What will drive future investment returns in Australia?
Having recently travelled overseas, I couldn’t fail to appreciate how small and largely insignificant Australia is in the investment world. For example, the Financial Times UK didn’t quote our ASX (Australian Stock Market) Index and there were no reports of company news relating to our top 200 companies.
On the other hand, the key drivers of future investment returns for Australian investors are collectively classified as global themes. The global themes that will have a direct influence on investment markets around the world are:
- Geopolitical developments (think Trump, Brexit, Middle East, China, Russia and Korea)
- The impact of rising interest rates in a debt-ridden world
- Demographics, particularly ageing and growth in the middle-income population
So why should we care?
The world appears to have a never-ending list of problems that aren’t going away. We can spend countless hours trying to guess what might happen next.
The fact is that none of us really know what’s around the corner and, for this reason, I’ll turn my attention to the two key themes that are much more predictable: demographics; and interest rates.
Global demographics: Why we should care
Demographics is a complex subject and big changes are underway.
For thousands of years, the world population expanded slowly. 200 years ago there were less than one billion people on earth (I’m not sure who was doing the counting!). According to experts, from 1900 to 2000 the world population grew from 1.6 Billion to 6.1 billion.
The current, estimated world population is around 7.5 billion people, and we add around 84 million people to the total every year. The good news is that the rate of annual increase is now in decline according to the United Nations.
I recently listened to a speech by Morten Springborg, Global Thematic Specialist from C Worldwide Asset Management (a Danish investment company) who highlighted the following key developments:
- Ageing and growth in the middle-income population. In particular, he pointed to wealthy youth in China and their luxury goods consumption. This is part of a booming Asian middle class in most Asian countries. The working age population of China and Japan is falling quickly. The International Institute for Applied Systems Analysis (IIASA) has been studying demographics for many years and one of their observations is that there is a strong link between education and fertility. Educated women have fewer children.
- Robotics, automation and artificial intelligence are winning investment areas. Morten spoke about the influence of ‘digital natives’. He defined these as individuals aged 16 with a secondary education living in countries with more than 50% internet access. The growth among these ‘natives’ is estimated to go from 500 million in 2016 to 2.5 billion in 2030—the fastest demographic shift in history.
- Europe is in relative economic decline amplified by the Brexit vote. The inability to control net migration has undermined the legitimacy of the political systems in the UK, Germany and France. The mass migration of people from the east of Europe to the west has been socially disruptive. Elections will be won and lost because of demographic challenges. The migration of displaced people from the Middle East and the desperately poor people from Africa will continue to present ongoing headwinds for politicians.
- China will age rapidly, but current trends support insurance products, luxury goods and digital business models. McKinsey & Company claim that when China hosted the Olympic Games in 2008, Chinese consumers accounted for only 12% of global luxury spending. In the eight years that followed, 75% of the total global growth in luxury spending can be attributed to Chinese consumers at home and abroad.
- India has the world’s best positioned large economy, and structural reforms are leading to a booming country. India has reformed their social security and tax systems, and digital systems are making it much harder to cheat the system!
The impact of rising interest rates in a debt-ridden world
Interest rates underpin the valuation of most financial assets because their expected future cash flows are discounted relative to government bond yields. As discount rates fall, the present capital values rise. This largely explains why property prices and share prices have risen significantly since the Global Financial Crisis.
This was exaggerated by the intervention of Central Banks, leading to low interest rates and high asset prices. In turn, this has propelled investors to take more risks.
Arguably the most disturbing trend over the past 10 years has been the willingness of governments, business and households to go deeper and deeper into debt. The upside has been economic growth, better than average employment and little in the way of inflation. These trends are common to developed countries around the world.
Things are beginning to change. The US Government 10-year-bond rate is rising, and this will impact the real economy by stifling activity, reducing property and share prices, and potentially causing social disruption.
As interest rates rise, shares in utilities, infrastructure and real estate lose ground. Many commentators believe we have reached an inflection point. The Macquarie Bank chief economist, Ric Deverall, expects to see interest rates rising for the next two-and-a-half years.
Rising interest rates are of particular concern to countries like Australia because our banks borrow from overseas. The Reserve Bank of Australia sets our official interest rate, but in the years ahead their hand could be forced to increase those rates because of developments outside of Australia.
The biggest concern centres around how fast local interest rates will rise.
So why should we care?
These global themes are all relevant to Australians and our way of life. The fact is we have little or no control over these big issues.
Which of the three global themes will be of immediate impact? At present, it’s a toss-up between geopolitical developments and rising interest rates. If the world can remain at peace, the rising interest rates will be the first to have an impact.
In the longer term, demographics will undoubtedly have an ongoing impact, and if all three of the global themes develop in the same year, we will need to rethink everything we know about investing.
While the future is unknown, the current global picture calls for a cautious financial strategy at this time. And particularly if you’re nearing retirement.
Owen Weeks is director and authorised representative of Lifestyle Matters Pty Ltd and a Registered Tax Agent. He is a Fellow of the Financial Planning Association, a Fellow of the Institute of Professional Accountants, and an Honorary Fellow of the Association of Superannuation Funds of Australia. He is also the co-author of Retire Bizzi and Where to Retire in Australia.
To receive a free copy of Three Things that Really Matter (in retirement) sign up here for the weekly RETIRENOTES.com email.