Investor Insight

October 2019

Ian Gillies talks to Will Hamilton, John Green and Kane Baranow about the third quarter of the 2019 calendar year, and asset class performance and outlook.


Ian Gillies 0:08
Hello and welcome. I am Ian Gillies and welcome to the Hamilton Wealth Management podcast 32 for October 2019. I’m joined today by Will Hamilton, Kane Baranow and John Green. Firstly, to Will, would you provide an update on markets?

Will Hamilton 0:24
Sure. Look, markets, we could only describe now as being an uncharted territory. I think if you go through the list of the things that we’re confronting at the moment, we’re now in the longest US economic expansion since 1852. The US Federal Reserve or the Fed, cut it’s funds rate to 2%, but the market is pricing in three more rate cuts by the end of 2020. Despite the Fed dot points suggesting no further moves. 70% of Euro government debt now has a negative yield. The ECB also the European Central Bank has cut rates in September, reintroduced limited quantitative easing or QE as people refer to, but more cuts are likely in the Eurozone. Balancing act for the ECB is that at minus 1% funds could start to leave the banking system. They’re not at that level yet, but that’s, we think is the danger level. Bond markets remain very volatile and equity markets remain firm. So as long as central banks continue to inject liquidity into the system, then the equity markets will remain underpinned. So regardless of the sign of global growth slowing. Geopolitical concerns, really were there in the last quarter. We have Brexit, Italian politics, Hong Kong political unrest, and the trade wars, they all dominated headlines. 2020 is an election year in the US and the importance of progress in the US China trade negotiations is growing for the US president. Opinion polls are turning against him. Yeah, tariffs’ pushing up prices, regardless of what he says. Margins for US companies have been being squeezed and consumer demand is being disrupted. So whilst growth in Europe continues to slow Germany is heading towards recession, there are nonetheless signs in the US that the easing cycle may be nearing an end. Core CPI data is now above target. Unemployment remains low. Quarterly wage growth was the strongest since 2008. And the consumer does remain resilient. The manufacturing sectors contracting but the service sector continues to expand. So the US fed governors are split as to whether any further easing is required. But if the market starts to unwind its current rate expectations in the short term reaction in equity markets, that’s when it could be severe. So Capital Economics as you often hear us talking about, they expect one further Fed funds rate cut this year, and no further cuts in 2020. So I’ve started off this podcast by talking about the three that were priced in but they’re only saying one more. And this combined with their prediction of a disappointing US earning season leads them to maintain their call of 2600 for the S&P 500 index by the end of this year.

Ian Gillies 3:08

Thanks Will. Kane, would you like to take us through how equity markets performed recently?

Kane 3:13
Sure Ian. So equity markets were mostly flat over the quarter and as Will mentioned, interest rate movements were the main drivers of markets. With further easing from the RBA in July trimming an additional 25 basis points from cash rates to 1% and signaling their intentions to ease further citing the labor market as a key indicator to watch. Below trend growth, global trade concerns and consistently low inflation pressures look to cement the supportive domestic monetary policy stance for the foreseeable future. US markets saw their first interest rate reduction since the GFC with two quarter point cuts over the quarter reducing the Fed Funds target to between a range of 1.75 and 2%. Additional stimulus was seen in Europe with the ECB cutting rates by 10 basis points to a record low negative 0.5% and announcing the reintroduction of quantitative easing later this year. Global equity markets responded to policies and as expected, rebounding from a mid quarter trough to end roughly flat over the quarter. An interesting development we’ve seen over the quarter has been a rotation, the market rotation away from momentum style growth names into more value orientated equities. This has been driven by the bottoming in bond yields towards the end of August as markets lower the expectations for a US recession, which in turn saw value sectors in financials and cyclicals outperform. It’s too early to call an end to the decade long outperformance of growth over value. But it’s a timely reminder of the need to diversify not only across asset classes, but also within asset classes. We will continue to look for opportunities to fade the equity market rallies to reflect our neutral domestic and global equity position.

Ian Gillies 4:59
Thanks Kane. John, would you like to comment on rates, the direction appears to be a little uncertain at the moment?

John Green 5:06
Sure. Gee, I mean they’ve had a terrific run this year, the bonds, probably the best one we’ve seen for quite a while from late last year to the first part or to the middle part of this year. As interest rates have kept coming down or central banks have kept cutting interest rates and inflation expectations and it kept falling. So there’s a lot of debate now at these levels as to where they go next. And look, the answer depends on just how bad the immediate outlook for growth is, and whether the world’s major economies can avoid recession. We believe recession is unlikely as do Capital Economics and therefore on that basis, the bond yields have fallen far enough for now. The market seems to be agreeing with that with US 10 year yields after reaching a low of 1.46 during the quarter, selling off quite dramatically to 1.9. They’ve come back a little bit over the last few weeks to 1.68. These are really large moves over a short period of time. I think a lot of people don’t realize how much money is being made and lost in this market at the moment. Durations paid off handsomely for most of this year. But caution is warranted looking forward. It’s also worth noting that the two year 10 year yield curve is no longer inverted, which again suggests that their recessionary outlook is slightly improved. In Australia, we’ve seen something similar in the their bonds after reaching a low of .88 sold off to nearly 1.2%. And they’ve come back a little bit over the last few weeks to finish just under 1%. Quite large moves again. But arguably the RBA is more inclined to cut rates further than the US Fed is right now. So there might be scope for a little bit further on the downside in yields here. We remain neutral fixed income and we’re not inclined to increase duration from these levels.

Ian Gillies 7:00
Thanks John. Kane returning to you now, what should one look for with rates?

Kane 7:05
I think a rates like equities, they’re trading off movements in interest rates. So at the beginning of the quarter they rally quite hard off lower interest rate expectations and this prompted a flurry of equity capital raisings as major players took advantage of favorable market conditions to restructure debt and fund future acquisitions. Domestic commercial property valuations have improved in relative terms following the interest rate reductions, but it’s still fully valued on most absolute valuation metrics. Vacancy rates are at cycle lows in major East Coast markets. However, it’s interesting that incentives still tracking at around 25%. So we’ll be paying close attention to the increasing supply for major East Coast CBD locations which is scheduled to hit the market over the coming quarters and in Melbourne’s case is the largest forecasted increase in supply since 1991. We’re continuing to evaluate selective unlisted deals as they become available and have introduced a small amount of exposure to unlisted global property over the quarter as a means of further diversifying property exposure across geographies. We have also maintained our neutral property position heading into quarter four.

Ian Gillies 8:23
Thanks, Kane. John alternative assets are becoming quite the topic these days, would you like to comment?

John Green 8:30
Yeah, look we really like alternative assets with the outlook for the returns from most asset classes lower for the next four or five years and they have been for the last four or five. The reality is that longer duration real assets are a really attractive asset class at the moment for the right clients. So we’re recommending these within asset allocation constraints. However, concentrating on those with low correlations to traditional markets, so particularly in the areas of real estate, infrastructure, transport as important components of portfolio construction. I do stress though they’re not for everyone because they are illiquid in many cases, but in the right context, they’re available part of portfolio construction.

Ian Gillies 9:21
Thanks, John. Now to Will, how would you summarize, markets?

Will Hamilton 9:25
Look, many are saying that the current market environment is the most difficult in recent memory. The truth is though that markets have and are never easy. But what’s true, though, is that we’re in I’d say unprecedented times. Interest rates are at historic lows and Australia and the US is experiencing record periods of economic expansion. Geopolitical tensions are high. So strict adherence, we think to appropriate asset allocation and therefore diversification within each asset class, though, still continues to remain essential.

Ian Gillies 10:01
Thanks, Will. Thank you to Will, John and Kane for today’s podcast. As always, if you have any questions or would like a copy of our Insight, please call us on 03 9275 8888. I am Ian Gillies and thank you for listening.