Despite significant bouts of volatility and the 11th hour shock of the Brexit vote, markets still achieved modest growth in 2015-16, making it seven years of positive returns in a row. Here’s a look at the economy and markets over that rollercoaster year, what’s in store for the year ahead, and how Mercer’s portfolio management team is navigating these uncertain times.
The year that was
The 2015-16 financial year was bookended by European Union (EU) ‘exits’ – the threat of a ‘Grexit’ following the mid-2015 debt crisis in Greece; and the actual vote to ‘Brexit’ as UK voters elected to leave the EU on 23 June 2016.
There were few places for investors to hide over July to September 2015. Although fears over Greece eventually subsided, market fears quickly elevated in response to the slowdown in China and the US Federal Reserve’s (the Fed’s) apparent determination to proceed with interest rate ‘lift off’. Along with the renewed decline in energy and other commodity prices, plus growing doubts over forecast US earnings growth, markets sold off. More positively, amid rising volatility, the continued decline in the Australian dollar provided something of a cushion against falling global equities for local investors. Toward the end of 2015, tentative signs of improving risk appetite had also become apparent, helping to secure a solid December 2015 quarter.
However, investment markets deteriorated sharply as we entered 2016, with developments in China, disappointing US economic data, the introduction of negative interest rates in Japan, and falling oil prices making for a volatile mix in January 2016. This resulted in a sharp slowdown in economic growth in key developed economies, contributing to renewed fears of recession and deflation, in turn fuelling volatile equity markets.
The Fed moved to calm the market over prospective interest rate rises while Japanese, Chinese and European Central banks moved again to ease monetary conditions. In Australia, the Reserve Bank (RBA) continues to leave the door open to further policy easing, noting the prospect of inflation remaining low for a prolonged period of time.
While such measures mitigated recession and deflation risks, markets remained dubious they would lead to a material upturn in global growth. Yet a recovery started in March and financial market returns were able to generally maintain their positive trajectory through April, May and June 2016. Market reactions immediately following the shock outcome of the UK’s Brexit vote on 23 June to exit the EU were significant. Initial sharp market moves saw the UK market down 7%, Europe down 8.6% and Japan down 8.4%. However, by the end of June markets had started to settle and, in some cases, partly reverse the post-Brexit losses. Further offsetting the post-Brexit turmoil was some strong some upward movement in the week leading up to the vote, as expectations (incorrectly) grew that the vote would be to stay in the EU.
Equity Market Performance
Over the year to 30 June 2016, the total return from Australian Shares (including dividends) for Australian Investors was 0.9% for the full Financial Year. Global equities returned 0.4% in unhedged terms, and -1.4% in hedged terms.
Superannuation funds finished in modest positive territory at 30 June 2016 in Australia, albeit not as strongly as they have done in the past couple of years.
Uncertainty continues in 2016-17
At the outset of the 2016-17 year, uncertainty prevails. The only likely outcome is elevated risks. The central case global economic outlook has been nudged down, but the downside risks have risen significantly in a world of fragile growth where Mercer already believes risks are high.
Mercer’s Dynamic Asset Allocation (DAA) team has not altered its previous view, which is to maintain a relatively neutral overall portfolio exposure to equities, whilst maintaining some level of downside protection (such as a low currency hedge ratio or exposure to “low volatility” equities). We are monitoring developments and will update this view should that be warranted by economic or market developments.
How we’re positioning our portfolios
Mercer’s portfolio management team has been steadily reducing its equity exposure over the last 18 months. At the beginning of July 2016, we carried a modest underweight to equities, together with other risk mitigation through exposure to low-volatility equities and our risk management overlay, which utilises options to provide some downside protection. Together with our global colleagues we continue to monitor economic and market developments and adjust portfolio exposures accordingly.