needs to “get Brexit done”.

We have become more cautious about returns over the next twelve months given the extent to which share valuations have risen, underpinned by historically low interest rates. We expect returns over the coming year to be more subdued than those of 2019.

11 February 2020