Despite strong returns from global share markets in recent years, rising trade tensions and political risks are undermining investor sentiment.
With the US economy now in its tenth year of expansion, the second-longest on record for the world’s largest economy, there is also growing focus on how much room this cycle has left to run.
Global economic conditions continue to look encouraging. In the US, Trump’s tax cuts and fiscal stimulus have helped to boost growth and prolong the business cycle.
The International Monetary Fund has forecasted continued strong growth of the world economy of 3.9% p.a. this year and next, which remains supportive of corporate earnings growth, and therefore positive for share prices.
Higher inflation (in the US) is one of the key risks to markets. US core inflation is on target at 2% p.a. having risen from effectively zero in 2015, showing the robust fundamentals of the US economy.
While expectations are for the US Federal Reserve to continue raising interest rates gradually, if the strong recent uptrend in inflation continues, the US Federal Reserve may be forced to hike interest rates aggressively, potentially ending the economic growth phase prematurely. Indeed, the pull-back in January/February this year was a result of the market anticipating higher interest rates due to faster-than-expected inflation.
Against this backdrop of strong growth, we remain optimistic about shares (and other risk assets), although returns are likely to be lower moving forward given the headwind of rising interest rates.
With market volatility picking up from record lows, a well-diversified portfolio will be key to stabilising returns and protecting capital. Australian investors can also help to reduce risk by including some non-AUD exposure in portfolios.
In the event of a downturn, whether due to domestic or global factors, the AUD generally declines, increasing the value of overseas investments in local currency terms, helping to smooth out any losses on underlying assets.
The effect on portfolios from a lower AUD can be seen over the past year with returns from unhedged investments boosted by approximately 10% over the 12 months ending 31 August 2018.
Should the gap between Australian and US interest rates continue to widen as predicted, we are likely to see further medium-term weakness in the AUD, which would continue to favour an unhedged exposure.
If you would like to discuss your portfolio, please contact your BDO adviser.
The information in this document reflects our understanding of existing legislation, proposed legislation, rulings, etc., as at the date of issue. In some cases, the information has been provided to us by third parties. While it is believed the information is accurate and reliable, this is not guaranteed in any way. The information is not, nor is it intended to be, comprehensive or a substitute for professional advice on specific circumstances.
The financial product advice or information in this document is of general nature only and has not taken into account the investment objectives, financial situation or particular needs of any particular person. Before making an investment decision on the basis of the advice above, a prospective investor needs to consider, with or without the assistance of a professional adviser, whether the advice is appropriate in the light of their particular investment needs, objectives and financial circumstances.