From Jonathan Bayes, Chief Investment Officer, Partners Wealth Group.
It’s a really human thing to insist on knowing ‘why?’ The vast majority of us have kittens when things are left unexplained.
This week’s market sell-off has everyone scrambling for the ‘why’, and I have seen a list of multiple explanations for this week’s sell off, which is rarely of any value to anyone after the fact.
But yet we all want to know.
Leverage unwind this week driven by higher bond yields
For me, the simplest explanation for this weeks near -10% fall in offshore share-markets is leverage.
We have spoken ad infinitum for months about the likely impact on asset markets of the gradual withdrawal of central bank liquidity, and whilst it is impossible to predict precisely when episodes like this week will occur, that they will indeed occur.
With global bond yields rising to reflect the strong economic momentum, the leverage in the financial system started to squeeze.
Not unlike the frog in the pot of boiling water.
Why the market fell so viciously is down to leverage.
Ever since the GFC, global central banks have doted over investment markets, providing monetary stimulus at the faintest whiff of market concern precisely to avoid any collapse back to the dark days of 2008.
This became known as the ‘Fed put’, which is the concept that the US Federal Reserve would do anything to protect markets and the economy.
Arguably, we have all been spoilt.
This faith in the idea of central bank protection has allowed investment markets to careen ever higher in what has been a near 10 year bull-market, and allowed many investors to profit from ever rising prices and a continuing environment of low volatility.
Investors like a trend because it gives them ever greater confidence to back what works – the longer the trend continues, the greater the confidence investors have in it, and the greater the sum backing that trend.
The adage about picking up pennies on the rail-track is a great one in this instance.
Huge sums of money have been betting on the status quo, and prior to this week ignored the steadily increasing bond yields.
This week the train came hurtling down the line and took out the penny collectors.
Economic backdrop remains sound – this sell-off is not the big one
Global economic momentum, if anything, gets better by the day.
Australia’s local economy is also finally catch a whiff of momentum. The RBA Governor himself commented last night that he ‘detects animal spirits coming back in Australia’, and this is a good thing.
Full-time employment surged in 2017 and continues to push higher earlier in the year, and this will drag wages higher, which is precisely what is needed to allow households to deleverage some of their enormous housing debt.
My point here is that from a fundamental economic and earnings standpoint, the outlook is good, and it’s rare to see bear-markets begin when the economic cycle is strengthening.
So I would expect that this week’s sell-off finds support, and for Australian and international equity markets to regain much of their lost ground in the coming weeks and months.
We all should pay attention to this week’s move because it will happen again.
The leverage in the system remains substantial, and the trends toward rising bond yields remain.
Should we ever get a genuine inflation scare, a risk that is surely rising, or a disappointment on the economic growth side, then lord help us as the fall will be twice that of what we saw this week and will feel very much like 1987 again.
We are trying our best to watch for these risks, and as we said in our ‘Year Ahead’ piece in January, we feel the risks to markets begin to heighten as we push closer towards the middle of 2018.
Strategy implications – reduce ETF exposures in favour of discretionary managers
We have been slowly adjusting recommended portfolio’s in advance of this by reducing investor exposure to ETF and ‘index’ products and by taking on greater exposure to discretionary fund managers who we think will handle this volatility with greater skill.
Our moves to favour Antipodes (APL) and Platinum Asia (PTM) in particular in our international model portfolio’s is done precisely because these managers are absolute return managers and we think able to outperform as market gains become harder to find.
Wesfarmers (WES) – a dead weight
We are seeing so many better opportunities than WES emerging in the Australian share-market after this week’s fall.
For any of you that read this column regularly you will know that I was never a major fan of WES and the bullish valuation investors paid for the shares.
WES is in many respects not unlike Commonwealth Bank (CBA) in that it has been afforded a premium valuation on the basis of past performance.
But like CBA, core earnings growth is becoming harder to find for WES, all the while other companies around them are doing interesting and profitable things.
This week’s news that WES were losing 3x more money in the UK DIY business than analysts expected was a new negative, and crimps the prospect of any earnings growth for shareholders in 2019 and 2020.
WES shares have underperformed the market for 5 years running and look set to see this trend continue.
With the share-market fall and opportunities in companies such as IOOF (IFL), BT Investment Management (BTT), Downer (DOW) and APN Outdoor (APO) becoming compelling, we see little reason for investors to persist with holding onto WES for past glories.
AMP wholesale Australian property fund update
We had a great catch-up with the manager of this fund this week and felt it worthwhile sharing.
This is our go-to Australian property fund for many reasons, but mostly because we feel the fund gives investors a true and genuine Australian commercial property exposure with little to no leverage and monthly liquidity – a rarity amongst property funds.
The fund has had a flurry of activity in the past few months, making several large acquisitions in south-east Queensland that they hope will prove to be fund stalwarts for years to come.
Having had returns drag due to excess cash, the fund is now modestly geared and this will further enhance returns.
The fund delivered 7% growth in 2017 and we are hopeful for this figure or more again in 2018 with only very modest risk given the strong occupancy and low financial leverage.
Next week earnings – reportings kick into gear
I won’t dwell on this week’s earnings releases since most were in-line (MQG and NAB of note for us), but next week it becomes more relevant for our portfolios since we have results from AMCOR (AMC), Healthscope (HSO) and Telstra (TLS).
Fingers crossed they all account for themselves well.
Friday 11 am values
|S&P / ASX 200||5795||-310||-5.1%|
|Property Trust Index||1287||-60||-4.5%|
Thursday Closing Values
|U.S. S&P 500||2581||-238||-8.4%|
Key Dates: Australian Companies
|Mon 12h February||Earnings – AMCOR (AMC), Ansell (ANN), Aurizon (AZJ), JB Hi Fi (JBH)|
|Tue 13th February||
Earnings – Boral (BLD), Cochlear (COH), Transurban (TCL)
|Wed 14th February||
Earnings – Computershare (CPU), CSL (CSL), Dominos (DMP), IOOF (IFL), Woodside (WPL)
|Thu 15th February||
Earnings – ASX (ASX), Healthscope (HSO), Origin (ORG), Sonic Healthcare (SHL), Telstra (TLS), Treasury Wine (TWE)
|Fri 16th February||Earnings – Medibank (MPL)|
For more information on the above please contact your Partners Wealth Group advisor directly or on 1800 333 143.