How the economy performed in 2008/09

Full report from Watson Wyatt, LUCRF Super's asset allocation consultant.

In Australia this financial year, we saw:

• The Australian real economic growth rate contract for the first time in eight years(during the December 2008 quarter) 
• The Reserve Bank of Australia (RBA) cut interest rates from 7.25% to 3.00% over the year, to stimulate the economy
• Continued weak performance from Australian share markets, following the sub-prime crisis.

Australia

In late 2008, the Australian economy began to show some signs that the ongoing effects of the global financial crisis were starting to bite.  Figures showed that the economy contracted for the first time in eight years during the quarter ending December 2008, with real Gross Domestic Product (GDP) recording a drop of 0.5%. Unemployment hit a three year high of 5.2%, emphasising a declining labour market. 

The Reserve Bank of Australia cut interest rates from 7.25% to 3.00% over the year. Coupled with a significant stimulus package in the first half of 2009, this formed a coordinated effort from the deferral government, aimed at boosting the economy.

World markets

On the international front, the major advanced developed nations are suffering from the deepest recession since World War II.  The start of the financial year saw the US financial system experiencing significant events with the collapse of Lehman Brothers, the merger between Bank of America and Merrill Lynch and the intervention of the US Government to provide support to American Insurance Group (AIG), Fannie Mae and Freddie Mac.  The US experienced its sharpest quarterly GDP decline since 1982, with real GDP falling by 1.6% during the final three months of the 2008 calendar year. With interest rates effectively near or at 0%, the US Government resorted to additional fiscal stimulus measures to help boost the world’s largest economy. US unemployment increased to a 25 year high of 8.5%. 

The Japanese economy was weak throughout the financial year driven by poor capital expenditure, declining net exports and a softening labour market. 

Towards the end of the financial year, the Chinese economy was showing signs that the government response to the global recession is beginning to have a positive impact, with a surge in spending on infrastructure projects and increased investment in fixed assets. 

Over the same period, the European economic landscape experienced a significant contraction in real GDP with weakened confidence, business conditions and industrial production.

Australian Shares
Investment options with large investments in the Australian share market, including the Balanced, Indexed Shares and the Australian Shares options, were adversely affected by the negative returns generated by these investments during the financial year.  Despite the Australian share market posting strong positive returns towards the end of the financial year, it still recorded one of its weakest performances in recent years, falling by 20.3% for the year to 30 June 2009 (as measured by the S&P/ASX 300 Accumulation Index).

International Shares
The global share market also fell significantly in the last financial year, negatively impacting the performance of the investment options which have exposures to international equities, including the Balanced, International Shares and Indexed Shares options. The weakness was particularly evident in the financial sector, which saw the bankruptcy of Lehman Brothers and the nationalisation of Fannie Mae, Freddie Mac and AIG, in September and October last year.

The Australian dollar fell significantly against the US dollar and the Japanese yen in the first half of the financial year, but has experienced some recovery over the second half of the financial year.  These currency movements resulted in weaker returns on hedged international investments when compared to unhedged investments for Australian investors. The MSCI World ex-Australia Index in Australian dollars (unhedged) returned -16.2% for the financial year, while the return on hedged international shares was -28.4% over the same period.

Property
The Australian listed property market continued to suffer severe losses throughout the 2008/2009 financial year, which negatively affected members invested in the Property option. Excessive debt within the sector combined with a dysfunctional credit market forced many investors to write down the value of assets and issue profit downgrades. 

The S&P/ASX 300 Property Accumulation Index returned -42.1% for the financial year. The property exposure within LUCRF Super’s Balanced option is unlisted property.  Unlisted property returns were weak, but not as weak as the listed property market. That said, it is normal for unlisted markets to lag their listed counterparts, and significant falls in unlisted property assets are expected to occur in the 2009/2010 financial year.

Cash and Fixed Interest
The Australian fixed interest market delivered a solid performance over the 2008/2009 financial year (relative to equities), with multiple interest rate cuts favouring longer-term bonds during this period. The Australian 90 Day Bank Bill index posted a positive return of 5.5% for the financial year, providing strong defensive returns to those invested in the Cash option. The UBSA Composite Bond Index (All Maturities) returned 10.8% for the financial year.

International fixed interest markets underperformed the Australian fixed interest market but still posted a positive returns, with the Barclays Global Aggregate Index (hedged to Australian dollars) returning 9.9% for the year.

In the second half of 2008, forced liquidations from the de-leveraging process as well as negative economic reports led to credit spreads widening to historical highs. This had a negative impact on LUCRF Super’s investments with exposure to credit. Towards the end of the financial year, broader market sentiment started to improve and the credit markets saw a recovery with the tightening of credit spreads.   

Looking forward

Public policy around the globe has been very active in addressing the financial and economic effects of the credit crunch. This has been most noticeable after the de-leveraging process accelerated in September 2008, as governments and central banks have committed large amounts of money to stabilising their economies.  The implications for financial markets continue to be complex and wide ranging and there is still uncertainty as to how events will unfold and how investment returns will be affected as a result of this.

Note: This investment commentary does not constitute advice. All investment figures quoted relate to before-tax performance of the relevant industry benchmark.