December was a hugely volatile month for global share markets, with the Australian share market coming through relatively unscathed. The All Ordinaries index fell by 0.7% to close the month at 5,709.4 points (marking the fourth consecutive month of decline). For the 2018 calendar year, the All Ordinaries index fell by 7.4% (excluding dividend income).
The Australian Dollar gave back its recent gains, falling by 3.5% in the month of December, with 1 Australian Dollar now buying 70.50 US cents. As widely expected, the Reserve Bank of Australia (RBA) board kept the official Cash Rate on hold at 1.50% per annum. The RBA board don’t meet again until February.
Global shares produced significant negative results in the month of December, with the United States Dow Jones index falling by 8.7%, the London FTSE falling by 3.6%, the Japan Nikkei 225 falling by 10.5% and the Hong Kong Hang Seng Index falling by 2.5%.
With such significant falls in investment markets it is only natural to question whether we are experiencing another prolonged market downturn like the Global Financial Crisis?
The Global Financial Crisis was essentially caused by heavily indebted United States households, falling property values, the realisation that financial institutions had “packaged and on-sold” dodgy loans as high-quality credit, negative economic (or GDP) growth, then rising unemployment.
The chart below shows the United States household debt to GDP ratio over time.
As shown above, since the Global Financial Crisis, United States households have significantly reduced their level of debt. While the same cannot be said for Australian households, as is typically the case, global investment markets are more focussed on the United States economy when determining future global economic growth.
It is also important to note that the United States economy is continuing to grow. The chart below shows the annual GDP growth rate of the United States economy in recent times.
Strong GDP growth is essentially the reason why the United States Federal Reserve has been comfortable in increasing interest rates – as the economic growth story is good!
Another factor to consider when assessing if a major downturn is likely is the unemployment rate. The chart below shows the United States unemployment rate over the last 10 years.
As shown above, United States unemployment has been trending down consistently and is now near a 50-year historical low level.
Given the above, it is hard to see exactly why financial markets are so “bearish” other than to think that the “market noise” of a United States-China trade deal being formed, the United States partial government shutdown over funding for the “Mexico Boarder Wall”, and a “Brexit” deal being resolved is taking its toll.
For what it is worth, I do expect a United States-China trade deal sooner rather than later (noting President Trump recently commented that he would be “buying shares on the dip”). Assuming a fair negotiated outcome is reached, global investment markets should react favourably and the bounce-back could be swift.
A quick comment on the Australian economy is also warranted. The Australian household debt to GDP ratio remains at record levels (and has increased since the Global Financial Crisis). While the domestic unemployment rate remains good, there is significant risk in the domestic economy surrounding housing.
I note that the latest housing data suggests that house prices in Sydney and Melbourne fell by as much as 10% in 2018. It remains to be seen what flow-on effect this will have to the broader economy, however in my view the RBA will not be increasing interest rates this year – with the next move a cut in rates if domestic economic growth staggers.
In context of the above, the Australian Dollar should (in my view) continue to depreciate relative to the United States dollar.
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This article is general information only and is not intended to be a recommendation. We strongly recommend you seek advice from your financial adviser as to whether this information is appropriate to your needs, financial situation and investment objectives.