Correlation causes concern
September may be remembered as the month where the markets reached their most recent peak. At this stage the market has become very data dependant again, and the “lower for longer” argument is being well and truly tested as we approach the next US Federal Reserve Open Committee meeting.
In the first two weeks of September we have seen the US S&P500 index decline, and more interestingly the global bond market also sell off (yields rise). This correlation in performance between bonds and shares has been something that Private Wealth Advisers has been concerned about for a long period of time, and hence we have been recommending larger levels of cash in our clients’ portfolios.
Secondly we have reports from OPEC that the demand for oil is expected to stay lowers for longer, and the production from non-OPEC members is expected to remain high. This has led to a fall in oil prices, and made the markets nervous.
So is this the start of the next major correction (bear market), or is this simply another “Tapper Tantrum” as seen back in June 2013? The Taper Tantrum in 2013 was when the share and bond markets became very volatile for a short period of time as the US Fed ceased their “quantitative easing” (printing of money). This time around it is concern that the US Fed will start to increase interest rates again in the US to try to reduce the risk of higher inflation.
Over the past 5-6 years the markets have been addicted to the quantitative easing around the world. This is apparent in the movement of the price of shares higher on the back of poor economic data. This behaviour was driven by a belief that poor data would equal lower interest rates, and sustained money printing. The most recent bout of volatility is an indication that belief in this support is now waning, and the markets are finally starting to focus more on the underlying fundamentals as opposed to simply a lower for longer mentality.
As an example of how a little move in interest rates can have a large impact on capital value, over the past 5 days the 30 year US bond yield has moved from 2.22% to 2.48%, or an increase of only 0.26%. This small move has led to the US 30 year bond price reducing by around 10.91%.
US 30 year bond prices fall
Source: The Daily Shot
Bounces are bigger – in the Fed we Trust
Source: The Daily Shot
So what could the central banks do next?
As discussed above the markets are becoming less certain that the low and negative interest rates we are seeing around the world will actually lead to escape velocity for inflation around the world, so what’s the next trick up the central banks sleeve, helicopter money?
“Helicopter money” is term that was first created in a paper written in 1969 by Nobel prize winning economist Milton Friedman. In his paper Mr Friedman discussed a sure fire way to generate inflation pressure in an economy. Drop $100 bills straight from a helicopter onto the local population, and guarantee to not remove the new cash from the market. The theory is that is we all have more money to spend and the same amount of goods to spend it on that the price of the goods will go up.
As crazy as this may sound the markets are starting to think that this sort of behaviour may be first seen in Japan later this year, as they continue to struggle to produce inflation. The challenge for Japan will be how to action this as their nation is well known as savers so if you give them cash they will simply save it.
This sort of possible behaviour from central banks comes with some risks, but is one of the main reasons that we continue to recommend a cautious investment approach into global share markets. In a world where consumers may be incentivised to spend you would want to own shares in the companies that they are spending the money with.
Continue to expect the unexpected
In June this year the British public went to the polls to vote on staying in the Eurozone (Bremain) or leaving (Brexit). Brexit won by a vote of 51.9% to 48.1%. This came as a shock to both the markets, and apparently a number of the folks who actually voted to leave.
So what is the next “unexpected” event? We need look no further that the USA where Donald Trump has already beaten everyone’s expectations to become the candidate for the Republican Party in the pending presidential election in November of this year.
US 2016 Election Polls September 2016
While the rest of the world continues to scratch their heads about how someone can come to power on such an anti-immigration, anti-trade stance, the Americans are lapping up his xenophobic scare mongering. Apparently elections are no different to the local news in that fear sells, and Donald Trump is the king of peddling fear.
Donald Trump has largely been dismissed as a crackpot throughout his campaign by the majority of commentators. His “factual statements” have consistently been found to be lacking actual provable facts, and he has shown himself to be extremely ignorant of both local and global politics. Does this sound like the sort of leader that you want running the free world? Apparently half of the USA thinks he is, so watch out for the pending elections and don’t count him out yet as he has a very solid chance of beating Hilary Clinton to the Whitehouse. All he needs to do is continue to make inflammatory statements that get him in the media.
His rise in the polls and the unexpected Brexit vote are symptoms of a wider loss of faith by the masses with those in power that we are now seeing globally. This can be seen in the US elections where both candidates are seen as corrupt officials, with the US voters equally distrusting them both.
The majority of supporters for Trump are not in agreement with his views, but their vote for him will be a vote against Hillary, and the political establishment that have allowed the gap between the haves and have nots to expand to unprecedented levels. As shown in the table below 81% of US citizens have had their incomes decline over the past 9 years, with most states in the EU also having had significant falls in income.
Households with flat or falling income over the last decade
Source: INSEE, Bank of Italy, CBS, Stats Sweden,ONS ,CBO McKinsey Global Institute
Support for the New Zealand dollar continues
Over the past 12 months the New Zealand dollar (NZD) has been strengthening against our trading partners. As shown in the table below the biggest rally has been against the pound, which the NZD has strengthened 25.1% against over the past 12 months. This is a direct symptom of the Brexit vote.
More detrimental to portfolio performance has been our strengthening against the AUD, given the number of the international fund managers that we access are denominated in Australian dollars.
New Zealand dollar vs. trading partners
Source: Financial Express
What is leading to this climb in the New Zealand Dollar?
As always when talking about currency there is no one thing that you can point to that is driving the strength of the NZD, but one of the usual candidates for a higher NZD, milk prices, is certainly not the reason this time. So what is driving this rally?
Sovereign Bond Yields
NZ 10 year government bond
Source: September 2016 Daily Shot
One of the more apparent reasons for the high currency is the high interest rate/yield investors can secure in New Zealand. In a world where negative interest rates are the norm New Zealand is shining light of hope with the “very attractive” 2.47% gross per annum that the 10 year government bond offers investors.
Another reason for large demand for the NZD is the funds that are flowing into the NZX50 from offshore as global investors chase anything that is paying an above average interest rate. At present over 50% of the NZX50 is owned by foreign investors.
NZX50 Foreign Ownership
Source: Forsyth Barr NZ Equity Strategy
How do we position your portfolios in this uncertain environment?
As the world becomes more uncertain, and global and local interest rates continue to decline, we believe the return that investors can get from investing into riskier assets is no longer high enough to justify investors taking the risk, and as such we continue to recommend lower percentages held in local and global shares, and the exclusion of local and international passive bond holdings. Elsewhere in the world we are witnessing other portfolios increasing their exposure to risky assets in an effort to obtain higher levels of income. We believe this approach is dangerous and has the potential to lead to more volatile performance as markets normalise, and riskier assets get sold down.
US portfolio mixes required to deliver 7.5% on average
Whilst remaining invested in share markets, in anticipation of possible continued growth into the end of the year, we hold these positions with managers who can offer investor’s good downside protection should volatility return again.
Markets remain very sensitive to new information, and we recognise the potential for a major sell off should a “black swan” event occur. Accordingly on a tactical basis our share exposures remain underweight. If markets do reduce further, we will look to identify a share price level where investors might wish to consider increasing their share exposures.
6-month global index performance – ending August 2016
PWA is on the move (soon)
As we continue to grow we require more office space. We are planning to move, towards the end of 2016, to the bottom of Parnell. At this stage the occupation date will hopefully be early-December, however we will provide an update to all clients once we have more certainty around timing.
This is a very fast growing area, with some stunning old style architecture. We are moving to what is currently the Mondial Source building, on the corner of Faraday and St Georges Bay Road in Parnell. This is currently under development, below is a current picture alongside the architects drawing of the completed product.