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Rockanomics
ROCKANOMICS - June 2016
It’s quite something to witness a herd (of anything really!) stampede. Images of bulls running through Pamplona, surprised wildebeest in Africa and a Pokemon sighting in New York City come to mind. The oft heard “he’s got a gun!” (in poor taste some will say but simply an observation of the tragic state of American affairs) is more than enough to get one going over there.
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What was?

It’s quite something to witness a herd (of anything really!) stampede. Images of bulls running through Pamplona, surprised wildebeest in Africa and a Pokemon sighting in New York City come to mind. The oft heard “he’s got a gun!” (in poor taste some will say but simply an observation of the tragic state of American affairs) is more than enough to get one going over there.

A stampede it was then on June 23rd as nearly every investor, bookie (yes apparently financial markets at one point were solely tracking bookmaker odds and not their own – economics being quite dismal at forecasting and all), Ladbrokes junkie and unsuspecting BRE-MAIN voter was caught pants down as the U.K. (against all odds obviously) voted to BREXIT out of the European Union! The ensuing financial fireworks, brought about by a herd – caught on the wrong side of the trade- stampeding for the exit, were nothing short of eye popping.

An estimated USD 3 Trillion was wiped off global equities in a single session. Europe’s large cap share index suffered its largest 1 day drop since its inception. The British pound closed down 8%, down more than 11% at one point. A plunge even deeper than when billionaire financier George Soros infamously “broke” the Bank of England in 1992. G. Ros apparently had his pants around the knees this time around on the pound but the sly old fox always brings his gold plated underwear to any game. Stock indices around the word closed down anywhere from a bare minimum of 3%, all the way to double digits for markets like Greece and Italy on contagion fears (Italeave anyone?). Safe haven assets rocketed as gold closed up big for the day blasting through a stubborn price barrier for the first time in two years. The Yen and U.S. 10 year treasury bonds rallied.

The dust did settle however as central banks around the world pledged, once again, their undying love and support. And markets responded like they so often have in the past when a sugary gift is presented – they rallied and recouped most of those losses by month’s end. U.S. indices were only marginally in the positive for the month but finished the quarter up 2.6%, due mostly to small caps. Coincidentally the Russell 2000 small cap index is now up a staggering 21% from its February bottom! European equities, despite a hellish few days in June, finished down 2.6% and were flat for the quarter. Asia and emerging market shares were the better performing regions for June, up between 3% and 4%. A multi month rally in commodities (powered in part by a weakening US dollar) looked to be still in effect, though oil started to once again exhibit a familiar disconcerting volatility.

The ASX 200, while unable to totally shake off the Brexit headwinds for the month (down 1.7%), was actually up a very respectable 4.7% for the June quarter! Property, resources, materials and energy outperformed the general market, while financials, industrials and consumer staples were overall drags. CBA and NAB took another tumble in June after some promise in May while BHP continued a slow ascent from a January bottom on the back of improving commodity prices. The Aussie dollar (vs the USD) being particular sensitive to risk events and having had quite a ride this year, managed a 3.2% gain for the month, which helped to shave the quarterly loss to 2.6%.

What now?

Investors by now, must be getting strangely familiar (intimate almost) with the outsized volatility that has gripped the equity markets in particular, for the better part of the last 2 years. But the question without a doubt on everyone’s mind, given these events, must still resoundingly be… and as Guns N Roses anthemically put it to us 29 years ago (feel old?)…….“Where do we go now?”

Macquarie analysts recently put out a thought provoking yet highly feasible view on what might come next. They’ve “likened the bizarre and inherently contradictory moves in markets to a ‘twilight zone’ which is leading investors to a world where free-market economic thinking will be overtaken by the ‘nationalisation of credit’ and state-sponsored growth”. Here’s what they observed and hypothesized:

· “Assets historically linked to ‘risk on’ and ‘risk-off’ have inexplicably rallied in unison.” The mad rush into global bonds (pushing yields to historic lows – even to negative) is a classic safe haven play but seemingly at odds with where equity prices are at.
· Zero and negative interest rate policies do not work, punishes savers, “taxes the banking system, has not encouraged real investment by businesses, exacerbated inequality but has been kind to asset prices”.
· Typical investment strategies and signals will cease to work with the erosion of the classic business/economic cycle and the perishing of credit spreads and the price of risk.
· “This ‘state driven paradise’ will be brought on by ongoing high levels of volatility and ‘discontinuities’ similar to what markets are grappling with today” and eventually reveal brand new investment signals.
This makes for interesting times indeed. Quality diversification away from pure market beta, which is the general direction (up or down) or an investment market, is critical in the current climate. As many of our clients know, we were positioned for such volatility over the last 2 years but for new capital entering the market, we are taking a cautious approach.

Recent portfolio reviews are seeing the removal of a Macquarie fixed income investment which has been on the watch list for the past 12 odd months and the introduction of a conservatively managed hedge fund, which has also been on our watch list over the last year.

What's that!?

Safe haven assets.

In times of increasing or persistent volatility, this a term that starts to get thrown about. Some of our readers may already be familiar with gold and the US dollar taking centre stage during skittish times.

A safe haven is “an investment that is expected to retain or even increase its value in times of market turbulence”. Precious metals (gold in particular – 5,000 years of value perception ain’t going to change overnight), US Treasury Bills (backed by the full faith and credit of Uncle Sam) and the Swiss Franc make up some of the usual suspects. Certain economic sectors (typically utilities – a hot shower never goes out of fashion – and consumer staples) can serve as safe havens during periods of equity market stress.

The Japanese Yen of late has garnered some attention as a safe haven but has curiously always been so. Decades of current-account surpluses have positioned Japan as a net creditor to the world. If you take the value of foreign assets held by Japanese investors, and subtract the value of Japanese assets owned by foreign investors, the sum places Japan among the world’s largest owners of foreign assets. Banzai!

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