InvestSense Pty Ltd
10 January 2020
December is historically a good month for equities and more often than not we have enjoyed a ‘Santa rally’. This time around the US Federal Reserve seemed particularly keen to ensure that this would be the case by flooding the market with liquidity, seemingly very keen to avoid a repeat of the market rout we saw in December 2018. While the Fed has also sought to dissuade market participants of the notion that this amounted more ‘Quantitative Easing’ it was still the biggest intervention we have seen in short-term money markets, rivalled only by their pre-emption of potential Y2K issues and the response to 9/11. Try telling markets Santa doesn’t exist.
Earlier in the month the US scrapped plans of newly imposed tariffs and reigned in some existing ones while China agreed to buy more US goods. The reaction to the “phase one” trade deal struck between the world’s two economic superpowers was somewhat muted by comparison but also probably served to keep markets in the black.
Lastly, the landslide re-election of UK Conservative party leader Boris Johnson provided markets with some certainty surrounding Brexit as well as some relief that the country had not lurched to the left with a minority Labour government. The pound spiked on the initial news and UK equities rallied as the UK looks set to exit the EU on January 31st.
In this context, and with much hindsight, it was hardly surprising that markets were ahead for the month led by the US amongst developed markets (up 3%) and with trade-dependent emerging markets rising even more strongly (high single digits in most cases). Even though it was a largely positive month for equity investors around the world overseas equities in Australian Dollar terms were actually down by almost 1% as our Dollar appreciated by around 3%. As it happened this sharp moved reversed itself in the first week of January. The relative strength of the Australian Dollar during the month mean that even Australian equities, on the other hand, ran counter to this trend and ended down -2.0% for the month. It is difficult to be sure exactly why this is the case but our initial analysis suggests that it was related to changes in long term bond yields (particularly relative to US funding rates) and the interest rate sensitivity of what have become dominant areas of our market (so-called expensive defensives, the banks and certain quality growth stocks). This may also be related to overseas funding strains that were alleviated for large US banks but at any rate, the relative losses seen in our market during the month were concentrated in the sectors mentioned before and happened on 2 separate days when Australian long-term rates moved higher. Needless to say, we will be watching this dynamic closely.
A slightly more positive global economic backdrop has also seen bond yields drift upwards around the world, undermining fixed interest investments and leading to more pronounced negative returns from real estate trusts (Australian and global REITs dropped -4.2% and -1.1% respectively). Despite this, infrastructure assets (which are often also interest rate sensitive) rose +3.0%, perhaps given the increasingly robust political consensus around infrastructure spending. Gold finished the month up 3% in USD terms, +0.8% in local currency terms, and has since shot up by a further 4-5% in the first week of January. This is somewhat unusual in the context of a rising market and rising bond yields and adds to the sense that markets have been very much liquidity-driven in recent weeks.
2019 was a stellar year for equities with many developed markets finishing the year flirting with all-time highs. While markets have been eager (perhaps over eager) to discount future rate cuts we have also seen that the Fed seems ready ‘to do whatever it takes’ to keep markets afloat and the system remains awash with liquidity. In the words of the economist Andrew Hunt this week “The Fed is belatedly removing liquidity again at present but the Fed’s actions in 2019 tell us that it would rather inflate what are now wealth rather than capital- allocating markets.” In short, this means that the US Federal Reserve is effectively underwriting markets and the old adage ‘don’t fight the Fed’ is probably especially true right now. As a result, we remain cautiously long in our equity positions but favour parts of the market which have been out of the spotlight in recent times such as emerging markets, Europe and Japan, which we think offer better value than the US and Australia. On the other hand, we are also watching liquidity trends (where money is going and what central banks are doing) and are ready to take risk off the table if we see a change in the current buoyant conditions. Any sign of inflation and upward pressure on interest rates would also be a warning sign although that is not likely until later in the year.
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