The first half of 2018 has shaped up to be a fairly volatile year with regards to equity markets. We have had a correction in both Australian and Global Equity markets in February/March only to then post a recovery in April/May. We have and continue to remain cautious with regards to our outlook for equity markets certainly over the next year. To this end, we have held a higher allocation in defensive asset classes to ensure we are well supported in case of another correction.
Based on the recent PIMCO Global Advisory Board Meeting discussion by Joachim Fels (Global Economic Adviser for PIMCO), Andrew Balls (CIO Global Fixed Income), and Daniel Ivascyn (Global Chief Investment Officer), I relay the thinking on markets in this write-up. This board has as members such as the likes of Dr Ben Bernake, Former Federal Reserve Chairman; Gordon Brown, former Prime Minister of the UK; Ng Kok Song, former Group CIO of the Government of Singapore Investment Corporation; and Jean-Claude Trichet, former President of the European Central Bank, to name a few.
The global markets have generally, over the past 10 years since the GFC, outperformed the respective economies. However, this may not run true for the next decade, especially given current valuations which are either at fair value or slightly stretched globally. The consensus view is that there will be a recession in the US in the next 3 to 5 years and whilst this may eventuate, it is expected to be shallower, but last longer and be more risky.
Shallower because there are no signs so far of corporate or housing overinvestment or overconsumption in the US and the Global Financial sector looks better than in the past few years. Last longer given the low interest rate environment, the tremendous debt burden on the government balance sheets due to QE and Asset Purchasing, the levers available to central banks to combat another recession are not plentiful. Riskier because, based on the populist movement we are currently witnessing in Italy, have witnessed with Brexit, there may be an increase in further anti-establishment movements. This could further derail economic growth and encourage deglobulisation of trade and more protectionism— all things that lead to lower growth and productivity.
“One way the real economy could break out from the post-crisis lull on a sustainable basis is through a significant pickup in productivity growth as the diffusion of new technologies finally accelerates via stronger business investment.” (By Joachim Fels, Andrew Balls, Daniel J. Ivascyn)
Therefore, whilst there is the potential for continued growth and equity market returns, the productivity gains required for further growth may be slow to come and may come over the longer-term horizon (5 years +). It would also require further stimulus through investment such as the US has embarked upon with regards to its infrastructure rebuild. The “trade war” issues between China and the US could also have spill over effects across other countries. However, given the Chinese leadership’s longer-term view of economic progress, there is a greater chance of a “fairer and freer trade deal” that includes better protection of intellectual property rights that satisfies the U.S.’s short-term goal, whilst still allowing China to keep pursuing its longer-term goals.
In conclusion, volatility will remain elevated, whilst the new regime of lower interest rates will also continue to pressure investment returns from the defensive part of a diversified portfolio. Therefore, whilst the environment remains difficult, it will pay to remain prudent and maintain a diversified portfolio with a longer-term view and seek out opportunities as and when they become available.