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The investment outlook – it’s not all that bad! Here are nine reasons why

Posted On:Jul 20th, 2016     Posted In:Rss-feed-oliver    Posted By:Provision Wealth
Introduction

The past few weeks have been messy with Brexit, the Australian election, another terrorist attack in France and an attempted coup in Turkey. In fact, the last 12 months have been – starting with the latest Greek tantrum and China share market plunge a year ago. It’s almost as if someone has listened to Taylor Swift’s song “Shake It Off”

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Introduction

The past few weeks have been messy with Brexit, the Australian election, another terrorist attack in France and an attempted coup in Turkey. In fact, the last 12 months have been – starting with the latest Greek tantrum and China share market plunge a year ago. It’s almost as if someone has listened to Taylor Swift’s song “Shake It Off” and decided to try and shake up investment markets. This has all seen a rough ride in investment markets with most share markets falling into bear market territory at some point over the last year and bond yields plunging to record lows. This note reviews the worry list from the last 12 months, the impact on returns and looks at the outlook going forward.

There’s been a long worry list

The past year has seen a long worry list with:

  • Another Greek tantrum in June-July last year;

  • A 49% plunge in Chinese shares with worries about debt, growth & capital outflows as the Renminbi was devalued;

  • An ongoing collapse in commodity prices;

  • Intensifying concerns about deflation;

  • Recession in Brazil and Russia and concerns about a new emerging market debt crisis;

  • Worries about energy producers defaulting on their loans;

  • Ongoing angst about the end of the mining boom and the risk of a property crash in Australia;

  • A slump in manufacturing globally led by the US & China;

  • Concerns that the Fed raising rates and causing a further surge in the $US would accentuate problems for China, the emerging world and commodity prices;

  • Another soft start to the year for US growth;

  • Falling profits in the US, Australia and most regions;

  • Numerous IS related terrorist attacks;

  • A “surprise” vote by the UK to Leave the European Union setting of a new round of fears that there will be a domino effect of countries seeking to leave the Eurozone;

  • A messy election result in Australia with likely an even more difficult Senate which will make it even harder for the Government to control spending and implement reforms;

  • An escalation of tensions in the South China Sea; and

  • An attempted coup in Turkey.

The success of Donald Trump in the US, the Brexit vote & the close election in Australia highlight a growing angst at rising inequality and a loss of support for the economic rationalist policies of globalisation, deregulation and privatisation. While understandable, the resultant populist policy push risks slower long term economic growth and lower investment returns.

Constrained and uneven returns

The turmoil over the last 12 months has shown up in very messy share markets (with most falling into bear market territory with 20% plus falls from last year’s highs to their lows early this year before a rebound) and a sharp decline in bond yields to record lows. However, unlisted assets like commercial property, infrastructure and listed yield-based plays like real estate investment trusts have done very well. Reflecting the constrained environment, balanced growth superannuation funds saw average returns of around 1-2%.

Source: Thomson Reuters, AMP Capital

Nine reasons why it’s not all that bad

But while super funds had soft returns over the last year they were not disastrous and moreover they averaged 8-9% over the last three years – which is not bad given how low inflation is. What’s more, while the worry list may seem high that has been the story of the last few years now. For example, 2014-15 saw worries about the end of the US Fed’s quantitative easing program, Ukraine, the IS terror threat, Ebola, deflation, a soft start to 2015 for US growth (we hear that one a lot!), worries about China, soft Eurozone growth and on-going noise about a property crash/ recession in Australia. So nothing new really! More fundamentally there are nine reasons for optimism.

First, global growth is okay – there has been no sign of the much feared global recession. Global business conditions surveys point to ongoing global growth of around 3%.

The shift to overvaluation more than a decade ago went hand in hand with a surge in the ratio of household debt to income, which took Australia’s debt to income ratio from the low end of OECD countries to now being around the top.

Source: Bloomberg, AMP Capital

In Australia, growth has in fact been particularly good at around 3%. The economy has rebalanced away from a reliance on mining and it has benefitted from the third and final phase of the mining boom which has seen surging resource export volumes.

Second, central banks have signalled easier monetary policy for longer post-Brexit which is likely to ensure that liquidity conditions remain favourable for growth assets.

Third, while the shift to the left by median voters in Anglo countries resulting in more populist policies is likely to harm long term growth potential, it could actually boost growth in the short term (including under Trump in the US) as it sees a relaxation of fiscal austerity.

Fourth, we may have seen the worst of the commodity bear market. After huge 50% plus falls some commodity markets are moving towards greater balance (notably oil and some metals).

Fifth, deflation risks look to be receding. Oil prices which played a huge role in driving deflation fears look to be trying to bottom and a shift towards more inflationary policies by governments and some central banks are likely to start shifting the risks towards inflation on a 2-5 year view.

Sixth, the profit slump may be close to over. US profits are showing signs of bottoming helped by a stabilisation in the $US and the oil price. Australian profits are likely to rise modestly in the year ahead as the commodity price driven plunge in resource profits runs its course.

Seventh, the latest falls in interest rates and bond yields have further improved the relative attractiveness of shares and may unleash yet another extension of the search for yield.

Eighth, investors have been more relaxed about the latest decline in the Chinese Renminbi – reflecting slowing capital outflows from China, reassurance from Chinese officials and a growing relaxation about fluctuations in the value of the RMB.

Finally, all the talk has been bearish lately – Brexit, Chinese debt, US slowing, messy Australian election – which provides an ideal springboard for better investment returns!

What about the return outlook?

The August–October period can often be rough for shares. But looking through short term uncertainties and given the considerations in the previous section, – it’s hard to see the outlook for investment markets differing radically from what we have seen over the last few years albeit stronger than over the last 12 months for shares. Growth is not flash but okay, inflation is low and monetary conditions overall are set to remain easy. For the main asset classes, this has the following implications:

  • Cash and term deposit returns to remain poor at around 2%. Investors remain under pressure to decide what they really want: if its capital stability then stick with cash; if its a decent stable income flow then consider the alternatives.

Source: RBA, AMP Capital

  • Ultra-low sovereign bond yields of around 2% or less, with a third of the global bond index in negative yield territory, indicate that the return potential from bonds is low.

  • Corporate debt should provide okay returns. A drift higher in bond yields is a mild drag but with continued modest global growth the risk of default should remain low.

  • Unlisted commercial property and infrastructure are likely to benefit from the ongoing “search for yield”.

  • Residential property returns are likely to be mixed with some cities continuing to see price falls and a further slowing in Sydney and Melbourne property prices. Very low rental yields are not good, particularly in oversupplied apartments.

  • The rising trend in shares is likely to continue as: shares are okay value, monetary conditions remain very easy and continuing moderate economic growth should help profits. Within shares, we favour European, Japanese and Chinese/Asian shares over US shares.

  • Finally, the downtrend in the $A is likely to resume enhancing the case for global shares (unhedged).

Things to keep an eye on

The key things to keep an eye on over the year ahead are:

  • Global business condition PMIs – these currently point to constrained but okay growth.

  • Signs of European countries seeking to leave the Eurozone and investors demanding higher borrowing rates to lend to countries like Italy, seen to be at risk of leaving. Italian banks are also a risk worth keeping an eye on.

  • When/if the Fed starts to raise rates again later this year and the impact on the US dollar.

  • Chinese economic growth readings.

  • Whether Australian non-mining activity keeps improving.

Concluding comments

The September quarter is historically a rough one for shares and the prospect of a Trump victory in the US and worries about Italian banks may cause some nervousness. But looking beyond near-term uncertainties, the mix of reasonable share valuations, continued albeit constrained global growth, easy monetary conditions and a lack of investor euphoria suggest returns are likely to improve from those seen over the last year.

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.

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Australia’s messy 2016 election

Posted On:Jul 05th, 2016     Posted In:Rss-feed-oliver    Posted By:Provision Wealth
Introduction

This note takes a look at the implications of Australia’s Federal election. The Australian Federal election has delivered a messy result suggesting an even more difficult Senate for the Coalition if it is able to form government and the risk of return to minority government. The risk is that we will see a further slippage in the budget outlook – with

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Introduction

This note takes a look at the implications of Australia’s Federal election. The Australian Federal election has delivered a messy result suggesting an even more difficult Senate for the Coalition if it is able to form government and the risk of return to minority government. The risk is that we will see a further slippage in the budget outlook – with a downgrade in Australia’s AAA sovereign rating looking increasingly likely – and that significant economic reform will remain off the agenda. This is dampener for long term economic growth and share market returns. That said, it’s not a disaster as the period of true minority government over 2010-13 saw the economy continue to grow and it’s not unusual for Australian governments to face a difficult Senate.

The messy Federal election result

As with the Brexit vote betting markets and the smart money also got the Australian election wrong, with an ultra close result more in line with what the polls were saying. With a large number of postal votes yet to be counted it may be several days before the result is finally known if individual seats are very close. While there is an argument that postal votes may favour the Coalition, this may not be the case and there is a risk that neither of the major parties will have the necessary 76 seats to form government in their own right and will have to negotiate with independents. This may favour the Coalition but again depends on how the postal votes go and which way the required number of independents lean.
The vote to Leave poses several risks.

After the 21 August  2010 Federal election it took several days for the result to be known and then 17 days of negotiation before a minority Labor led government was appointed on 14 September. Even if the Coalition is able to form government it looks like facing an even more difficult Senate.

Policy implications

If the Coalition is able to form government, the even more difficult Senate will mean that it will have little chance of passing some key aspects of this year’s Federal Budget including its company tax cuts (at least not for large companies), some of its superannuation changes and the still to be passed savings from the 2014 budget. The likelihood would be more slippage in the return to budget surplus, particularly if it has to “pay” for minority government with additional spending to get the support of independents in the House or the Senate. Serious economic reform – including tax reform – would yet again be off the agenda. It would be next to impossible for a Coalition government to get enough votes to reinstate the Australian Building and Construction Commission.

Alternatively, if Labor is able to form government via say a minority government with the Greens and others it will likely mean faster public spending growth via more spending on health and education, partly funded by tax increases on higher income earners (retention of the budget deficit levy and cutbacks in access to negative gearing and the capital gains tax discount and superannuation savings similar to those of the Coalition although all the details haven’t been spelled out) but a higher budget deficit in the next few years, a royal commission into banking and greater intervention in the economy. The influence of left leaning Greens and populist independents could risk seeing an even great slippage in the budget over the forward estimates than Labor Party election policies indicated.

Economic risks

The prospect of another three years of de-facto “minority” government (either in the lower house or with an unfriendly Senate) coming on the back of the minority Gillard/Rudd government over 2010-13 and the 2013-16 Coalition government facing a hostile Senate making it unable to pass much of its economic and budget reform agenda is not a great outcome for the Australian economy.

More broadly, the success of the Labor campaign offering more spending and higher taxes coming on the back of the Brexit outcome in the UK and the success of Trump and Sanders in the US adds to evidence that median voters are shifting to the left and away from the economic rationalist policies of deregulation, smaller government and globalisation.

There are a number of economic implications. Firstly a renewed sense of political and policy instability (minority government, an intractable Senate, a possible early election) may weigh on consumer and business confidence. In terms of the latter this was not such a big deal in overall growth terms for the 2010-13 minority Labor government because mining investment was very strong. It could be more of an issue now as we need to see a pick-up in non-mining investment.

Secondly, serious economic reform to boost productivity growth and keep living standards rising in the fashion we have become used to is likely to remain missing in action. This will be a long term drag on Australia’s growth potential.

Thirdly, there is a danger in relying on tax hikes on the rich (whether retention of the budget levy or cutting access to concessions) in that Australia’s top marginal tax rate of 49% is already high, particularly compared to our neighbours; 33% in NZ; 20% in Singapore; and 15% in HK. Australia’s income tax system is already highly progressive; 1% of taxpayers pay 17% of tax (with an average tax rate of 42%) and the top 10% pay 45% of tax. Longer term this could start to weigh on the incentive to work further reducing Australia’s growth potential.

Fourthly, there is now a serious risk that Australia will lose its AAA sovereign credit rating. The perpetual slippage in the return of the budget to surplus over the last 5-6 years or so has been tolerated by the ratings agencies because we had only had a few years of budget deficits and a low starting point for net public debt. But recently they have started to lose a bit of patience. The last time we lost our AAA rating was in September 1986 – see the next table. We are now looking at a much longer and bigger run of budget deficits (as a percentage of GDP), our public debt ratios are worse and our reliance on foreign savings (the twin deficit problem) is little changed.


So as ratings agencies have started to lose patience recently, any further slippage in our return to surplus could tip one or more of them over into putting us on “negative credit watch” ahead of a downgrade. Short term political uncertainty as to “who will form government” is not enough to trigger this but a negative impact of the election on the return to budget surplus would. Unfortunately all the scenarios leading to a new government above point in that direction. So a downgrade would not surprise me.

What would this mean? In theory it should mean higher interest rates as foreigners demand a higher yield on Federal debt and this flows through to state debt, banks, corporates and potentially to out of cycle mortgage rate hikes for households. In reality this impact may be muted. The US in 2011 and the UK last week actually saw bond yields fall after ratings downgrades and many lower rated countries borrow more cheaply than Australia (eg, Italy and Spain). And in any case the RBA can still offset higher interest rates with another interest rate cut.

Rather the biggest impact from a ratings downgrade would be the blow to the national psyche. Australia worked hard reforming the economy after the 1986 downgrade and won a AAA rating back in 2002. Losing it again would signal that we have become unable to control public spending, that we have lost our way to some degree after all the hard work of the Hawke/Keating and Howard/Costello years.
Finally, the negative impact of the messy election result and continued “minority” government adds to the case – along with low inflation, Brexit risks, etc – for another RBA interest rate cut.

Implications for investors

So far the Australian share market has taken the election uncertainty in its stride. But it’s early days. Shares rose an average 4.8% over the 3 months after the last 12 Federal elections with 8 out of 12 seeing gains. Will we see a post-election rally over the next 3 months this time around? Relief at getting the election out of the way may help but the messy outcome and the likely less friendly Senate (at least for a Coalition government), September quarter seasonal weakness in shares and Brexit uncertainty are likely to weigh in the short term even though I still see shares being higher by year end


Longer term the shift to populist policies, budget slippage and the lack of economic reform are dampeners on share gains.

The prospect of “minority” government in one form or another is likely a negative for the $A, particularly if it results in lower interest rates than otherwise and a ratings downgrade. That said I have long seen further downside to around $US0.60 for the $A anyway and there is no reason to change that.

For property the increased uncertainty that may flow from the election is a negative but only a small one and should be offset by any additional lowering in interest rates. The bigger impact will come if Labor forms government and its policy to restrict negative gearing to new property and to halve the capital gains tax discount comes to pass in which case it will be a dampener on long term investor demand for property.

But there is no reason to get too negative

The election outcome is not great. And the widening left/right divide in Australian politics suggests greater policy uncertainty and dwindling prospects for productivity enhancing economic reform, which could be a dampener on growth in living standards. However, there is no reason to get too negative.

Firstly, we have seen “minority” government before – in 2010-13 in the true sense of the word, and for much of our history where the government has not had control of the Senate. And these periods have not normally seen economic disaster.

Secondly, many other countries are facing similar pressures with populist anti-establishment movements and minority governments, so Australia is not alone.

Finally, regardless of the politics the Australian economy does have a degree of resilience. This in part owes to low interest rates and the low $A but also to the reforms of the 1980s and 1990s. So while things could be a lot better it’s not that bad.

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.

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Brexit wins – implications for the world, Australia, and investors

Posted On:Jun 27th, 2016     Posted In:Rss-feed-oliver    Posted By:Provision Wealth
Introduction

In a shock for financial markets which had been increasingly confident that Britain would vote to Remain in the European Union, a victory for the Leave outcome by 52% to 48% triggered an abrupt bout of “risk off” in financial markets late last week. I suspect it was probably also a shock to many Brits themselves some of

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Introduction

In a shock for financial markets which had been increasingly confident that Britain would vote to Remain in the European Union, a victory for the Leave outcome by 52% to 48% triggered an abrupt bout of “risk off” in financial markets late last week. I suspect it was probably also a shock to many Brits themselves some of whom seem to be going through a bit of Bregret (thinking they were just delivering a protest vote against the establishment and assumed that Remain would win anyway). Of course, it wasn’t a good week for Europe either. This note tries to put it all in perspective.

Risks and uncertainties

The vote to Leave poses several risks.

  • For the UK economy its bad news. According to estimates from the UK Treasury and the OECD the impact on trade, the financial sector and labour mobility could leave the UK economy 5% or so smaller than otherwise in 15 years’ time. But in the short term there is a risk of recession given the blow to business confidence as UK businesses will be uncertain about their continued access to the EU. Some financial institutions and foreign companies may also consider relocating their operations to other EU countries given this uncertainty. Of course the negative impact on the UK economy will be partly offset by a weaker British pound, making UK businesses more competitive, and easier than otherwise Bank of England monetary policy. But political uncertainty won’t help with Prime Minister Cameron to step down by October, uncertainty over the leader of the opposition Labour Party, pro-EU Scotland pushing for another independence referendum and some in Northern Ireland pushing for integration with Ireland.

  • For Europe it will help fuel fears that some Eurozone countries may seek to follow the UK, setting off a domino effect, much as had been feared regarding a Grexit (or Greek exit from the Eurozone) over the last few years. This could see a tightening in financial conditions as investors fear a break up in the Euro and start to require a premium to lend to countries like Italy or Spain fearing that they may not get paid back in Euro’s, but in depreciated liras or pesetas.

  • Renewed uncertainty regarding Europe in turn poses risks to global growth, much as we saw through the Eurozone debt crisis of 2010-2012. This risk in the short term could simply come via tighter financial conditions in Europe and if we see a flight to safety out of the Euro into the $US which in turn will weigh on the Renminbi (sparking new fears of capital outflows from China), commodity prices (sparking new concerns about say oil producers defaulting on their debts) and emerging countries (with fears they may not be able to service their US dollar denominated debt) taking us back to the global growth fears we saw earlier this year.

  • The Brexit vote also highlights and threatens to add momentum to a backlash against establishment economic policies and specifically to a move away from economic rationalist policies in favour of populism and a reversal of globalisation which would be a negative for long term global economic growth. The shift away from globalisation could also add to geopolitical instability (note: Russian President Putin was a supporter of Brexit – with many speculating he is hoping for a less united and weaker Europe)…but of course the world has a long way to go down that path.

Market reaction

Reflecting the worries about the impact on the UK and more significantly Europe, financial markets reacted sharply in “risk off” fashion on Friday with the British pound (-8.1%), British shares (-3.1%), the Euro (-2.4%) and Eurozone shares (-8.6%) down sharply and this seeing global share markets down generally along with the $A. Safe haven assets such as bonds, the $US, Yen and gold have all benefitted. This could have further to go in the short term until some of the dust settles.

Some perspective

However, it’s worth putting all of this in perspective. First, the moves in some markets were exaggerated because those that occurred during the first four days of the last week when markets thought Remain would win had to be reversed. So, for example, while Eurozone shares fell 8.6% on Friday they only fell 2.6% over the last week. Over the week as a whole US shares lost 1.6%, Japanese shares lost 4.2%, Chinese shares fell 1.1% and Australian shares fell 1%. Bad but not monumental. The British share market actually rose 2% over the last week. While the British pound fell 8.1% on Friday it only fell 4.7% over the week as a whole and the $A actually rose 1% last week. It was similar with bonds and oil – big moves on Friday but only modest moves over the week.

Second, Britain has only started down a process to exit and has a long way to go yet. At this stage it still has all the benefits (free trade) and obligations (free movement of people) of a full EU member. It will first need a new PM, then formally notify its intent to exit which will then kick off a negotiation process that will take up to two years. This will determine the ultimate impact on the UK economy – either it will retain free trade access to the EU but have to continue to allow the free movement of people, agree to EU rules and regulations and contribute to its budget (like Norway) or forgo free trade.

At this stage it’s hard to see which way this will go, although I suspect that having seen the turmoil the Brexit vote has unleashed that the UK will opt for the least disruptive option, which may out of interest involve another referendum before it’s all over. But the point is that for some time the UK will still be in the EU. In any case it should be noted that while the UK economy is big it’s only 2.5% or so of world GDP so a recession in the UK will not be a huge drag on global growth on its own.

Third, while the Brexit vote will likely trigger a guessing game as to which Eurozone country will try and follow the UK’s lead and ask for a similar referendum it’s doubtful that Eurozone countries will actually seek/vote to leave because the hurdle to leave the Eurozone is higher than Britain leaving the EU as it will mean adopting a new currency, paying higher interest rates, etc. Just think of Greece despite its woes over the last few years consistently deciding to stay in the Eurozone. Britain has always identified itself as being less European than other European countries. And it’s notable that people in the rest of Europe see the EU/Eurozone as a source of strength and force for peace and less as a driver of economic prosperity. It’s also worth noting that Sunday’s Spanish election actually saw support for the governing People’s Party increase with no gain for anti-establishment Podemos suggesting that the Brexit mayhem may have seen voters opt for stability. A key country to watch is Italy following the recent success in municipal elections of the Eurosceptic Five Star Movement. Of course the mere agitation for, and reality of, any referendums on the issue of exit by Eurozone countries will cause periodic market jitters even if they vote to remain as I expect.

Fourth, the Brexit vote is unlikely to be akin to a Lehman moment because conditions are radically different. Lehman came after a long period of global strength and a credit boom where liabilities and exposures were opaque. That is not the case now and Brexit has been talked about endlessly so is not the surprise Lehman was.

Finally, central banks have quickly adopted a “whatever is necessary” stance to provide liquidity to markets and support their economies, notably the Bank of England which is already providing £250bn. The ECB is monitoring the situation but its liquidity measures (eg, TLTRO and quantitative easing) are probably more than enough at present, although they may be extended. The more important point is that global monetary policy will remain easier for longer. The Fed certainly will be slowed further in raising rates because it won’t want to put more upwards pressure on the $US which is being boosted by safe haven demand. A G7 Statement decrying excessive currency volatility has arguably given Japan close to a green light to intervene to stop the Yen rising much further. Expect more Bank of Japan easing soon which should help Japanese shares.

The bottom line is that Brexit is unlikely to knock the global economy into recession and we see little reason at this stage to change our expectation for continued moderate global growth.

Short term opportunities

I am not so confident about British assets given the long period of uncertainty the UK will now face both economically and politically. So while the pound is undervalued and oversold the risks remain down until the nature of Brexit is sorted out.

However, the global bout of “risk off” that we have seen is likely to provide a buying opportunity as Europe is ultimately likely to hang together, global monetary policy is likely to be even easier than previously thought and the global economy is likely to continue to see modest growth.

What about the impact on Australia?

Given that only 2.7% of Australian exports go to the UK and that the Leave victory is unlikely to plunge Europe into an immediate recession, the main impact on Australia will be on financial markets. This could affect short term confidence and may add to the case for the RBA to cut interest rates again particularly if banks increase their mortgage rates out of cycle due to higher funding costs flowing from an increase in lender caution and if the $A is pushed higher due to an ongoing delay in the Fed raising interest rates. That said, we expect the RBA to cut rates again anyway and a falling $A will ultimately provide a shock absorber for the Australian economy if the global economy and financial system really gets hit. Overall, Brexit barely changes the risk of recession in Australia which is low.

What to watch?

Key indicators for investors to watch include the following:

  • The EU leaders’ summit this week – this is unlikely to see big increase in European integration but will likely see more statements pointing in that direction. An increased focus on border control to prevent a repeat of last year’s immigration crisis given that immigration played a major role in the Brexit vote is also likely.

  • Geopolitical events in Europe – the key event in the short term is the Italian referendum on Senate reforms to be held by October. This is necessary for economic reform to succeed in Italy. Next year will also see a Dutch general election and French presidential election (although it’s interesting that support for Marine Le Pen in France appears to be falling).

  • If the “who’s next” guessing game really heats up then Italian and Spanish bond yields will start to surge higher again as investors start to demand a greater Euro break up premium. Ten year bond yields did spike in Italy and Spain last week but only to 1.55% and 1.62% respectively which is well below the 7% plus levels reached in 2011-12. I suspect the ECB’s “whatever it takes” to preserve the Euro commitment may limit any blowout here.

  • Eurozone bank share prices are also worth watching given this is where financial stress will show up in Europe.

  • The nature of the Brexit – a minimalist Brexit (ie, like Norway’s arrangement) would send a strong signal dissuading other Eurozone countries from doing the same.

  • A renewed surge in the value of the $US – this would be bad for the global economy and signal problems in China, commodities and the emerging world. Further Fed delays in hiking rates may dampen the $US though. It’s noteworthy that the US money market now sees a greater chance of rate cuts (albeit 10-14%) than of rate hikes (zero chance) at the July and September Fed meetings and sees only a 15% chance of a hike by year end.

Concluding comment

We are now going through what is traditionally a rough time of the year for investors (“sell in May and go away…”), and the Brexit vote is contributing to that this year. The key for investors is to either look through the short term noise caused by the Brexit decision or look for investment opportunities that it throws up as investment markets become oversold.

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.

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Brexit or Bremain – or does it really matter?

Posted On:Jun 21st, 2016     Posted In:Rss-feed-oliver    Posted By:Provision Wealth
Introduction

Y2K, Bird Flu, Peak Oil, Swine Flu, the end of the Mayan Calendar, Grexit, the fiscal cliff, US debt default, ghost cities, Ebola, Grexit again, imminent property crashes, etc…the world seems full of key events and phenomena upon which its whole existence – well at least the financial realm – supposedly hinges. Brexit seems to be the latest. In the

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Introduction

Y2K, Bird Flu, Peak Oil, Swine Flu, the end of the Mayan Calendar, Grexit, the fiscal cliff, US debt default, ghost cities, Ebola, Grexit again, imminent property crashes, etc…the world seems full of key events and phenomena upon which its whole existence – well at least the financial realm – supposedly hinges. Brexit seems to be the latest. In the last few weeks interest in Brexit has skyrocketed as indicated by searches on Google for the term. With this has come a surge in financial market volatility in the last two weeks.

Source: Google, AMP Capital

What is the Brexit referendum?

Well if you don’t know you must be off the planet…or then again just someone who is wisely focussed on the long term and not short term noise!

It’s basically a referendum this Thursday on whether the UK should Leave or Remain in the European Union. While not binding it would be dangerous for UK parliamentarians not to pass a law to Leave the EU if Leave wins the referendum.

A problem is that voting is not compulsory so a close vote to Leave (say 50.1% v 49.9%) with only 50% turnout would mean only 25% of the voting population voted to Leave. A close vote could lead to a degree of political instability in the UK, particularly in the Conservative Party which has been divided on the issue.

How would exiting the EU work?

Under the Lisbon Treaty which governs the European Union on this type of issue, after notifying the European Council of intent to leave a withdrawal agreement would be negotiated. This could take up to two years after which membership lapses. At stake would be what sort of trade relationship the UK will have with the EU. Here there are various models, eg, if Britain becomes a member of the European Economic Area like Norway and Iceland it would continue to enjoy free trade access to the rest of Europe but would have to accept the free movement of people, contribute to the EU budget and accept virtually all EU rules and regulations without having a say in determining them. All of which would of course beg the question as to why Leave in the first place!

What would be the impact on the UK of a vote to Leave?

Leaving the EU is generally seen as negative for the UK economy given the impact on trade, the UK financial sector (which may over time lose its status as the pre-eminent European financial centre) and on labour mobility. The precise impact depends on the sort of exit deal negotiated in terms of trade access to the EU, but has been estimated by the UK Treasury and the OECD at around a cumulative 5% of GDP over 15 years. In other words GDP would be around 5% lower 15 years after exiting. Of course these numbers are very rubbery but expectations of something like this would be negative for British assets, particularly the British pound (as the UK share market is dominated by a bunch of multinationals anyway).

However, given the two year negotiation period it may take some time for the economic impact to become apparent. There is no reason why a Leave vote per se on Friday will plunge the UK into recession (unless the British talk themselves into it).

As an aside, both sides of the Brexit debate have been grossly exaggerating their case.

Longer term though a decision to Leave could see Scottish independence pressures resurrected with Scots known to favour EU membership more than the rest of the UK. So Leaving could mean a weaker and smaller economy long term, further diminishing Britian’s global influence.

What about the impact on Europe?

The British economy isn’t what it used to be. In fact I spend most my time focussing on Europe, the US, China and to a lesser degree Japan these days. The UK does not get much of a look in (except right now!). In fact it only takes 2.7% of Australian exports. So a 5% hit to the UK economy spread over 15 years would not be a global disaster (as it would be less than 0.03% of global GDP per annum).

The real issue is the potential impact on the Eurozone. Brexit would not be the same as a Grexit (Greek exit from the Eurozone) because Britain is not in the Eurozone unlike Greece. But the worry is that a Brexit could lead to renewed worries about the durability of the Euro to the extent that it may encourage moves by Eurozone countries to exit the EU and Eurozone. In turn this could reignite concerns about the credit worthiness of debt issued by peripheral countries and lead to a flight to safety out of the Euro into the $US. In other words investors would fear being paid back on their peripheral country investments in a depreciated currency so we could see a guessing game of investors trying to work out “who’s next” in seeking to leave. This would place downwards pressure on the Euro, pushing the US dollar up which could in turn put renewed downward pressure on emerging market currencies, the Chinese Renminbi and commodity prices and push up corporate borrowing costs. Then we are back in the turmoil we saw earlier this year, with fears that it could adversely affect global growth!

This is why global financial markets have been jittery over the last two weeks. With “risk off” – basically financial market lingo for investors selling assets that are seen to be risky in favour of safe havens (global and Australian shares down led by European shares, the euro down, commodities down and government bonds, the $US and Yen benefitting) whenever opinion poll support for the Leave campaign has gone up. Conversely, we have seen “risk on” (basically the reverse of all of these moves) whenever poll support for the Remain campaign has improved. An 8% top to bottom fall in Eurozone shares was at the centre of recent financial market jitters.

However, fears about the break-up of the Eurozone are likely to yet again prove to be premature. The hurdle for a Spain, an Italy or a France to leave the Eurozone is much higher than for the UK to leave the EU as they would end up with a depreciated currency and higher debt costs. Just think of Greece which despite all its woes over the last six years consistently wants and decides to stay in the Eurozone. In fact, support generally remains high for the Euro within Eurozone countries. So fears that a Brexit will lead to a domino effect threatening the Euro may be premature. Of course investor’s won’t know that initially.

What would happen if Remain wins?

If Remain wins then the “risk off” moves in financial markets over the last two weeks are likely to fully reverse led by sharp rallies in the British pound and Euro and a rebound in share markets (including Australian shares) led by Eurozone shares. Bond yields in peripheral Eurozone countries will also fall again relative to German bond yields.

What would happen if Leave wins?

If Leave wins there would likely be more “risk off” turmoil, eg; shares down, commodities down, bond yields down, British pound and Euro down and $US, Yen and gold up. The $A would probably fall against the $US but rise against the British pound and Euro. Eurozone and British shares could easily fall 10% or so and Australian shares maybe 5%.

But this will likely prove to be a buying opportunity as Europe is likely to hang together as it did through its sovereign debt crisis for the reasons noted above and central banks led by the Bank of England and European Central Bank would run easier monetary policies than otherwise fearing an adverse financial and economic outcome. In which case, Brexit would ultimately be a storm in a teacup with financial markets yet again over-reacting.

What will be the impact on Australia?

Given that a Leave victory is unlikely to plunge the UK or Europe into an immediate recession the main impact on Australia will be on financial markets as indicated above. This could affect short term confidence and may add to the case for the RBA to cut interest rates again particularly if banks increase their mortgage rates out of cycle due to higher funding costs flowing from an increase in lender caution. That said we expect the RBA to cut rates again anyway.

Will Brexit happen?

Until about a week ago the polls had been moving in favour of Leave – as the Leave campaigners focussed on the more emotive topic of immigration. Late last week they started to edge back towards Remain and this may have been given a push along by the killing of pro-Remain Labour Politician Jo Cox by a mad Brexiteer.

Source: WhatUKThinks.org

I lean to a Remain outcome on the grounds that undecided voters are likely to favour the status quo, telephone polls which were more accurate in last year’s UK election lean to Remain & the murder of Jo Cox may swing support back to Remain. But it’s a close call and markets are likely to remain on tenterhooks until the outcome is known, taking their lead from opinion poll updates.

When will we find out?

Since polling stations won’t close until 10pm UK time on Thursday night (7am Sydney time) we may not get a clear indication as to the outcome until 6-7am the next day in the UK (around 3-4pm Friday in Sydney). If it’s a very close vote it could take longer.

Concluding comment

Ultimately many of the fears around a Brexit are likely exaggerated, but global investors and hence markets are not to know this. The key for investors is to look for opportunities that Brexit related volatility may throw up, particularly in the event of a win for the Leave campaign.

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.

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The political pendulum swings to left – implications for medium term investment returns

Posted On:Jun 20th, 2016     Posted In:Rss-feed-oliver    Posted By:Provision Wealth
Introduction

What do the success of Donald Trump and Bernie Sanders in the US Presidential campaign, the close Brexit vote on Britain’s membership of the European Union and the Australian election have in common? They all signal some shift towards populism and support for more left wing policies in the electorate. If this trend flows through to actual policy making it’s

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Introduction

What do the success of Donald Trump and Bernie Sanders in the US Presidential campaign, the close Brexit vote on Britain’s membership of the European Union and the Australian election have in common? They all signal some shift towards populism and support for more left wing policies in the electorate. If this trend flows through to actual policy making it’s another reason to expect constrained medium term investment returns.

The long term political cycle

Everything goes in cycles – both short and long. This is true of the weather, economies and financial markets. And it’s also true of politics, even beyond standard electoral cycles. After the economic disaster of the high tax, protectionism, growing state intervention and the welfare state of the late 1960s and 1970s became apparent in the stagflation of the 1970s/early 1980s popular support for economic rationalist right of centre policies grew in the 1980s. As a result Margaret Thatcher in the UK, Ronald Reagan in the US and Bob Hawke and Paul Keating in Australia ushered in a period of deregulation, freer trade, privatisation, lower marginal tax rates, tougher restrictions on access to welfare, measures to reign in budget deficits and other supply side economic reforms designed to boost productivity. This was helped along by the collapse of communism and the entrance of Russia, China, etc into the global trading system. There was even talk of “The End of History” to the extent that there seemed to be general global agreement that free market democracies were seen as the superior economic/political system. Economic rationalist policies remained the focus through the 1990s.

However, post the global financial crisis (GFC) it seems the pendulum is swinging to the left again. Not necessarily radically but it seems support for economic rationalist policies is fading. This appears to reflect a range of developments: the feeling that the GFC indicated financial de-regulation had gone too far; constrained and fragile economic growth in recent years; high household debt levels blocking off taking on more debt as a way to boost living standards; stagnant real incomes for median income households; and rising levels of inequality. The latter has not been as much of an issue in Australia (where the targeted tax and welfare system appears to have done its job). It is more so in the US and UK however, where the top 1% of income earners have seen their income share grow by around 10% and 5% respectively since the early 1980s, whereas lower and middle income earners have fared less well. The next chart shows the change in the Gini coefficient (a measure of income inequality) for major countries over the last 30 years.

Data is after taxes and welfare transfers. Source: OECD, AMP Capital

In this environment populist politicians have been able to easily tap into voter anger and argue the case for greater public sector involvement in the economy and a reversal of globalisation.

  • In the US, Donald Trump and Bernie Sanders (an avowed socialist) have done this very well. Trump was clearly to the left of other contenders in the Republican primaries and is advocating more government spending, appears to have no concerns about blowing out the budget deficit, is in favour of protectionism and curtailing immigration and has suggested that taxes on the rich and minimum wages will have to increase. Both Trump and Sanders are forcing centrist Democrat Hilary Clinton to the left. Maybe whoever ultimately wins the election will swing back to the centre but that may be difficult if voters have swung to the left.

  • In the UK the Labour Party has ditched the “New Labour” of Tony Blair and others and taken a left wing turn under Jeremy Corbyn. The success so far of the Leave campaign in the Brexit referendum appears to reflect a backlash against globalisation and immigration.

  • In Australia, it’s arguable that we are seeing the greatest left right divide in any election since those of the 1970s with the ALP being a long way from the economic rationalist policies of Hawke and Keating. Policies of higher taxes for high income earners (making the Budget Repair Levy permanent and winding back various tax concessions), significantly increased spending on health and education, a Royal Commission on banks, arguments against corporate tax cuts, a willingness to let the budget deficit expand further relative to the forward estimates, tax levies on foreign property purchases at a state level, etc, all suggest a populist focus reflecting a change in voter preferences (for at least that of the median voter). The policies of the Greens and minor parties who look likely to retain the balance of power in the Senate are of course further to the left. Gone from the election campaign is much debate about the need to undertake further economic reforms (including tax reform) if we wish to maintain decent sustainable growth in our living standards post the mining boom and ways to make government spending in areas like health and education as productive as possible. Even if the Coalition is re-elected there is a high risk that it remains constrained in implementing economic rationalist policies by the Senate.

I have focussed here on Anglo countries because it’s here that the swing to the right and economic rationalism was most pronounced in the 1980s and 90s and so the swing back may be more pronounced. Europe is arguably already more to the left anyway so it’s less of an issue there. One might add the retreat of Russia from the global economy at the margin in recent years and the stalling of the Doha round of trade negotiations are not good signs for globalisation.

What does it all mean for investors?

It’s hard to know how far the populist shift to the left will go in terms of actual economic policies. But the risk over time is that a more left leaning electorate will mean a tendency towards: faster growth in government spending; bigger than otherwise budget deficits; more regulation; higher effective top marginal tax rates; less globalisation; and tougher rules on immigration in some countries. Or it may just mean a stalling in economic reforms. The risk though is that it will act as another constraint on economic growth and eventually see a problematic pick-up in inflation if the supply side of the economy suffers.

It’s worth putting this in context. The secular bull market in global and Australian shares that saw them average strong double digit gains from 1982 to 2000 (or to 2007 in Australia’s case) was underpinned by several drivers. In particular:

  • High starting point investment yields. In 1982 bond yields were around 15%, short term interest rates were similar, dividend yields on shares were around 7-8% and the rental yield on housing was around 8%. High starting point yields helped set up high average returns over many years.

  • There was a shift from high to low inflation which enabled assets to be revalued/yields to fall all of which resulted in strong capital growth for investors.

  • Deregulation, cuts to high marginal tax rates and a shift towards small government all helped boost the supply side potential of economies. This and the next point is where the economic rationalist policies of the 1980s and 90s kicked in.

  • Globalisation – as reduced barriers to trade and the entrance of communist bloc countries to the global economy led to a surge in trade helping boost growth and keep inflation down.

  • Peace dividend – the collapse of communism and the ascendancy of the US as the main global power ushered in a period of (relative) geopolitical stability that allowed reduced defence spending which helped balance budgets.

  • A low profit share after the class warfare of the 1970s helped set up a good starting point for profit growth in the 1980s and 1990s as profit shares rose.

  • The starting point for household debt levels in the early 1980s was low relative to incomes but set to expand reflecting the increasing availability and affordability of debt which in turned helped fuel growth in consumer spending.

Now the environment is very different:

  • Starting point investment yields are ultra-low for most assets with bond yields averaging 1% or so, cash rates pushing near zero, gross residential property yields around 3% and global dividend yields around 2%. Some asset classes still have decent yields (eg, Australian shares and commercial property) but it’s a far more constrained starting point.

  • Deflation and then maybe rising inflation risk – the boost to investment returns from the shift from high to low inflation is well behind us. Deflation is far more negative than simple low inflation and if inflation ultimately does break out it could threaten some reversal of the return boost the shift to low inflation provided in the 1980s and 1990s.

  • Re-regulation, higher taxes and more government – this is already evident in financial re-regulation but if economic rationalism gives way more broadly to more left leaning policies it could slow productivity and hence the supply side of the economy which could ultimately add to inflation.

  • Backlash against globalisation – a reversal of free trade will slow growth.

  • Terror threat and the waning of US power – the peace dividend gave way to the terrorist threat last decade but more recently it seems that the relative decline of the US as a geopolitical power has given rise to tensions in the Middle East as Saudi Arabia, Iran and Russia vie to fill the gap left by the US and in the South China Sea as China seeks to flex its muscles. What is clear is that the favourable direction of change from the fall of the Berlin Wall in 1989 is over.

  • While less evident in Australia, the profit share is high in the US and vulnerable if economic policies take a leftist turn.

  • Household debt levels relative to incomes are now high with households post GFC much more reluctant to add to debt. This has in turn cut off a potential driver of growth.

Constrained medium term investment returns

The key point is that the powerful tailwind from the economic rationalist policies (deregulation, smaller government and globalisation) is now behind us and is contributing along with a range of other factors to a much more constrained return environment for investors. Our medium term projections for the investment returns from a balanced mix of assets have been steadily declining in recent years and fell below 7% this month.

Source: AMP Capital

While this does not mean there won’t be individual years with high returns it does point to ongoing average returns being constrained compared to the past. Of course in a world of ultra-low inflation, a just below 7% nominal return is not disastrous.

But what it does indicate is that in a constrained investment return environment like the present, there is a strong case to focus on investment strategies targeting the achievement over time of goals defined in terms of returns, investment income or whatever is required and using a flexible approach to do so as opposed to relying solely on set and forget strategies that depend heavily on market based returns.

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.

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Where are we in the roller coaster of investor emotion?

Posted On:Jun 08th, 2016     Posted In:Rss-feed-oliver    Posted By:Provision Wealth
Introduction

Recently I was asked where we are in the cycle of investor emotion between the extremes of “euphoria” and “depression”. This is a good question, as knowing where the investment crowd is at and being wary of it is essential to successful investing. The late 1980s Japanese bubble, the Asian miracle of the mid-1990s, US tech stocks in the late

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Introduction

Recently I was asked where we are in the cycle of investor emotion between the extremes of “euphoria” and “depression”. This is a good question, as knowing where the investment crowd is at and being wary of it is essential to successful investing. The late 1980s Japanese bubble, the Asian miracle of the mid-1990s, US tech stocks in the late 1990s, US housing and dodgy credit in the mid 2000s and arguably the commodity boom early this decade all had one thing in common: investors had jumped on a bandwagon, resulting in assets that became overvalued, over loved and ripe for a crash. But how do crowds get into such a muddle and what are they telling us now?

Investor psychology and the madness of crowds

The trouble with crowds from an investment perspective has its source in investor psychology. Individuals suffer from various lapses of logic. In particular, they:

  • Tend to down-play uncertainty & project the current state of the world into the future – eg, resulting in a tendency to assume recent investment returns will continue;

  • Give more weight to recent spectacular or personal experiences in assessing probabilities. This results in an emotional involvement with an investment – if it’s been winning an investor is likely to expect it to keep doing so;

  • Tend to focus on occurrences that draw attention to themselves, such as stocks or asset classes that have risen sharply or fallen sharply in value;

  • Tend to regard events as obvious in hindsight – by fostering the illusion that the world is more predictable than it really is this tends to promote overconfidence;

  • Tend to be overly conservative in adjusting expectations to new information – explaining why bubbles and crashes normally unfold over long periods; and

  • Tend to ignore information conflicting with past decisions.

Naturally the result is magnified if many investors make the same lapses of logic at the same time, as part of a crowd. This can easily arise when several things are present:

  • A means where behaviour can be contagious – mass communication with the proliferation of electronic media are a perfect example of this as more than ever investors get their information from the same sources. And the influence of this is growing;

  • Pressure for conformity – interaction with friends, performance comparisons, the fear of missing out, etc;

  • A precipitating event or displacement which motivates a general investment belief – the IT revolution of the late 1990s or the rapid industrialisation of China which led to talk of new eras are examples of positive displacements upon which were built general believes that shares will only go up.

The combination of lapses of logic by individuals in making investment decisions being magnified by crowd psychology go a long way to explaining why speculative surges in asset prices develop (usually after some good news) and how they feed on themselves (as individuals project recent price gains into the future, exercise “wishful thinking” & get positive feedback via the media, their friends, etc). Of course the whole process goes into reverse once buying is exhausted, often triggered by contrary news to that which drove the rise initially. Investor psychology through a market cycle looks like what Russell Investments called the roller coaster of investor emotion.

Source: Russell Investments, AMP Capital

In a bull market ‘optimism’ gives way to ‘excitement’, then ‘thrill’ and eventually ‘euphoria’ as the actions of investors push the asset class – be it shares or whatever – ever higher. It is at this point that investors are most bullish. Unfortunately it’s usually at this point that the market has become overvalued and with the crowd fully on board everyone who wants to buy has, so it only takes a bit of bad news to tip the market down.

When a bear market begins investors initially see it as a short term setback. But as ‘anxiety’ gives way to ‘fear’ investors eventually ‘capitulate’ and become ‘despondent’, selling their investments. However, the point of maximum crowd pessimism, when the crowd has sold and the asset class is cheap and unloved is the time when it provides its best opportunity. It then only takes a bit of good news to push the market higher.

So the behaviour of the crowd gives a great guide to investment market opportunities. Tops are usually associated with some form of crowd euphoria and market bottoms are associated with mass depression and despondency. So being a contrarian and doing the opposite to the crowd at extremes makes sense.

As always there are qualifications. Ideally, one needs to look at what investors are thinking (sentiment) and what they are actually doing (positioning). Secondly, negative crowd sentiment at market bottoms can tend to be associated fairly quickly with market bottoms reflecting the steep declines associated with panics as a market falls. But during bull markets positive sentiment or even euphoria can tend to persist for a while as it takes investors longer to build exposures to assets than to sell them.

So where are we in the emotion roller coaster?

For shares crowd sentiment ranges from very cautious to neutral. According to the American Association of Individual Investors bullish sentiment amongst retail investors has been averaging around 20% over the last few weeks, which is about as low as it ever gets and half its long term average.

Source: Bloomberg, AMP Capital

A broader composite measure of US investor sentiment that includes surveys of investment newsletter writers, the ratio of puts (options to sell shares) to calls (options to buy) amongst retail investors is more positive but a long way from euphoria.

Source: Bloomberg, Sentimentrader, Investors Intelligence, AMP Capital

Finally, in terms of positioning, US share market mutual funds and exchange traded funds have been seeing outflows.

In Australia, the proportion of those surveyed by the Westpac / Melbourne Institute consumer survey nominating shares as the wisest place for savings is just 7.6%, half its long term average. See the next chart.

Source: Westpac/Melbourne Institute, AMP Capital

Overall this suggests that crowd sentiment towards shares is a long way from the sort of euphoria that normally characterises major market tops. In fact it sometimes feels as if we are stuck between ‘hope’ and ‘relief’ in the roller coaster. What about other asset classes?

Australians’ interest in residential property appears to have taken a hit recently as indicated in the last chart. Sentiment towards property seems a lot more cautious than was the case around 2013-15. However, an increasing supply of units, restrictions on bank lending to housing and the fact that Sydney and Melbourne have already seen huge price gains cautions against treating this too positively.

From the above chart, in Australia the most popular asset class continues to be bank deposits with 27% of those surveyed seeing them as the wisest place for savings. With term deposit rates now pushing 2% this may prove to be another example where the crowd gets its wrong – in this case in terms of their relative returns.

Implications for investors

There are several implications for investors. The first thing to do is recognise that investment markets are not only driven by fundamentals, but also by the often-irrational and erratic behaviour of an unstable crowd of other investors. The key here is to be aware of past market booms and busts, so that when they arise in the future you understand them and do not overreact (piling into unstable bubbles near the top or selling everything during busts and locking in a loss at the bottom).

Second, try and recognise your own emotional capabilities. In other words, be aware of how you are influenced by lapses in your own logic and crowd influences like those mentioned above. For example, you could ask yourself: “am I highly affected by recent developments (positive or negative)? Am I too confident in my expectations? Can I bear a paper loss?”

Thirdly, to guard against this choose an investment strategy which can withstand inevitable crises whilst remaining consistent with your financial objectives and risk tolerance. Then stick to this broad strategy even when surging share prices tempt you into a more aggressive approach, or when plunging values suck you into a highly defensive approach.

Fourthly, if you are tempted to trade, do so on a contrarian basis. Buy when the crowd is bearish, sell when it is bullish. Extremes of bullishness often signal market tops, and extremes of bearishness often signal market bottoms. Successful investing requires going against the crowd at extremes. Various investor sentiment and positioning surveys provide a guide.

Finally, investor sentiment right now towards shares still seems to be relatively cautious – nothing like the ‘euphoria’ seen at major market tops.

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.

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