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Managing investment risk and economic uncertainty

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COVID-19 has created tremendous investment and economic uncertainty. Here are some insights to what’s going on and how investors can get their plans back on track.

COVID-19 has uprooted our lives and done some strange things to investment markets. First there was a major crash. Then a major rally. What’s going on? What does it mean for you and your super? And how can you adapt to the new investment landscape?

Governments and central banks across the world have unleashed a massive amount of policy firepower to support economies in the face of the COVID-19 and associated lockdowns.

In Australia, a total of $213.7 billion has been rolled out with the aim of keeping people in work and supporting those in need. The United States implemented a US$2 trillion stimulus package, the largest in the country’s history, while Germany and Canada’s stimulus programs were estimated to be worth around US$189 billion and US$145 billion, respectively.1

At the same time, official interest rates across the world’s wealthy countries range from a remarkable -0.10% in Japan, and 0.0% in the Euro area,2 and 0.10% and 0.13% in the UK and United States, respectively.3 Both Australia and Canada, with 0.25% official interest rates, round out the low rate club.4

Despite all this, April saw Australia’s unemployment rate spike to 6.2 % per cent from 5.2% in March.5 Almost 600,000 jobs were lost in that month as airlines were grounded, clubs and pubs closed, and entire industries came to a standstill. The Reserve Bank of Australia warned that the “unemployment rate is forecast to rise to around 10 per cent in the June quarter.6

US data is even more grim with an unemployment rate of 13.3% in May, and new applications for state unemployment benefits estimated to have totalled a seasonally adjusted 1.55 million for the week ended June 6.7 Even though the number of people applying for unemployment benefits is now falling, estimates suggest claims for jobless benefits would still be more than double their peak during the 2007-09 Global Financial Crisis.8

Given such a background, it’s remarkable that share markets have regained much of the ground they lost during the deep falls of March.
 

The markets versus the economy

So, what explains the decoupling of the stock market from the economy?

Part of the answer is that investment markets are ‘forward looking.’ They discount current and near-term data, events and bad news, and look further ahead. On that basis, it seems that markets are assuming that massive government support programs and low interest rates, combined with a gradual return to more normal life, will cause economies to spring back.

From MLC's perspective, it looks like people may be getting a little ahead of themselves. We are more cautious as there is so much uncertainty, and we’re not convinced that the share market recovery is sustainable.

Such rallies are common during market corrections and prematurely create the impression that things are heading back towards normal. Usually, these ‘bear market rallies’, as they’re called, unwind as investors process uncomfortable realities.

Currently, those realities include economic and company-specific news continuing to point in a pessimistic direction, at least for this year, and maybe a little longer. So many industries have been disrupted that a wide range of companies in Australia and around the world have stopped offering profit guidance. Many companies have also been cutting dividends.

The biggest issue, of course, is COVID-19 itself. Societies and economies will not be able to return to truly normal activity until a vaccine becomes available. That has significant implications for profits – and employment - in a whole range of sectors.

It’s true that some businesses are opening up again, including café and restaurants.  But that easing is accompanied by limits on the numbers of patrons – with real consequences for revenue and profits. We are yet to see any sign of easing in the international tourism or university sectors – and they’re big sectors of our economy.
 

Stretching the investment dollar in retirement

Ultimately, economic uncertainty translates to investment uncertainty as the economic environment is an important driver of investment returns. This can be especially problematic for retirees as they are reliant on investment returns, including dividends.

One estimate suggests that the combination of dividend cuts and suspensions by Australian companies will add up to a $26 billion hit to Australian investors.9

This, in turn, means a hit to retirees’ living standards whether their investment income comes from an account-based pension payable from their super fund, or from investments outside super.

Another thing to bear in mind is that future investment returns are likely to be lower than the strong returns of the past decade.

With interest rates and cash returns from term deposits already at historic lows, the return potential for other assets is also lower. This is because official interest rates, set by the Reserve Bank of Australia and other central banks, are like gravity. They ultimately pull returns from all forms of savings and investments down towards them.

Assuming no other changes (for example, strong wage growth that fires up consumer spending, or consistently good company profit growth), low interest rates means that the return potential for riskier investments, such as shares, real estate, or infrastructure, is lower as well.

Term deposits and other cash-like investments have already felt the gravitational pull of low interest rates. They’re unlikely to be the last.

Helping you navigate your finances during COVID-19

Chasing returns

That said, simply increasing the level of investment risk to try and generate higher returns is unlikely to appeal to retirees or even be a useful strategy for them.

Investing in retirement is very different from investing while you’re still working.  The margin for error when investing in retirement is much smaller. There’s far less time to recover from investment setbacks. This often means investing in a way that puts the onus on capital preservation and then seeks some growth.

A health check for your investments may be in order to see whether you remain on-track or whether some changes may be required.

Speaking to a financial adviser can raise the odds of achieving better investment outcomes.

For instance, to improve the income-generating potential of retirees’ investments, advisers might suggest allocating more money to corporate bonds, which are loans made by investors to major companies. Investors receive regular interest payments from corporate bonds.

Corporate bonds are generally regarded as less risky than shares, but they are far from being risk free. The value of corporate bonds, like shares, goes up and down depending on a combination of factors including the financial strength of the company; the interest rate outlook; and economic outlook.

All this underlines the importance of great financial advice. Retirees’ investment portfolios must be very carefully calibrated. They have to ‘thread the needle’ between generating a good enough return to support your living standards while making your money last as long as possible.

That’s a complicated dance that financial advisers can help you with.
 

An e-book to empower you

We’re strong believers in the value of great financial advice because great advice can potentially change peoples’ lives.

We’re also strong advocates for financial education. Why? Because there are many financial situations where small changes can make a large difference (think investment fees, compounding returns and tax-effective investing for starters). MLC has developed an easy to use e-book How to plan your finances in a changing world that can help you review and reset your goals.

It will also empower you – by giving you a better understanding of strategies to help get your spending and debt under control and manage your super, pension and investment plans for now and for the future.

This workbook will also help you prepare if you’re considering getting professional advice.

You can use it to set goals, reassess your plans and understand what actions you can take from a lifestyle and financial perspective.

With a variety of highly practical tips and tools, including worksheets for you to fill out and links to a range of resources and calculators, our workbook will give you the guidance you need to build a map of your finances and future.
 

Share markets up, but economic concerns remain: what's going on?

Markets have been buoyed by central bank and government support for economies. However, COVID-19 remains a threat and economies are still fragile.

1 Visualizing Coronavirus Stimulus Programs Around the World. Howmuch.net, April 8, 2020. https://howmuch.net/articles/worlds-economic-programs-against-coronavirus. Accessed 15 May 2020.
2 Euro area refers to the member countries of the European Union that use the euro.
3 F13 International Official Interest Rates. https://www.rba.gov.au › statistics › tables › xls. Accessed 11 May 2020.
4 Ibid.
5 Employment falls 594,300 in April to 12.4 million. Australian Bureau of Statistics Media Release 14 May 2020. https://www.abs.gov.au/ausstats/abs@.nsf/lookup/6202.0Media%20Release1Apr%202020. Accessed 15 May 2020.
6 Statement on Monetary Policy May 2020. Reserve Bank of Australia. https://www.rba.gov.au/publications/smp/2020/may/. Accessed 15 May 2020.
7 U.S. weekly jobless claims seen declining further, but millions still unemployed, Lucia Mutikani, Reuters, June 11, 2020. https://www.reuters.com/article/us-usa-economy/us-weekly-jobless-claims-seen-declining-further-but-millions-still-unemployed-idUSKBN23I0GQ. Accessed 11 June 2020.
8 Ibid
9 Australian investors facing $26b hit as blue chips slash dividends. Clancy Yates, May 5, 2020. https://www.smh.com.au/business/banking-and-finance/australian-investors-facing-26b-hit-as-blue-chips-slash-dividends-20200504-p54pll.html. Accessed 11 June 2020.

General advice and information only

Any advice and information on this website is general only, and has been prepared without taking into account your particular circumstances and needs. Before acting on any advice on this website you should assess or seek advice on whether it is appropriate for your needs, financial situation and investment objectives.

Tax disclaimer

Any general tax information on this website is intended as a guide only and is based on our general understanding of taxation laws. It is not intended to be a substitute for specialised taxation advice or an assessment of your liabilities, obligations or claim entitlements that arise, or could arise, under taxation law, and we recommend you consult with a registered tax agent.