Olivers Insights

In the upside-down world logic that applies to much of investing, there are a bunch of mistakes investors often make which makes it harder for them to reach their financial goals. This note looks at the nine most common mistakes investors make.

Mistake #1 Crowd support indicates safety

“Bull markets are born on pessimism, grow on scepticism, mature on optimism, and die of euphoria” – John Templeton.

Individuals often feel safest when investing in an asset when their neighbours and friends are doing the same and media commentary is reinforcing the message that it’s the right thing to do. Call it “safety in numbers”. But it’s invariably doomed to failure. It stands to reason that when everyone is bullish and has bought into an asset with general euphoria about it, there is no one left to buy in the face of more positive supporting news but lots of people who can sell if the news turns sour. Of course the opposite applies when everyone is pessimistic and bearish and has sold – it only takes a bit of good news to turn the value of the asset back up. So it turns out that the point of maximum opportunity is when the crowd is pessimistic and the point of maximum risk is when the crowd is euphoric, but unfortunately most don’t realise this because it involves going against the crowd and that’s uncomfortable.

Mistake #2 Current returns are a guide to the future

“Markets are in a constant state of uncertainty and flux and money is to be made by discounting the obvious and betting on the unexpected” – George Soros.

Because of difficulties in processing information investors adopt simplifying assumptions, or heuristics. One of these is that recent returns or the current state of the economy and investment markets are a guide to the future: so tough economic conditions and recent poor returns are expected to continue and vice versa for good returns and good economic conditions. The problem with this is that when its combined with the “safety in numbers” mistake it results in investors getting in at the wrong time (eg, after an asset has already had strong gains) or getting out at the wrong time (eg, when it is bottoming). In other words, buying when asset values are high and selling when they are low.

Mistake #3 Strong growth is good for stocks & vice versa

“It’s so good it’s bad, it’s so bad it’s good” – Anon.

This is generally true over the long term and at various points in the economic cycle, but at cyclical extremes it is invariably wrong. The problem is that share markets are forward looking, so when economic data is really strong – measured by strong economic growth, low unemployment, etc – the market has already factored it in. In fact the share market may then fret about rising costs, rising inflation and rising short term interest rates, and hence things are so good they start to become bad! For example, when global share markets peaked in 2007 prior to the GFC economic growth and profit indicators looked good.

Of course the opposite occurs at market lows. For example, at the bottom of the global financial crisis bear market in March 2009 after 50% plus fall in shares, economic indicators were very poor – unemployment was up, profits were falling and all the talk was about the worst global recession since the Great Depression. And yet share markets started to rebound. History indicates that the best gains in stocks are usually made when the economic news is still poor, as stocks rebound from being undervalued and unloved. In other words, things are so bad they are actually good for investors.

Mistake #4 Experts can tell you where the market is going

“There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know” – J.K. Galbraith

I must admit this one is kind of sensitive! But I have to be real. No one has a perfect crystal ball. It’s well-known that when the consensus of experts’ forecasts are compared to actual outcomes they are often out by a wide margin. Forecasts of investment and economic indicators are useful but they need to be treated with care. Usually the grander the forecast – calls for “new eras of permanent prosperity” or for “great crashes ahead” – the greater the need for scepticism as such calls are invariably wrong, either they get the timing wrong or its dead wrong.

Market prognosticators suffer from the same psychological biases as everyone else. Precise point forecast for say where the share market will be at the end of the year are conditional upon information available when the forecast is made. But they need to be adjusted as new facts come to light. If forecasting investment markets was so easy then the forecasters would be rich and so would have stopped doing it. The key value of investment experts – or at least the good ones – is to give an understanding of the issues surrounding an investment market and to put things in context. The latter can provide valuable information in terms understanding the potential for the market going forward. This is far more useful than a simple point forecast as to where the ASX 200 will be in a year’s time.

Mistake #5 Letting a strongly held view get in the way

“The aim is to make money, not to be right” – Ned Davis.

Many let their blind faith in a strongly held view – “there is too much debt”, “aging populations will destroy share returns”, “global oil production will soon peak”, “the Eurozone will break up”, “an Australian house price crash is imminent”, etc – drive their investment decisions. They could turn out to be right but end up losing a lot of money in the interim. In fact there is a big difference between being right and making money.

Mistake #6 Looking at your investments too much

This sounds perverse – surely checking up on how your investments are doing is a good thing? But the danger is that the more investors are exposed to news around their investments the more they may see them going up and down – on a day to day basis it’s close to 50/50 as to whether the share market will be up or down. This “noise” can cause investors to freeze up or worse still it feeds on our natural aversion to any reduction in the value of our investments and thus encourages a greater exposure to lower returning safer investments. As a 1997 study by US behavioural economist Richard Thaler found, investors “with the most data [about how their investment is performing] did the worst in terms of money earned”. The trick is to have patience (evidence shows that patient people make better investors because they can look beyond short term noise or are less inclined to jump from investment to investment after they have already run) and turn down the noise.

Mistake #7 Making investing too complex

“There seems to be a perverse human characteristic that makes easy things difficult” – Warren Buffett.

Given the increasing ease of access to investment options, various ways to assemble them and information and processes to assess and evaluate them investment complexity can become the norm. The trouble is that when you overcomplicate your investments it can mean that you can’t see the wood for the trees. That you spend so much time focussing on this stock versus that stock or this fund manager versus that fund manager that you ignore the key driver of your portfolio’s risk and return which is how much you have in shares, bonds, real assets, cash, onshore versus offshore, etc. Or that you end up in investments you don’t even understand. So avoid clutter around your investments, don’t fret the small stuff, keep it simple and don’t invest in products you don’t understand.

Mistake #8 Too conservative early in life

“How many millionaires do you know who have become wealthy by investing in saving accounts?” – Robert G. Allen.

Cash and bank deposits are low risk and fine for near term spending requirements and emergency funds but they won’t build wealth over long periods of time. The chart below is one of my favourites and shows the value of $1 invested in various Australian assets since 1900 allowing for the reinvestment of interest and dividends along the way. That $1 would have grown to $442,373 if invested in shares but only to $228 if invested in cash. Despite periodic setbacks (WW1, the Great Depression, WW2, stagflation in the 1970s, 1987 share crash, GFC, etc), shares and other growth assets provide much higher returns over the long term than cash and bonds.

Source: Global Financial Data, AMP Capital

Not having enough in growth assets can be a particular problem for investors early in their working career as it can make it much harder to adequately fund retirement later in life. Studies in the US have found that millennials (those born between 1980 and 2000) tend to hold more in cash and less in shares than older generations at a time when they should be starting to grow their wealth. Perhaps the tech wreck and the GFC have made them more wary. Fortunately compulsory superannuation in Australia and My Super funds that allocate a higher allocation to growth assets for younger members help manage this.

Mistake #9 Trying to time the market

Without a tried and tested asset allocation process, trying to time the market, ie selling before falls and buying ahead of gains is very difficult. Many of the mistakes already referred to above kick in and it can turn out to be a sure way to destroy wealth. Perhaps the best example of this is the comparison of returns if the investor is fully invested in shares versus missing out on the best days. Of course if you can avoid the worst days during a given period you will boost returns but this is very hard to do and many investors only get out after the bad returns have occurred, just in time to miss out on some of the best days and so hurt returns. The next chart shows that if you were fully invested in Australian shares from January 1995 you would have returned 10.4% per annum (including dividends but not allowing for franking credits). But if by trying to time the market you miss the 10 best days the return falls to 7.9% pa. If you miss the 40 best days it drops to just 3.4% pa. Hence the old cliché that its time in that matters not timing.

Source: Bloomberg, AMP Capital

Concluding comment

One way to overcome many of these mistakes is to have a long term investment plan that allows for your goals and risk tolerance and then sticking to it.

About the Author

Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital’s diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

Source: AMP Capital

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

From record lows just after the Brexit vote – government bond yields have spiked higher. Ten year bond yields have risen from 1.36% in the US to 2.2%, from -0.19% in Germany to 0.31% and from 1.81% in Australia to 2.64% in four months. This in turn has led to sharp falls in high yield share market sectors like real estate investment trusts and utilities that had benefited from the fall in bond yields as investors sought higher yields. The back-up in bond yields has been given an added push by the election of Donald Trump as President of the US. So this all begs the question – have we seen the end of the 35 year super bull market in bonds? What does it mean for investors?

A bit of context

For context, the next chart shows bond yields back to 1850.

Source: Global Financial Data, AMP Capital

So far, while the 0.6 to 0.8 percentage point back up in bond yields seen since their mid-year lows has been sharp, it barely registers as a flick off the bottom in the chart. And note that there has been several back-ups in bond yields through the super cycle bond bull market since the early 1980s that have proved temporary – eg in recent times Australian bond yields rose 2 percentage points in 2009, 1.7 percentage points in 2012-13 (the “taper tantrum”) and 0.9 percentage points early last year – only to see bond yields resume their downtrend.

Bonds 101

Let’s take a quick look at how bonds work. If the government issues a bond for $100 and agrees to pay $4 a year in interest, this means an initial yield of 4%. Obviously the higher the yield the better, but in the short term the value of the bond will move inversely to the yield. If growth or inflation slows and interest rates fall investors might snap up bonds paying 4% till the yield is pushed down to say 3%. In the process the value of the bond goes up giving a capital gain. This is what’s happened in recent years. But, if growth and inflation pick up and bond yields rise, investors suffer a capital loss. And if you buy a bond yielding 3% and hold it for its term to maturity the return will be 3% pa!

Why did bond yields get so low in the first place?

The collapse in bond yields to record lows into mid-year reflected a combination of factors: worries about deflation; investors extrapolating current very low official interest rates into the future; worries that economic growth will remain slow; safe haven investor demand for bonds in response to geopolitical concerns in recent years (eg Ukraine, Brexit); an increasing demand for safe income yielding assets as populations age; a shortage in the supply of bonds as budget deficits fell when central banks have been buying bonds; and yields in higher yielding countries like Australia being pushed towards low yielding countries by investors chasing yield.

So why are bond yields now rising again?

A range of factors are now driving a rise in bond yields:

• global growth has proved stronger than feared earlier this year – global business conditions indicators are trending up;

• the threat of deflation is fading and global inflation looks to have bottomed – commodity prices (notably oil) have stabilised or increased and continuing global growth is gradually eating into spare capacity;

• Donald Trump’s election as President has added to expectations of a “great policy rotation” away from relying on central banks to boost growth to relying more on fiscal policy – with expectations that his policies to cut taxes, boost infrastructure spending and deregulate will boost growth and inflation and allow the Fed to raise rates faster;

• having seen all this investors have then questioned whether ultra low bond yields are sustainable. Over the long term nominal bond yields tend to average around long term nominal GDP growth. And on the basis of our long term nominal economic growth expectations 10 year bond yields are well below sustainable levels;

Bond yields well below long term sustainable levels

Source: Bloomberg, AMP Capital

• finally, with money pouring out of US equity funds/ETFs for years & into bonds the crowd had gotten too long on bonds.

While there have been lots of premature calls that the bond super bull market that started in the 1980s is over there is good reason to believe that now it is. Bond yields have fallen way below levels that can be fundamentally justified, the threat of deflation is receding, the global economy looks okay and the focus seems to be shifting from monetary stimulus towards greater reliance on fiscal stimulus – led by the US.

Reasons to expect a gradual rise in bond yields

However, this is not likely to be the 1970s when bond yields shot up sharply or even 1994 (when there was a mini bond crash). Rather it’s likely to be a gradual process of base building and rising yields. Historically bond yields have remained low after a long term downswing for around several years, as it takes a while for growth and inflation expectations to really turn back up. This can be seen in the circled areas for US and Australian bond yields in the first chart in this note.

While the Fed is likely to raise interest rates more than currently expected by the money market next year the process of rate hikes is likely to remain gradual as inflation is not a problem, fiscal easing will take time to impact and a rising $US will act as a brake on the Fed. Moreover central banks in Europe, Japan and Australia are likely to continue with existing monetary policy or ease further. As such it’s hard to get too bearish on bonds. At least until inflationary momentum really builds up again and global growth gets up to 4% for a while. But the best is likely over for bonds and the trend is likely gradually up.

What does it mean for investors?

There are several implications for investors from the likely end of the super cycle bull market in bonds. Firstly, while Australian and global sovereign bonds returned around 6% pa over the last three years don’t expect this to be sustained. Over the medium term the return an investor will get from a bond will basically be driven by what the yield was when they invested. This can be seen in the next chart which shows a scatter plot of Australian 10 year bond yields since 1950 against subsequent bond returns based on the Composite All Maturities Bond Index. At 2.6% now we are off the bottom of the chart meaning record low returns for the next ten years. And in the short term rising bond yields will mean capital loses.

Source: Global Financial Data, Bloomberg, AMP Capital

Secondly, a rising trend in bond yields has the potential to constrain the returns on shares as the former make the latter relatively more expensive. However, there are two potential offsets to this. The yield on Australian shares never fell to match the declining yield on bonds – as can be seen in the next chart shares offer a decent risk premium over bonds.

Source: Bloomberg, AMP Capital

And if nominal economic growth picks up and this flows through to earnings it will provide an offset to higher bond yields. I suspect that shares will be okay if the rise in bond yields is gradual and so can be offset by rising earnings, but a large abrupt back up in bond yields will be more of a concern.

Thirdly, defensive high yield sectors of the share market are likely to remain under pressure. Australian real estate investment trusts and utilities benefitted immensely from falling bond yields (next chart). With bond yields now reversing and cyclical parts of the share market coming into favour, AREITs and utilities are likely to remain relative underperformers.

Source: Bloomberg, AMP Capital

Fourthly, when it comes to real assets like unlisted commercial property and unlisted infrastructure the search for yield is likely to remain a return driver unless bond yields back up dramatically further. As can be seen in the next chart the yield on commercial property has never caught up to the decline in bond yields. Heading into the GFC it was only when bond yields rose above commercial property yields that commercial property prices started to struggle. We are a long way from that.

Source: Bloomberg, AMP Capital

About the Author

Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital’s diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

Source: AMP Capital

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

After a seemingly long and difficult campaign Donald Trump has been elected president of the United States with the Republican Party retaining control of the House, and the Senate, in Congress. Just as we saw with the Brexit vote, the combination of rising inequality, stagnant middle incomes and the disenchantment of white non-college educated males has seen a backlash against the establishment and helped deliver victory for Trump. This note looks at the implications.

Trump’s key policies

Taxation: Trump promises significant personal tax cuts including a cut in the top marginal tax rate to 33% from 39%, a cut in the corporate tax rate to 15% from as high as 39% and the removal of estate tax.

Infrastructure: Trump wants to increase infrastructure spending.

Government spending: Trump wants to reduce non-defence discretionary spending by 1% a year (the “penny plan”), but increase spending on defence and veterans.

Budget deficit: Trump’s policies are likely to lead to a higher budget deficit and public debt.

Trade: Trump wants to renegotiate free trade agreements and has proposed various protectionist policies, eg; a 45% tariff on Chinese goods, 35% on Mexican goods.

Regulation: Trump generally wants to reduce industry regulation, which would be good for financials and energy.

Immigration: Trump wants to build a wall with Mexico, deport 11 million illegal immigrants, put a ban on Muslims entering the US and require firms to hire Americans first.

Healthcare: Trump wants to repeal Obamacare and allow the importation of foreign drugs.

Foreign policy: Trump wants to reposition alliances to put “America first” and get allies to pay more, would confront China over the South China Sea and would bomb oil fields under IS control.

Risks and uncertainties

A problem for Donald Trump and America is that he will start his Presidency as extremely unpopular – in fact he is the least popular candidate on record and the election campaign has also highlighted a deeply divided America.

Source: Gallup, BCA Research, AMP Capital

He also faces a difficult time negotiating with his Republican colleagues in Congress given many distanced themselves from him during the election campaign.

Trump’s victory, like the Brexit vote, adds momentum to a backlash against establishment economic policies and specifically a move away from economic rationalist policies in favour of populism and a reversal of globalisation which could be a negative for long term global economic growth. The shift away from globalisation could also add to geopolitical instability (Russian President Putin was a supporter of Brexit and Trump!). More positively though, a greater focus on using fiscal stimulus could help reduce the burden on monetary policy and policies to reduce inequality could help support longer term economic growth.

Economic impact

Some of Trump’s economic policies could provide a boost to the US economy. The Reaganesque combination of big tax cuts and increased defence and infrastructure spending will provide an initial fiscal stimulus and, with reduced regulation, a bit of a supply side boost to the economy. The downside though is that this will blow out the budget deficit and the risk is that his protectionist policies will set off a trade war, and along with much higher consumer prices and immigration cut backs will boost costs. All of which could ultimately mean higher inflation and bond yields and a faster path of Fed rate hikes in the US (apart from any initial delays associated with uncertainty around his policies).

There may also be negative geopolitical and social consequences – tensions with US allies, reduced inflows into US treasuries in return, a more divided America – if Trump follows through with policies on these fronts.

Australia being more dependent on trade than the US (exports are 21% of GDP in Australia against 13% in the US) will be particularly vulnerable if Trump were to set off a global trade war.

The ultimate impact will depend on whether we get Trump the populist (determined to push ahead with his protectionist policies and steam roll Congress) or Trump the pragmatist (who backs down on his more extreme policies, eg. around protectionism) leading to a smoother period for the US and global economies. If we get Trump the pragmatist there is a good chance the US will see a sensible economic stimulus program combined with long needed reforms in areas like corporate tax.

Likely market reaction

The last few weeks – with shares and other risk assets falling when developments favoured Trump and rallying when developments favoured Clinton – indicates Trump’s victory will not go down well with markets. In fact we have already seen this with the initial reaction in Asian markets:

• Trump’s victory is seeing a resumption of “risk off” with shares likely to fall 5% or so (both in the US and globally – although Asian and Australian shares have already reacted to some degree) and safe havens like bonds and gold rallying as investors fret particularly about his protectionist trade policies triggering a global trade war. Australian shares are particularly vulnerable to this given our high trade exposure. The “global shock” of a Trump victory will likely see the Yen and the Euro rally further against the $US but the $US rise further against the Mexican peso and trade exposed countries in Asia.

• While the Fed will be a bit less likely to hike in December with a Trump victory, the $A will likely suffer from the threat to trade and the initial “risk-off” environment. A Trump victory to the extent that it leads to falls in investment markets and worries about a global trade war, may also increase the chance of another RBA rate cut in Australia – but not until next year.

• Beyond the initial reaction, share markets are likely to settle down and get a boost to the extent that Trump’s stimulatory economic policies look like being supported by Congress, but much will ultimately depend on whether we get Trump the pragmatist or Trump the populist. Congress, along with economic and political reality, can probably be relied on to take some of the edge off Trump’s policies to some degree, but this would take time. But a more pragmatic approach by Trump to economic policy would probably see the initial market reaction present investors with a buying opportunity.

Historically since 1927 US total share returns have been weakest when Republicans controlled the presidency and Congress with an average return of 8.9% p.a.

Source: Bloomberg, AMP Capital

Concluding comments

While Trump’s victory will come as a bit of a shock to many, there is a good chance that economic realities and the checks and balances provided by Congress will see his policies become more pragmatic. A good initial guide to this will be what sort of advisers Trump appoints around him. And remember there was much concern a Yes Brexit vote would be a disaster for shares and the global economy. What actually happened was an initial knee jerk sell off but after a few days global markets moved on to focus on other things and shares rallied. So there is a danger in making too much of the US election. It’s also worth noting that recent global growth indicators have been improving – both business conditions PMIs and profit indicators – and this along with continuing ultra-easy global monetary policy provides support for investment markets in the face of short term political uncertainties. 

Finally, while the Presidential election is an important political event, investors should remain focused on adhering to their financial objectives, ensuring that their portfolios are well diversified across asset classes and geographies, and continuing to take a long-term view.

Source: AMP Capital

About the Author

Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital’s diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

Perhaps the best that can be said of the US election is that it will soon be over. While polls had been moving in favour of a Clinton victory, the FBI’s announcement that it is examining new emails in relation to her use of a private email server while Secretary of State has taken it back to being a close race. The attached note provides a brief summary of the key issues.

Populism (Trump) v the establishment (Clinton)

The combination of rising inequality, stagnant middle incomes and the disenchantment of white non-college educated males have led to a backlash against the establishment and this is driving support for Trump. As is often the case in such circumstances people offering simplistic solutions – such as protectionism and blaming foreigners and immigrants can easily garner popular support. The problem is that building walls and going back to the protectionism of the past is not the solution (and will only harm the people such policies claimed to help as the protectionism of the 1930s showed). That said, rising inequality will have to be dealt with.

But first some US election mechanics

The US president is not chosen directly by the people but via the Electoral College. Voters choose their preferred candidate but actually vote for electors (who are chosen by the candidates’ party) to represent their state. Each state has Electoral College votes equal to its number of House of Representatives seats plus their two senators, resulting in a total of 538 so the winning candidate needs 270 to win. Since all states except Nebraska and Maine are winner takes all, this turns the Electoral College process into a battle to win key swing states. This means states like California which is certain to be Democrat are largely irrelevant. For 2016 there are about 12 key battleground states including Florida and Ohio.

In addition to Trump and Clinton there are other candidates in the presidential race but combined they have been polling less than 10%, but could garner more if voters don’t like either Trump or Clinton. This in turn would increase the risk that neither gets the magic 270 votes in the College, in which case the House of Reps will decide and since Republicans will likely retain control of the House this would mean a win for Trump.

In addition to the vote for the president Americans will vote for all 435 seats in the House, 34 of the 100 Senate seats, some state governors and officials and various local officials and some referendums. And we thought it was complicated in the polling booth in Australia!

Of these, the Senate and House are most important. To gain a majority of the Senate the Democrats need to win 5 seats which is possible but difficult and they are unlikely to gain a filibuster proof level of 60 seats. In the House it is very hard to see the Democrats gaining the 30 seats necessary for control.

The key policy differences

Taxation: Trump promises significant personal tax cuts including a cut in the top marginal tax rate to 33% from 39%, a cut in the corporate tax rate to 15% from as high as 39% and removal of estate tax. Clinton promises higher tax rates for very high income earners, a cap on deductions, increased estate and gift taxes and a tax on high frequency trading.

Infrastructure: Both want to increase infrastructure spending.

Government spending: Trump wants to reduce non-defence discretionary spending by 1% a year, but increase spending on defence and veterans. Clinton wants to increase non-defence discretionary spending.

Budget deficit: Trump’s policies are more likely to blow out the budget deficit and public debt than Clinton’s.

Trade: Trump proposes protectionist policies, eg, a 45% tariff on Chinese goods, 35% on Mexican goods. Clinton largely supports free trade as long as America isn’t harmed.

Regulation: Trump generally wants to reduce industry regulation, which would be good for financials and energy. Clinton wants tougher industry regulation.

Immigration: Trump wants to build a wall with Mexico, deport 11 million illegal immigrants, put a ban on Muslims entering the US and require firms to hire Americans first. Clinton tends to favour expanding immigration.

Healthcare: Trump wants to repeal Obamacare and allow the importation of foreign drugs. Clinton has promised to defend Obamacare, expand access to healthcare and limit drug prices.

Foreign policy: Trump wants to reposition alliances to put “America first” and get allies to pay more, would confront China over the South China Sea and would bomb oil fields under IS control. Clinton wants to strengthen alliances and would continue the US “pivot” to Asia (being one of its architects).

Economic impact

Trump: many of his economic policies could provide a boost to the US economy. The combination of big tax cuts & increased defence and infrastructure spending will provide an initial fiscal stimulus and, with reduced regulation, a bit of a supply side boost. Longer term though the budget deficit will likely blow out and protectionist tariff hikes would likely set off a trade war along with much higher consumer prices and immigration cut backs would boost costs. All of which could ultimately mean higher inflation, bond yields and interest rates and a hit to growth. There may also be negative geopolitical and social consequences (tensions with US allies, reduced inflows into US treasuries in return, a more divided America) if Trump follows through with policies on these fronts. Australia being more dependent on trade than the US would be particularly adversely affected if Trump were to set off a global trade war.

Clinton: her policies would also provide a short term stimulus (albeit smaller) but higher top tax rates and more regulation may offset the short term boost. At least there is no risk of a trade war or increased social unrest (unless Trump’s refusal to accept the election outcome if he loses sets off the latter).

But politicians are well known for dropping more extreme aspects of their policies once they attain power as economic and political realities set in. Just look at Syriza in Greece! In the case of Trump it’s partly a case of whether we end up with Trump the pragmatist (who backs down on some of his extreme measures such as those around protectionism) or Trump the populist (who sticks to his policies once president) and whether Congress limits him or not.

Election scenarios and prospects

Putting aside the low risk of no candidate getting a 270 vote majority in the Electoral College (which would probably see Trump voted as president by the House of Reps) there are three scenarios worth considering (with probabilities):

A. Trump president, Republicans retain the House and Senate (45%).
B. Clinton president, Republicans retain the House and probably the Senate (50%).
C. Clinton president, Democrat majorities in the House & Senate (5%).

Following the debates and the revelation of misogynist Trump comments from 2005, Clinton’s average poll lead widened to over 5%, but has narrowed after Friday’s FBI announcement. I suspect that racist, misogynistic and narcissistic comments don’t go down well with independent voters who will decide the outcome and that this combined with the Democrat’s superior “get out to vote” effort favours Clinton but the latest news regarding her emails has returned it to being a very close call. In any case there is no sign of a wave of support building in favour of the Democrats that will see them win control of the House and Senate (Scenario C). Yes the Democrats had a clean sweep in 2008 with Obama but then they built on stronger starting positions in the House and Senate helped by a backlash against Republicans due to the GFC.

So a Clinton presidency would most likely see a continued divided government. This would mean that her more left wing policies (more regulation, tax hikes) would not be passed and it would just be “more of the same” (which was good under Obama and Bill Clinton).

By contrast a Trump presidency will likely see Republican majorities retained in both the House and Senate. This could provide an opportunity for significant tax reform and reduced regulation, but conservative Congressional Republicans would have to be relied upon to prevent a budget deficit blow out and aggressive protectionism.

Likely market reaction

The last few weeks – with US shares tending to sell off when developments favoured Trump (such as when Clinton got pneumonia and after Friday’s FBI news) and rally when developments favoured Clinton (such as after the 2005 tape revelation and debates) and get the jitters again (when there is talk of a Democrat clean sweep) – suggest investors favour a Clinton victory as long as it’s not a clean sweep. Given this:

• A Trump victory would likely trigger an initial bout of “risk off” with shares down by 5-10% or so (both in the US and globally) and safe havens like bonds and the $US rallying as investors fret particularly about his protectionist trade policies triggering a global trade war. Australian shares would be particularly vulnerable to this given our high trade exposure. While the Fed would be less likely to hike in December if Trump wins the $A would likely still suffer from the threat to trade and the initial “risk-off” environment. A Trump victory to the extent that it leads to falls in investment markets and worries about a global trade war may also increase the chance of another RBA rate cut in Australia.

  Beyond the initial reaction, share markets could then settle down and get a boost with bond yields and the $US rising to the extent that his stimulatory economic policies look like being supported by Congress and lead to a higher US budget deficit and tighter monetary policy, but much would ultimately depend on whether we get Trump the pragmatist or Trump the populist. Congress along with economic and political reality can probably be relied on to take some of the edge of Trump’s policies, but this would take time.

• A Clinton/Democrat clean sweep of the Presidency and Congress would likely also trigger a bout of nervousness in US shares as it would be easier for Clinton to implement less business friendly tax and regulatory policies that would weigh on US health, energy and financial stocks. This would likely be more focussed on US shares though with less of an impact on global/Australian shares.

• The best outcome for shares would be a Clinton victory but with Republicans retaining control of at least the House as this would be seen as “more of the same”. Since 1927 US total share returns have been strongest at an average 16.7% pa when there has been a Democrat president and Republican control of the House, the Senate or both. By contrast the return has only averaged 8.9% pa when the Republicans controlled the presidency and Congress.

Source: Bloomberg, AMP Capital

Finally a note of caution: Around the Brexit vote there was much concern a Yes vote would be a disaster for shares and the global economy. In the event there was an initial knee jerk sell off but after a few days global markets moved on to focus on other things. So there is a danger in making too much of the US election.

Source: AMP Capital

About the Author

Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital’s diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

We are going through one of those periods where it seems there is a long list of things for investors to worry about: the US election; the Fed; ever present fears about a break of the Eurozone; and China. To be sure these risks are real and in our view some combination of them could drive a short term correction in shares, but we don’t see them derailing the longer term rising trend in shares. More fundamentally there seems to be a never ending worry list which is receiving an ever higher prominence as the information age enables the ready and rapid dissemination of news, opinion and noise. The danger is that this is making us all worse investors as we lurch from one worry to the next resulting in ever shorter investment horizons in the process. The trick is how to manage the noise to avoid this.

Why the worries might seem more worrying?

The problem for investors is that the worry list seems more worrying than it used to be. Yes, there is a fundamental element: the nominal return potential from most asset classes are lower than they used to be, global growth is slower than it was pre GFC and the world seems awash in geopolitical risks.

But there is a huge psychological aspect to this that is combining with the increasing availability of information, and intensifying competition amongst various forms of media for clicks, that is magnifying perceptions around various worries.

Firstly, people suffer from a behavioural trait that has become known as “loss aversion” in that a loss in financial wealth is felt much more distastefully than the beneficial impact of the same sized gain. This probably reflects the evolution of the human brain in the Pleistocene age when the trick was to avoid being eaten by a sabre toothed tiger or squashed by a wholly mammoth. This leaves us biased to be more risk averse and it also leaves us more predisposed to bad news stories as opposed to good news stories. Flowing from this, prognosticators of gloom are more likely to be revered as deep thinkers than are optimists. As John Stuart Mill noted “I have observed that not the man who hopes when others despair, but the man who despairs when others hope, is admired by a large class of persons as a sage.” In other words bad news and doom and gloom find a more ready market than good news or balanced commentary as it appeals to our instinct to look for risks around the corner. Hence the old saying “bad new sells”.

Secondly, we are now exposed to more information than ever on both how our investments are going and everything else. On the one hand this is great – we can check facts, analyse things, sound informed easier than ever. But for the most part we have no way of weighing such information and no time to do so. So it becomes noise. This comes with a cost for investors. If we don’t have a process to filter it and focus on what matters we can simply suffer from information overload. This can be bad for investors as when faced with more (and often bad) news we can freeze up and make the wrong decisions with our investment as our natural “loss aversion” combines with what is called the “recency bias” that sees people give more wait to recent events which can see investors project recent bad news into the future and so sell after a fall. A 1997 study by US behavioural economist Richard Thaler and others showed that providing investors in an experiment “with frequent feedback about their [investment] outcome is likely to encourage their worst tendencies…More is not always better. The subjects with the most data did the worst in terms of money earned.”

Thirdly, there is explosion in media outlets all competing for your eyes and ears. We are now bombarded with economic and financial news and opinions with 24/7 coverage by multiple web sites, subscription services, finance updates, dedicated TV and on line channels etc. And in competing for your attention, bad news and gloom naturally trumps good news and balanced commentary as “bad news sells.” So naturally it seems that the bad news is “badder” and the worries more worrying than ever.

Google the words “financial crisis 2016” and you get 54.2 million search results with titles such as:

• “the looming financial crisis nobody is talking about…”;

• “the pieces are falling into place for another financial crisis”;

• “7 signs of a US economic collapse in 2016”;

• “coming financial collapse – 18 critical items you need to prepare, tomorrow may be too late”;

• “beware the great 2016 financial crisis”;

• “looking for economic crisis 2016? Find everything you need here”;

• “Trouble with money? The Bible has answers for you”; and

• The Illuminati (are those guys still around?) are supposedly behind the “global financial crisis 2016-2017”.

But you don’t even have to Google them – they just seem to pop up once it’s known you are into matters financial. I seem to constantly see an ad about why an Australian recession is inevitable in 2016 and how to protect my wealth…but they also told me it was inevitable in 2015 and 2014?

The trouble is that there is no evidence that all this noise is making us better investors. Average returns are no higher than in the past. A concern is that the combination of a massive ramp up in information combined with our natural inclination to zoom in on negative news is making us worse investors: more fearful, more jittery and more short term focussed.

Nine keys for successful investing

There are nine keys to successful investing (see http://bit.ly/1JmaIDU):

1. Make the most of the power of compound interest;

2. Be aware that there is always a cycle;

3. Invest for the long term;

4. Diversify;

5. Turn down the noise;

6. Buy low and sell high;

7. Beware the crowd at extremes;

8. Focus on investments offering sustainable cash flow; and

9. Seek advice.

But of all of these, number 5 – or turn down the noise on the information flow around us, is critical – if you can’t do that there is no point getting advice, you won’t be a long term investor, you won’t get the benefit of compound interest, you will be sucked into selling low in every cyclical downturn, etc.

Five ways to manage the perpetual worry list

So here are five suggestions as to how to manage the worry list and turn down the noise:

Firstly, put the latest worry list in context. Remember that there has always been an endless stream of worries. Here’s a list of the worries of the last four years that have weighed on markets: the fiscal cliff; Cyprus; Fed taper talk; the US Government shutdown and debt ceiling debacle; Ukraine; IS terror threat; Ebola; deflation; Greece; China worries; Australian recession, property & banks; Brazil and Russia in recession; energy producers defaulting; manufacturing slump; Trump; worries about the Fed raising rates; soft starts to the year for US growth; falling profits; Brexit and contagion to the rest of Europe; North Korea; messy Australian election result; and South China Sea tensions.

Yet despite this extensive worry list investment returns have actually been okay with average balanced growth superannuation funds returning 9.6% pa over the last four years and 7.4% pa over the last three years after taxes and fees.

The global economy has had plenty of worries over the last century, but it got over them with Australian shares returning 11.6% pa since 1900 and US shares 9.8%pa.

Source: ASX, AMP Capital

Secondly, recognise how markets work. A diverse portfolio of shares returns more than bonds and cash long term because it can lose money short term. As can be seen in the chart below while the share market can be highly volatile in the short term it has strong returns over all rolling 20 year periods. And invariably the short term volatility is driven by “loss averse” investors projecting recent events into the future and so causing shares to periodically from long term fundamental value. So volatility driven by worries and bad news is normal. It’s the price investors pay for higher longer term returns.

Source: Global Financial Data, AMP Capital

Thirdly, find a way to filter news so that it doesn’t distort your investment decisions. For example this could involve building your own investment process or choosing 1-3 good investment subscription services and relying on them. Or simpler still, agreeing to a long term strategy with a financial planner and sticking to it. Ultimately it all depends on how much you want to be involved in managing your investments.

Fourthly, make a conscious effort not to check your investments so much. If you track the daily movements in the Australian All Ords price index, measured over the last twenty years it has been down almost as much as it has been up. See the next chart. It’s little different for the US S&P 500. So day to day it’s pretty much a coin toss as to whether you will get good news or bad. By contrast if you only look at how the share market has gone each month and allow for dividends the historical experience tells us you will only get bad news 35% of the time. Looking only on a calendar year basis, data back to 1900 indicates that the probability of bad news in the form of a loss slides further to just 19% for Australian shares and 27% for US shares. And if you can stretch it out to once a decade, again since 1900, positive returns have been seen 100% of the time for Australian shares and 82% of the time for US shares.

Data from 1995 and 1900. Source: Global Financial Data, AMP Capital

The less frequently you look the less you will be disappointed and so the lower the chance that a bout of “loss aversion” will be triggered which leads you to sell at the wrong time. Try to avoid looking at market updates so regularly and even consider removing related apps from your smart phones & tablets.

Finally, look for opportunities that bad news and investor worries throw up. Always remember that periods of share market turbulence after bad news throw up opportunities for investors as such periods push shares into cheap territory.

Concluding comment

I read recently an opinion piece claiming that behind most financial scare stories is an economist. Perhaps – although I tend to think the exaggeration bit comes mostly from others. But my long term experience around investing tells me that it’s far more productive to lean into prognostications of financial gloom because most of the time they are wrong and end up just distracting investors from their goals.

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

Housing matters a lot in Australia. Having a house on a quarter acre block is part of the “Aussie dream”. Housing is a popular investment destination. And the housing cycle is a key component of the economic cycle and closely connected to interest rate movements. But in the last 15 years or so it has taken on a darker side as a surge in house prices that started in the late 1990s has led to poor affordability and gone hand in hand with surging household debt. Reflecting this, predictions of an imminent property crash bringing down the Australian economy have been repeated ad nauseam since 2003. This note looks at the risks of a property crash, particularly given the rising supply of units, implications from the property cycle for economic growth and how investors should view it.

High house prices and high debt

The big picture view on Australian residential property is well known. First, Australian housing is expensive. According to the 2016 Demographia Housing Affordability Survey the median multiple of house prices in cities over 1 million people to household income is 6.4 times in Australia versus 3.7 in the US and 4.6 in the UK. In Sydney it’s 12.2 times and in Melbourne it’s 9.7 times. The ratios of house price to incomes & rents are at the high end of OECD countries and have been since 2003.

Second, the surge in home prices has gone hand in hand with a surge in household debt, which has taken Australia’s household debt to income ratio from the low end of OECD countries 25 years ago to now around the top. This can be seen in the next chart which shows the deviation in the house price to income ratio against its long term average for Australia against the ratio of household debt to income. The shift to overvaluation and high debt mostly occurred over the 1995-2005 period.

Source: OECD, RBA, AMP Capital

How did it come to this?

While it’s common to look for scapegoats to blame for high home prices and debt the basic driver looks to be a combination of the shift from high to low interest rates over the last 20-30 years which has boosted borrowing and buying power and the inadequacy of a supply response (thanks to tight development controls, restrictive land release and lagging infrastructure) to suppress the resultant rise in the ratio of prices to incomes. The following chart shows a cumulative shortfall of over 100,000 dwellings relative to underlying demand had built up by 2014.

Source: ABS, AMP Capital

A home price crash remains unlikely…

The surge in prices and debt has led many to conclude a crash is imminent. But we have heard that lots of times over the last 10-15 years. Several considerations suggest a crash is unlikely.

First, we have not seen a generalised oversupply and at the current rate we won’t go into oversupply until around 2017-18.

Second, despite talk of mortgage stress the reality is that debt interest payments relative to income are around 2004 levels.

Third, Australia has still not seen anything like the deterioration in lending standards seen in other countries prior to the GFC. In fact in recent years there has been a decline in low-doc loans and a reduction in loans with high loan to valuation ratios.

Source: APRA, AMP Capital

Finally, it is dangerous to generalise. While property prices have surged 60% and 40% over the last four years in Sydney and Melbourne, they have fallen in Perth to 2007 levels and have seen only moderate growth in the other capital cities.

…but the risks on the unit supply front are a concern

To see a property crash – say a 20% plus average price fall – we probably need to see one or more of the following:

• A recession – much higher unemployment could clearly cause debt servicing problems. This looks unlikely though.

• A surge in interest rates – but rate hikes are unlikely until 2018 and the RBA knows households are more sensitive to higher rates so it’s very unlikely rates will reach past highs.

• Property oversupply – as noted above this would require the current construction boom to continue for several years.

However, the risks on the supply front are clearly rising in relation to apartments where approvals to build more apartments are running at more than double normal levels.

Source: ABS, AMP Capital

Due to the rising supply of units, vacancy rates are trending up & rents are stalling, making property investment less attractive.

Outlook

Nationwide price falls are unlikely until the RBA starts to raise interest rates again and this is unlikely before 2018 at which point we are likely to see a 5% or so pullback in property prices as was seen in the 2009 & 2011 down cycles. Anything worse would likely require much higher interest rates or recession both of which are unlikely. However, it’s dangerous to generalise:

• Sydney and Melbourne having seen the biggest gains are more at risk and so could fall 5-10% around 2018.

Source: CoreLogic, AMP Capital

• Price growth is likely to remain negative in Perth and Darwin as the mining boom continues to unwind but this should start to abate next year.

• The other capitals are likely to see continued moderate growth and a less severe down cycle in or around 2018.

• But units are at much greater risk given surging supply and this could see unit prices in parts of Sydney and Melbourne fall by 15-20% as investor interest fades as rents fall.

The property cycle and the economy

Slowing momentum in building approvals points to a slowdown in the dwelling construction cycle ahead. While this might be delayed into 2017 as the huge pipeline of work yet to be done is worked through, slowing dwelling investment combined with a slowing wealth affect from rising home prices mean that contribution to growth from the housing sector is likely to slow. However, as this is likely to coincide with a fading in the detraction from growth due to falling mining investment and commodity prices it’s unlikely to drive a slowing in the economy.

Source: ABS, AMP Capital

However, a likely decline in rents (as the supply of units hits) will constraint inflation helping keep interest rates low for longer.

Implications for investors

There are several implications for investors:

• Firstly, over the very long term residential property adjusted for costs has provided a similar return to Australian shares. Its low correlation with shares, lower volatility but lower liquidity makes it a good portfolio diversifier with shares. So there is clearly a role for property in investors’ portfolios.

Source: ABS, REIA, Global Financial Data, AMP Capital

• Secondly, there remains a case to be cautious regarding housing as an investment destination for now. It is expensive on all metrics and offers very low income (rental) yields compared to other growth assets. This means a housing investor is more dependent on capital growth.

• Thirdly, these comments relate to housing in aggregate and right now it’s dangerous to generalise. Apartments in parts of Sydney & Melbourne are probably least attractive but for those who want to look around there are pockets of value.

• Finally, investors need to allow for the fact that they likely already have a high exposure to Australian housing. As a share of household wealth its nearly 60%. Once allowance is made for exposure via Australian shares it’s even higher.

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.