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Rockanomics – March Quarter 2019

Comprehensive investment commentary from the BlueRock Private Wealth experts for the March quarter.

What was?

Grab yourself a cuppa, as this is a long, albeit very important, update on the state of play.

They’re only words…

A few choice ones uttered by a certain central bank, in the nick of time, triggered a (now often seen) V-shaped reversal in equity markets. And just like that, most of the previous quarter’s declines were nearly recouped and the memory of black Christmas 2018 was quickly put down to market amnesia!  

But was it the combination of obvious tightening conditions, a sharp growth slow down and lack of consumer price inflation that caused the Federal Reserve to change course on its rate rise trajectory? Or was it the constant twit-sized tantrums and threats to job security (for the Fed chief at least) emanating from the comically exhausting reality show that is the current White House administration? We might never know!

Either way, the broad-based, global All Country World (Equity) Index responded promptly to rise over 13% last quarter!

Relief in all corners

In the U.S, the primary and most watched indices registered similar gains with the tech-heavy NASDAQ alone rising a whopping 18%! Silicon Valley enjoys running money like tap water but not so much the interest payments on it. Who even needs a net profit anymore? Strangely, while gains were primarily shared across the tech, real estate and industrial sectors, all other market segments flat lined or continued to dip into the negative. So not as broad-based a recoup as the headlines might suggest.

Though European equities enjoyed a near identical bounce, economic growth in the region seems to be grinding to a halt, with Germany very narrowly avoiding a recession and Italy officially entering one. Despite Brexit continuing to bamboozle the UK, with the English parliament clearly confused about how to pull out, the uncertainty must surely now be priced in. Proof came in the form of UK markets rising 11% for the quarter.

Latin American, Asian, Japanese and emerging markets also enjoyed various levels of relief this past quarter – between 6% and 11%. As further trade threats by a much-loved presidential caricature fizzled, China (which itself currently has several nations by their monetary kahunas via it’s ’One Belt, One Road’ foreign policy initiative) said “whatever dude!”, shot itself up with more domestic stimulus and saw its own markets power to impressive double-digit gains, reversing plenty of 2018’s pain.

The broad-based sentiment reversal gave commodities a 6% bounce as well, as crude oil, on its own, gained 30% for the quarter. While gold had a very modest bump, it has enjoyed a notable rise since the depths of August 2018 having gone up 14% to the end of February. It came off a little, but this was clear evidence of safety being highly prized at the start of 2019.

After being under pressure for the better part of 2018, fixed income, globally and on aggregate (as measured by a popular Bloomberg Index) surged in the first quarter of 2019 to almost match a five-year high. As a result, bond yields plummeted to record depths as the US 10-year treasury notes fell below 3 month treasury bills for the first time since 2007. In Australia, 10-year bond yields hit a new record low of just 1.73%.

Meanwhile, at home…

Locally the ASX 200 enjoyed a relief to the tune of 9.4% last quarter. While most sectors benefited from reversals of various magnitudes to claw back last quarter’s losses, steep gains were seen in the tech, materials (aided by 28% quarter gain in iron ore prices) and industrial spaces.  Persistent underperformance (against the benchmark index) was noted in financials and telecoms. The Reserve Bank of Australia is now forecasting lower than anticipated growth figures due to weakness in household income and lower house prices affecting household consumption as well as the drought that has affected parts of the country.

The Aussie dollar (vs the USD) whipsawed all quarter (between 68 to 73 cents) but finished up 1.5% to settle at 71 cents.

On such a broad-based upswing, it’s usually rewarding to be ready on your board to ride the ensuing wave! And Private Wealth did just that and then some. While our managed domestic equity portfolio matched benchmark indices (with our mid- cap exposures outperforming as expected), our international allocations notched impressive double-digit gains overall. Fixed income was modestly positive at 2.5% and our specialist type investments (micro-cap equities, property, infrastructure and alternative strategies) yielded nearly 7% on average.

What now?

One thing is certain. Metrics galore have confirmed that global growth is trending lower as the effects of vast monetary stimulus (for the better part of the last decade), fade. China’s de-leveraging and the negative fallouts from trade conflicts have also been sighted as significant drivers of this slowing. The U.S. Federal Reserve itself left rates untouched this past quarter acknowledging tighter financial conditions in 2018, a sharp slowdown in growth and a lack of consumer price inflation despite historic levels of low unemployment.

Fixed income markets have also priced this in via a sustained move lower in global yields. These have also resulted in concerning yield inversions, historic lows as well as negative yields in some regions.

Hazards ahead – keep your eyes on the can!

And unfortunately, we don’t mean a beer can! We mean the one that the U.S. Fed has punted down the street. The risk posed by inevitable interest rate rises has not disappeared. It’s simply been delayed. The view of the BlueRock Investment Committee is that we’re in the latter stages of the growth cycle. Whilst there were signs this was rolling over into a slowdown (and hence the volatility experienced in the latter half of 2018), the dynamic relationship between interest rates (led in the short term by central bank commentary) and inflation, along with the sustainable need for a return to ‘normalised’ interest rates, must be watched. There is no doubt that interest rate risk, at least in the near term, has reduced. And this is likely to extend the growth cycle, perhaps, late into 2019.

Against this backdrop, investors will also have to contend with developing and other potential trade flare-ups. For example, we now have the US pegging imported cars as…wait for it...national security threats! Although this particular ridiculousness doesn’t warrant further elaboration, preparation for these (albeit clownish) missteps and other fiscal landmines is a must. Despite markets coming within reach of early December 2018 levels again, any prudent investor should be anticipating further bouts of volatility up ahead. If the last 18 months are anything to go by.

Investors in the local markets also have their eyes on the upcoming Australian general election. A surprise Coalition win would likely give markets a short-term boost, given the risks of Labor’s franking credit, negative gearing and CGT policies (which should otherwise be largely priced into markets).

Look outside the box

And with all this in mind, if you intend to keep playing the game, a focus on high quality, defensive, growth equities should be unrelenting. Even the chaos surrounding Brexit seems to have yielded good value in some UK businesses, particularly financials. With U.S rates seemingly on hold, one might ask if there could now be renewed opportunities in emerging market currencies and, by extension, in its equities. Rising rates have also made short term U.S bonds (government and agency type) an attractive source of income again. Two-year Treasuries, for example, now offer around 90% of the 10-year yield with only one-fifth of the duration risk.

Though opportunities lie in wait, caution is a must. So please keep your seatbelts fastened and hands inside the vehicle, at all times.

What's that?

The yield curve

Anyone with a passing interest in finance can attest that these two buzzwords have, in recent times, been doing the rounds with the press pool. So, what is it exactly and why is something seemingly mundane (and straight out of Economics 101) getting a bigger spotlight of late?  

While avid petrolheads might mistake it for a pretty impressive power curve on a dyno graph, a yield curve is simply a graphic illustration of the relationship between interest rates and time to maturity. As Investopedia states, it is “a line that plots the interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates”. While commonly used as benchmark for lending and mortgage rates, it is also used (amongst other metrics) as a predictor of the economic future.

There are three main shapes – normal, flat and (the not-so-fan-favourite) inverted.

While it’s normal for investors to demand more compensation further out on the time axis (greater risks associated with the far yonder and all that), when it ‘inverts’ the other way is usually the time a large segment of the investment world goes “uh oh!” All things considered, inverted yield curves, rare as they are, have a pretty good (not perfect) track record of foretelling impending economic slowdowns. Why the curve inverts is because nervous investors start buying longer dated bonds based on the accepted notion that they will offer a cushion against falling equities. And this demand pushes down yields, as per bond basics.  

While we witnessed an inversion during the September quarter of 2018 (which proceeded to right itself), the latest brouhaha concerns the yield spread between 10-year US government bonds and 3-month treasury bills dipping into the negative (i.e. inverting the curve). Last time this happened? 2007. Hence the freak out. Lesser known and on the other side of the Atlantic, yields on 10-year German government debt fell below zero for the first time in three years i.e. investors are once again, willing to pay to hold this investment!

The yield curve is by no means a perfect predictor (nothing is), and it has plenty of fans and critics. And while it should be read with other indicators/signals, given the increasingly challenging conditions over the last one-and-a-half years, it simply couldn’t hurt to pay attention and respect the inverted yield curve, as any prudent investor would.

For more expert advice on the current investment landscape, get in touch with BlueRock Private Wealth.

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