Why super and growth assets like shares really are long term investments – Oliver’s Insights

Key Points

  • While growth assets like shares go through bouts of short-term under-performance versus bonds & cash, they provide superior long-term returns. It makes sense that superannuation has a high exposure to them.
  • The best approach is to simply recognize that super and investing in shares is a long-term investment.


After sharp share market falls when headlines scream about the billions wiped off the market the usual questions are: what caused the fall? what’s the outlook? and what does it mean for superannuation? The correct answer to the latter should be something like “nothing really, as super is a long-term investment and share market volatility is normal.” But that often sounds like marketing spin. However, the reality is that – except for those who are into trading or are at, or close to, retirement – shares and super really are long-term investments. Here’s why.

Super funds and shares

Superannuation is aimed (within reason) at providing maximum (risk-adjusted) funds for use in retirement. So typical Australian super funds have a bias towards shares and other growth assets, particularly for younger members, and some exposure to defensive assets like bonds and cash in order to avoid excessive short-term volatility in returns.

The power of compound interest

These approaches seek to take maximum advantage of the power of compound interest. The next chart shows the value of a $100 investment in each of Australian cash, bonds, shares, and residential property from 1926 assuming any interest, dividends and rents are reinvested along the way. As return series for commercial property and infrastructure only go back a few decades I have used residential property as a proxy.

Because shares and property provide higher returns over long periods the value of an investment in them compounds to a much higher amount over long periods. So, it makes sense to have a decent exposure to them when saving for retirement. The higher return from shares and growth assets reflects compensation for the greater risk in investing in them – in terms of capital loss, volatility and illiquidity – relative to cash & bonds.

But investors don’t have 90 years?

Of course, we don’t have ninety odd years to save for retirement. In fact, our natural tendency is to think very short term. And this is where the problem starts. On a day to day basis shares are down almost as much as they are up. See the next chart. So, day to day, it’s pretty much a coin toss as to whether you will get good news or bad. So, it’s understandable that many are skeptical of them. But if you just look monthly and allow for dividends, the historical experience tells us you will only get bad news around a third of the time. If you go out to once a decade, positive returns have been seen 100% of the time for Australian shares and 82% for US shares.

This can also be demonstrated in the following charts. On a rolling 12 month ended basis the returns from shares bounce around all over the place relative to cash and bonds.

However, over rolling ten-year periods, shares have invariably done better, although there have been some periods where returns from bonds and cash have done better, albeit briefly.

Pushing the horizon out to rolling 20-year returns has almost always seen shares do even better, although a surge in cash and bond returns from the 1970s/1980s (after high inflation pushed interest rates up) has seen the gap narrow.

Over rolling 40-year periods – the working years of a typical person – shares have always done better.

This is all consistent with the basic proposition that higher short-term volatility from shares (often reflecting exposure to periods of falling profits and a risk that companies go bust) is rewarded over the long term with higher returns.

But why not try and short-term market moves?

The temptation to do this is immense. With the benefit of hindsight many swings in markets like the tech boom and bust and the GFC look inevitable and hence forecastable and so it’s natural to think “why not give it a go?” by switching between say cash and shares within your super to anticipate market moves. Fair enough if you have a process and put the effort in. But without a tried and tested market timing process, trying to time the market is difficult. A good way to demonstrate this is with a comparison of returns if an investor is fully invested in shares versus missing out on the best (or worst) days. The next chart shows that if you were fully invested in Australian shares from January 1995, you would have returned 9.7% pa (with dividends but not allowing for franking credits, tax and fees).

If by trying to time the market you avoided the 10 worst days (yellow bars), you would have boosted your return to 12.4% pa. And if you avoided the 40 worst days, it would have been boosted to 17.3% pa! But this is very hard, and many investors only get out after the bad returns have occurred, just in time to miss some of the best days. For example, if by trying to time the market you miss the 10 best days (blue bars), the return falls to 7.6% pa. If you miss the 40 best days, it drops to just 3.6% pa.

The following chart shows the difficulties of short-term timing in another way. It shows the cumulative return of two portfolios.

  • A fixed balanced mix of 70 per cent Australian equities, 25 per cent bonds and five per cent cash;
  • A “switching portfolio” which starts off with the above but moves 100 per cent into cash after any negative calendar year in the balanced portfolio and doesn’t move back until after the balanced portfolio has a calendar year of positive returns. We have assumed a two-month lag.

Over the long run the switching portfolio produces an average return of 8.8% pa versus 10.2% pa for the balanced mix. From a $100 investment in 1928 the switching portfolio would have grown to $218,040 compared to $705,497 for the constant mix.

Key Messages

First, while shares and other growth assets go through periods of short-term under-performance relative to bonds and cash, they provide superior returns over the long term. As such it makes sense that superannuation has a high exposure to them.

Second, switching to cash after a bad patch is not the best strategy for maximising wealth over time.

Third, the less you look at your investments the less you will be disappointed. This reduces the chance of selling at the wrong time or adopting an overly cautious stance.

The best approach is to simply recognize that super and investing in shares is a long-term investment. The exceptions to this are if you are really into putting in the effort to getting short-term trading right and/or you are close to, or in, retirement.

Dr. Shane Oliver, Head of Investment Strategy & Chief Economist

Planning for what’s next – Living in retirement

Living in retirement can last decades as life expectancies continue to increase. You will need to plan for different stages of retirement – starting with when you are relatively young and active through your later years when you may find yourself slowing down, both physically and mentally.



  • Continue to reinvent yourself

Whether through physical activity, staying socially connected, or by learning something new, engaging in physical and mental activities encourages your health and well-being as you age.

  • Retirement can mean continuing to work

Find something you enjoy whether it is part-time, an encore career, or volunteering.



  • Keep and eye on your budget and your income

Stay fiscally flexible. Be prepared to make adjustments to your spending and your lifestyle. Financial conditions are seldom the same year after year.

  • Review your asset allocations

Be sure that your investment portfolio reflects your age and risk tolerance. Remember, generating retirement income from investments is not the same thing as growing your investments.

  • Monitor your situation regularly and adjust if conditions warrant

This is especially critical in terms of distributions and regular income payments from your accounts, so you can ensure your savings sustain you through your later years.

  • Be proactive in your tax planning

Plan ahead and understand the tax implications of your investment decisions. Consider getting money to your heirs of your financial situation allows.

  • Mange debt

Pay down your debt, including your mortgage.

  • Consider getting professional financial advice

An objective third-party review can be critical at this stage and may assist you in developing a sustainable withdrawal strategy.



  • Make a plan for your future medical expenses

Healthcare expenses can be large or small, expected or unexpected. Think ahead to line up the income you need to meet these expenses.

  • Review your situation regularly

Evaluate your current and potential future healthcare needs, and determine whether private health insurance (or your current cover) is appropriate.



  • Review your estate plan
  • Who do you trust?

Establish powers of attorney in case you are incapacitated.

  • Have a family meeting

Openly discuss your finances in the event that you can no longer manage your own affairs. Educate adult children regarding treatment of your asset upon your death.



  • Elder financial abuse is a growing problem

Take steps early to protect yourself. Consider confiding in relatives or a trusted friend regarding your financial situation.

  • Review and assess

Confirm that all beneficiary designations are in place and that you have a proper will, or other estate planning tool, to ensure your money goes where you want it to go.

Planning for what’s next – Approaching retirement

As retirement nears, you will want to continue planning for this next phase of your life. Remain focused on saving for retirement while beginning to envision and organise how you plan to enjoy these future years.


  • Determine what you want to do in retirement.

Maybe you don’t want to stop working altogether, but would rather work part-time or volunteer. Consider ways to keep your mind and body active through physical exercise and hobbies. Determine how to stay connected to friends and family.

  • Want to relocate?

Consider spending time there to help determine whether the move will be right for you.

  • Prepare for the unexpected

Have an emergency fund and plan in place.


  • Don’t stop saving!

Continue to contribute as much as you can financially handle to your retirement savings, as it is still important. For example, setting up a Transition to Retirement pension can be used in conjunction with increased concessional super contributions to save tax in the lead-up to retirement, and your super balance will get a boost through any increased concessional contributions.

  • Develop a retirement income strategy

Identify sources of income in retirement. Determine how much the sources will generate, and when to use them.

  • What about the Age Pension?

Determine whether you are eligible for a part or full Age Pension. Even if you aren’t eligible, you may still be entitled to other benefits, such as cheaper medicines and reduced water and council rates.

  • What are you planning to do with your superannuation account(s)?

If you have multiple superannuation accounts, consolidating them into one can save you some fees and paperwork. As you approach retirement, your super fund or financial adviser can help you with options for converting your super savings into a stream of income in retirement.

  • Review your asset allocations

How you allocate money to each asset class is one of the most important decisions faced when constructing an investment portfolio. As retirement gets closer, you’ll want to pay closer attention to how your portfolio is allocated.

  • Manage debt

Pay down your debt, including your mortgage.

  • Consider getting professional financial advice

With many decisions, an objective third-party review can be critical at this stage


  • Health care in retirement can be a major expense

Determine how you will cover pharmaceutical and other medical expenses.

  • Understand all insurance options

Medicare doesn’t cover everything. Consider private health insurance for seniors and determine whether you qualify for a government rebate.


  • Make informed insurance decisions

Decide if long-term care insurance makes sense for you

  • Your plans are not set in stone

Review your estate plan and beneficiary designations and adjust if necessary


  • Review and assess

Review your retirement savings and investments, as you still have time to make changes and close any gaps to help you enjoy your later years. Make sure your will is up-to-date.

  • Managing ongoing dependent children

Whether you decide to provide continuing support or adopt a “tough love” strategy, consider the impact on your retirement plans – both financially and emotionally.

Preparing for what’s next

When retirement is approaching, it’s important to plan for what’s next. Below are several resources to help you better understand your current situation and get your questions answered.

Oliver’s Insights-Five reasons why I am not so fussed about the global outlook

Key Points:

  • There is no denying concerns about global debt, seemingly never ending QE, more debt trading on negative interest rates, inequality and geopolitical threats.
  • However, some of these concerns are exaggerated and there are five reasons why I am not so fussed about the global outlook. In particular, there is good reason to expect a pick-up in global growth over the next 12 months. This should help underpin further gains in share markets over the next 6-12 months.

There is always someone telling us that there is some sort of economic/financial disaster coming our way. However, there does seem to be a higher level of hand wringing now about the global economic outlook than normal. These concerns basically go something like this:

  • Global debt – both public and private – is at record levels relative to GDP and with public debt ratios so high there is no scope for fiscal stimulus should things go really bad.
  • Years of quantitative easing and other unconventional monetary policies like negative interest rates by central banks in major advanced countries haven’t worked and seem to have no end.
  • More and more debt globally is trading on negative interest rates – it’s now around $US14 trillion including around 25% of all government bonds – which is unnatural and causing distortions in valuing assets with risks of asset bubbles.
  • Inequality (as measured by Gini coefficients) is rising – particularly in the US – which is driving a populist backlash against rationalist market-friendly economic policies of globalisation/free trade (as evident in Trump’s trade wars), deregulation and privatisation.

  • This along with the relative decline of US economic and military power is contributing to geopolitical tensions as we move from a “unipolar world” (dominated by the US after the end of the Cold War) to a “multipolar world” as other countries (China, Russia, Iran/Saudi Arabia, etc) move in to fill the gap left by the US or even “challenge” the US.

This is all seen as being bad for global growth and hence growth assets, all of which is being heightened by the downturn in global growth seen over the last year or so.

Five reasons not to be too fussed.

There is no denying these concerns. Debt is at record levels globally. QE has been running in various iterations for more than a decade now in some countries. Inequality is up – albeit its mainly a US and emerging country issue. Support for market-friendly economic rationalist policies such as globalisation, deregulation and privatisation seems to have waned (except in France). And geopolitical risks are up. All these developments point to the risk of slower global growth and investment returns ahead and may figure in the next major bear market. But there is always something to worry about (otherwise shares would offer no return advantage over cash) and trying to time the next downturn is hard. Moreover, there are five reasons not to get too fussed about the global outlook.

1. Debt is more complicated than being at a record
History tells us that the next major crisis will involve debt problems of some sort. But what’s new – they all do! Just because global debt is at record levels does not mean that a crisis is imminent. There are several points to note here:

  • debt has been trending up ever since it was invented;
  • comparing debt to income (or GDP) is like comparing apples to oranges as debt is a stock and income is a flow – the key is to compare debt against assets and here the numbers are not so scary because debt and assets tend to rise together
  • debt interest burdens are low thanks to low interest rates
  • all of the rise in debt in developed countries since the GFC has come from public debt and the risk of default here is very low because governments can tax and print money.

While Modern Monetary Theory has its issues, it does remind us that as long as a government borrows in its own currency and inflation is not a problem, it has more flexibility to provide stimulus than high public debt to GDP ratios suggest.

2. QE’s end point is not necessarily negative

Quantitative easing and other unconventional monetary policies actually do appear to have helped. Since its high in 2013 unemployment in the Eurozone has fallen from 12% to 7.5% and in the US it fell from 9% in 2011 to 4% in 2017 enabling the Fed to start unwinding unconventional monetary policy. Inflation has not been returned to 2% targets, but wages growth has lifted and at the start of last year it looked like the global economy was getting back to normal. What kicked the global economy off the rails again was a combination of Trump’s trade wars, a debt squeeze in China and tougher auto emission controls. But this it wasn’t due to a failure of quantitative easing.

As to how quantitative easing is eventually unwound there is no easy answer, but there is no reason to believe that it will end with a calamity. First, in the absence of a surge in inflation necessitating a withdrawal of the money that has been pumped into the global economy there is no reason to withdraw it. And when inflation does start to rise it can be reversed gradually by central banks not replacing their bond holdings as they mature.

Second, the assets central banks purchased as part of QE have boosted the size of their balance sheets but the varied size of central bank balance sheets from one country to another as a share of their economy shows that there is no natural optimal level for them. In fact, the Fed is now resuming natural growth in its balance sheet as occurred prior to the GFC so its balance sheet may just stay high (as along as inflation is not a problem).

Finally, if push came to shove just consider what would happen if say the Bank of Japan told the Japanese government that it no longer expects payment at maturity for the 50% of Government bonds it holds? The BoJ would write down its bond holding and the Japanese Government would suffer a loss on its investment in the BoJ but that would be matched by a write down in its liabilities. Basically, nothing would happen except that Japanese government debt would fall dramatically!

3. Inflation and interest rates are low

The key thing that has caused many sceptics to miss out on good returns this decade is that they focussed on low inflation as reflecting low demand growth but missed out on the positive valuation boost to assets like shares and property that low inflation and low interest rates provides.

4. Rapid technological innovation and growth in middle income Asia is continuing

This is well known and has been done to death, so I won’t go over it suffice to say that there are still a lot of positives helping underpin the global outlook and these two remain big ones.

5. Global growth looks like it may pick up

While the slowdown in global growth over the last 18 months has been scary and associated with share market volatility, the conditions are not in place for a deeper slide into global recession like we saw at the time of the GFC – excesses like overspending, surging inflation, excessive monetary tightening are not present. In fact, various signs are pointing to a cyclical global pick up ahead:

  • Bond yields are up from their lows & look to be trending up
  • The US yield curve is now mostly positive – suggesting the inversion seen this year may have been another false recession signal like seen in 1996 and 1998

  • European, Japanese & emerging shares are looking better
  • Cyclical sectors like consumer discretionary, industrials and banks are looking better
  • The US dollar looks like it might have peaked; and
  • Business conditions PMIs for the US, Europe & China were flattish in October & may be stabilising. This saw the global manufacturing PMI go sideways and a rise in the services PMI and both still look like the 2012 and 2016 slowdowns.

These could be pointers to global monetary easing getting traction. Of course, much depends on what happens to geopolitical risks. The US election next year will be a big one to keep an eye on and beyond that US/China tensions look likely to be with us for years. But there is reason to expect some respite in the short term on the geopolitical front:

First, the economic slowdown in both China and the US is pressuring both to defuse the trade dispute in the short term. This pressure is greater now as Trump wants to get re-elected next year and knows that he won’t if he lets the US slide into recession or unemployment rise. China may prefer to wait till after the election but is more likely to opt for the devil it knows.

Second, Trump’s avoidance of retaliation after the attack on Saudi’s oil production facilities in September shows a desire to avoid getting into military conflict in the Middle East.
Third, Brexit risks are on the back burner for now (although they could still come up again next year).

Concluding comment

There is good reason to expect the global economic cycle to turn up in the year ahead just as it did after the growth in 2012 and 2016. This should be positive for growth assets like shares. Finally, for those worried that more and more debt will trade at negative interest rates our view is that this is unlikely: many countries have already sworn off using rates including the US and RBA Governor Lowe says it’s extremely unlikely in Australia. And if growth picks up as we expect the proportion of global debt on negative rates will decline as it did after 2016.

Dr Shane Oliver, Head of Investment Strategy & Chief Economist 

4 surprises about planning for retirement income

Franklin Templeton’s 2019 Retirement Income Strategies and Expectations (RISE) Survey uncovered four findings that may surprise you.

  1. Retirement Expenses May Be Higher than Expected

Australians don’t seem to be under any illusions about the cost of retirement. Nearly 3 in 4 pre-retirees are concerned about rising expenses draining their retirement savings. Furthermore, 40% expect their expenses to increase in retirement – well above the 28% who expect them to decrease.

Unfortunately, the experience of retirees doesn’t provide any relief to these anxieties. Concern about rising expenses is even higher among the retiree population, while nearly half of retiree’s state that their expenses have increased since retirement.

Concern about rising expenses doesn’t fade after retirement


Higher expenses in retirement is more common than expected


Part of being confident in a retirement strategy is understanding what to expect and then planning for that reality. Consider how each type of expense may change over time – do they rise with inflation? Are they impacted by changes in the economy? By anticipating the types of expenses, you will likely face, you can plan for the appropriate income to meet those needs.


  1. Health- Related Concerns are Top of Mind Across All Ages

Planning for retirement isn’t just about saving money. It’s also about appreciating the reality of factors that can have a major impact on an individual’s ability to experience retirement success. Our survey indicated that people are acutely aware of the role health might play.


  1. Retiree’s Approach to Spending Their Nest Eggs Is Not Always Strategic

One may assume that once someone is living in retirement, they have a plan for how they will spend their nest egg throughout their retirement years. Our results highlight a different story. Over a third (34%) of retirees are winging it, stating they are ‘spending what they need and hoping it will last.’ And even more (36%) are trying to avoid dipping into their savings at all. When we took a closer look as to why, uncertainty emerged as a common theme – whether it’s not understanding how much they can sustainably spend, what future expenses will look like, or what their time horizon is.

  1. Professional Financial Advice is Critical in Planning Retirement Income

For most pre-retirees, planning for their retirement income is a daunting task. How much will they need? Where will it come from? What strategy is best suited to their situation? These are not always questions with simple answers.

While a range of resources exist to help plan for retirement income, individual advice from a licensed financial professional appears to be one of the most effective ones. One survey indicated that working with a financial adviser is strongly tied to better preparation, reduced stress and increased confidence around the transition to retirement.

Plan for Surprises

No matter what your stage of retirement. There may be surprises that can catch you off guard. Having enough confidence in your income sources when you stop working ultimately comes down to knowledge and planning. Work with a financial adviser to help create a custom, written plan to fit your retirement needs and prepare for the challenges.


Oliver’s Insights: Australian house prices back from the abyss – seven things you need to know about the Australian property market


After the biggest fall in at least 40 years – with a 10.2% top to bottom fall between September 2017 and June this year – average capital city home prices have turned up again. I thought prices would fall further with a 15% top to bottom fall led by around 25% falls in Sydney and Melbourne. But the facts changed from May – with the election removing the threat to negative gearing & the capital gains tax discount, earlier than expected interest rate cuts & a relaxation of APRA’s 7% interest rate test all pushing prices up again. So, where to from here?

Extreme property views

There are basically two extreme views amongst “property experts”. On the one hand, some real estate spruikers still wheel out the old “property will double every seven years” line. On the other hand, property doomsters say it’s hugely overvalued and over indebted with massive mortgage stress and so a 40% or so crash is inevitable. The trouble with the former is that implies home price growth of 10.3% pa, so even if wages growth picks up to 3.5% (a big ask!) it implies that the average price to income ratio of Australian housing will rise to around 9 times over the next 7 years from around 6 times now and in 14 years’ time it will be 14 times! The trouble with the doomsters is that they’ve been saying that for 15 years and we’re still waiting for the crash. In between, first home buyers are wondering why it’s so hard to do what my and my parent’s generation took for granted: be part of the Aussie dream with a quarter acre block. The reality is it’s far more complicated than these extremes. Here’s seven stylised “facts” regarding Australian property.

First – it’s expensive

This has been the case since early last decade and remains so despite the recent correction in prices:

  • According to the 2019 Demographia Housing Affordability Survey the median multiple of house prices to income is 5.7 times in Australia versus 3.5 in the US and 4.8 in the UK. In Sydney, it’s 11.7 times & Melbourne is 9.7 times.
  • The ratios of house prices to incomes and rents relative to their long-term averages are at the high end of OECD countries.


  • The surge in prices relative to incomes has seen household debt relative to household income rise from the low end of OECD countries 25 years ago to the high end now.

These things arguably make residential property Australia’s Achilles heel. But that’s been the case for 15 years or so now.

Second – it’s diverse

While it’s common to refer to “the Australian property market”, in reality there is significant divergence between cities. This divergence has been extreme over the last five years with Perth and Darwin seeing large price falls in response to the end of the mining investment boom, as other cities rose.

The divergence is also evident in gross rental yields that range from 8.7% in regional WA units to 3.1% in Sydney houses.

Third – talk of mortgage stress is overstated

Headlines of excessive mortgage stress have been common for over a decade now. There is no denying housing affordability is poor, household debt is high and some households are suffering significant mortgage stress. But most borrowers appear to be able to service their mortgages. And despite some seeing negative equity and a significant proportion of borrowers switching from interest only to principle & interest loans (which has seen interest only loans drop from nearly 40% of all loans to 23%) there has been no surge in forced sales and non-performing loans. Non-performing mortgages have increased but remain low at around 0.9%. While Australia saw a deterioration in lending standards with the last boom, it was nothing like other countries saw prior to the GFC. Much of the increase in debt has gone to older, wealthier Australians, who are better able to service their loans. Low doc loans are trivial in Australia and the proportion of high loan to valuation ratio loans has fallen as has the proportion of interest only loans.

Fourth – it’s been chronically under supplied

Annual population growth since mid-last decade has averaged 373,000 people compared to 217,000 over the decade to 2005, which requires roughly an extra 75,000 homes per year. Unfortunately, the supply of dwellings did not keep pace with the population surge (see the next chart) so a massive shortfall built up driving high home prices. Thanks to the surge in unit supply since 2015 this is now being worked off, but it follows more than a decade of accumulated under supply which is the main reason why housing has remained relatively expensive in Australia. Not tax breaks or low rates – all of which exist in other countries with far more affordable housing!

Fifth – house prices go up and down

After several episodes of price declines ranging from 5 to 10% across various cities over the last 15 years and 15%, 21% and 31% for Sydney, Perth and Darwin respectively in recent years home buyers should be under no illusion that prices only go up.

Sixth – the housing market remains rate sensitive

While it varies from city to city, despite much scepticism recent rate cuts have helped push up the property market again.

Finally – house price crashes are not easy to forecast

The expensive nature of Australian property and associated high debt levels have seen calls for a property crash pumped out repeatedly over the last 15 years. In 2004, The Economist magazine described Australia as “America’s ugly sister” thanks in part to soaring property prices. Property crash calls were wheeled out repeatedly after the Global Financial Crisis (GFC) with one commentator losing a high-profile bet that prices could fall up to 40%. In 2010, a US newspaper, The Philadelphia Trumpet, warned that “Los Angelification” (referring to a 40% slump in LA home prices around the GFC) will come to Australia. Similar calls were made a few years ago by a hedge fund researcher and a hedge fund: “The Australian property market is on the verge of blowing up on a spectacular scale.” Over the years these crash calls have often made it on to 60 Minutes and Four Corners.

But our view remains that to get a national housing crash – as opposed to periodic falls in some cities – we need much higher unemployment, much higher interest rates and/or a big oversupply. But while the risk of recession has increased it remains unlikely, aggressive rate hikes are most unlikely and while property supply still has more upside it’s unlikely to lead to a big oversupply as approvals to build new dwellings are now falling. As we have seen for years now overvaluation and high debt on their own are not enough to bring on a crash.

So where to now?

The rebound in buyer interest since May has seen auction clearance rates in Sydney and Melbourne rise to around 75% and prices lift nearly 2%, albeit other cities are mixed.


This has so far come on low volumes, but they now look to be rising. Our base case is that house price gains will be far more constrained than the 10-15% implied by current auction clearance rates. Compared to past cycles debt to income ratios are much higher, bank lending standards are tighter, the supply of units has surged with more to come and this has already pushed Sydney’s rental vacancy rate above normal levels and unemployment is likely to drift up as economic growth remains soft. So, we don’t expect to see a return to boom time conditions and see constrained gains through 2020 – eg around 5% or so. There are three key things to watch:

  • The Spring selling season – if auction clearances remain elevated as listing pick up then it will be a positive sign that the pick-up in the property market has legs.
  • Housing finance commitments – these have bounced but will have to pick up a lot further to get 10-15% price rises.
  • Unemployment – if it picks up significantly in response to slow economic growth then it will be a big constraint on house prices and could result in another leg down in prices.

We don’t see the rebound in the Sydney and Melbourne property markets as a barrier to further monetary easing, but it may reduce the need as it turns the wealth effect from negative to positive. And if it continues to gather pace then expect a tightening of the screws again from bank regulators.

Implications for investors

Over long periods of time residential property provides a similar return to shares (at around 11% pa) but it offers good diversification as it performs well at different times to shares so it has a role to play in investors’ portfolios. The pull back in prices in several cities in the last few years provides opportunities for investors, but just bear in mind that rental yields remain relatively low in Sydney and Melbourne and be wary of areas where there is still a lot of new units to hit. There is probably better value to be found in regional centers and Perth, and Brisbane looks attractive in offering reasonable yields, a low vacancy rate and improving population growth.

Dr. Shane Oliver, Head of investment strategy and Chief Economist.

Market Update 6 September 2019 – Shane Oliver

Investment markets and key developments over the past week

Good news week! It certainly seemed that way for financial markets with a lot of relatively small positives – the US and China indicating that face to face trade war talks will start again next month, Hong Kong withdrawing the extradition bill, the UK parliament standing up to block a “no-deal Brexit” and confirmation that Italy has a new government without another election – all serving to drive “risk on”. This saw share markets, bond yields, oil and metal prices and commodity currencies like the A$ all rise. The iron ore price was an exception though and it slid a bit further as the global supply outlook continues to improve. For the week US shares rose 1.8%, Eurozone shares gained 2.1%, Japanese shares rose 2.4% and Chinese shares rose 3.9%. Australian shares followed the global lead higher led by IT, consumer stocks, the miners and financials but the defensive nature of the local market constrained it to a 0.7% gain for the week as bond sensitive property, telco and utility stocks all fell in value as bond yields rose.

Good news on trade but just recall we have seen this movie several times before. The news of the resumption of the trade talks is good and likely follows China’s decision a week ago not to retaliate against the latest round of threatened tariffs from the US, which provides hope that with China playing the adult in the room maybe the situation can start to de-escalate. President Trump is likely also under a lot of pressure given the increasing recession talk in the US. He even noted for the first time that were it not for his trade war US shares would be a lot higher which by implication means that he must also acknowledge that the US economy would be a lot stronger. But while the resumption of talks (assuming it happens) is good this will be the fourth attempt with the previous three ending in a Twitter tantrum and more tariffs and so it would be wrong to get too optimistic just yet. No doubt we will hear lots of “the talks are going well” and “they really want a deal” from President Trump again. But we need to see clear evidence that both sides are prepared to compromise. Share markets may still have to fall further to pressure Mr Trump to resolve the issue.

It may be wrong to say that they are connected but China’s more conciliatory approach on trade a week ago and now a more conciliatory stance on Hong Kong with support for the withdrawal of the extradition bill are positive signs given that a week ago hardly anyone expected such a concession. On the one hand the protest leaders have said the move is not enough. On the other, HK leader Carrie Lam has said it’s only the “first step” to resolving the political, economic and social issues causing the deadlock so maybe the risk of military action to put down the protests is receding.

The Brexit debacle is getting up there with the party for laughs. Looks like PM Johnson’s move to suspend Parliament has backfired with those opposed to a “no-deal” Brexit in Parliament (ie leave the EU without a free trade deal) moving to block such an exit on October 31 and to move to block the PM calling an early election. The strategy looks to be to only allow an early election if a no-deal Brexit is off the table. Financial markets like that because of the fear that a no-deal Brexit would wreak havoc on the UK economy as 46% of its exports go to the EU. So, the British pound rose. The only thing is that the Brexit comedy has a long way to go yet so it’s too early to go long the pound. But it does seem that the risk of a no-deal Brexit has receded a bit and no Brexit at all remains possible.

Another word on Italy – Itexit remains as far off as ever! It’s questionable how durable the new Italian coalition government will be. However, recent events highlight several positives. First, the Northern League (NL)/Five Star Movement (5SM) government showed that Italy’s two main populist parties are pragmatic to the point of working with the European Commission to avoid a financial meltdown. Second, 5SM has shown the same again in being able to cooperate with the Democratic Party (PD) to form a new coalition. Third, the new 5SM/PD government will likely push for fiscal stimulus, but this is coming at a time when the rest of Europe is likely to be a bit more flexible given the economic slowdown. Finally, polls show that 68% of Italians support the Euro which is why 5SM and NL had to drop their anti-Euro stance to get a decent share of the vote in the first place. Barring a big economic downturn in Italy and a big new surge in immigration, those waiting for an Itexit to pose a threat to the Eurozone will continue to be disappointed.

Per capita GDP growth – how does Australia compare? Ultimately, it’s real per capita economic growth (or economic growth per person) that matters for material living standards as opposed to just real GDP growth. The problem in Australia is that per capita GDP declined over the last year by 0.2% thanks to headline economic growth of just 1.4% which is less than population growth of 1.6%. While the damage was done in the September and December quarters last year, growth in per capita GDP has been trivial so far this year. The next chart compares per capita GDP growth across Australia, the US, the Eurozone and Japan. As can be seen Australia (the blue line) is the weakest over the last year highlighting the real slowdown in Australia. But it can also be seen that all countries go through periodic soft patches so it’s important to get a longer-term perspective as well. For the whole period shown per capita GDP growth in Australia of 1.3% pa has exceeded that of the other comparable countries. That said over the last decade per capita GDP growth in Australia has slowed to 1% pa which puts it ahead of the Eurozone (at 0.9% pa) but behind the US (1.4% pa) and Japan (1.3% pa). The slowdown in Australia partly reflects payback for the mining boom driven outperformance seen last decade. To get growth in per capita GDP (and hence material living standards) back up in Australia will require a mix of cyclical policies to boost short term growth and structural reforms to enhance productivity which has also declined over the last year. Interesting to note that after allowing for Japan’s falling population it has been doing a lot better than often credited in the last decade or so.



A “stronger” inflation target for Australia with talk from the Treasurer suggesting it will remain 2-3% (I would hope so -otherwise it will lose credibility) but that it may be strengthened by requiring an explanation when the target is missed. I am not sure that this would change things that much, but it could see the RBA getting more aggressive to bring inflation back to target whenever it is outside it (like now), which is contrary to the more flexible approach adopted just three years ago.

Major global economic events and implications

US economic data got off to a bad start with a sharp fall in the manufacturing conditions ISM and weak construction spending, but it got better as the week went on with a rise in the non-manufacturing ISM, a narrowing in the trade deficit and reasonably solid jobs data. Payrolls rose a less than expected 130,000 in August and continue the trend slowdown in hiring, but the underlying details were solid with very strong growth in the household employment survey, solid gains in hours worked and temporary employment, rising workforce participation and unemployment remaining ultra-low at 3.7%. Meanwhile, wages growth remains relatively soft at 3.2% year on year. The slowdown in the pace of payroll employment and still soft wages growth keeps the Fed on track to cut rates this month, but the jobs market is not weak enough to justify a 0.5% cut so 0.25% remains more likely. Comments by Fed Chair Powell that the Fed is monitoring “significant risks” and will “act as appropriate to sustain this expansion” but that the jobs market is still strong also point to a 0.25% cut as opposed to 0.5%



Final composite business conditions PMIs in the Eurozone and Japan were confirmed to have risen in August with the services sector still doing better than manufacturers. China’s Caixin PMIs also rose in August. Consequently, despite a fall in the US, the global composite business conditions PMI fell only slightly in August and has been tracking sideways over the last few months holding out a bit of hope for the global economy despite all the talk of recession. It still looks like the slowdowns around 2012 and 2015-16 rather than the slide into what became the GFC recession.



The key message out of Chinese policy makers over the last week is that more policy stimulus is on the way with the threat to growth clearly remaining a big concern. This was followed up by a cut in banks’ required reserve ratios of 0.5% from September 16 and for some city banks by another 1% from mid October.

Australian economic events and implications

The past week saw June quarter GDP data confirm the ongoing weakness in the Australian economy. June quarter growth wasn’t as bad as feared but it still showed that annual growth has slowed to just 1.4% year on year, its weakest since the GFC and were it not for strong growth in public demand and net exports the economy would have gone backwards. What’s more retail sales continued to fall in July and industry data showing softness in car sales into August raise questions about the impact of the tax and rate cuts – but maybe it’s a bit too early to tell yet. And ANZ job ads fell anew in August pointing to much slower jobs growth ahead as does the huge disconnect between GDP growth of just 1.6%yoy and employment growth running at 2.4%yoy.

But there was also some good news. First, the current account returned to surplus for the first time since 1975. While the trade surplus remained strong in July its likely to decline given the recent plunge in iron ore and coal prices suggesting a return to a current account deficit. However, its likely to remain a lot smaller than seen in recent decades and means that Australia’s dependence on foreign capital is much reduced. Second national average house prices have started to rise again and while it’s hard to see a return to boom time conditions the threat of a debilitating negative wealth effect on consumer spending looks to be receding. Finally, the AIG’s manufacturing and services conditions PMIs rose in August, but this needs to be taken against the CBA’s versions that fell and on average they are pretty soft.

The bottom line is that while recession remains unlikely, growth and activity is well below where it should be and this means ongoing upward pressure on unemployment and subdued wages growth and inflation. This is consistent with the Melbourne Institute’s Inflation Gauge running at just 1.7% year on year in August. So while the RBA left rates on hold in September and seemed a bit oblivious to the run of negative domestic and trade war news over the last month we remain of the view that it will need to ease further and still see the cash rate falling to 0.5% by

year end.

What to watch over the next week?

The key focus of investors over the week ahead will be the European Central Bank on Thursday which is expected to deliver a much-anticipated easing of monetary policy designed to deal with weak growth and inflation chronically below target. We expect the ECB to announce a package of rate cuts, tiering of negative rates on bank reserves and renewed quantitative easing which will result in asset purchases of around €30bn a month.

In the US, core CPI inflation for August (Thursday) is expected to show a small rise to 2.3% year on year and retail sales (Friday) are expected to show reasonable growth. Small business confidence and labour market indicators will also be released on Tuesday.

Chinese data is expected to show a slight dip in CPI inflation (Tuesday) for August to 2.6% year on year, continuing low underlying inflation, some slowing in exports and imports and a rebound in credit growth.

In Australia, expect to see a modest bounce in July housing finance commitments (Monday) and the NAB business survey (Tuesday) and the Westpac/MI consumer survey (Wednesday) to show confidence remaining around average levels.

Outlook for investment markets

Share markets are still at high risk of further weakness/volatility in the months ahead on the back of the ongoing US/China trade war, Middle East tensions and mixed economic data as we are in a seasonally weak part of the year for shares. But valuations are okay – particularly against low bond yields, global growth indicators are expected to improve by next year and monetary and fiscal policy are becoming more supportive all of which should support decent gains for share markets on a 6 to 12-month horizon.

Low yields are likely to see low returns from bonds once their yields bottom out, but government bonds remain excellent portfolio diversifiers.

Unlisted commercial property and infrastructure are likely to see reasonable returns. Although retail property is weak, lower for longer bond yields will help underpin unlisted asset valuations.

The combination of the removal of uncertainty around negative gearing and the capital gains tax discount, rate cuts, tax cuts and the removal of the 7% mortgage rate test are leading to a rise in national average capital city home prices driven by Sydney and Melbourne. But beyond an initial bounce, home price gains are likely to be constrained through next year as lending standards remain tight, the record supply of units continues to impact and rising unemployment acts as a constraint.

Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 0.5% by early next year.

The A$ is likely to fall further to around US$0.65 this year as the RBA cuts rates further. Excessive A$ short positions, high iron ore prices and Fed easing will help provide some support though with occasional bounces and will likely prevent an A$ crash.

Nine reasons why recession remains unlikely in Australia


Australian economic growth has slowed to the weakest since the GFC. Talk of recession remains all the rage. And economists don’t have a great track record in predicting recessions globally – with an IMF study finding that of 153 recessions seen in 63 countries around the world between 1992 and 2014, economic forecasters only predicted five in April of the year before they started – so why should they pick one this time? As someone who forecast two of the last one recessions in Australia I am a bit wary. Perhaps the best way to predict recessions would be to forecast one every year and then you would have a perfect track record in predicting them! Some actually do this. But they are totally useless because they miss out on the 90% or so of the time that countries are not in recession and the positive lead this provides for share markets and other growth assets.

Recessions come along when there is a shock to the system (usually high interest rates), invariably at a time when the economy is vulnerable after a period of excess (such as rapid growth in spending, debt or inflation). The shock causes a loss of confidence, lots of little spending decisions are delayed and excesses are unwound. But given the natural tendency of most economies to grow given population growth and new innovations, increasing economic diversity, counter cyclical economic policies and the rise of the more stable services sector recessions are relatively rare at around 10-12% of the time globally. In Australia the last one was 28 years ago.

Why there has been no recession for 28 years

The absence of an Australian recession – whether defined by two quarterly GDP contractions in a row or negative annual growth – for 28 years is instructive. Many forecast recessions at the time of the 1997-98 Asian crisis, 2000-2002 tech wreck, the GFC and from around 2012 as the mining investment boom ended. But it didn’t happen. There are seven reasons why:

  • economic reforms made the economy more flexible;
  • the floating of the $A has seen it fall whenever there is a major economic problem providing a shock absorber;
  • desynchronised cycles across industry sectors;
  • strong growth in China that helped through the GFC;
  • strong population growth;
  • counter cyclical economic policy – like stimulus payments and monetary easing that helped in the GFC; and
  • good luck – which can never be ignored lest hubris set in!

But is our luck running out?

June quarter GDP growth was just 0.5%. And annual growth has fallen to 1.4% which is the slowest since the GFC and below population growth of 1.6%. Housing and business investment fell, and consumer spending remains very weak. Were it not for public spending and net exports the economy would have gone backwards in the June quarter.

Going forward, the housing downturn has further to run with building approvals pointing to a further fall in home building.

This is likely to amount to a 0.5-0.6 percentage point pa direct detraction from growth. This along with low property turnover (less people moving) and lagged negative wealth effects from the earlier fall in house prices will all act as drags on consumer spending. In total the housing downturn is likely to detract around 1-1.2 percentage points from growth in the year ahead.

The drought will likely also act as an ongoing drag on growth with a “mild” El Nino hanging around although this may be modest at around a 0.2 percentage point growth detraction. The threats to global growth from trade wars also suggests downside risks to export growth.

The weakness in relation to the economy is clearly evident in soft profit results in the recent June half year profit reporting season. The ratio of upside surprise to downside was the weakest since 2009, only 58% of companies saw profits rise from a year ago and the proportion of companies raising or maintaining their dividends fell to the lowest since 2011 suggesting a lack of confidence. Earnings growth slowed to 1.3% and excluding resources stocks was around -2.4%.

Slow growth but probably not recession

Since last year our view has been less upbeat on growth than the consensus and notably the RBA. This remains the case as the housing construction cycle turns down and weighs on consumer spending. As a result, it’s hard to see much progress in reducing high combined levels of unemployment and underemployment, and hence wages growth and inflation are likely to remain low. But there remains a bunch of positives that should help the economy avoid a recession even though growth will remain weak for a while yet. Here are nine.

  • Rate cuts and tax cuts should provide some growth boost – while July retail sales were disappointing, the experience from the GFC stimulus payments is that the tax cuts will provide some lift to growth in the months ahead and various retailers have expressed optimism about this recently.
  • The threat of crashing property prices looks to be receding – while it’s so far been on low volumes, buyer interest has returned to the Sydney and Melbourne markets and we never saw the much-feared surge in non-performing loans or forced selling. This has helped remove the threat of a debilitating negative wealth effect on consumer spending.
  • Infrastructure spending is booming – recent state budgets saw the projected peak in infrastructure spending pushed out yet another year to 2020. And it’s likely states will seek to take even greater advantage of ultra-low long-term borrowing costs to further push out the peak in infrastructure spending.
  • The low $A is helping to support the economy – the $A is down 39% from its 2011 high and is likely to fall further and this provides a boost to Australian businesses that compete internationally by making them more competitive.
  • The business investment outlook is slowly improving – the big drag on growth as mining investment fell back to more normal levels as a share of GDP is over and mining investment plans are rising. This is driving some pick-up in the outlook for overall business investment.

  • Australia has a current account surplus – the June quarter saw the first current account surplus since 1975. The slide since then in iron ore and coal prices suggests it may not be sustained, but the reasons for the improvement are more than just commodity prices so the deficit is likely to be well below the norm of recent decades going forward. What’s more there has been a significant improvement in our foreign liabilities with a less short-term debt and a growing net equity position. This all means that our reliance on foreign capital inflow has declined. So much for the boiling frog!
  • There is scope for extra fiscal stimulus – the Federal budget is nearly back in surplus and while we have had a long run of deficits our public finances are in good shape compared to the US, Europe and Japan. As a result, there is scope to provide more fiscal stimulus and this is probably more important than a narrow focus on the surplus.
  • Population growth remains strong – Australia’s population growth at around 1.6% pa remains strong. Of course, strong population growth is not without issues and in terms of living standards it is economic growth per person (or per capita) that matters. But solid population growth also has significant benefits in terms of supporting demand growth, preventing lingering oversupply and keeping the economy dynamic.
  • Finally, cyclical spending (consumer durables, housing and business investment) as a share of GDP remains low – suggesting that apart from bits of the housing market there’s not a lot of excess in the economy that needs to be unwound.

Concluding comment

Our assessment remains that growth will remain soft and that the RBA will have to provide more stimulus – by taking the cash rate to around 0.5% and possibly consider unconventional monetary policy like quantitative easing. Ideally the latter should be combined with fiscal stimulus which would be fairer and more effective. While Australian growth is going through a rough patch with likely further to go, recession remains unlikely barring a significant global downturn.


Retirement today: the challenge of generating retirement returns and making them last

19 Aug, 2019

By, Dermot Ryan

Sydney, Australia

Once elected, one of the first things the new Morrison Government announced was a review of the retirement income system.

The review was proposed due to the increasing complexity of the current system and the challenges brought about by higher life expectancies, the impact of low interest rates and the lack of income available in many asset classes due to current lofty valuations.

In what will be a broad-based review it will look across the key tools to generate an adequate retirement income: the age pension, superannuation (including compulsory contribution levels) and savings outside super.

It will also address some divisive topics such as potential changes to the tax treatment of retirement savings, the role of the family home in retirement, and super contribution limits. It is quite an ambitious agenda that will give retirees and financial advisers much to think about in the months ahead.

Until we hear more about the direction of this review, we thought it would be interesting to take a look at the challenges of generating a reasonable income in retirement. When investing with a goal – such as retirement – in mind, it pays to think long-term. But there is no escaping the realities, and challenges, of today’s investment environment for retirees.

Impact of interest rate changes and high valuations

Interest rates have an impact on the investment landscape when they are low as well as high. Currently, interest rates are as low as they have ever been and this has driven valuations of defensive assets to unprecedented highs.

High valuations mean low yields and we are seeing record-low yields across many fixed income assets and some types of property. Term deposit rates are also at fresh lows following the Reserve Bank of Australia’s decision at its July meeting to drop the cash rate to one per cent, with expectations of more cuts to come later this year.

Low interest rates affect variables such as inflation and investment returns, and as such they have consequences for investment products. This has flow-on effects to all asset classes and, in turn, affects every Australian worker’s ability to save for retirement.

In the past, we had more options as investors – in the high interest rate era of the late 70s and 80s even relatively low-risk assets like term deposits and bonds offered double-digit returns. These days rates of return are all closer to one per cent.

Similarly, property yields in Australia are around two to four per cent depending on the type of property and geography.

Yields on Australian equities are still at 4.3 per cent before franking and about 5.5 per cent including franking. This shows that better yields are available but investors must either accept the valuation risk of defensive assets or take on more earnings risk in growth assets like equities, perhaps alongside a higher cash allocation.

The inflation perspective

Inflation has a big impact on retirees as they are in less of a position to accumulate capital after their working lives have finished. Falling returns mean providing for retirement is challenging, but although returns are low now compared to in the past, the view is not as bad when inflation is considered.

Inflation was running at around 15 per cent in the late 70s and 80s, which ate up much of the bond and term deposit returns mentioned above.

With inflation currently sitting at 1.8 per cent in Australia and returns for an average diversified fund at seven per cent, real returns don’t look so bad compared to two decades ago, taking into account the higher inflation levels of the time. Nevertheless, the combination of low interest rates and low inflation create a challenging returns environment for retirees.

There are risks too, should the current global inflation rate of about three per cent ever break higher than the defensive asset classes. As these assets are priced for the very low inflation of today, they would face major negative revisions. A reason, perhaps, to reduce valuation risk with a bar belled approach, increasing both cash and some growth assets.

The longevity conundrum

With Australians now living longer, another risk to retirement savings is longevity risk – the risk a retiree will outlive his or her savings. Back in 1980, a man starting a pension at age 65 had a life expectancy of 78 – an additional 13 years. Now, a male starting a pension at 65 has a life expectancy of 86 – an additional 21 years. While this is great news in many ways, it poses challenges financially as there are higher income needs as well as the need to grow the assets over time to make up for rising costs of living.

This is a particular concern in an environment which sees retirees drawing down on their pool of retirement assets because they can no longer generate sufficient income returns. This means retirement account balances are being depleted relatively quicker than in the past, especially if retirees lack exposure to growth assets to generate some capital growth over their longer lives.
No easy solutions

Supporting an ageing population to achieve their retirement goals in a market of lower investment returns is one of the major challenges facing our society and financial services businesses. A stable policy framework for superannuation and a long-term approach will be important in giving retirees the best chance of achieving a comfortable retirement.





Olivers Insights: Plunging bond yields & weak share markets amidst talk of recession – what does it mean for investors?


Only last month share markets in the US and Australia were at record highs. But ever since President Trump ramped up the US-China trade war again at the start of August, financial markets have seen a significant increase in volatility. Share markets have had a 6% or so fall from their highs to recent lows and bond yields have plunged to new record lows in many countries. This note takes a look at what is driving the market turmoil, the risk of recession and what it means for investors.

Market Turmoil – what’s driving it

The bout of market turmoil we have been seeing this month basically has three inter-related drivers. First, President Trump ramped up the US-China trade war again with another round of tariffs on China.

Second, Chinese economic data showed more than expected in July and the manufacturing heavy German economy contracted in the June quarter. This is on the back of weak global data.

Third, economic uncertainty drove more money into bonds pushing bond yields down and driving a further “inversion” of bond yield curves – which is when long-term bond yields fall below short-term yields – leading to more talk of recession.

This all drove share markets down. Of course, the turmoil in Hong Kong, Brexit, tensions with Iran, political uncertainty in Italy and increasing risks that a Peronist government will return in Argentina aren’t helping. Talk of policy stimulus has provided some relief though with occasional sharp rallies in shares.

Australia is not in the trade war but anything that weakens global growth threatens our exports and confidence, so we are naturally seeing bouts of weakness in Australian shares and bond yields just like we did last year when the trade war started.

Reason for concern

There are several reasons for concern. First, the trade war still shows no sign of letting up. Optimism on US trade talks with China have been dashed several times now, the threat of tariffs on autos remains and maybe China has decided to wait till after next year’s US elections.

Second, the trade war and the twists and turns it takes is weighing on business confidence and it’s hard to make firm investment plans when they may be rendered uneconomic by a tweet from Trump. This is particularly evident in a slump in manufacturing conditions PMIs worldwide. See the next chart.

Third, it’s been hoped Chinese policy stimulus will offset the trade war for the last year now, but China has continued to slow.

Fourth, inverted yield curves have preceded post-war US recessions so the recent inversion can’t be ignored.

Finally, global and Australian share markets are vulnerable to weakness after roughly 25% gains from their December lows to their July highs left them overbought and vulnerable to a correction. This risk is accentuated as the August to October period often sees share market weakness.

Reasons for optimism

However, while the risks have increased there are several reasons not to get too concerned. First, President Trump is getting twitchy about the negative economic effects of the trade war: he delayed some tariffs last week after some sharp share market falls and had a meeting with major US bank heads on share market falls. The historical record shows that US presidents get re-elected after a first term (think Nixon, Reagan, Clinton, Bush junior and Obama) except when there were recessions in the two years before the election and unemployment is rising (think Ford, Carter and Bush senior). Trump would be aware of this. Share markets have regular corrections but major bear markets are invariably associated with recession and so Trump is wary whenever shares take a sharp lurch lower. As a result, our view remains that at some point Trump will seek more seriously to resolve the trade issue.

Second, policy stimulus is being ramped up: with numerous central banks now cutting interest rates and indicating that more cuts are on the way including from the Fed; the ECB looks like it will soon return to quantitative easing; Chinese economic policy meetings indicate that more policy easing is on the way; Germany is reportedly thinking about some sort of fiscal stimulus; and there is talk of more US tax cuts. This is very different to last year when the Fed was tightening, the ECB and ended QE and other central banks including the RBA looked to be edging towards tightening.

Third, while the risks have increased, a US or global recession remains unlikely: services indicators have held up well (see the first chart) and the services sector is the dominant part of most major economies; we have not seen the sort of excesses that precede global and notably US recessions – there has been no investment boom, private sector debt growth has been modest and inflation is low such that central bankers have not slammed the brakes on; & monetary and fiscal stimulus will provide support.

Finally, the decline in bond yields is making shares relatively cheap. The gap of 4.8% between the grossed-up dividend yield on Australian shares of 5.7% and the Australian 10-year bond yield of 0.94% is at a record high. Similarly, the gap between the grossed-up dividend yield and bank term deposit rates of less than 2% is very wide. In other words, relative to bonds and bank deposits shares are very cheap which should see them attract investor flows providing we are right and recession is avoided.

But what about inverted yield curves?

Long-term bond yields should normally be above short-term bond yields because investors demand a higher return to have their money locked away for longer periods. But sometimes long-term rates may fall below short-rates. This happened briefly in the US in the last week in relation to the gap between 10-year and 2-year bond yields but had already happened a few months ago in relation to the gap between 10-year yield and the Fed Funds rate. See the next chart.

This so called “inversion” is causing increasing consternation as an inverted US yield curve has preceded US recession so it’s natural for investors to be concerned. But the yield curve is not necessarily a reliable recession indicator at present: it can give false signals (circled on the next chart); the lags from an inverted curve to a US recession averaged around 18 months in relation to the last three recessions so any recession may be some time off; various factors unrelated to US recession risk may be inverting the curve such as increasing prospects for more quantitative easing pushing down bond yields, negative German bond yields dragging down US yields and investor demand for bonds as a safe haven from shares; yield curves may be more inclined to be flat or negative when rates are low; and as noted earlier we have not seen other signs of an imminent US recession such as over-investment, rapid debt growth, excessive inflation and tight monetary policy. So, our base case remains that a US recession is not imminent.

The Australian yield curve has also gone negative with 10-year bond yields of 0.94% below the cash rate of 1% but the gap between the 10 and 2-year bond yields only just positive. But it’s worth noting that Australian yield curve inversions around 1985, 2000, 2005-2008 and in 2012 were useless recession indicators.

What does this all mean for investment markets?

In the short-term share markets could still fall further as trade and growth uncertainties remain as we go through the seasonally weak months ahead. This could be associated with further falls in bond yields. In fact, further share market weakness may be needed to get Trump to seriously resolve the trade issue (as opposed to just go through another trade talks/ breakdown cycle again).

However, providing we are right and recession is avoided, a major bear market in shares (i.e. where share fall 20% and a year later are down another 20% or so) is unlikely and given that shares are cheap relative to bonds we continue to see share markets as being higher on a 6-12-month horizon.

What should investors do?

Since I don’t have a perfect crystal ball, from the perspective of sensible long-term investing the following points are repeating.

  • First, periodic sharp setbacks in share markets are healthy and normal. This volatility is the price we pay for the higher long-term return from shares. After 25% or so gains from their lows last December shares were at risk of a correction.
  • Second, selling shares or switching to a more conservative strategy after falls just locks in a loss. The best way to guard against selling on the basis of emotion is to adopt a well though out, long-term investment strategy.
  • Third, when growth assets fall, they are cheaper and offer higher long-term return prospects. So, the key is to look for opportunities that pullbacks provide.
  • Fourth, while shares may have fallen in value, the dividends form the market haven’t. The income flow you are receiving from a diversified portfolio of shares remains attractive. So for those close to or in retirement they key is to assess what is most important – absolute stability in the value of your investments or a decent sustainable income flow
  • Fifth, shares often bottom at the point of maximum bearishness. So, when everyone is negative and cautious its often time to buy
  • Finally, turn down the noise. In times of crisis the negative news reaches fever pitch, which make sit very hard to stick to a long- term strategy, let alone see the opportunities.