The 2016 financial year in review
The 2016 financial year (FY16) was a challenge, largely due to negative macroeconomic and geopolitical factors and spiking volatility at levels not seen since the European sovereign debt crisis in 2011. Central banks experimented with negative interest rates for the first time and the notion of negative real returns coupled with pessimistic outlooks for global growth were reflected in bond prices. Gold in fact emerged as one of the best performing asset classes, appreciating by approximately 25 per cent in the second half of the financial year.
FY16 saw an increasing number of emerging geopolitical risks
Donald Trump’s election campaign defied expectations and tensions in Europe rose in the face of one of the most serious humanitarian crises since World War II. Conflicting views on immigration policies combined with existing tensions regarding austerity measures saw increased popularity for right-wing anti-establishment groups and arguably contributed to the UK voting to leave the European Union. We have previously highlighted the growing prominence of anti-establishment politics and expect geopolitical risk to remain elevated. Against this backdrop, a diminishing outlook for world growth became apparent.
Muted growth in Australia was recorded amid lower interest rates
Australian shares suffered their worst annual performance since 2011/12, with the financial, material and energy sectors all closing lower. Australian banks came off all-time highs as stricter capital requirements saw the outlook on the underlying return on equity fall, while historically low bad debts began showing signs of rising – sparking questions about the ongoing sustainability of dividends. Energy was the worst performer as a global energy glut slashed more than 20 per cent off the market capitalisation. And as Australian economic indicators continued to wallow, the Reserve Bank of Australia lowered its target cash rate to a historical low of 1.75 per cent, while leaving the door open for future cuts. We continue to remain cautious about the Australian economy.
Australian property performed well, however valuations are stretched
Investors flocked to commercial property in response to the ongoing hunt for yield, with direct commercial property and listed real estate investment trusts (REITs) providing strong returns. Yields on direct property compressed to around (or slightly below) long term averages while a number of REITs traded up to large premiums to their asset values. Residential property was a shining light for Australian investors, led by Sydney and Melbourne. Prices were largely buoyed by low interest rates and there has also been ongoing debate as to whether residential property is approaching ‘bubble’ prices, with average gross rental yields at or near all-time lows. Concerns around the risks to inner city apartment prices in Melbourne and Sydney are growing with a significant amount of supply sparking fears around oversupply.
International markets struggled, however opportunities remain in select regions
Developed markets finished with negative returns. When the US Federal Reserve lifted rates in 2015—the first time in almost a decade—it bolstered debate around the merits of one of their biggest financial experiments. The year rounded out with heightened volatility and sharp market swings in the wake of Brexit, while Asian equity markets closed significantly lower although buffered to an extent by the currency. Chinese markets saw a sell-off following concerns around debt levels and its ability to transition from an industrial-based economy to a consumption-focused one, and emerging markets finished lower as economic and geopolitical issues provided headwinds for a number of smaller countries. Despite preparations to host the upcoming Olympic Games, Brazil plunged into its worst recession in over two decades in the wake of high inflation, falling currency and a collapse in prices for their three major exports—oil, sugar and coffee. This was surprising given in 2011 Brazil surpassed the UK as the world’s sixth largest economy. The collapse in energy prices also saw obstacles for oil-exporting nations, whereas oil-importing emerging economies like India benefited. While developed markets are generally fully valued, we continue to see opportunities in select emerging markets and Asian equities.
Overall FY16 was a relatively underwhelming year for equities
Investors struggled to justify higher valuations in light of several years of low cash rates and earnings growth failing to materialise. While there were pockets of strong performance (notably defensive, yield-focussed equities such as infrastructure and industrial stocks), the market is increasingly coming to terms with interest rates being ‘lower for longer’ and applying a significant premium for safety in a time of increased caution. With geopolitical issues still prevalent and the US yet to manage to raise rates beyond the initial 0.25 per cent increase, it is expected that these issues will continue to impact markets into the next financial year.
This insight contains general financial advice and was prepared without taking into account your objectives, financial situation or needs. Any forward looking statements in this insight are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct. As always, your personal circumstances are critical when considering any financial strategy and seeking professional personal advice is highly recommended.