Why did shares do well despite a weak economy?

Let’s take a look at how investment markets have done over the last financial year.

A good but strange year for shares

Last year was an odd one for share markets. While returns were strong – Australian shares returned 11.5% and international shares 6.6% – most overseas share markets were softer.

Even more curious was that share prices rose both in Australia and overseas despite the deterioration in economic fundamentals. Average earnings growth in Australia over the last 12 months was positive, but low, and the market is expecting the next 12 months to be even weaker.

So why are share prices high even though the earnings outlook isn’t great? Well, it’s all to do with changing interest rates.

Central banks ‘flip-flop’ on rates

Through the first six months of the financial year, central banks around the world were responding to above-average growth conditions by reducing the amount of stimulus to the economy. That is, they raised interest rates.

But this probably had a greater impact on growth than expected, so by Christmas time, with share markets down 15-20% from their peak, central banks quickly reversed their policies and began easing rates.

Australia's Reserve Bank followed suit, cutting rates by a quarter per cent in both June and July, taking the cash rate to a record low of just 1%.

This has been a great environment for defensive assets like Australian bonds, which returned 9.5%% for the year.

So is bad news really good news?

It’s surprising just how well growth assets like shares have performed over this period. Perhaps investors are comfortable that central banks will turn economic growth around, or they feel that in a low interest rate environment, they have to chase returns in other types of assets.

Either way, we’ve seen a strange combination of bad economic news translating into higher share prices – or good news for share markets.

But there’s a limit to bad news being seen as good news. We’ve already seen that tensions around trade and geopolitics can cause volatility, so it’s pretty clear that the share market doesn’t think a trade war is good news!

And if the market starts to worry about rising rates, or that central banks can't hold off a recession, then it could be bad news all round.

What does all that mean for me?

If you’re approaching retirement, or you’re on a pension, having a plan to manage market volatility is part of retiring well. Make sure you have a properly diversified portfolio. And don’t over-react to the "bad-news-good-news" roller coaster. That should help to keep you on track.