(This is an expanded version of the Cuffelinks newsletter introduction of 14 December 2018).
In the six years I have been writing the weekly introductions in our newsletter, I have been reluctant to make macro forecasts. There are so many factors at play that predictions become an unsatisfactory 'on the other hand' exercise. Sound reasoning can be overtaken by a late-night tweet from an egotistical and unpredictable leader.
Former Leader of the Federal Opposition and prominent economist (and one of my tutors at university in 1983!), Dr. John Hewson, told an EY client function at the end of November 2018:
"Today, it's harder to predict how things will unfold in the world than at any time in the last 40+ years. It is a riskier environment than I can ever remember. A lot of the relationships economists took for granted no longer seem to apply."
In previously unreported comments, Dr Hewson was worried about Donald Trump's capacity to govern the world's largest economy. He said:
"Most of the global forecasts for the US economy show a slowing through 2019. I am personally very pessimistic about 2020. I think the US economy could be sliding into recession in 2020, and the damage that will be done to Trump in 2019 as an individual and as a political leader will make 2020 a very tough presidential year if the Democrats can get themselves organised. There will be a lot of volatility coming out of that."
Set a portfolio for the long run, but watch for market extremes
My investing philosophy is to construct portfolios based on risk appetite and goals, which enables you to sleep comfortably and not panic if the stock market falls. Tactical asset allocation based on market expectations can lead to constant portfolio switching at the wrong time with higher costs.
Contrary to my instincts to minimise tampering, this is a time for greater caution in portfolios. Central banks have spent the best part of a decade stimulating economies and expanding their balance sheets, including buying US$18 trillion of government bonds in QE. This money found its way into other asset classes and inflated prices. A major deceleration is now underway, with their balance sheets flat or falling. The US Fed wants to raise rates further, corporate credit spreads are widening and geopolitical risks are high.
In Australia, risks are heightened by the Royal Commission-induced crackdown on business and residential property lending, especially for investing. Anecdotal evidence from mortgage brokers writing to Cuffelinks suggests it's worse than yet seen in official data. The OECD issued a report this week showing Australian household debt rising rapidly, even at a time of record low interest rates. Falling property prices and the transition from interest-only loans will contract the local economy, and any increase in unemployment will make high household debt levels problematic.
Household debt as a % of net household disposable income
Source: OECD Economic Survey of Australia 2018.
There has been much debate about a recent speech by Guy Debelle, Deputy Governor of the Reserve Bank. The controversial statement was this:
"The Reserve Bank has repeatedly said that our expectation is that the next move in monetary policy is more likely up than down, though it is some way off. Should that turn out not to be the case, there is scope for further reductions in the policy rate. It is the level of interest rates that matters and they can still move lower ... QE is a policy option in Australia, should it be required."
Are the possibility of Australian QE and rate falls a warning? The fact that the Reserve Bank this week relaxed quantitative restrictions on banks lending interest-only loans shows how much they are concerned about the slowdown in housing and tighter lending conditions.
The summer holidays is a time to think about portfolio risk, and three articles examine the market outlook.
Graham Hand is Managing Editor of Cuffelinks.