Dividend cuts the theme for 2020
The slowing global and domestic economy over the past year continues to create challenges for the Reserve Bank of Australia (RBA) and the government.
Policymakers will need to remain alert and deliver additional effective and timely stimulus to address the challenges ahead.
This creates opportunities for investors as they reflect on their return expectations across the various asset classes and their risk tolerance.
In short, investors will need to anticipate even lower yields in the year ahead including dividend cuts.
The International Monetary Fund (IMF) has consistently downgraded global growth for calendar year 2019 from 3.7 per cent over a year ago to three per cent earlier this month.
This will be the slowest economic pace since 2008-2009, creating challenges for investors.
The ongoing slowing global economic activity is not being helped by the trade war between the US and China, the largest and second largest respective economies globally.
The supply chain disruption has impacted trade flows and it could always escalate, potentially slowing global trade even further.
Globally, these trade tensions and geopolitical events impact business conditions and sentiment. Further, the ongoing Brexit drama will impact both the UK and EU economies.
This uncertainty looks set to continue for now despite the many fatigued Brexit watchers.
Hence, global central banks will continue to deliver even further accommodative stimulatory policy to help cushion the downside risks to global growth.
Slowing global trade is not ideal for the Australian economy which is effectively a resource (bulks, metals), energy and food exporter.
However, the services part of the Australian economy has been expanding over the past decade whereby education, tourism and financial services are becoming significant parts of the economy and should hold up well with a lower Australian dollar.
Also, some of the past private sector investment is also helping in a number of ways.
The very large capital expenditure investment in our resource sector over the past decade was a very significant stimulus to the domestic economy at the time and while the resource investment boom is behind us, the export oriented resource sector will benefit from this investment for decades to come.
The dividend for this investment will continue for some time. Further, the government will benefit from the corporate profits that are increasingly derived from this investment.
The housing construction boom that followed the resources boom is now well behind us.
The sharp fall in dwelling investment over the past three years has been driven in part by tighter credit conditions for investors (prudential regulation), broader tighter mortgage lending conditions following the Banking Royal Commission and household confidence to name a few.
Going forward, there will be some additional stimulus measures that will be required to cushion the downside risks.
The recent recovery in median house prices in the major Melbourne and Sydney markets are welcome to help sentiment recover following recent rate cuts; however, house prices have come off very elevated levels.
While house prices are a very emotive topic, the fall in median prices from the highs seen a few years ago has partly addressed some of the extreme housing debt liabilities ratios that the Australian market has been known for by global investors.
On the fiscal side, the tax cuts have been the single largest household income boost for some time – effectively higher incomes with immediate effect.
Interestingly, it appears that most of these tax cuts have not flowed through to retail sales, as households have preferred to retire debt and increase savings.
Additional targeted fiscal stimulus would be required in the year ahead and one would anticipate some announcement following the federal budget in May 2020.
Further, the independent Fair Work Commission increase of the minimum wage to 3.0% annually earlier this year (following the 3.3 per cent and 3.5 per cent increases the following two years) was timely.
These cumulative increases in recent years are significantly larger than inflation and will transfer into the broader economy. It would be expected that these “greater than CPI” increases will continue in 2020.
Also, the boom in government supported infrastructure spending (at both the federal and state levels) will continue to absorb some of the softening housing cycle capacity for some time.
With the 10-year government bond yield now just below 1.15 per cent, bond yields are broadly around historical lows to fund future projects. Clearly, the current low rate bond environment requires fiscal discipline at all times, which is monitored by the various global rating agencies.
On the monetary policy front the RBA looks set to drive the cash rate even lower from the current historical low of 0.75 per cent to 0.5 per cent. Many commentators point out that the marginal benefits of lower rates diminish.
This is a valid point; however, the stimulus is still required and Australia is finally catching up to challenges that other key economies have been dealing with.
The lower rates will support the labour market and help encourage further investment. They will also support the current longstanding SMSF investments in equities for the dividend (that will be cut) and the very precious imputation credit.
The subdued inflation conditions and slowing global growth allow for even lower rates going forward.
This will be additional relief for households with existing mortgages who are effectively pre-paying their debt at a faster rate.
In summary, a combination of household income growth (tax cuts, wage rises above inflation rate), the ongoing large scale infrastructure programs, even lower cash rates and a lower Australian dollar all combine to help cushion the global slowdown and help drive investment and confidence going forward.
Risk assets (equities, sub investment grade bonds, hedge fund alternatives) have delivered very strong returns year-to-date (circa 20 per cent). Investors have effectively received two years’ return in the first 10 months of the year.
A lower return expectation is advisable and some profit taking is prudent. Dividends will be cut and volatility will become more elevated unless global policy stimulus is even more pre-emptive and aggressive.
With higher volatility anticipated your reaction to your investment portfolio is behavioural.
For the long-term investor (greater than five-year time horizon) they will still need to be invested through the cycle ahead despite some challenges ahead.
George Boubouras is the chief investment officer of Atlas Capital. The information provided is the opinion of the author. The AJN recommends that readers seek independent financial advice.
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