Unfortunately, the run of strong performance in share markets has turned around in recent months, with October and December seeing particularly poor returns. As a result, our options with the highest exposure to shares suffered the most, while the defensive options still posted positive returns; albeit small. More specifically, the ‘Balanced Growth’ option, for our super members, returned minus 2.3% for the six-month period ended December.
In global markets, a key catalyst for the weakness in shares was a statement from the US central bank regarding the path for interest rates. In recent years, US interest rates have slowly been lifted off the emergency levels that were set during the financial crisis. While the increases in interest rates have been gradual and measured, during the quarter the US central bank indicated they might increase the pace, and size, of future interest rate increases. Understandably, share markets were concerned with this new information, worrying that interest rates might be lifted too high. Higher interest rates hurt companies and consumers through increased borrowing costs. Given that higher rates negatively impact both the corporate and consumer sectors, share market valuations pulled back. In addition to the developments in the US, the European Central Bank announced it will bring quantitative easing to an end, which is a way of reducing long term interest rates and supporting financial markets.
Importantly, a dispute over trade, between China and the US developed significantly in the period. In addition to the problems noted above, this trade dispute also depressed share prices, as trade restrictions typically increase costs. Partly as a result of this trade dispute, Chinese growth continued to slow over the period.
In domestic markets, there have been concerns about the very high level of debt held by Australian households for some time, and these concerns have increased recently given ongoing house price falls. While price falls have been relatively modest to date, the decline in house prices is tending to reduce consumer demand. The Royal Commission’s investigation into the banks has also reduced the supply of credit to home buyers.
Given these challenging conditions, we continue to monitor and manage the portfolios. Specifically, we have been moderating our holding of risky assets throughout the entirety of the calendar year 2018.
Looking forward, and if we take a long-term view, we generally don’t think the next 10 years will be as good as the last. Importantly, up to December 2018 we had seen ten consecutive years of positive returns for Balanced Growth. As we discussed above, central banks lowered interest rates very heavily in the financial crisis, and this has already helped support share market pricing. However, this decline in interest rates has brought forward some of tomorrow’s return to today. Nevertheless, inflation remains contained and economic growth remains sound in most major economies, which should provide some support to investment returns for now.