So, what did you expect?
In last Friday's "Hedge Clippings" (which seems much longer than just a week ago) we warned that as a result of yields on 10 year US Treasury Bonds having risen to levels not seen since April 2014, the time was approaching for a seismic shift or tipping point in asset allocations, potentially destabilising the long-running equity bull market.
Having got that call correct, (albeit vague on the definition of "the time") we then incorrectly stated that following Janet Yellen's final remarks at the Fed, that markets "pretty much took things in their stride." Come last Saturday morning - what a difference a day makes! However, we did go on to warn that bull markets rarely end in a whimper, and one shouldn't bet the house on an orderly transition. Two out of three isn't too bad!
There have been some who have been surprised at the extent of the volatility over the past week, particularly in Australia where, while tied to the US, we have a significantly different economy, and market conditions. Meanwhile Hedge Clippings' old friend and sparring partner, Peter Switzer, has today predictably included hedge funds as the culprits. Consider the following:
The yield on US bonds at 2.8% vs. represented a premium of 0.4% to the S&P500's dividend yield of 2.4%, and which had risen more than 20% over the previous 12 consecutive positive months, including more than 5.5% in January alone. Compare that with Australia where the ASX200 has a yield of 4.77%, before even considering the effect of franked dividends and CGT benefits, or that the market had risen at less than half that of the S&P500.
Volatility dropped below 10%, and equities responded with stretched valuations as even 2.4% looked attractive vs. next to nothing as an alternative. All the Central Banks were longing for was a sign of growth, and inflation to go with it.
The US (and Europe) has been force fed with a diet of QE and low/zero/negative interest rates in order to revive their economies, which were dead in the water, and pump priming the equity market boom. Meanwhile the Australian economy, in spite of a market that was a poor performer, has now put together a quarter of a century of continuous economic growth.
So now the Central Bankers have delivered the growth and the first signs on inflation, (still low by historical standards) what did investors expect? Only those with short memories should have expected an orderly transition.
Let's put some perspective into the extent of the falls. The headlines may scream at the record 1,000 point falls, but in percentage terms they're not (not yet anyway) close to the percentage falls of 1987, or those in 2008 when Lehman's hit the wall, and triggering the GFC.
And for the record, while Lehman's demise might have triggered the GFC falls, it was the activity of the previous 5-7 years that caused it. This is just a case of Déjà vu.
The US economy is steadily growing, unemployment is historically low, as is wages growth and inflation, albeit rising. Interest rates remain low and although on the up (except in Australia) only in line with a growing economy, the fundamentals of which remain sound. Equity valuations which were stretched (less so in Australia), will now be coming back into line, but provided the underlying businesses are sound, should find "fair value" once again.
