By Raymond Chan

During recent market volatility, we noted the underperformance of our S&P/ASX 20 stocks as compared with the rest of the market. Why?

Firstly, during uncertainty, the most liquid Top 20 stocks are likely to be the funding source or target for short sellers, and therefore the ex Top 20 stocks are likely to outperform the Top 20 stocks.

Secondly, in an interview with “Investment Magazine”, John Pearce, CIO of UniSuper also commented “… the falls were heightened by CTA trading, which use computers to determine buy or sell decisions, following momentum, volatility or risk parity strategies … You know that [systematic trading] is gripping the market when you are seeing these big liquid blue chip stocks being hammered. That it is because the CTAs are unable to sell the futures because their limit is down, so they are using their proxies which are the blue chip stocks which should not have been hammered at all.”

Thirdly, “quantitative tightening” is adding to the selling pressure on resource Stocks. Latte with Ray also noted the continued capital outflows from emerging markets. Deutsche Bank calls this “quantitative tightening” with emerging market’s foreign reserves running down from a peak of almost US$12 trillion in 2014 to today’s US$11.4 trillion. Less reserve accumulation should mean higher bond yields, a rising US dollar and lower commodity prices.

Last but not least, weak Australia June GDP numbers triggered another round of selling in our bank stocks. Weak GDP figures raised fears of Australia going into recession. As shown in the below chart, if the RBA hadn’t cut back in Jan 2015, we would already be on a negative yield curve, which is a strong indication of Australia heading into recession.

Latte with Ray feels more cuts will be required and maintains our RBA cut rate call of 25 basis points before the end of this financial year.