It pays to take the long view

It has been another unsettled year for investment markets. Apart from ongoing concerns over the strength of economic recovery and unsustainable government debt in many developed countries, there was a string of other events that affected the
markets – natural disasters in Australia, New Zealand and Japan, new minority governments in Australia and the UK, and civil uprisings in the Middle East and North Africa.

There have certainly been plenty of issues to fuel the daily news cycle and keep financial markets on edge. However, most sharemarkets around the world continued to recover from their lows of March 2009, until drifting in the final quarter, while credit markets were relatively stable.

Despite the comparative strength of Australia’s economy and government debt position, our sharemarket substantially underperformed most other developed nations, in local currency terms. On the other hand, with the US economy battered by the global financial crisis, a recession and escalating government debt, the US sharemarket posted very strong returns. Unfortunately for Australian investors with unhedged portfolios, any such gains were diminished by the rise in the Australian dollar against the US dollar.

Such is the unpredictable nature of financial markets, from day to day and year to year. That’s why, when it comes to investing, it pays to take the long view. Financial markets recover from major crises in fits and starts, but history shows they always stabilise and prosper over time. 

Whatever the economic and financial market conditions, some key investment principles continue to stand the test of time.

How markets performed in 2010-11

Financial markets had a mixed year, with a broad range of factors affecting different regions, asset classes and industry sectors.

Most sharemarkets started positively, buoyed by an improving US economy supported by continued financial stimulus. Major emerging markets, including China and India, sustained their strong growth while corporate credit markets continued to stabilise. Indeed, the global economic concerns centred on the need to control emerging inflation.

In Australia, the Federal Election in August 2010 produced a minority government and subsequent proposal for a new carbon tax, as well as a commitment to a revised mining tax negotiated with the industry, although neither had been legislated by year’s end.

Despite these legislative risks, the mining boom gained new momentum. Continued strong demand from China in particular, further boosted commodity prices and saw the Australian dollar appreciate to its highest levels against other major currencies since it was floated in 1983.

With the economy growing strongly and the resource sector rolling out massive development programs, the Reserve Bank of Australia remained wary of inflation, although it only raised its target cash rate once during the year, by 0.25% in November 2010 to 4.75%.

In contrast to the mining industry, sectors directly exposed to the higher Australian dollar, such as tourism, suffered, while retailers recorded lacklustre trading due to the increased personal savings levels that have continued since the global financial crisis.

In the second half of the year, several issues converged to unsettle financial markets worldwide.

The unsustainable debt levels of some European governments and lack of confidence in the ability of European authorities to resolve the issue continued to undermine market confidence. To a lesser extent, similar concerns began to surface over the soaring US government debt and their own political gridlock on the issue.

Civil unrest in North Africa and the Middle East created volatility in oil prices and further risks for the global recovery, and the tsunami and nuclear meltdown in Japan slowed down the world’s third largest economy.

Together with some signs of fragility in the US economic recovery, and concern over the possible effects of winding back its massive financial stimulus, all these factors combined to weigh heavily on investor sentiment.

However, many emerging markets and some developed economies continued to grow strongly and despite all the bad news and continuing risks, at year’s end the global economic recovery was continuing and all major asset classes had recorded positive returns.

Australian shares

Australian shares returned 11.9% in another volatile year for the domestic share market, as measured by the S&P/ASX 300 Accumulation Index. Industrial shares returned 9.2%, as measured by the S&P/ASX 300 Industrial Accumulation Index.

Commodity prices and mining stocks rose, due to supply constraints and ongoing demand from China. The mining boom also forced up the Australian dollar which peaked at $US1.10 at the end of April 2011. Industrial shares had mixed fortunes based on sector and stock-specific factors.

Resource stocks outperformed industrial stocks over the financial year. At a sector level, Materials (+20.5%), Utilities (+14.6%) and Consumer Staples (+11.4%) were the best performers, while the underperforming sectors were Information Technology (-13.8%), Telecommunication Services (-0.7%) and Consumer Discretionary (-0.3%).

International shares

International shares produced returns of 22.3% in their local currencies over the year, as measured by the MSCI World ex Australia Index (net return). However, unhedged returns to Australian investors were severely reduced by the continued rise of the Australian dollar, returning only 2.7% in Australian dollar terms. Over the year the Australian dollar appreciated 26.8% against the US dollar, 18.1% against the British pound and 7.1% against the Euro.

In similar fashion to the preceding financial year, international shares achieved strong gains prior to Christmas, triggered by the announcement of a second round of stimulus by the US Federal Reserve, while commodities also rallied sharply due to strong emerging market demand.

Despite losing momentum over the second half of the year due to heightened risks over government debt, political instability and mixed signals on economic growth, most developed markets were still substantially higher for the year.

Property

The Australian listed property sector recorded total returns of 5.9% for the financial year as measured by the S&P/ASX 300 A-REIT Accumulation Index. There was some divergence in the performance of the sub-sectors, with office property performing strongly as leasing activity improved across capital cities. Industrial property also performed well while retail property was softer due to subdued consumer sentiment.

After recapitalising following the global financial crisis, the sector as a whole now has much lower gearing levels and has refocused on its core business of owning and managing Australian properties.

The most notable corporate activity for the year was the demerger from Westfield Group of Westfield Retail Trust, a new entity for the Group’s Australia and New Zealand based assets, which includes its major redevelopment in central Sydney.

Fixed income

Australian fixed income returned 5.55% over the financial year, as measured by the UBS Australian Composite Bond Index. International fixed income returned 10.51% in $US, as measured by the Barclays Capital Global Aggregate Index.

Despite bouts of volatility stemming from global issues, the extra yield investors demand to hold Australian corporate bonds compared to Australian government bonds, declined over the year. This reflected improved corporate fundamentals and strong investor demand.

Internationally, corporate credit spreads remained firm in response to additional stimulus by central banks and continued low cash rates. In particular, spreads on financial sector bonds tightened, based on positive results from stress tests and the comfort of more stringent capital and liquidity requirements. The performance and security of government bonds diverged widely based on each country’s government finances, economic strength and prospects.

Mortgages

Despite the overall modest credit growth, Australian mortgages continued to generate consistent income over the year. Business credit resumed growth after a period of contraction. In contrast, growth in household credit softened in the latter part of the year, as did housing prices in several cities.

Cash

Cash continued to provide protection from general market volatility but yields changed little over the financial year. Despite proclaiming a bias towards higher rates to maintain a lid on inflation the RBA only raised its cash rate once during the year, by 0.25% to 4.75% in November 2010. Cash returns over the year were 4.98%, according to the UBS Bank Bill Index.