Managing investment risk and economic uncertainty

COVID-19 has uprooted our lives and done some strange things to investment markets. First there was a major crash. Then a major rally. What’s going on? What does it mean for you and your super?  And how can you adapt to the new investment landscape?

Governments and central banks across the world have unleashed a massive amount of policy firepower to support economies affected by COVID-19 and the associated lockdowns.

In Australia, a total of $213.7 billion has been rolled out with the aim of keeping people in work and supporting those in need. The United States implemented a US$2 trillion stimulus package, the largest in the country’s history, while Germany and Canada’s stimulus programs were estimated to be worth around US$189 billion and US$145 billion, respectively.1

At the same time, official interest rates across the world’s wealthy countries have been slashed. They range from a remarkable -0.10% in Japan, and 0.0% in the Euro area,2 and 0.10% and 0.13% in the UK and United States, respectively.3 Both Australia and Canada, with 0.25% official interest rates, round out the low rate club.4

Despite all this, Australia’s unemployment rate jumped to 7.1 per cent in May, up from a revised 6.4 per cent in April, as the economy shed 227,700 jobs during the COVID-19 pandemic.5 Unemployment is now at its highest since October 2001, when the rate reached 7.2 per cent, 19 years ago.6

US data is even more grim, with an unemployment rate of 13.3% in May, and new applications for state unemployment benefits estimated to have totalled a seasonally adjusted 1.55 million for the week ended June 6.7 Even though the number of people applying for unemployment benefits is now falling, estimates suggest claims for jobless benefits would still be more than double their peak during the 2007-09 Global Financial Crisis.8

Given such a background, it’s remarkable that share markets have regained much of the ground they lost during the deep falls of March.

The markets versus the economy

So, what explains the decoupling of the stock market from the economy?

Part of the answer is that investment markets are ‘forward looking.’ They discount current and near-term data, events and bad news, and look further ahead. On that basis, it seems that markets are assuming that massive government support programs and low interest rates, combined with a gradual return to more normal life, will cause economies to spring back.

From MLC’s perspective, it looks like people may be getting a little ahead of themselves. We are more cautious as there is so much uncertainty, and we’re not convinced that the share market recovery is sustainable.

Such rallies are common during market corrections and can create the impression that things are heading back towards normal. Usually, these ‘bear market rallies’, as they’re called, unwind as investors process uncomfortable realities.

Currently, those realities include economic and company-specific news continuing to point in a pessimistic direction, at least for this year, and maybe a little longer. So many industries have been disrupted that a wide range of companies in Australia and around the world have stopped offering profit guidance. Many companies have also been cutting dividends.

The biggest issue, of course, is COVID-19 itself. Societies and economies will not be able to return to truly normal activity until a vaccine becomes available. That has significant implications for profits – and employment – in a whole range of sectors.

It’s true that some businesses are re-opening, including café and restaurants.  But that easing is accompanied by limits on the numbers of patrons – with real consequences for revenue and profits. We are yet to see any sign of easing in the international tourism or university sectors – and they’re big sectors of our economy.

Navigating a tricky investment terrain

Situations like the current one can be especially problematic for people nearing retirement. Well laid out plans can be thrown out of kilter and retirement dreams derailed when markets go through a major period of volatility like the GFC or the COVID-19 crisis.

Careful financial navigation becomes even more important.

Everyone’s circumstances are different and so one-size-does-not-fit all. That said, here are some very broad ideas that can improve financial decision making.

1. Manage risk

The needs and attitudes of mature people are very different from those starting out on their careers or at the midway point of their working lives.

For mature people, loss limitation in falling markets is crucial as they have less time to rebuild the value of their investments. We saw in 2008, with the GFC, the damage that can be caused permanently to people’s retirement prospects.

Mature investors are also more likely than younger investors to have accumulated reasonable balances in their super and non-super investments, and so achieving spectacular returns is probably not top-of-mind.

Capital preservation is crucially important. Yet at the same time, they need to protect the purchasing power of that capital – by ensuring at least some of their investment portfolio is growing faster than inflation. 

2. Diversification

In effect, this is about balancing two competing imperatives – protecting capital and growing capital. A well-diversified portfolio is a recognised way of doing this. A well-diversified portfolio would likely have some (but not necessarily large) exposure to ‘growth assets’, such as shares, as well as unlisted assets such as infrastructure, real estate and private equity (investment in privately owned companies not listed on share markets).

The growth assets exposure would probably be balanced with investments in ‘defensive assets’ such as government bonds and corporate bonds, which are loans made by investors to governments and large companies.

The bottom line: diversified portfolios help protect retirement capital from the full effect of a major fall in one asset class (such as equities in March this year). They also make it possible to balance capital preservation and growth.

3. Be realistic about future returns

Another thing to bear in mind is that future investment returns are likely to be lower than the strong returns of the past decade.

With interest rates and cash returns from term deposits already at historic lows, the return potential for other assets is also lower. This is because official interest rates, set by the Reserve Bank of Australia and other central banks, are like gravity — they ultimately pull returns from all forms of savings and investments down towards them.

Assuming no other changes (for example, strong wage growth that fires up consumer spending or some massive technological innovation), low official interest rates mean that the return potential for riskier investments, such as shares, real estate, or infrastructure, is lower as well.

However, this “lower for longer” situation doesn’t mean investors should just throw in the towel and settle for low returns. What it does means is that it’s time to take stock – and adapt. There are a whole range of investment, social security and lifestyle strategies you can use to adapt to the new post-COVID reality. 

4. Get expert help

A health check of your investment portfolio may be in order to see whether, given recent events, it remains suited to your needs or whether some strategy changes may be required.

Speaking to a financial adviser can help investors raise the odds of achieving better investment outcomes.

All of us reach out to experts for help. We go to qualified mechanics when cars need fixing. Plumbers when pipes are blocked. Doctors when we’re unwell.

Seeing a financial adviser is no different. The have the education, training and knowledge to help you improve your financial well-being.

Please contact us on 0422 287 760. 

Source : MLC Insights August 2020 

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