Another exceptional year in financial markets

By Russell Investments, UniSaver’s investment manager and consultant

Members of UniSaver benefited from another great year in financial markets. Shares around the world continued to deliver strong performance through 2017. And although the US Federal Reserve and the Bank of England raised interest rates, inflation continued to be subdued, helping to drive pleasing returns in bond markets as well.

As a result, UniSaver’s principal investment options – Growth, Balanced and Conservative – all had returns well above their long-term targets – much like they did in 2015 and 2016. In contrast, Cash – having no exposure to share or bond markets - performed in line with expectations in 2017.

Conservative, Balanced and Growth also did very well in comparison to KiwiSaver funds. Returns were significantly above the median KiwiSaver fund with similar risk characteristics. Both strong returns as well as lower fees contributed to this result.   1

While it is great to have another strong year of returns behind us we must caution members against extrapolating the results of the last few years into the future. Although the global economy is still improving, there are a series of global economic and political challenges on the horizon that could create a negative reaction in financial markets.

The economic recovery quietly continues in the midst of all the noise surrounding American politics

2017 started with the inauguration of President Trump in the United States. As a result, a lot of chatter and commentary in the media focused on the threats and opportunities of new policies and actions by the President. More importantly, however, economic data and earnings reports by companies in the United States continued to demonstrate the ongoing resilience of the economy in the first few months. And in contrast to previous years, other important parts of the world showed more positive developments as well. The news out of China were generally pleasing and the European economy started to gain more traction as well. Furthermore, the election of President Macron in France in May also helped to calm fears about a potentially deepening rift among members of the European Union. As a result, share markets moved higher in the first half of the year.

Markets shake off North Korean nuclear scares and FBI investigation into the US election

Between North Korea conducting missile and nuclear tests and the FBI launching an investigation into Russian interference in the 2016 US election there was enough room for a more jittery period in share markets during the second half of 2017.  However, investors largely ignored those threats and the resulting political turmoil, and continued to focus on the fundamentally positive results of companies and economies around the world. After a quick pause in the rally in July, markets continued to go higher over the following months. In part, this was also helped by the United States’ decision to cut corporate taxes.

By the end of the year share markets around the world had delivered returns above 20%, far above what we would expect on average for investors over time. Furthermore, the steady upward trend - with few corrections or temporary swings to the downside - was quite unusual as well.

Outlook

Construing the strong returns and calmness in markets in 2017 as a sign of a permanent shift is not advisable, in our view. We should always assume - based on human behaviour in the past - that share markets and, to a lesser extent, bond markets, can turn negative for prolonged periods of time.

Given the length of the recovery since the global financial crisis in 2008/09 it is fair to expect that we are getting closer to a potential turning point. And perhaps not surprisingly, we have seen a bit of turmoil in financial markets already in early 2018.

However, the fundamental state of the global economy is sound, with potential further improvements in emerging markets and Europe on the horizon. Furthermore, key central banks around the world have done a good job to date of moving slowly but steadily away from expansive monetary policy, without letting inflation run rampant.

We continue to position our portfolios in light of the opportunities and risks that we see around the world. However, it is extremely hard to predict political events and potential policy mistakes by central banks, both likely sources of heightened uncertainty in financial markets in 2018.

But regardless of what the year brings, short-term movements should not worry members too much, assuming they have selected an option that suits their investment horizon and personal circumstances. And inevitable periods of negative performance should be viewed in a longer-term context: We have seen share markets around the world double in value just in the last five years.   2 

For those that were disciplined enough to stay invested in markets -  throughout the ups and downs along the way – this created a significant buffer against potentially more difficult periods in the future.

1For more information on the fee comparison see our February 2018 newsletter

2As measured by the Russell Global Large Cap Index NZD hedged.

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