Hedge Clippings | Friday 09 August, 2019
 

Hedge Clippings | Friday 02 August, 2019
 

With the US Federal reserve cutting interest rates for the first time in 11 years overnight - the last easing being an early Christmas present way back in 2008 - it was yet another sign that what The Donald wants, The Donald usually gets. 

But not always. No sooner had Donald advised that the Fed's easing was the first in a series (as he had wanted), than Fed Chairman Jerome Powell contradicted him by saying:

"We're thinking of it essentially as a mid-cycle adjustment to policy. I'm contrasting it there with the beginning, for example, the beginning of a lengthy cutting cycle. That's not what we're seeing now. That's not our perspective or outlook."

No wonder the markets were confused! One wonders exactly where the "mid-cycle adjustment to policy" terminology came from, or for those wondering what the next move is, how to factor those comments into their investment decisions. As a result, markets that should have been buoyed by lower interest rates were left decidedly underwhelmed, although while the consensus seems to be that there will be at least one more cut in the US before this year is out, they weren't banking on it.

At the same time Trump flagged the potential for further tariff action against the Chinese, no doubt just to remind everyone that, as far as he's concerned, he holds the upper hand in the trade war.

From Australia's perspective the expectation from economists is certainly that there is at least one more cut of 0.25%, and possibly a further one after that, before the RBA is finished. Obviously what happens in the US will have some impact on that outcome, but so will the effect of the past two cuts and the stimulus provided by tax refunds which should start to flow through.

Elsewhere overnight news came through that the U.K.'s new prime minister had lost his first by-election (that didn't take long!), taking his parliamentary majority down to a minuscule, and minimum, of one. Boris is quite happy, it appears, to take the UK out of the EU with a no deal Brexit, which might just be a better outcome than a general election resulting in a Corbyn Labour government.

Hedge Clippings | Friday 26 July, 2019
 

We'd love to have been able to read ScoMo's mind as he listened to Andrew Bragg's maiden speech in Parliament on Wednesday. The newly elected Senator from NSW suggested that Australia's compulsory superannuation regime, rated by many to be one of the best in the world, should be made optional, particularly for the young and lower paid members of the workforce.

Whilst not doubting that a significant majority of workers would happily opt for a 10% pay rise now (equivalent to a bird in the hand) rather than wait for 30 or 40 years to be self-funded in their retirement (equivalent to 2 in the bush), the reality is that superannuation was set up to reduce the budget's age pension burden from an ageing population. Furthermore, it is precisely the lower paid members of the workforce who are most likely to need both capital and income in retirement.

Bragg was out of order on a number of other fronts. Firstly, using one's maiden speech to lob a contentious idea likely to cause your own party some embarrassment probably wasn't that smart - unless you are just seeking attention. Secondly, it is completely at odds with Bragg's previous arguments in 2016 when working for the Financial Services Council when he wrote "The fact remains that lower superannuation savings would force more Australians onto the age pension, pushing the cost of an ageing population onto future generations."

What a difference three years makes! However the Prime Minister subsequently reiterated that there will be no changes to superannuation even if recommended by the upcoming review into retirement incomes. We take this to mean that under his government the incremental increase in the SGL from the current 9.5% percent and, commencing in 2021, taking it to 12% by 2025 is safe - or as safe as anything is in politics.

That doesn't mean to say there aren't some necessary and meaningful changes that could and should be made to the superannuation system. In addition to many of the 31 changes recommended in the Productivity Commission's report into superannuation released in January - such as reduced fees, removing multiple accounts, and poor performance estimated to make workers $3.8 billion a year, here's a few more from Hedge Clippings just for good measure: 

For a start simplifying the complexity of the rules and regulations surrounding super might make it easier for the majority of the workforce to understand it. Encouraging or incentivising workers to make additional superannuation savings would be another. Ensuring that at least a portion of a worker's superannuation balance on retirement is taken as a pension, rather than a lump-sum, would also be on our "must review" list. Finally, given that superannuation balances accumulate over 40+ years, ensuring that a significant portion of all superannuation is allocated to appropriate infrastructure projects, which also share a long-term timeframe and are in the national interest, would also seem to be a win-win given there's almost $3 trillion in super now.

Of course, being able to use a portion of one's super to assist first-time buyers to get into the property market would be a great idea - if it can be achieved. However unfortunately in the early years super balances are not that high, so in practical terms the level of assistance that affords might be limited.

Superannuation is simple in concept, but complicated in practice, and has been further complicated over the years by successive governments tinkering with the rules. After almost 30 years Australia's superannuation system needs reviewing, updating and simplifying to ensure it meets current and future objectives. Let's just hope Senator Bragg is not part of the decision making process.

In other news this week global politics just became more interesting (if nothing else) with the election of Boris Johnson as Great Britain's 77th PM. Whether he manages to achieve its objectives we will have to wait and see, but boring he is not. Donald is not boring either, (although he probably does qualify as a boor) so between the two of them, apart from a mutual admiration society, expect to see plenty of head (and hair) lines.

Hedge Clippings | Friday 19 July, 2019
 

There has been plenty in the media recently regarding the difficulties facing active fund managers, mainly focusing on the negative side of things, and possibly with good reason. Performance has suffered following a period of one of the more challenging market conditions that most active fund managers we have reviewed can remember - including during the GFC and immediately afterwards.

Naturally with sub-par performance relative to the market (even if not actually negative) comes the difficulty of attracting investors and raising FUM. The rise of passive investing and ETF's with ultra-low fees, particularly with an equity market buoyed by extreme interest rates, makes it hard for the average active manager to build a business.

Diminishing or static FUM has also been accentuated by the move by many institutions and industry super funds to revoke mandates and take them back in-house as they continually attempt to reduce their own fee structure. Once again, the market conditions of the past five years have made low-cost index investing ultra-attractive. As a result, there has been a surge in the number of fund and manager consolidations, whilst others have simply elected to close and return the cash to investors. By and large in Australia there has been limited shuttering of funds, unlike in the UK where a large and previously successful manager has had to "gate" the fund to protect positions and investors in the short-term, but in doing so has inevitably inflicted terminal damage on the management company, or at least its reputation.

In the short to medium term it is hard to argue against this move to index funds. The ASX 200 total return index is up 19.73% year-to-date since January, 11.55% over the past 12 months to 30th June, outperforming even the S&P500's total return, 18.54% YTD and 10.42% over 12 months. In the medium to long-term investors that have taken this path will need to understand that volatility will return at some stage.

In this environment, while 95% of the funds tracked on www.fundmonitors.com have provided positive returns year-to-date, this number drops to 70% over 12 months. More concerning, from both investors' and fund managers' perspective, is the fact that less than 10% of funds have outperformed the ASX200, both year-to-date and over the past 12 months. 

Of course, there is a danger in looking at returns over six or 12 months. All the disclaimers and warnings clearly state that investors should have at least a three and preferably a five year investment horizon. We would add that they should carefully evaluate not only the fund and the investment manager, but also invest across multiple funds and look carefully at how closely each fund's returns are correlated. Even a portfolio of five funds, carefully selected, can provide significantly lower volatility and frequently a higher return than its component parts.

While the chart below shows an unusually high correlation between AFM's index of equity funds and the ASX200 over the past 12 months, over the longer terms it also shows both a higher cumulative result, with lower volatility, principally by avoiding the market drawdowns of 2008, 2001 and 2015.

When the current interest rate cycle ends, even though that doesn't appear to be close by, so that volatility will return.

Hedge Clippings | Friday 05 July, 2019
 

If Hedge Clippings dredges back into his (or his children's) childhood far enough he can recall a tale of a big bad wolf threatening to "huff and puff and blow your house down". Of course, he failed when the house was sturdy and made of bricks.
 
This week the opposition huffed and puffed fighting against tax cuts before finally realising that the government's house, based on its recent election victory, was sturdy enough. So, what did they do? A 180 degree turn, and voted in the Senate to approve them. Pauline's One Nation abstained, and Cori Bernadi was absent, leaving only the Greens voting against.
 
The Greens voted "NO" but they vote NO to anything and everything. What's new? 
 
Whether phase 3 of the tax package ever gets delivered in 2024 is a moot point, but if Albanese and Co are in power by then I'm sure if they wind them back they'll pay the price. That's nearly 2 more elections away, and fancy going to an election with a promise to increase income tax, even if it is for the higher (but not the highest) tax bracket?
 
The question is whether the immediate tax hand out, coupled with the RBA's rate cut, will be enough to make a difference to the economy. For those who say consumers will put the combined effects towards reducing debt rather than spending it, dream on. OK, some might, but most will do the obvious, even if not the most prudent thing, and spend it, whether at the local electrical outlet as Gerry Harvey hopes, or down at the TAB or the pub.
 
As far as the RBA's decision goes, it did seem a little panicky given the previous cut was only 28 days prior, the effects of which are yet to flow through, and the tax cuts were in the offing, even if not in the bag. Added to which reductions in mortgage rates only benefit those with a mortgage, while damaging those with bank savings. What we do concur with is the RBA's call that there's only so much that monetary policy can do.
 
Now it's up to ScoMo, business and consumers to follow through!

Hedge Clippings | Friday 28 June, 2019
 

All eyes will be on the G20 Summit being held in Japan over the next couple of days, but in particular on the outcome - if any - of the discussions between Presidents Trump and Xi as they continue their arm wrestle over tariffs. At stake is the potential to ramp up the battle, which could lead to a full-scale trade war, which would not only damage both the US and China, but also the global economy.

Neither leader is going to want to be seen as the one giving ground, and given their domestic politics and economies, neither can probably afford to. However, history is littered with wars that shouldn't have been fought, and wouldn't have been save for the intransigence of at least one of the parties involved. Common sense and "for the greater good" might well be the best solution, were it not for the individual egos of Trump and Xi.

Having said that, based on a combination of the premise that "people behave the way they're allowed to" and "that's what you get if you reward bad behaviour", over the past 30 years the Chinese have been allowed to operate by their own rules almost with impunity. Along the way they have stolen a march (along with a huge amount of IP) on US and Western companies' technology, and the US and the West have happily let them do so as they swarmed around the honeypot of over a billion (previously out of reach) consumers.

China profitably exported deflation to the world, thanks in part to their incredibly low labour costs, and deliberate over production, but also as US and other manufacturers happily lowered production costs by relocating their production. At the same time they turned a tin ear to issues such as social justice, democracy, bribery ("it's the local taxation process"), IP theft* and pollution (if it's not in our back yard, it's not our problem). Meanwhile resource rich Australia, as a major beneficiary, wasn't prepared to spoil the party, and still doesn't really want to.

And now back to interest rates: The RBA meets again next week, with markets expecting a further easing. If that eventuates either the RBA is panicking, or they can see some serious problems ahead. Not that we think there aren't problems ahead, but the cut just gone seems to have stabilised residential property prices, and with (hopefully) tax cuts to come in early July, one would assume they'd pause to review before cutting again.

As we've mentioned previously, setting monetary policy based on an inflation target of 2% doesn't seem to work, particularly when rates are so low that the effect of further cuts is not only limited, but leaves no room or fire power if the above-mentioned trade war escalates and results in a global recession. Meanwhile, ultra-low bond yields have pushed asset prices, and equities in particular, to eye watering levels. We're reliably informed that globally there are $13 trillion of government bonds on issue which carry a negative yield, whilst Austria has just issued a 100 year - yes, one hundred years - bond at a yield of 1.1%, down from 2.1% two years ago.

We've used the boiling frog analogy before - ultra easy money has driven debt fuelled asset prices, and seen a gradual turning up of heat or pressure on the global economy which sooner or later (and possibly sooner rather than later) is going to end in tears.  
  
*Hedge Clippings is not without guilt, happily playing golf (albeit not well) with a Chinese-made $100 knock-off set of "Callaway" clubs. Maybe the stubbornly high handicap is IP karma? Or possibly lack of talent and application.

Hedge Clippings | Friday 21 June, 2019
 

It's difficult preaching the gospel of risk aversion at a time when markets, both in Australia and the US, are at record levels and, given the outlook for interest rates, likely to head higher still. However the fact is that equity markets are being driven by those very interest rate cuts which are signalling that all is not well with the economy, both locally and, despite whatever the Donald might say or tweet, in the US.

As the governor of the RBA points out, there's only so much that monetary policy can do to stimulate the economy, and there's the risk that come the day - and it will come - that the policy cycle turns from easing to tightening, there will be plenty of pain for both individuals and those businesses that have loaded up on super cheap credit.

However, as we've noted above, the "careful of what you wish for" message is not easy to get across - akin to trying to sell umbrellas in the bush during a drought. There may be some bumps ahead for some companies come reporting season, as investors and fund managers react - or possibly overreact - to negative surprises, particularly at current stretched valuations.

One additional relentless driver of the market has been the popularity of index and ETF's. And while the market continues to rise it's easy to see why these products are so easy to sell; the market's on the up with little sign of interest rates changing direction to spoil the party, so jump aboard and relax as you're only paying a few bps in fees. As the market rises so inflows increase, with little to no care taken of stock selection. If it's in the index, the good will be bought along with the bad.

However, when the tide turns the opposite will occur, and falling markets will result in ETF redemptions and sell orders, putting further downward pressure on the market and triggering further sell orders... and so on.

While there's a place for ETF's and index investing, there's also a place for active fund managers, albeit sorting the good ones from the bad is neither easy or simple. But then as Kerry Packer once reportedly advised "if it was easy son, everyone could do it." 

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.

Hedge Clippings | Friday 31 May, 2019
 

Last week we thought it "more likely than ever" that next Tuesday's RBA meeting would result in a rate cut. According to the markets, and it seems 100% of the economists, that's now not only a certainty, but some are predicting a 50 BP cut, while others (or maybe the same ones) are suggesting official rates will be as low as 0.5% by this time next year.

While Hedge Clippings is not prepared to put money on the chance that every noted (and other) economist is wrong, particularly given the messages coming from the RBA itself, we certainly hope they are not correct, simply because of the implications for the economy, and various sections of it, and the community if they are (correct).

Firstly, it was only 12 months or so ago that all and sundry were lamenting the property boom, and housing affordability. Whilst part of that was caused by overseas buyers, particularly from China, and some by lax lending standards or approval processes from the banks, a significant part of it was historically low interest rates. We may have seen the boom times disappear, but property prices are still way above where they were 5 years ago, and re-kindling the fire under them again will cause further issues down the track when (maybe that should be "if") rates rise again.

Overall debt levels in Australia - and the US and elsewhere if it comes to that - are at record levels, both at a consumer and corporate perspective. In the US in particular the level of sub investment grade corporate debt is a worry - as so-called Zombie companies pile up the debt such that all their cashflow is directed towards paying the interest, leaving nothing for investment or expansion.

Next, anyone relying on bank deposits for their income is struggling as it is. Their income is going to be trimmed further - although this will support equity markets. But supporting equity markets by lowering rates only makes equities look reasonably priced on a relative basis. If an investor's choice is 1% or less keeping their money in the bank, or 3 or 4% or more from putting it into the ASX it's pretty easy to see what's going to happen. However, when (sorry "if") inflation ever kicks in again, and rates rise, the opposite will happen, resulting in a capital loss on equities, and tears before bedtime for some.

Thirdly, depending on what happens to rates in the US, where the Donald is doing everything that he can to talk or Tweet the FED into lowering rates, lower rates here are likely to see further weakness in the Aussie dollar. This of course is a double-edged sword, making imports more expansive, and exports more competitive. But at 0.5% (if we get there) the A$ will lower significantly, unless the US$ weakens in line.

Had Bill "it wasn't my fault" Shorten been elected PM then it might have been necessary to cut rates as business confidence, and thus consumer confidence, would have taken a hit. The market, and business, has spoken about the benefits of Sco-Mo's re-election, as unlikely as it might have seemed a fortnight ago. We'd like to see the newly elected government - having been given a clear mandate - give the economy a clear kick through their tax cuts, business investment and infrastructure. 

And while they're at it, simplify superannuation and redefine its original purpose of encouraging workers to save for their own retirement, thereby taking them off the public payroll when they get there.