What has happened?

Over the year (FY17/18),  ASX 200 (XJO) +8.3%, Dow Jones +13.7%, S&P 500 +12.2%, NASDAQ +22.3%, Nikkei +11.3%, Hang Seng +12.4%, Shanghai -10.8%, FTSE +4.4%, AUD/USD -3.8%, Iron Ore +5.5%, Gold +1.0%, Brent +62%, Coal +43%, Copper +9.4%, US 10 year bond yield 2.30% to 2.86% (steepening), Aust 10 year bond yield 2.60% to 2.63% (flattening)

A new normal in FY18/19

  • Our Strategist Andrew Tang provided a useful insight to our market. 
  • Abundant liquidity and accommodative monetary policy have been significant tailwinds for equity markets since the GFC. Liquidity conditions are at an inflection point. Major Central Banks are, or at least considering, normalising policy in the near-future. The Fed has embarked on a steady path of interest rate normalisation, taking the Fed Funds rate from 0.25-0.50% in December 2016 to 1.75-2.00% in June 2018, while the ECB earlier this month committed to ending its asset purchase program by year-end. 

  • Central banks have provided the backstop when financial conditions deteriorate, but this is no longer the case. The Fed did not veer from its commitment to normalising policy in March despite the 12% plunge in the Dow in February. And two weeks ago the ECB announced it would taper and end its asset purchase program, despite the potential fallout from Italy’s precarious political situation.  
  • The Fed believes that it can orchestrate a ‘beautiful normalisation’ though we’re not convinced. Historically the withdrawal of liquidity coincides with a reversal of carry trades and bursting of asset bubbles. We think market disturbances will be more pronounced from now on, but the good news is we don’t see the US entering a recession anytime soon.

  • The outlook for the Australian economy is to pick up in the near term and for the current 26-year expansion to continue for the next few years. But there are some questions over how much of the ongoing economic growth will flow through into share prices. We currently expect the S&P/ASX 200 index to finish the year around the current level, but the outlook, particularly this late in a sustained business cycle, is becoming more vulnerable to various risks, notably higher cost capital and geopolitical risks.
  • We think investors need be more tactical for alpha in a market lacking conviction and without the support of Central Banks.

Some tactical recommendations

  • Barbell strategies and dry powder. Back conviction, growth tailwinds are scarce but not extinct. Retain cash to protect capital and capture opportunities during volatility. This also applies to crystallising profits.
  • Alpha over beta – The abundance of liquidity helped support nearly all asset classes since the GFC. The withdrawal of liquidity will not be as kind. With an estimated 60% of US trading through passive or quant driven flow, conditions will not be as favourable for those simply following the market. We think vanilla passive exposures will struggle (Passive-like LICs, Broad market ETFs: global, emerging markets).
  • Uncorrelated and market neutral exposures – together with cash, cross-asset and uncorrelated market exposures will provide some insurance against the downside risks.