Hedge Clippings | Friday 14 June, 2019
 

Hedge Clippings has been known to be cautious, risk averse, glass half empty, negative even, call it what you will. Indeed, we know this not only as a result of some intense and painful navel gazing (not only painful as a result of the gazing, but also the shape of the navel) but due to some of the feedback we occasionally receive to that end.

However in our own defence - after all if we can't defend ourselves, it is left to others to defend us, and we can't always rely on them - we're firmly in the camp of always making sure that the downside is fully evaluated prior to taking risk. Sometimes this is easier said than done, which is when the rear-view mirror comes in handy, but essentially investing success is as much the result of not losing one's capital as it is making great returns.

That possibly explains our preference for those hedge and absolute return funds, which might not shoot the lights out in bull markets, but aim to protect investors' capital when it matters most. By and large, and taken on the average, this has proven itself over the years as shown in the chart below, where since 2003 equity funds in AFM's database have significantly outperformed the ASX200 Accumulation Index mainly by avoiding the latter's drawdowns:

As highlighted below, this is particularly evident from October 2007 to February 2009, and again from February 2015 to February 2016:

However this logic has been sorely tested over the past 12 to 24 months, particularly in the last quarter of 2018 and the first quarter of this year when the correlation between the ASX200 Accumulation Index and AFM's Average Equity Index became unusually high.

Much of this can be attributed to the vagaries of US Fed policy and 10 year bond yields, which in September last year were expected to reach 3.5% (this making US equities judged by the S&P500 with an average yield of just 2% look expensive) prior to a policy reversal which now sees 10 year bonds at 2.11%, and the 30 year yield at 2.59%. 

Fund managers and investors who had struggled to reset portfolios in the last quarter of last year were then faced with a double whammy as markets reversed in the first quarter of this year. Not easy therefore for "momentum" investors, while the issue for many "value" investors is that it is difficult to find value at historically high PE's, or amongst tech or new economy stocks with great forward estimates but negative earnings.

The investment outlook is being clouded by doubt - doubt about economic issues such as growth, interest rates, inflation, low wages growth and employment, all overlaid by geo-political and trade tensions as a result of the Trump-Xi trade tussle, Brexit, and China (where the latest monthly auto sales fell over 16% y-o-y), be it demonstrations on the streets of Hong Kong, Taiwan, or the control of the South China Sea.

Closer to home, employment rose last month by an unexpectedly high 42,300 in May, of which only 2,400 were full time jobs, and April's number was revised upwards from 28,400 to 43,100. However, unemployment is locked firmly at 5.2% - some of that is possibly election related. Consumer and business confidence are showing little correlation either - again possibly election related. 

The RBA has focussed on employment and inflation, and it seems likely therefore that the market is correct in forecasting further rate cuts in official rates to 1% or even less, but that in itself won't fix the economy - in fact the reduction in deposit rates will curb consumer spending further.

It's not to say there aren't opportunities. In spite of all the above, Hedge Clippings is not pessimistic. However, we think we can - and should - be excused for being cautious.

Hedge Clippings | Friday 07 June, 2019
 

When the RBA's decision to cut the official cash rate came through this week it was somewhat of an anti-climax given it had been well flagged by the RBA themselves. In addition, nearly every economist had factored it into their models, and they have now moved on to when the next cut may be, and how low rates may eventually go.

At 1.25% it took the RBA Governor to point out that there was a limit to how much monetary policy can do to stimulate the economy, employment or inflation, correctly indicating that fiscal policy must play a part as well. There's still an element of doubt about the certainty of the tax cuts due in July once Parliament returns, but along with the reduction in loan repayments for those homeowners with a mortgage, they'll help consumer spending - provided the additional income doesn't go towards debt reduction.

One option is an increase in spending through increased infrastructure projects, but the government will be loath to not deliver a surplus, although with a further three years in power this may be a better - or more politically acceptable - solution. Hedge Clippings has repeatedly called for an allocation of a portion of all superannuation into infrastructure given the alignment of interests and the similarity of the investment requirement and life cycle of each.

Looking further afield, although it will potentially impact the Australian economy to a significant degree, the US/China trade spat - not quite a war, but getting mighty close to becoming one - appears to show no sign of diminishing. We were reminded on the 30th anniversary of the Tiananmen Square massacres that the Chinese government is not fond of losing face - or control.

One economic issue for China is their current account balance as a share of GDP. According to an excellent piece of analysis by the UK's Longview Economics this showed a surplus of just 0.4% in 2018, whereas as recently as 2007 it was just shy of 10%. As Longview's chart below shows the IMF is forecasting a modest continued surplus through to 2021 before moving to a deficit.

However Longview believe that it is more realistic to expect a deficit this year as the underlying dynamics of the Chinese economy continue to deteriorate due to a range of factors, including the US induced trade war, increased credit fuelled consumption and a shrinking of their working age population and employment. The above reference is just a snippet of Longview's in-depth analysis, and if you are not familiar with their work, or their founder and CEO Chris Watling, it is well worth taking a look.

But back to Trump: Last week after we dispatched Hedge Clippings Trump upped the overall threat of a global trade spat by taking a shot at Mexico's tariffs as well, before setting off to the UK and Europe for the D-Day commemorations, where generally he actually seemed to present "presidentially" - but only after giving London's Lord Mayor a verbal serve.

One thing you can say about the Tweeting Donald, he's not short of an opinion.