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Rockanomics

Rockanomics - July 2015

Was it cheaper petrol and tzatziki’s revenge? Unfortunately the former did not occur despite tumbling oil prices (but no thanks to Oz’s trend for offshoring its refining operations) and definitely a non-event for the latter, as Greece’s economic gamesmanship backfires and the pioneers of democracy cave in to yet another deal with Europe’s paymasters. A resuming commodity complex slump and China’s ever fascinating yo-yo stock market continued to steal the headlines from the spectre of a US Federal Reserve rate hike and were last month’s primary drivers of uncertainty and trepidation in global markets, already frothing from years of easy money steroid injections
minute read

What was?


Was it cheaper petrol and tzatziki’s revenge? Unfortunately the former did not occur despite tumbling oil prices (but no thanks to Oz’s trend for offshoring its refining operations) and definitely a non-event for the latter, as Greece’s economic gamesmanship backfires and the pioneers of democracy cave in to yet another deal with Europe’s paymasters. A resuming commodity complex slump and China’s ever fascinating yo-yo stock market continued to steal the headlines from the spectre of a US Federal Reserve rate hike and were last month’s primary drivers of uncertainty and trepidation in global markets, already frothing from years of easy money steroid injections.

There have been well publicised supply side arguments as to why oil is falling i.e. the Saudis are bent on soaking the world with the stuff in order to choke the profits of the Yank’s shale operations and remind the world (again!) GREASE is THEIR word! However the demand side is finally getting its day in the sun and what was hard to admit before (for perennial bulls!) is that consumption -and its favourite friend, demand- are grinding to a noticeable halt across the world and growth has in fact been below trend for some time. If you need more proof take a look at the way the other commodity cousins i.e. gold, silver, iron, copper (very useful in electronics I hear), platinum etc., have gone. The combination of soft growth, below par earnings and hugely inflated valuations is also now working its way into the Chinese stock market as it starts to come back down to earth.

Closer to home, weaker growth and slowing demand from China along with another tumble in the price of iron ore to test its multi-year lows continued to take its toll our markets. Despite this, the benchmark ASX 200 demonstrated some resiliency and even managed to eke out a 4% gain for July, bouncing back from a poor finish to the financial year after the index finished down 4% in June. The Australian dollar lost another cent (down to 74 cents) and the RBA laughed and patted its own back as they get closer to Glenn Stevens’ magic number 72. How this will benefit exports and tourism in the face of slowing demand will be interesting to see.

At Private Wealth we were pleased to report that many of our recommended investments, despite a challenging June quarter, have held up reasonably with some aspects of portfolios performing very well over the 2014/2015 financial year. Our tunnel vision like insistence for reputable portfolio managers who focus exclusively on pure quality plays in their circles of competence, yielded some noteworthy returns in the global and Asian spheres. One of our managers in fact had the foresight to invest in China via the higher quality, far less speculative H Shares (listed in Hong Kong) and more importantly the impeccable timing to lock in gains right before the tumble on the mainland bourse. Who says you shouldn’t sometimes bet on red

What now?

Will they or won’t they? No I’m not taking about another Jurassic Park sequel (that’s a given!), but will the US Federal Reserve finally raise rates in the coming months? If so, what will be the knock on effects (if not already priced into the market) on the wider financial universe? Since the effects of low rates continue to dazzle us on a daily basis (weird and wonderful things happen when money is overly cheap – bought a house lately?) let’s put out JUST a few scenarios of what might happen should rates be hiked:

If the expectation (and the magnitude) of this hike has not been fully priced into the market, then US equities could be looking at a tumble from the levels they currently reside at. Finance 101 dictates that higher interest rates would be mean higher discount rates used on a company’s cash flows, which will translate to lower valuations and stock prices. And when the US market sneezes……

Borrowing costs in USD would go up resulting in some level of unwind in the massive carry trades that proliferate the universe because of ultra-low interest rates in developed economies vs those of the emerging type nations; we could see a rush to the exit door on the these trades resulting in currency devaluations across these nations brought about by rounds of foreign investment outflows.

Bonds being the bewildering beast they are don’t always tell a clear story. We know that interest rates and bond prices have an inverse relationship and that longer dated bonds are more sensitive to interest rate changes i.e. rates up, bond values down. At present short term yields have been rising in anticipation of this hike but strangely the reaction in longer term bonds have been muted. This is possibly a sign that many investors are still doubtful about the health of the economy, and the ability of the Fed to keep raising rates without jeopardizing growth. Once again we need to use that unholy word – “expectation”. Yields tend to swiftly adjust to expectations but should investors misjudge the timing, magnitude and frequency of future rate rises, we could be in for some serious volatility.

The growing challenge now, more than ever, will be to unearth further return opportunities in an environment of slack demand, a possible tightening cycle (of interest rates) and ever-present geopolitical dangers. And even more importantly, to focus on investments which can be nimble and defensive to the ever-present risks that pepper the market and stay true to our overarching goal of capital preservation. While not currently and directly exposed to commodities in portfolios, it is important to acknowledge that falling demand and prices will affect the profitability (and value) of companies in the energy and commodity markets, such as our very own powerhouse of the early naughties, BHP. Portfolio managers will be faced with decisions as to whether to rotate out of unloved sectors or batten down and seek further value in these areas should they see fit. A very wise and ridiculously rich man once said “be fearful when others are greedy and greedy when others are fearful”! The current situation in commodities may just be presenting investors with such an opportunity in the short to medium term.<br />
**At the time of writing and since July, there has clearly been some major and concerning disruption in global markets in line with some of the key themes mentioned. Please keep a close eye out in early September for our August edition**

What's that!?


A troy ounce – An imperial measure used to gauge the mass of precious metals and equivalent to 1.097 regular ounces. A standard gold bullion/bar is 400 troy ounces (12.4kgs) and at current prices, is worth around $432,000. A very pretty store of value and also handy to drop on someone’s foot when you don’t like them. Interesting to note and notwithstanding its weight, gold has been in a bear market for the last 3 years. As gold, like most commodities, is typically priced in USD, the fall in our dollar (relative to the greenback) from lofty heights would have made gold investors want to smash their own feet.

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