The Experts

David Poppenbeek
+ About David Poppenbeek

David joined K2 Asset Management in 2004 as a Portfolio Manager and is currently Head of Australian Strategy. This role has David responsible for overseeing the asset allocation for the Australian strategy in conjunction with the CIO, Mark Newman.  

David has over 20 years industry experience and prior to joining K2 worked in Institutional Equity Sales for both Macquarie Bank and Bankers Trust. David began his career in equities at Daiwa Securities, working as an analyst in a team lead by Harry Markowitz.  David holds a Bachelor of Applied Science in Mathematics from RMIT University.

K2 Asset Management Market Outlook

Wednesday, November 05, 2014

By David Poppenbeek

There is currently no shortage of analysis suggesting that long-term bond yields are too low and accordingly higher rates are inevitable. Further to that, consensus thought is that higher bond yields must equal asset price volatility and a subsequent equity market sell-off. However, recent experiences are to the contrary. When the average long term bond yield of the ten main developed regions has moved up by more than 75 basis points, equity markets have generally rallied.

So are long-term bond yields for all the major developed economies heading higher? It would certainly look as though US rates have an upward bias, particularly given that the economy is regaining momentum. Since the depths of the GFC in early 2009, the US unemployment rate has improved from 10 per cent to near 6 per cent today. Over the same time frame the US Manufacturing PMI has expanded nearly 70 per cent. The Open Market Operations (OMO) of the Federal Reserve (FED) has clearly helped keep a lid on interest rates; $3.5 trillion of long term US securities have effectively been removed from circulation.

Offsetting an improving US economy however is a very mixed set of conditions in Europe. The unemployment rate for the Eurozone has actually risen from 8.6 per cent in 2009 to 11.5 per cent currently. As a result, much like the FED, the European Central Bank (ECB) has conducted open market operations. The most recent program will accumulate a broad portfolio of asset-backed securities so as to support the provision of credit to the broad economy. We feel that the ECB has learnt from its experiences in 2011 and would quickly step in to the market so as to smooth out any predatory selling of government bonds.  It is worth remembering what the ECB President said a few weeks ago;

“The risks of doing too little – i.e. that cyclical unemployment becomes structural – outweigh those of doing too much – that is, excessive upward wage and price pressures.”

Hopefully the Reserve Bank of Australia (RBA) is taking note. The RBA at present seems to be more focussed on Australia's current performance relative to its own historic averages. However, it would appear to us that global capital is far more active today and is subsequently more motivated by the relative indicators of the main economic regions.

The most influential relative indicator must be Australia's inflation rate; the 60 per cent premium to peers is clearly excessive. The abolition of the carbon tax, along with lower demand, should ensure that retail electricity and gas prices decline substantially in FY2015. In addition, domestic petrol prices are starting to reflect lower demand from the resources sector as well as from the average household. Hence we do not believe that Australia should be seen as having a permanent inflationary bias.

As a result of significant equity raisings during the GFC, Australian corporates do not need to retain profits to grow. Accordingly, Australian listed companies generally distribute nearly 30 per cent more profits to shareholders than peer regions. Accordingly, Australian listed companies offer shareholders a significantly higher starting yield than just about any other country in the world. This is becoming increasingly relevant as a large share of the world’s population trends towards retirement.

Finally it is probably worth looking at the performance of equities over longer horizons. We think that in a world of risk weighted capital, longer cycles should be applied to long duration assets. If banks are encouraged to prioritise lending to low loan-to-valuation borrowers, and insurers are corralled into investing in short duration, low yield assets, it would follow that the risks of high leverage will ultimately lie within the balance-sheets of a smaller number of participants. As a result, given its premium yield and long duration of capital, listed equity should be seen as more valuable to those investors who can hold assets for the long term. As a result, we believe it is worth considering the trough-to-peak performance of US share prices since the 1920’s. Maybe the current up-trend in share prices has a structural component to it and could continue to surprise on the upside.