September 2019 Newsletter
Moving into a new financial year there has been lots happening in investment markets. After a very low volatility decade, share markets are moving significantly in response to announcements relating to the US/China trade war. Brexit is still a major consideration, particularly for UK and European markets as that saga continues and Iran tensions are also worth watching. Hong Kong and the South China sea are geopolitical issues that are impacting regional markets.
The big picture for share markets is whether we are on the edge of a recession or not and will that impact heavily on equity valuations or will continued stimulus and Government interventions “kick the can” down the road for some time to come. Equity market valuations are high but by no means extreme in many sectors and even more so when the low interest rate environment is taken into account. By historic standards it has been a long bull run since the GFC but that was off a very low base and unconventional monetary policy (quantitative easing) has given asset prices plenty of reason to keep rising.
The value of negative yielding bonds has rocketed in 2019
Bonds have been rising in stark defiance of many investors who thought the rally over in late 2018 when the US Fed appeared determined to hike rates (graph on leftside). This insatiable appetite for bonds has seen yields plummet to record lows in several markets and the amount of negative-yielding debt is climbing ever higher. Negative-yielding bonds now make up around one quarter of the market. This means paying for the privilege of depositing your money. European safe-havens like Germany and France make up most of this with more than 80% of Germany’s federal and regional government bonds offering negative interest rates. We are starting to see risks elevate in this sector and recommend caution with respect to fixed income.
Market fears of a faltering US economy are becoming more evident with the US Federal Reserve taking out some insurance with a 25 basis-point cut to interest rates at the end of July. There is a good possibility there may be further cuts especially if the US China trade situation is not resolved soon.
Unsurprisingly, most other developed nation yields have also come under pressure. Going forward it is expected that global yields will continue to suffer a downward trajectory as the global economy weakens. The prospect of various central banks providing additional support to financial markets is once again up for discussion (i.e. more quantitative easing), although there is no consensus view (noting in recent times Malaysia, New Zealand, Iceland and Sweden have all cut interest rates). With stubbornly low inflation in the US, geopolitical tensions with China, another move by the Federal Reserve to ease pressures would not be surprising.
In Australia the rhetoric of the RBA has also changed signalling there is still some room (in fact we believe it is highly likely) that there will be further rate cuts. Looking forward, low inflation remains a key issue, as does spare capacity in the labour market. Pleasingly house prices have appeared to stabilise in Sydney and Melbourne, and the impact of further stimulus in the form of tax cuts and spending are yet to be fully felt.
The Australian dollar has proved volatile over the quarter. Going forward the Australian dollar is expected to come under increasing pressure as lower rates begin to bite. This will provide a tailwind for unhedged International equities. It also makes Australian exports more competitive including our iron ore industry.
In summary, Australian equities are always somewhat attractive as they provide a reliable source of franked dividends in a low yield world. We are however not overly optimistic about prospects for banks, miners or listed supermarkets over the coming decade and hence are weighted toward International equities which have greater diversification and a currency effect that may help returns in Aussie dollars.
Dolfinwise view is that it’s a time to be cautious and “keep some powder dry” in portfolios. As well as using active management to buy companies with good growth prospects, buy assets that can provide some downside protection when the next significant market down turn does arrive. This may not be for a few more years however as history suggests markets often get significantly overvalued before correcting and government policies and low interest rates will defer this as long as possible.
We look forward to assisting you individually with you portfolios over the coming months.