GPL Financial Group GPL Partners

November 2018

The global financial crisis: Behind us but far from over

Ten years ago this month, Lehman Brothers, the fourth-largest US investment bank, filed for bankruptcy protection.

         

 

It was a seminal event in what has come to be known as the global financial crisis (GFC). Even a decade on, the massive damage it inflicted across the world continues to shape both the global economy and investor behaviour.

Just how bad was it?

The epicenter of the crisis was a wave of US subprime mortgage failures that hit the housing and financial sectors and then spilled over into the broader economy and far beyond the United States. It created a synchronised global recession. For a number of countries, including Greece, Italy, and Spain, recovery from this recession to pre-crisis GDP levels has taken even longer than it had from the Great Depression. Other countries still aren't there yet.

Although numbers alone can't capture the full impact of what happened, below are some indicators for the United States that at least give a sense of the scale of the crisis.

Sources: Vanguard, Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, and “The 2007–2009 Financial Crisis: An Erosion of Ethics: A Case Study” in Journal of Business Ethics, December 2017, Volume 146, Issue 4, pp. 805–830.

Some healing from the GFC and some enduring scars

“Obviously, we're in a much better place right now than we were a decade ago,” said Roger Aliaga-Díaz, Vanguard chief economist for the Americas. “The global economy has been expanding—the US is in its ninth year of expansion, which is the second-longest on record, and most developed economies are at or near full employment. And inflation remains modest despite unprecedented monetary stimulus.

“But on the other hand,” he noted, “the GFC set in motion or accelerated some deep shifts in the global economy that leave us still short of 'pre-crisis normal,' according to some key metrics. I'd point specifically to wages, global growth, international trade, and interest rates as prime examples of that.”

  • Slower global growth, less international trade. The financial meltdown put a brake on the debt-fueled consumption boom in the developed world and, with it, the main growth driver for export-oriented emerging markets. The US, for example, began buying less abroad, causing its trade deficit to drop from close to 6% of GDP in 2006 to about 2.5% post-crisis, while China's trade surplus shrank from 10% of GDP to around 2%. (They are still at roughly those levels today.) The abrupt drop-off in international trade accelerated the drive of some emerging markets like China to rebalance their economies from export-oriented manufacturing production toward domestic-oriented services. Other emerging markets, especially commodity exporters, have struggled to reorient their economies. As a result, emerging markets are not the engines of global growth they once were. Growth in China has slowed from an annual average of about 10% for the two decades prior to the GFC to about 6.5% since then. Overall emerging-market growth has fallen from about 7% to about 4% over the same time frame.
     
  • Persistently low interest rates. Global demand for “safe assets,” such as high-quality government bonds, had been increasing well before the GFC. One reason was the burgeoning retirement savings of aging populations transitioning toward more conservative portfolios. A second reason was a buildup of reserves by emerging-market central banks in response to their traumatic currency crises of the 1980s and 1990s, and more recently by their attempts to offset the effect of quantitative-easing policies of the last decade on their currencies.  The GFC caused a collapse in the availability of those assets, effectively shrinking the pool of what constituted “safe.” Before the crisis, many investors felt that financial assets, such as synthetically engineered AAA-rated securities, securitised mortgages, and related derivatives in the US, as well as euro-backed peripheral government bonds in Europe, were all valid alternatives to Treasuries. After the US housing and European debt crises, investors learned that that was not the case. 

    The deteriorating global supply/demand imbalance resulted in a massive shortage of high-quality, risk-free assets around the world. This had the effect of pushing the prices of the few safe assets left—mainly US Treasuries, British gilts, and German bunds—to extreme highs. Since bond prices and yields move in opposite directions, bond yields and interest rates have reached historical lows. 

    This global shortage of safe assets is likely to persist and long-term interest rates could well remain at current levels for some time.
     

  • Stagnating wages. In a typical economic recovery, companies have to raise wages in order to attract and retain increasingly scarce workers. However, there hasn't been as strong a demand for more workers in this recovery because global growth has been slower. 

    Demographic trends across developed markets are an important part of the explanation. In the US, the main reason for the fall in the unemployment rate has been the retirement of baby boomers, a trend that the recession probably accelerated and that is likely to continue for decades. The US labour force participation rate has shrunk by almost 4%, or more than 9 million workers, since the GFC. And because the retiring boomers have been replaced by younger and cheaper workers, the usual post-recession surge in wages, after adjusting for inflation, hasn't materialised.

And yet the financial markets have been surprisingly robust

“The contrast between the economy and the markets couldn't be starker,” observed Vanguard Chief Investment Officer Greg Davis. “While most economic variables showed subpar performance, stocks have delivered solid returns.”

The US market has delivered an outstanding annualised average return of 19% since March 2009 (the crisis-era low) following a meltdown of –47% in the six months prior to that. Those returns put the average annual return for the full ten-year period at 11%, or slightly better than the comparable return of 9% for two decades prior to the crisis.

The performance of bonds was also decent given the low-interest-rate environment—the average annual return for US bonds was 3.5% for the decade. Given the demand for safe assets, neither the extended period of economic expansion nor the unprecedented quantitative easing across much of the developed world has lifted rates very high.

*Data for Hong Kong bond returns were not available.

Note: The periods cover the global financial crisis (September 2008 through February 2009) and the post-crisis period (March 2009 through August 2018).

Sources: Vanguard calculations of stock returns, using data for MSCI Total Return Indices, and Vanguard calculations of bond returns, using Bloomberg Barclays indices.

Lessons for investors

There's no better illustration of the importance of staying the course through good markets and bad than the US equity market's impressive turnaround since the GFC. Investors with a broadly diversified portfolio of 50% stocks and 50% bonds who didn't hit the panic button saw an average annual return of 7% from the pre-crisis market peak in 2007 through June of this year.

Notes: Stocks are represented by the Standard & Poor's 500 Index. Bonds are represented by the Bloomberg Barclays US Aggregate Bond Index. The 50% stock/50% bond portfolio was rebalanced monthly. Data are provided by FactSet and cover the period from 9 October 2007, through 29 June 2018. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Source: Vanguard calculations using data provided by FactSet, as at 29 June 2018.

As would be expected, more risk-tolerant investors with larger portions of their portfolios in stocks would have done better. It's worth noting, however, that a 100% stock portfolio would have been under water for the first four years after the market peaked in 2007.

Maybe the GFC's most enduring effect on investor behaviour is greater fear of loss. Millennials who started investing with Vanguard after the GFC were twice as likely to hold zero-stock portfolios as those who started investing before it occurred. For them, market risk seems to be more salient than potential return.

“Bond returns are likely to remain modest and US equities also face some headwinds due to high valuation levels,” said Mr. Davis, “which translate into subdued return expectations for the next decade. For all the contrast between the performance of the economy and market returns over the past ten years, we may be heading into a period of lower portfolio returns over the next ten years. A global balanced portfolio may return between 3% and 5% after accounting for inflation, compared with a historical return of around 7%.”

One of Vanguard's main goals in providing forecasts about capital markets is to arm investors with realistic expectations about portfolio returns so they can calibrate an appropriate level of savings in order to ensure they reach their investment goals.

Timeless advice

The global economy is in a very different place a decade after the GFC and some investors remain risk-shy (especially those who didn't participate in the great stock bull market that ran from 1982 through 2000). But Mr. Davis said Vanguard's investment approach hasn't changed: “Think about how much risk you can take on and still sleep at night, diversify your portfolio across the globe among stock and bonds, and make sure to rebalance from time to time—those steps should still offer you the best chance for investment success.”

 

Roger Aliaga-Diaz
Chief Economist for the Americas
vanguardinvestments.com.au

 

‘Hefty penalties’ with TRIS payment failures, SMSFs warned

With clients who fail to pay the minimum pension payments for TRISs potentially up for illegal early release and significant penalties, SMSF practitioners have been urged to pay close attention in this area.

           

 

With failure to pay minimum pension payments for TRISs potentially resulting in illegal early release and significant penalties, SMSF practitioners have been urged to pay close attention to their clients’ pension payments.

Speaking in a webinar, DBA Lawyers director Daniel Butler said SMSF clients who have a transition to retirement income streams (TRISs) and have not yet retired can land themselves in serious trouble where they fail to meet the minimum pension payments.

Where a client fails to make the minimum pension payments, the pension ceases for that income year and the withdrawn amounts become a lump sum, he explained.

Typically, most TRISs contain preserved money only, and it is only possible for a member to take preserved money as a lump sum once the member has retired, he said.

“If it is preserved money then effectively you have an early release on your hands,” warned Mr Butler.

Therefore, unless the member has an unrestricted non-preserved amount, the fund has contravened a very important operating standard and the ATO could decide to “apply the full force of the law”, he cautioned.

“[Consequently], the client could get slammed with fully assessable income, even though the money from the TRIS was tax-free,” he said.

“Not only that, but they could potentially get an admin penalty of $4,200, so that’s a hefty penalty. If the client doesn’t have a corporate trustee, then that penalty amount could be doubled or tripled depending on the number of members in the fund.”

Mr Butler said it is vital therefore that SMSF practitioners stress to their clients the serious consequences that can arise from failing to make the minimum pension payments for their TRIS, especially where the client hasn’t retired. 

 

Miranda Brownlee
26 October 2018
smsfadviser.com

ATO claws back $850m in unpaid SG in FY 17-18

Compliance activities undertaken by the ATO in the 2017-18 financial year saw the ATO raise around $850 million in unpaid super entitlements.

         

 

ATO deputy commissioner, superannuation, James O’Halloran said that during the 2017-18 financial year, the ATO received around 31,000 employee notifications and contacted approximately 24,000 employers.

“We also completed 19,000 employee-generated cases. Additionally, we initiated a further 13,000 SG audits and reviews based on our risk modelling. Total liabilities raised by this casework were approximately $850 million,” said Mr O’Halloran.

From the beginning of this financial year, Mr O’Halloran said the ATO has begun undertaking additional SG casework using the funding provided from the government for the SG Task Force.

“We’ve completed 537 cases and raised $22.8 million in liabilities, including $3 million in penalties,” he said.

“We’re on track to close over 2,600 cases, raising about $130 million in 2018–19.”

 

Miranda Brownlee
25 October 2018
smsfadviser.com

Market downturns, like this one, are to be expected

It's been awhile since there's been a drop in the markets as sharp, broad and sudden as last week's.

           

 

A recap of where we stand

US markets fell 3.1% (as measured by the Standard and Poor's 500 Index), on Wednesday, followed by greater declines in Asia. The impact to European markets was more muted. The S&P 500 was down an additional 2.06% on Thursday. The Australian sharemarket wasn't immune, falling some 2.7% during Thursday's trading day.

What's behind the rout?

After an extended period of relative calm and steady market gains, we're entering a period when investor sentiment is getting shakier. Geopolitical tensions between the US and China are ratcheting higher, nervousness is increasing about the approaching US corporate earnings season and US interest rates are climbing.

Taking a step back for some perspective

It's important to remember that corrections and bear markets happen often. From 1980 through 2017, there were 11 market corrections and eight bear markets in global stocks. That means on average there's been one attention-grabbing downturn every two years.

Another lesson from history is that stock market sell-offs related to geopolitical events have often been short-lived.

Some of the investor angst may be related to the belief that rising interest rates are a harbinger of poor stock returns. The reasoning goes that higher rates make bonds relatively more attractive compared with stocks and that they put a brake on economic growth, which in turn weighs on corporate profits. Vanguard research, however, suggests otherwise. We looked at 11 periods of rising rates over the past 50 years and found that stock market returns were positive in all but one of them. In addition, those periods together produced an average annualised return of roughly 10%—not a performance to be feared.

High stock valuations have been a concern as well, especially since the start of 2018. The recent market decline, in that context, is a sign that valuations are moving closer to fair value—a healthy adjustment that leaves more room for upside.

Advice for weathering the markets' ups and downs

Staying informed about market events is prudent, but so is maintaining a long-term view. Investors who already have a sensible investment plan designed to carry them through good markets and bad will hopefully have the discipline and perspective to remain committed to it despite this downturn.

Doing so will probably result in better investment outcomes than giving in to the temptation many investors may have right now to head for the exits. Market timing rarely turns out well, as the best and worst days often happen close to each other. In many cases, timing the market for reentry simply results in selling low and buying high.

Even with the latest market pain, patient investors with broadly diversified portfolios who rebalance and keep an eye on investment costs are likely to be rewarded over the next decade with fair inflation-adjusted returns.

 

 

16 October 2018
vanguardinvestments.com.au

Superannuation gender gap narrowing, research shows

Over the past decade, there has been improvement in the number of women holding superannuation accounts and the size of their superannuation balances compared with that of men, according to a research house.

         

 

Research from Roy Morgan indicates that the proportion of women with superannuation has improved with 64.7 per cent of women now holding assets in super, compared to 57.4 per cent of women in 2008.

The proportion of men holding super has also improved but not as significantly, rising from 66.5 per cent in 2008 up to 69 per cent for this year.

The results were based on the Roy Morgan Single Source survey, which has conducted personal interviews with over 500,000 Australians over the past decade.

The survey also indicates that the average balance for women has also grown by 87 per cent, jumping from $68,000 in 2008 up to $127,000 this year.

The average balance for men grew 53 per cent from $115,000 up to $176,000.

According to Roy Morgan, the gap in superannuation balances between women and men has been closing across all age groups in the past decade.

The research shows that the biggest gain was made by the 50 to 59 female group, which improved by 15.2 percentage points, jumping from only 54.5 per cent of the male average in 2008 up to 69.7 per cent  in 2018.

The other groups to show big improvements were those aged 35 to 49 with a 14.2 percentage point increase to 75.4 per cent, and the 60+ segment, up 9.8 percentage points to 72.1 per cent.

The female age that is closest to the male average is the 14 to 34 segment at 85.6 per cent, which has increased marginally from 83.9 per cent back in 2008.

Roy Morgan industry communications director Roy Morgan said that with the current gap indicating that the average superannuation balance for women represents just 72.2 per cent of the average male balance, there is still a long way to go, but is still a significant improvement on the 59.1 per cent recorded in 2008.

“In addition to problems associated with lower average incomes, females are more likely to have interrupted employment. However, despite these negative factors operating against them, women have made gains in closing the superannuation gap to men,” said Mr Morgan.

“Generally, both sexes are still unlikely to fund an adequate retirement entirely from superannuation unless contribution levels are increased and continue higher for several decades.”

 

Miranda Brownlee
15 October 2018
smsfadviser.com

Retiree self-protection: A volatility-and-downturn ‘bucket’

The latest fall in share prices close to the 10-year anniversary of the global financial crisis (GFC) is likely to prompt more retirees and near-retirees to think about creating a volatility-and-downturn cash bucket.

         

 

This is a straightforward strategy intended to reduce the possibility of retirees – particularly those with many years of retirement ahead – having to sell investments at depressed prices to maintain their income in the event of an extended future downturn.

What is a volatility-and-downturn cash bucket?

Retirees and investors approaching retirement often set aside about two to three years of living expenses if possible in a volatility-and-downturn cash bucket. This provides a buffer against being forced to sell assets at the wrong time, which may cut the expected longevity of a portfolio and its ability to produce enough future growth.

In a recent commentary, actuaries Rice Warner emphasises how disciplined investor behaviour is critical to handling a sharp fall in share prices and how a cash bucket can assist them to remain disciplined.

There is typically a close link to market behaviour and investor behaviour. (Regular Smart Investing readers may have read our past discussions of these buckets.)

“The behaviour of stock markets is unpredictable as sentiment big part in short-term price movements,” Rice Warner comments. “When people are upbeat about the economy, prices often rise exuberantly; when the market turns down significantly, it is usually fast and without notice.

“So, while we can say that investment markets,” Rice Warner adds, “follow a cyclical pattern, no one can predict when the market will rise or fall. We also know that markets usually recover their losses over time, sometimes quite quickly.”

And as the commentary says, the impact of a market downturn could be magnified for investors who “lock in losses by moving into more defensive strategies [such as switching to all-cash portfolios] at an inopportune time”.

When and how can I create a cash bucket?

Investors often begin to build-up a cash bucket or buffer in their last few years before their planned retirement. For instance, some investors direct a proportion of their super contributions from their last few years in the workforce into a cash bucket within their super funds.

Other opportunities may arise to create a cash bucket including, say, an inheritance or the sale of an investment property. Some investors will simply increase the asset allocation to cash in their super funds – perhaps when periodically rebalancing their portfolios.

How big should I make my cash bucket?

While investors often set aside two to three years of living expenses in their volatility-and-downturn bucket, the size of the buffer and how it is built-up will depend on such personal circumstances as the size of an individual's retirement savings, age, investment timeframe and perhaps professional advice. When determining the size of your cash bucket, keep the age pension in mind if applicable.

How can I top-up my cash bucket?

Some investors direct a proportion of unspent income from their main diversified portfolio, such as a balanced or growth super fund, to top-up their cash bucket from time to time – particularly during stronger-performing years. And proceeds from regular rebalancing of an investor's main diversified portfolio can provide top-up money.

 

Written by Robin Bowerman
Head of Corporate Affairs at Vanguard.
16 October 2018
vanguardinvestments.com.au