Back in mid-February, we published an article that responded to the ‘bear market’ status that had just been achieved by the ASX200. In it we warned against knee-jerk reactions and selling down, just on the basis of a ‘label’ that acknowledges that markets are down by 20%. We further postulated on the possibility of a quick 10% rally from that point, as had happened in previous bear markets, and the impact this might have on creating a double mistake for investors.
Since then we have seen the ASX200 Accumulation index up almost 15% in a little over three and a half months. Selling in reaction to ‘bear market’ status was clearly the wrong thing to do. Timing with any sort of perfection is very difficult. Not to say that we don’t consider valuation and risk, we certainly take these factors into account when setting tactical asset allocations, but big bets either way are likely to produce disappointing results. Better a live dog than a dead lion, so the proverb goes.
The ‘dis-inflation’ theme continued to play out in April as the March Quarter CPI numbers surprised on the downside, and the RBA followed that up with a cut to the Official Cash Rate. Our comments on the date of the cut suggested that if the AUD/USD level of $0.755 was broken we would see even more downside. That has come to pass with the AUD since hitting a low of $0.7144 in late May.
The surprise CPI number led to some notable changes to predictions of interest rates. Macquarie Bank have adjusted their expectations and see interest rates falling to 1.00% before this cycle of cuts bottoms out. JP Morgan’s Sally Auld sees rates down to 1.00% by mid-2017. Over at CBA, the expectation is that rates will fall to 1.25% by November this year. National Bank still have a 1.75% bottom, and see this lasting through until mid-2018, that’s another two years away before any increase. If any of these are near the mark, and if we do see two rate rises by the US Federal Reserve this year, then we could expect the AUD to trade well under $0.70 for most of the next twelve months.
Against this backdrop of lower rates, with economic activity that weak but not exactly collapsing, assets with yield will continue to be attractive. Low rates and easier credit have resulted in booming apartment construction, and that sector will see some price weakness as investors feel the reality of an oversupply and lack of willing tenants. However, real estate, where yields are 5% plus, will still be attractive, as long as tenant demand has reasonably low correlation to economic activity.
With the rally in equities, we are looking to lighten up on exposures, and clients with managed portfolios will see a move to fund managers that have a history of risk aversion. We are also introducing investors to some other alternative funds with low equity market correlations.
Big political catalysts remain on the horizon this year, including the Brexit vote in the UK on June 23, our own elections on July 2, and of course the US Federal elections in November. We pass no comment on the US candidates except to say that on both sides the thinkers are clearly outnumbered by the populists, and it looks like:
“two wolves and a lamb voting on what to have for dinner” – Hat tip to James Bovard.