The benefits of bonds allocations in diversified portfolio's
JCB Advisory Economist -
Saul Eslake year ahead top 10 themes.
JCB returns +5.23% (gross) YTD 2017, following on from +2.99% in calendar 2016 and +4.94% in 2015.
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MARKET UPDATE JANUARY 2017
JCB Active Fund is a portfolio of long only AAA and AA+ rated explicitly guaranteed Government Bonds. Since inception annualized returns are currently 3.41% net of all fee’s.
JCB secular theme – consolidation after long trend with RBA on hold at 1.50% for 2017 -
Jamieson Coote Bonds (JCB) has recently had the privilege of speaking on interest rate policy and the macro outlook at two portfolio conferences focused on 2017 financial market outcomes (please contact us if you would like a copy of these presentations including a detailed scenario analysis of fixed income total returns over 2017 under 4 differing market scenarios). JCB’s secular theme remains that after a 35-year period of declining long term interest rates, a multi-year period of consolidation is highly likely. We have observed that long-term trends rarely rotate and reverse without such a period of consolidation. Those that assume interest rates will quickly spike higher to ‘’normal’’ will be sorely disappointed as high debt burdens, declining western demographics and technological evolution around robotics and automation will maintain structural pressure containing interest rate rises. Domestically we expect the RBA to remain on hold at 1.50% in 2017, also limiting the medium-term scope to lifting Australian yields.
Narcissistic Rage – disproportionate retaliation -
After delivering our conference outlook we had a chance to hear many other thought-leaders’ investment and research perspectives. President Trump’s agenda for significant change was naturally a major focal point. A major emphasis amongst speakers was on the possibility of extreme outcomes materialising – both good and bad. So, for instance, the Trump Administration’s agenda may gain traction and generate dramatic economic activity (representing the right tail of excess positive return).
The widening of possible market outcomes – with extreme events commonly referred to as “tail risks”.
For instance, the Trump initiatives could get traction and work well (representing the right tail of excess positive return). Equally, with regard to portfolio outcomes the wider ‘’tail risks’’ (on a normal distribution curve) received strong debate with consideration of all that could work well (the right tail of excess positive return) and what could go wrong (the left tail of negative returns) in a protectionist Trumparian world.
Currently markets continue to focus on the positive right tail of higher domestic growth and inflation. Details remain non-existent around tax and infrastructure policy – so far we have only been told Trump has ‘’a plan to have a plan’’. Let’s hope the details match the current market expectations. In discussing these scenario’s both conferences also focused on the left tail risk – the unknown things that could potentially go wrong for investors in 2017. Much of this was viewed as political risk, either stemming from European politics and the continued march of populism (with elections in Holland, France and Germany) or geo-politics in a more US sponsored protectionist global environment.
One element we found fascinating was as a speech by a clinical psychiatrist, Dr Deeta Kimber, regarding Trump and his severe narcissism. Dr Kimber suggested Trump is unlikely to change (the office will not maketh the man) and went on to propose Trump suffers from acute narcissistic rage - an uncontrollable and irrational rage akin to temporary insanity in short bursts. Recent news articles quoting Secretary of State Rex Tillerson have suggested that the United States will not allow China to land or cultivate the Spratly and Paracel Islands, a highly concerning development (among others) from a geo-political stand point. Investors should deliberate on the implications for portfolio’s given the potential for disproportionate retaliation in the years to come if that rage should manifest into action.
US Treasury market at extreme short positioning, on watch for squeeze -
Forecasting longer dated interest rates is a very difficult task. With much discussion around the outlook for US interest rates it is important to make the following observations. US based economists, as surveyed by Bloomberg, have a poor history of forecasting longer dated interest rates. Since September 2011, when asked ‘’where will rates be in 6 months’ time’’ responded ‘’higher’’ in 90% of forecasts, however interest rates were higher only 42% of the time. The only time they universally responded ‘’lower’’ was if Trump was elected. Whilst JCB pays great attention to forecasts, we also use additional micro inputs such as flow of funds and positioning data to help signpost possible future interest rate moves. Currently, speculative positioning in US Treasury Bond futures has reached a once in a generation short extreme as viewed by Chicago Board of Trade holding data. Bond futures contracts are at multi decade short levels with current readings far higher than previous short positioning build ups. Over the last 25 years of data, every time this has occurred a significant short covering rally has ensued, pushing 10 year US bond yields 50 to 100 bps lower (or raising capital prices of US 10 year Bonds by 3.5% to 7%). Holding a short position in interest rates is an expensive game if the market is not consistently moving to lower prices, as the short holder is paying away carry, or the bond coupon/dividend. This is magnified by capital losses if the market starts to rally on a negative change in the news flow. This type of excessive short positioning is a great example of why any move to higher interest rates will not be a straight line and tactical opportunities for active fund managers will abound inside our secular theme of consolidation.
Investors wrong footed by AUD, Asia’s reserve currency -
Official Interest rates in Australia are unlikely to move in 2017. The Australian dollar refuses to move lower despite tremendous hits in recent times. Despite speculation of a credit downgrade the currency continues to frustrate investors with its ongoing resilience. Indeed, in the Brexit debacle of 2016, an event that would have caused the AUD to fall down the “firepole” (the pricing cycle is ‘’up the stair case down the firepole’’) we saw the AUD fall from 76 cents to only 73cents. In a different era we would have been plumbing into the 50s. Over January the AUD rallied more than 6.00% catching many long USD positions off guard. We remain constructive on the AUD as commodity prices remain strong and terms of trade continue to improve. This resilience of the currency maintains an easing bias from the RBA, who may be required to act by cutting interest rates to stoke inflation and ease currency pressure if the AUD continues to climb over the year.
Fund update for JANUARY
The CCJCB fund gained 4.12% in January. The fund maintains an underweight duration position with the majority of the portfolio allocated to front end bonds with a higher correlation to RBA cash rates. JCB view the long-dated bond curve as a tactical allocation post the US election and will continue to hold a core underweight duration position. JCB historically has held a lower risk weighted portfolio than the index and we believe markets will produce plenty of opportunity to generate alpha over 2017. This lower risk holding helps improve our risk adjusted returns over time. The fund benefited from the performance of Supra bond positions which are retained for both credit quality (they will remain AAA rated if Australia is downgraded to AA+) and additional spread in short dates.
MARKET UPDATE FEBRUARY 2017
JCB SECULAR THEME – GLOBAL INTEREST RATES CONSOLIDATION AFTER LONG TREND WITH
RBA ON HOLD AT 1.50% FOR 2017
US Federal Reserve to hike in March, bonds historically rally as Fed ''walk the walk'', rather than
''talk the talk'' -
JCB expect the US Federal Reserve (Fed) to hike interest rates at it's upcoming March meeting. If recent history is any guide, expect longer dated bonds to perform well after the rate hike. That is critical if you are a bond investor, invested in yield sensitive equities, REIT's or thinking about fixed or floating loan exposure.
When the Fed hiked in December 2015, 10 year Government Bonds went on to rally from 2.30% to 1.66% (lower yields equal higher prices) in the following two months in early 2016. In the two months since the rate hike of December 2016, 10 year Government Bonds have rallied from 2.60% to 2.32%. So whilst the ''funding rate'' is moving higher, longer dated bond rates can often move the in the opposite direction. There are a number of technical reasons for this beyond the scope of this update, however, this is primarily due to the markets estimation of inflation expectations changing with an active vs dormant Fed. A Fed sitting on their hands whilst the economy is heating up is a concern for markets, who worry inflation may accelerate and the Fed may ''fall behind the curve'' in delaying action to cool the economy. When the Fed actually lift funding rates the market acknowledges such moves by re pricing longer dated debt securities.
In the 2004-2006 US Federal Reserve hiking cycle of 4.25% (1.00% to 5.25%), US 10 years Government Bonds only moved 0.37% over that period or less than a 10th of the Central Bank rate. Is this time different? Big implications for bonds, yield sensitive equities and REIT’s.
In the last full Fed hiking cycle of 2004-2006, the Fed moved the funding rate from 1.00% to 5.25% over a 2 year period. The first hike in that cycle was on June 30th 2004. 10 year US Government Bonds yielded 4.87% in mid June of that year, just shy of the first rate hike. By the end of the hiking cycle on the 29th of June 2006, the US Fed funding rate had moved an astonishing 425 bps to 5.25% (sowing the seeds for the GFC as to much leverage was created at low interest rates), a day short of 2 years later. Over that 2 year period the 10 year US Government Bond yields was higher by only 37 bps to a yield of 5.24% or less than a 10th of the move in funding rates. This is very counter intuitive for many casual observers of the bond market, who assume a hiking Fed is universally bad for all bonds. Early in this hiking cycle US 10 years Government Bonds rallied significantly, despite US Fed rate hikes. Over the first 3 rates hikes from 1.00% to 1.75%, 10 year Government Bonds rallied from 4.87% to 3.88%.
It is important to consider the hiking cycle in full and it's impact on differing asset classes. When the Fed are hiking, they are trying to slow down the economy by making the cost of funding capital more expensive. This usually requires more than one adjustment, and each adjustment comes with a significant lag to the real economy. The more the Fed hike funding interest rates, the more they are ''tightening'' financial conditions in the economy through the funding (cost of capital) mechanism. Whilst funding rates are higher for borrowers (making loan servicing more difficult), rates are also higher for lenders, and thus international capital flows from other currencies into USD to benefit from higher interest rates as a lender. This usually pushes the USD currency higher, further tightening financial conditions as imports are more expensive and exports are less competitive.
Early in this cycle, all we get is ''talk'' from the Fed. As there is little Fed action (''walk the walk''), this tends to be the period where all bonds and yield sensitive equities pullback whilst growth assets continue to thrive, exactly what we observed in the later part of 2016. Once the hikes actually commence, low quality loans start to sour, as the most indebted feel the pinch of higher funding costs first. Short dated bonds suffer, however longer dated bonds will usually remain stable or perform. Growth assets tend to slow but can continue to perform. As the hikes continue and cross the ''neutral rate of funds'' (the rate that takes policy from accomodative to contractionary) the economy starts to slow, as debt servicing costs continue to bite. Discretionary spending slows as a result, less spending leads to lower business revenues, which brings job cuts and the spiral becomes self fulfilling. This point in the hiking cycle has an adverse effect on growth assets and long dated bonds do extremely well, in anticipation of a deleveraging cycle and deflationary type conditions experienced in a recessionary period.
Of course ideally central bankers would stop at the neutral rate and avoid tipping the economy into a contractionary phase. Unfortunately, no one knows what the neutral rate actually is - it is different in every cycle. We do know that global debt has exploded from $140 trillion pre GFC to $230 trillion nearly a decade on. Unquestionably, we now live in a very fragile system that relies on both the free availability of credit AND low interest rates to fund that credit. If either one of those to pre conditions is removed the system is severely challenged. JCB believes the new neutral rate is significantly lower than previous cycles
''I'm not predicting it, I'm observing it'' George Soros -
Whilst the markets are mainly focused on Trump and the US Fed, a sobering environment is brewing in the European debt markets. Concern around elections in Holland, France and Germany has seen dramatic under-performance of some European debt. Some of these moves have not been witnessed since the height of the Eurozone debt crisis. Debt markets are becoming extremely nervous about Europe and the stability of the Euro. Could this all blow over if we get a market friendly political result ? Absolutely. Except populism is very anti-establishment, because the establishment have failed the middle classes in the west. The Eurozone project is the antithesis of establishment. European election polls remain volatile but this situation requires ongoing monitoring.
Record $20 billion demand for new long dated Australian Government Bond -
Australia launched a new November 2028 Government Bond in late February, via a syndicated new issue (this is essentially a debt market IPO). Orders for the new bond broke all existing records for a new issue Australian Government bond - exceeded $20 billion in less than 24 hours. This demonstrates significant global demand for long dated bonds with higher yields after the pullback post US election. The government issued only $11 billion, leaving substantial demand unsatisfied.
Positioning update, short positions continue to grow as the bond market rallies -
JCB noted in our January update that speculative short positions in US interest rate futures are at a once in a generation extreme. Every time we have previously seen high speculative short positions the market has experienced a substantial squeeze, stopping these positioning at losses and cleansing the positioning bias in the process. These speculative positions continued to climb through February, despite the market performing. Could the Fed rate hike in March be the catalyst to generate the squeeze? This sounds counter intuitive but as we highlighted previously, long dated bonds have historically performed very well after rate hikes.
JCB continue to believe that this heavy positioning skew will remain a tactical opportunity for active managers in the near term. It will require a spark, but the positioning is extreme and tinder dry (plus expensive to carry paying away bond coupons). This type of positioning build up will continue to drive market volatility inside a secular environment where rates are unlikely to break the ranges of the last few years. After a long period declining rates, a period of consolidation is highly likely. Long term trends rarely end and immediately reverse. The bond market has essentially been on a large round trip through Brexit and the election of Donald Trump, but net net it hasn't really moved when viewed on a longer time frame.
Fund update for FEBRUARY
The JCB active fund returned 0.58%, outperforming its benchmark by 0.44%. The fund benefited from intra month volatility driven around the pricing of the new syndicated new issue November 2028. It also benefited from performance of some short dated supra national bonds. The fund remains under weight duration, however, we continue to look for tactical opportunities to drive additional performance and protect capital.
MARKET UPDATE MARCH 2017
JCB returns +2.21% in Q1, 2017 following on from +2.99% in 2016 and +4.94% in 2015
The Swamp drains Trump
Jamieson Coote Bonds (JCB) have written on a host of topics since the election of President Trump in Q4 2016, many of which disagreed with mainstream media opinion. We argued Trump would struggle to swiftly deal with Washington and that his agenda would likely be watered down and delayed. As we close the first quarter of 2017, it is the swamp that is draining President Trump.
Healthcare is dead in the water; the Republicans are divided whilst the budget is in gridlock as we approach the US debt ceiling. Tax reform and financial deregulation remain on the agenda as the great hope for the risk market bulls, but given the total failings in healthcare reform they must be getting nervous. Add increasing geo-political tensions and 2017 is shaping up as being a challenging year to navigate for investors.
APRA and RBA are worried about housing as mortgage rates will continue to rise
Trump and his higher growth agenda have a host of implications for Australian investors. We have already seen out of cycle mortgage hikes from Australian banks before Christmas last year and again this year in response to higher funding costs from the US Federal Reserve (the Fed). Australian banks still source a significant amount of their internal funding from US markets where the cost to borrow funds will increase with every US Fed hike, and this increased cost will be passed through to Australian mortgage rates.
APRA and the RBA have increased public comment on the pending risk to the Australian economy from the highly-leveraged property sector as mortgage rates have moved higher over the last few months. Debt to income levels continue to push higher whilst wages growth remains at the weakest levels on record. Australian households have never been as interest rate sensitive. A historically slight rise in mortgage rates by 200 bps would add 50% to the cost of servicing a 4.00% loan. Assuming interest only mortgage payments of $1000 a week, this would result in loan servicing jumping to $1500 a week. With the weakest wages growth on record that would generate significant stress to mortgage servicing, with flow on implications for banks and the broader Australian economy. Add to that Labour’s commitment to curtail negative gearing and all the elements are present for a significant change in the wind. As market forces led from the US dominate the cost of global capital, JCB believe that the RBA will remain dormant in 2017.
How exposed is your portfolio to the Australian housing and financial sector as tail winds turn to headwinds? -
Australian property buyers have enjoyed twin tail winds of declining interest rates and easy availability of credit for a significant period. Given the changing backdrop of debt servicing costs (via the Fed rate hikes passed on as out of cycle rate hikes) and in tightening of credit supply (via APRA macro prudential mortgage criteria) it is again prudent to consider portfolio exposures to the financial system. Term deposits, corporate bonds (mainly financial in Australia), hybrids, negatively geared property and bank shares are all financial sector exposures. Whilst we applaud portfolio diversification, we urge investors to consider the tightly correlated risks associated with investing in highly aligned exposures, particularly as long term trends are changing.
The Fed will continue to hike US interest rates, lifting the global cost of capital, a precursor to recessions in other cycles -
The US Federal Reserve have used the window of Trump inspired optimism and robust equity valuations to bring forward planned 2017 rate hikes, delivering a March 2017 hike in the first back to back interest rate hikes in more than a decade. The current market expectation remains for 3 rate hikes over 2017, all of which have been reflected in current market pricing. JCB continues to expect a further rate hike in June followed by an additional hike in H2 2017 taking the upper bound for US interest rates to 1.50%, matching that of the RBA.
When the Fed are hiking, they are trying to slow down the economy by making the cost of funding capital more expensive. This usually requires more than one adjustment, and each rate hike comes with a significant lag to the real economy. The more the Fed hike funding interest rates, the more they are ''tightening'' financial conditions in the economy through the funding (cost of capital) mechanism. Whilst funding rates are higher for borrowers (making loan servicing more expensive), rates are also higher for lenders, and thus international capital flows from other currencies into USD to benefit from higher interest rates received as a lender. This usually pushes the USD currency higher, further tightening financial conditions as imports become more expensive and exports are less competitive.
With the Fed intent on continuing this tightening cycle, JCB expect short dated fixed income products to revalue to higher yields. However, as we pointed out in our February monthly, once the Fed actually start hiking interest rates longer dated bonds tend to perform quite well. This is because they enjoy a relief rally given that inflation expectations are being met by an active Fed and because they also price in the increased probability of a financial accident in a tighter monetary environment. If you had bought US 10 year Government Bonds a week before the hiking cycle of 2004-2006, despite the Fed hiking 425 bps (rates being lifted by 4.25%), you would have enjoyed a total return of 6.50% over that rate hiking period. US 10 year government bond yields have rallied significantly since the Fed hiked in March this year, leading Australian 10 year bonds to higher prices.
JCB Secular Theme – global interest rate consolidation after long trend with RBA on hold at 1.50% for 2017 -
Despite all the recent media attention on bonds, we noted this month that since starting the JCB Active Fund in 2014, Australian 10 year bond yields have not really moved. The closing yield for bonds at year end 2014, 2015 and 2016 has been very close to 2.80% (actual yields have been 2.74%, 2.88% and 2.76%) As at the end of Q1 2017, Australian 10 year Bonds yielded 2.70%. Our broad secular theme remains that bond yields will remain in a consolidated range during a benign period for the RBA who remain very unlikely to raise or cut interest rates in the near term. This will offer up significant opportunity for alpha generation for active managers.
Chris Manuell and Paul Chin join the JCB team, alpha generation continues to grow with improved investment process -
JCB has expanded the investment team with the addition of Chris Manuell (previously worked with Charlie Jamieson at BAML London), joining Paul Chin who joined the firm in 2016. Chris brings 23 years’ experience (16 years offshore) and is a holder of the converted Chartered Market Technician (CMT) nominal – one of the few in Australia to hold this prestigious US based designation. Chris joins Paul Chin who brings 21 years’ experience as a portfolio manager and investment research and strategist (with 7 years offshore working for Blackrock (BGI) San Francisco).
The JCB investment team is now complete with 4 senior employees with a collective 80 years’ experience in fixed income markets, 42 years of which was generated offshore.
JCB is moving offices -
JCB will be relocating up 3 floors to Level 30, 101 Collins Street, Melbourne as of the end of April. In the interim our contact details will remain the same although our telephone numbers will be updated in coming months. JCB looks forward to welcoming you to our newly designed customised offices, execution dealing floor and boardrooms in the coming months.
Fund update for MARCH
JCB returns +2.21% in Q1, 2017 following on from +2.99% in 2016 and +4.94% in 2015.
In March 2017, the JCB active fund returned 0.91% (gross), outperforming its benchmark by 0.425%. The fund benefited from increasing duration exposures into the US Fed rate hike in the middle of the month which we had previously identified as an opportunity to add duration given the market concessions on offer. The fund also benefited from performance of some short dated supra national bonds which tightened on spread as international buyers continue to have elevated demand for high quality AAA securities. The fund remains under weight duration in keeping with its lower beta exposures, however, we continue to look for tactical opportunities to drive additional alpha opportunities and performance whilst at all times protecting capital.
MARKET UPDATE APRIL 2017
JCB returns +2.75% (gross) YTD 2017, following on from +2.99% in calendar 2016 and +4.94% in 2015
Leading Canadian mortgage lender collapses, critical parallels to Australia.
The Canadian economy has several striking parallels to Australia. Both economies are:
The recent collapse of leading non-bank Canadian mortgage lender Home Capital Group Inc (HCG) is of serious concern. Are the foundations of the exponential rise of property prices starting to crack?
HCG is a non-bank lender who specialise in subprime mortgage lending. Last week the company was forced to borrow C$2 billion at penalty interest rates up to +22.5% to stem a deposit run which would lead to its insolvency. Bankruptcy or break up and sale appears inevitable, with the stock price off more than 83% in the last 12 months.
Is this Canada’s Countrywide moment? It is certainly a stark reminder that when the tail winds of momentum in property markets turn to headwinds, people and corporations sailing close to the wind will be exposed. All 4 members of JCB investment team were living offshore during the GFC and experienced first-hand how quickly liquidity can evaporate from markets, financial and property and the pricing damage that can be unleashed by forced selling due to inability to meet interest repayments.
For property to remain well supported 4 key elements must remain in place in some combination, however we see decay or risk in all the following:
Domestic tailwinds to headwinds, Sydney property drops in April following global declines in leading markets.
Domestically the rise in mortgage rates is starting to bite, with lower auction clearance rates observed and the first recent decline in Sydney house prices posted in April. JCB has written previously regarding the headwinds from out of cycle mortgage hikes from Australian Banks placing pressure on disposable incomes at a time when wages growth is at the lowest ever recorded level. We believe only the financial effect of the December 2016 mortgage hike is currently in the market, with March mortgage hikes only now hitting April mortgage statements for the first time. Given the large debt loads and high interest rate sensitivity the domestic data should decay into H2 2017. We expect that banks will continue to lift mortgage rates throughout 2017 as the Fed continue to lift US interest rates.
Global data decays significantly vs expectations, momentum remains negative.
Global data has taken a significant turn negative vs expectations, with the US Citigroup Surprise index dropping below zero for the first time since November 2016 (current reading -20 from +56 in March). First quarter US GDP growth came in well below expectations at 0.7% only, whilst US CPI was negative at -0.1% in April. The US employment report also disappointed in April, dragging the 6-month average lower to +163k, well below the US Federal Reserve (Fed) target of +200k. Despite this weakness in current data JCB still believes the Fed will lift interest rates again in June and September and then pause for the remainder of 2017 to assess the impact of lifting interest rates 3 times in the year – driving the global cost of capital higher and tightening financial conditions.
‘’I do like a low-interest rate policy, I must be honest with you, as soon as [rates] go up, the stock market is going way way down’’ D. Trump
100 days into Donald J Trumps presidency and so far, we have little but broken campaign promises. We have been critical of Trump promises, but we do agree with his above comment regarding the stock market being dependant on a low interest rate policy. This fits with JCB’s overarching secular thematic that interest rates will likely stay low for an extended period by historical standards, notwithstanding an attempt from the US Federal Reserve to lift funding rates away from emergency levels over the balance of 2017.
The change in positioning from Trump is dramatic - China is no longer a currency manipulator, healthcare is no longer a priority, interest rates are now preferred to remain low. JCB continues to believe that Trumps agenda will be partially delivered, albeit watered down and delayed in timing.
Tomahawks and mega bombs. Geo-politics reminds investors to be diversified against left tail negative portfolio outcomes.
April’s geo-political flares reminded investors that portfolio diversification is critical. Thankfully the North Korean threat remains just that at this point, however, we cannot discount further tension between the US and North Korea or Syria. Trumps show of force in bombing Syrian airfields whilst meeting with the Chinese leadership was good politics, but Trumps eagerness to control foreign policy outcomes using force on foreign soils re-energises geo-political concern and creates implications in the 2nd and 3rd derivative as Russia and China are drawn to support allies. JCB expect (and hope) that these flares remain flashpoints without escalation, however the tail risk remains possible.
Observations of buyers and sellers in Australian Government Bonds.
Flows over the month of May remained positive for Australian Government Bonds with flow of funds data suggesting strong participation from Japan and Asian Central Bank community. Markets continue to lower estimations for terminal rate pricing from the US federal reserve, driving continued performance across medium to long term fixed income curves.
JCB has moved offices – our new phone number is 03 8580 0088.
JCB has relocated, and moved three floors upwards to Level 30, 101 Collins Street, Melbourne.
In the interim our contact details will remain the same although our telephone numbers will be updated shortly.
In April 2017, the JCB active fund returned +0.602% (gross), underperforming its benchmark by -0.254%. This trims our YTD outperformance to +0.70% (gross)
The fund held underweight duration exposures vs benchmark going into April as the market had performed strongly out of the March Fed rate hike as expected by JCB (generating strong alpha in month of March). The surprise US Tomahawk missile strike on Syria created a powerful flight to quality rally in bonds leading to the underperformance vs benchmark of the Active Fund, however this came on strong absolute performance.
The supra exposure we are currently holding also underperformed mildly into this rally, widening on spread by a few basis points, however this comes after strong outperformance YTD. We have trimmed some exposure in supra’s, taking profit on these structures but continue to retain a core position for both carry and credit quality (these would remain AAA if Australia’s rating was cut to AA+). As the market retreated from geo-political shock highs in mid-April we added additional duration as global data has decayed materially, justifying additional exposure.
The fund remains neutral on curve exposures at this time and awaits better opportunity to build positions at more attractive levels.
MARKET UPDATE MAY 2017
JCB returns +3.85% (gross) YTD 2017, following on from +2.99% in calendar 2016 and +4.94% in 2015.
Standard and Poor’s (S&P) downgrades the Australian financial system as property prices fall nationwide in May.
The downgrade of twenty-three financial institutions by ratings agency Standard and Poor’s (S&P) in May is a stark reminder of high debt levels creating excessive credit risk. The reasoning cited by the ratings agency was because the Australian financial system faced an ‘’increased risk of a sharp correction in property prices’’. JCB has written extensively about why mortgage rates will likely continue to increase in Australia because of international forces beyond our control (‘’The Fed will continue to hike US interest rates, lifting the global cost of capital, a precursor to recessions in other cycles’’ JCB March monthly), adding further funding pressure to a system loaded to the gunnels with highly interest rate sensitive leverage.
Following on from a slight decline in Sydney house prices in April, Australian house prices posted their weakest monthly result in a while at -1.1% nationwide. Weakness was very much centred in the unit and apartment market, with the decline in Brisbane unit prices gathering pace (now -4.6% y/y) and Melbourne unit prices also now in negative territory at -3.8%. A combination of mortgage rate rises, increased regulation curtailing mortgage availability and potentially oversupply looks to be having an impact in these markets.
Hybrids cut to Junk as S&P do not expect the Government to support major bank names.
S&P does not expect the Government to support hybrid security holders if a big bank gets into trouble and as a result many hybrid instruments have been downgraded to junk. Investors should take note and reassess current portfolio allocations and portfolio risk/return in light of junk ratings on securities that JCB has long argued are more akin to preferred equity.
Equity-like characteristics of hybrids add significant risk to portfolios. They are subject to non-viability triggers, which means that if the Australian Prudential Regulation Authority determines that a trigger event occurs the notes will be converted to ordinary shares or written off.
Trigger events are designed to make hybrids the loss absorption instrument for financial institutions in conditions of financial stress including serious impairments and insolvency, both of which are rising in probability.
David Copperfield calls the outlook from the year 1849 (not the illusionist).
Higher global funding rates (higher US Fed Funds, potential lifting of depo rates in Europe, higher Shibor funding in China) will create stress and delinquency. Charles Dicken’s famed character David Copperfield knew that 168 years ago: “Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds and six, result misery.’’
For a large number of people, annual expenditures are rising, whilst they face the weakest ever recorded income growth in our nation’s history. The books don’t balance now and we have more funding pressure to come. Credit delinquency is building. Arrears data continues to climb showing growing mortgage stress. The mathematics just simply don’t add up. We cannot have record debt levels (global debt grown from 140 trillion pre GFC to 230 trillion now) and expect that higher funding doesn’t matter. There is no economic escape velocity without cancelling the debt. Credit quality not only matters but is critical towards the end of the cycle.
Obstruction of Justice or Obstruction of Greatness? A swift impeachment would be hugely bullish for risk markets.
JCB believes a possible 46th President Mike Pence (orthodox Republican) would ‘’make America great again,’’ but only if he comes to power quickly. Whilst an impeachment charge against sitting president Trump would be viewed market negative, JCB believes this would be hugely constructive in the medium term. Legislative progress under President Pence, an orthodox Republican, would be swift with Republican controlled House and Senate. However, as with many things market based, the themes are clear but the timing is difficult. Midterm elections are fast approaching in 2018 with all 435 House of Representatives seats up for election plus 34 of the 100 Senate seats. Campaigning for midterms starts in November this year, making sizeable legislative reform unlikely from early 2018 onwards. The longer any Russia/Obstruction investigation lingers, the more likely Democrats can produce a large swing and change an all Republican majority as voters become disillusioned with a perceived criminal Republican leadership and a party polarised by infighting (Freedom caucus versus Two State caucus).
‘Sell in May and go away’’ works again for risk assets, but don’t believe the hype, stay diversified.
The adage ‘’Sell in May and go away’’ worked again for risk markets, with Australian equities suffering large drawdowns after S&P ratings actions against the financial system. Philip Parker’s Altair Asset Management is concerned enough to close his equity investment funds and hand back hundreds of millions of dollars to investors. His reasoning is the prediction of a large property market unwind in Australia which he believes will lead a deleveraging cycle in other asset classes, namely equities.
Whilst JCB is sympathetic to some of these themes, this sell everything growth is an extreme position. A combination of growth and defensive assets allows portfolios to ride the tides and perform through uncertainty, both positive and negative. Modern day portfolio theory suggests being diversified in their portfolios and remain acutely aware of contagion risk. Term deposits, corporate bonds (mainly financial in exposures), hybrids, negatively geared property and bank equity are all financial sector exposures at a time when there is clear evidence of decay and delinquency.
Observations of buyers and sellers in Australian Government Bonds.
Flows over the month of May remained positive for Australian Government Bonds with flow of funds data suggesting strong participation from Japan and Asian Central Bank community. Markets continue to lower estimations for terminal rate pricing from the US federal reserve, driving continued performance across medium to long term fixed income curves.
JCB has moved offices – our new phone number is 03 8580 0088.
JCB has relocated, and moved three floors upwards to Level 30, 101 Collins Street, Melbourne.
In the interim our contact details will remain the same although our telephone numbers will be updated shortly.
JCB returns +3.85% (gross) YTD 2017, following on from +2.99% in calendar 2016 and +4.94% in 2015.
In May 2017, the JCB Active Fund returned +1.03% (gross), underperforming its benchmark by -0.28%.
The fund was positioned underweight duration exposures vs benchmark in May (in keeping with our risk first investment process) into the large domestic risk event of the federal budget. We maintained this position into June as we believe the market is broadly at fair value given the known economic data to this point and we are happy to run less risk and protect capital in keeping with our primary fund objectives.
Over the month JCB reduced its holding in supra national bonds, taking profit after significant performance. These positions where initially upsized to protect against a near term lowering of Australian Sovereign rating (supras would remain AAA if Australia was cut to AA+), however, JCB feels this is no longer potentially imminent, therefore lowering our holdings in supras and increasing ACGB exposures.
We continue to retain a core position in supras for both carry and credit quality. We have positioned the fund to remain neutral on yield curve exposures at this time and await better opportunity to build positions at more attractive levels.
MARKET UPDATE JUNE 2017
JCB returns +3.06% (gross) YTD 2017, following on from +2.99% in calendar 2016 and +4.94% in 2015.
“All great literature is one of two stories. A man goes on a journey or a stranger comes to town.”
When we look back upon the financial excess into the GFC, the great bust and near financial Armageddon, the multiple bouts of global quantitative easing transferring private debt to governments thereafter, it will make a historic story for the grandchildren. Boom to bust to boom again within a decade, with reckless investors in the most part being saved by governments who facilitated in privatising the gains and socialising the losses. Did you actively manage that journey or did the quantitative easing stranger come to your portfolio?
If you think the US Federal Reserve still has your back, Mr and Mrs Investor, the way they had your back in 2009, 2010, 2011, 2012, 2013,2 014, 2015 and 2016 … well, you may be mistaken. I think Janet Yellen just broke up with you. B. Hunt, Salient Partners
Since the GFC, Global Central Banks have provided a substantial tail wind for markets. June 2017 may well be a significant turning point for investors. If you take Central Banks at their word, they just packed their bags and walked out, not to return. Investors are on their own, albeit, at some of the highest asset valuations in recorded history. If ever there was a time for regret minimisation as an investor, now must be close.
European elections and political risks have passed, global data remains decent and markets remain calm, giving global Central Banks the confidence to begin removing the extraordinary stimulus of the post GFC crisis era. Central Banks of The United States, Europe, Norway, UK, and Canada are all openly discussing the removal of policy accommodation. Whatever form that may take (raising short dated funding rates, not reinvesting maturing bonds, reducing bond purchases) the net result is a contraction of financial market liquidity and a raising of the global cost of capital. Both of these measures are in stark contrast to the investment environment enjoyed since 2008.
The implications for investors after the extraordinary post crisis period should therefore be profound. For a decade a “buy any dip” and fade “volatility” was amply rewarded by markets with ever lower cost of capital and excess liquidity. This low volatility environment will likely give way to market based price discovery rather than CB controlled markets via asset purchases programs, and some asset classes should suffer badly under reduced liquidity. This is due to the “pricing cycle” effect in asset markets. Prices tend to go “up the staircase and down the fire pole”. Bull markets grind higher, gaining ground in small incremental moves. Investors remain optimistic and owning assets feels virtuous as income and capital gains make for healthy portfolio returns. Bear markets tend to be chaotic, as leveraged sellers are stopped out and forced to chase pricing lower, leading to a death spiral of lower pricing and reduced confidence until value is ultimately restored which encourages new buyers. Huge global debt burdens suggest this time will likely follow most historical cycles with similar transmissions from monetary policy through to investment markets.
Global inflation is MIA, although Australian inflation should rise due to utilities prices jumping. The poisonous mix of rising global short dated yields and falling global inflation
JCB has written consistently about Australia’s unique domestic issues that will be amplified by the moves of the US Federal Reserve. The addition of other major central banks to his reduction of global accommodation will add to the burdens of Australian households as the cost of capital the world over is pushed higher, restricting discretionary spending via an income shock.
JCB does expect near term Australian inflation to receive a one off boost from utilities price increases. This is an unwelcome development at a time when non-discretionary costs are already high. Housing has never been more expensive, whilst health care, education and utilities already place pressure on weekly pay packets. An income shock from higher funding costs should hit discretionary spending, and that will be sour news for the Australian economy into H2 2017.
Building approvals becomes construction work done, mind the gap
Australian building approvals continue to decay, falling -5.6% again in May and bringing the year on year number to -19.7%. Building approvals becomes construction work done, you cannot build without a permit. With 9% of Australia’s workforce employed in the construction industry, a circa 20% drop in building approvals is cause for serious concern. Development funding markets continue to tighten pushing developer’s costs higher. A loss of pricing power in real estate development can see futures planned projects mothballed, which can lead to a ‘mind the gap’ moment for the construction workers. This situation requires heightened monitoring for further development into H2 and beyond.
Outlook for Australian Bonds as Global Central Banks look to hike funding rates
effect on markets comes with a lagged delay. Once the pause and access is complete the cycle either continues if growth allows, but also can see a reversals of policy due to struggling domestic economies under a higher cost of capital.
As we have already witnessed over H1 2017, long dated interest rates tend to remain stable or fall (increasing long dated bond prices) once Central Banks hike short dated funding rates (rates tend to raise before the hikes aka Q4, 2016) JCB wrote on this topic at length in our February and March 2017 outlooks available on the website jamiesoncootebonds.com.au. We recently re-examined our secular investment themes at our June Advisory Board meeting and remain confident that longer dated global interest rates will likely consolidate after a powerful and long trend. We continue to believe the RBA will remain on hold at 1.50% for the balance of 2017.
As we close the 1st half of 2017, Australian 10 year Government Bonds yielded 2.60%. The closing yield for bonds at year end 2014, 2015 and 2016 has been very close to 2.80% (actual yields have been 2.74%, 2.88% and 2.76%) As at the end of Q1 2017, Australian 10 year bonds yielded 2.70%. Our broad secular theme remains that bond yields will remain in a consolidated range during a benign period for the RBA, who remain very unlikely to move interest rates (raise or cut) in the near term, as bank funding rates tighten economic conditions in the economy making any RBA hike redundant. It is unlikely the RBA will cut barring an external shock or significant decay in housing or employment.
JCB believes the outlook continues to remain positive for risk adjusted returns in fixed income. Looking at historical returns data for Australian Government Bonds, it has taken active and consistent RBA rate hikes of significant magnitude to dampen bond returns in any calendar year. This type of action from the RBA in foreseeable future is extremely unlikely. We do note that historically if the RBA have hiked, bond returns are extremely powerful in the following 3 year period. In 1994 the RBA hiked 2.75% in 6 months pushing both bonds and equities negative in a tough year for investors. Australian Government Bonds went on to return 18.8%, 11.9% and 12.5% in the subsequent years of 1995, 96, 97.
In 1999, again the RBA hiked interest rates 1.50% denting bond returns, however Australian Government Bonds posted positive returns of 12.5%, 4.5% and 9.2% in years 2000, 01 and ’02. Again in 2009, after Government bonds providing more than positive 20% returns whilst equities posted circa negative 40%, the RBA actively hiked interest rates dragging on bond returns for the year of 2009. Bonds went on to post positive 5.2%, 13.4% and 5.5% in 2010, 11 and 12.
Are the RBA about to embark on multiple rate hiking cycle? Well if the last 100 bps (1.00%) of rate cuts over 2015 and 2016 has propelled the housing market by circa +30%, what would 100 bps of rate hikes do to property markets? And what would the flow on effects be for the economy? Add to this the multiple out of cycle rate hikes already pushed onto indebted borrowers from higher bank funding costs and JCB sees such a scenario as highly unlikely. Remember the pricing cycle is ‘’up the staircase, down the fire pole’’ and headwinds are building for many growth assets via the removal of global Quantitative Easing. That adjustment alone is reason to be cautious and embark on regret minimisation after a period of extraordinary asset returns from the lows of the GFC. JCB doesn’t argue for a particular asset tilt (that is an investor specific requirements depending on investor’s goals and risk tolerance) aside from always arguing for broadly diversified portfolios in keeping with modern day portfolio theory. We are likely to navigate unprecedented times soon enough, as the environment of the last 10 years is changing. Janet Yellen just broke up with you.
The JCB Active fund returned -0.788% in June, outperforming its index by 0.294% on a gross basis. This brings portfolio returns to 2.93% for H1 2017.
The portfolio benefited from a short duration position, combined with a butterfly risk structure across the term premium which performed late in the month as global Central Bank hawkish speak re priced European Bonds, generating a pullback in Australian Fixed Income. This pull back brings valuation back to similar levels seen at the end of Q1, however at that time the market still held high hopes for legislative progress in the US and we had not added geo political risk into valuations via Tomahawks in Syria or tough talking against North Korea. As such JCB believes this improvement in valuation offers an attractive entry point given the sobering glide path we see for the Australian economy over H2, combined with heightened geo-political risk.
MARKET UPDATE JULY 2017
JCB returns +3.06% (gross) YTD 2017, following on from +2.99% in calendar 2016 and +4.94% in 2015.
Economic Neutral Rate for RBA between 1.75% and 3.50%
The release of July RBA minutes contained a reference to a ‘’3.50% neutral rate’’ which caused significant volatility for short-dated bonds and AUD FX over July. In direct response, the AUD/USD exchange rate rose above 80 cents. The markets were correct to change forward pricing expectations around the RBA cash rate ahead of receiving clarification from the RBA regarding this statement. In the days after the minutes were released, markets priced in more than a full RBA rate hike by May 2018. JCB estimated that this ‘’neutral rate’’ reference was included in the RBA minutes to remind markets that interest rates will be lower for a significant period. This proved correct after hearing clarification remarks from RBA Governor Lowe. However, this has sparked an interesting debate amongst economists as to what is the current Australian neutral rate. JCB believes the RBA assumption that ‘’neutral’’ at 3.50% is absurdly high given the current debt loads in the domestic economy. We have written extensively about the ‘’income shock’’ that material rate hikes would unlock on indebted households and we have examined this secular theme with our Advisory Board on numerous occasions. Our best sense is that rates will remain low for an extended period. Deutsche Bank published a report in late July suggesting the neutral rate could be as low as 1.75% (remembering that the ‘’neutral rate’’ is that rate at which interest rates are neither accommodative nor restrictive in the economy).
Explicit RBA speeches crush any ‘’rate hike’’ chatter in markets
LOWE: SOME COVERAGE OF NEUTRAL RATE MISINTERPRETED OUR INTENTION
RBA’S LOWE: WE DON’T NEED TO MOVE IN LOCKSTEP WITH GLOBAL PEERS
LOWE: WOULD BE BETTER IF A$ IS A BIT LOWER THAN IT IS
The key takeaways from Lowe’s speech were:
Governor Lowe went on to stress that the RBA did NOT follow other economies to zero interest policy rates and Quantitative Easing and hence has nothing to undo as those emergency policies are unwound offshore. He essentially broke any perceived linkage between monetary policies of Canada and Australia (despite the economic similarities between Canada and Australia – both being a commodity based nation dependant on a large trade partner). Many global hedge funds looking to profit from speculating that Australia would follow the Bank of Canada into a rate hiking cycle were badly hurt as Governor Lowe explicitly changed market expectation.
AUD rally is deflationary under RBA internal models
We see the above pick up in domestic inflation unlikely until the USD currency can find its feet. The 5%+ jump in the Australian dollar over the past months could mean a 0.5 per cent decline in core inflation over the next three years, according to internal RBA’s currency modelling. Traditionally, a higher currency has a direct impact on a country’s inflation print (via tradeables inflation) but recent shifts in the retail landscape mean this relationship has become more complicated. A general rule of thumb for measuring the impact of currency moves on inflation, according to research by the Reserve Bank of Australia, is that a 10 per cent move in the currency would add or detract 1 per cent to annual inflation evenly weighted over three years. The recent rise in the Australian dollar has pushed the Trade Weighted Index – an average of currencies reflecting the sum of Australia’s exports and imports of goods by country – 5 per cent higher since the RBA’s last monetary policy statement.
Trump versus Congress (possible US Government Shut down)
The West Wing looks to be imploding after the events of the last few weeks. Tax reform has been pushed to after the summer recess (Congress back on Sept 5th) and we remain concerned that the debt ceiling debate and possible government shut down (early October on current spending) will be used by a desperate Trump as a bargaining tool against Republicans, trying to force their hand to support unfunded tax reform. A government shutdown would be a powerful motivator as Congress remains mindful of looming mid-terms elections into 2018 (something that doesn’t concern Trump at this point – sadly he isn’t up for re-election until 2020). Trump has nothing to lose. JCB expect this could be a potential source of financial market volatility leading into this period, with highly binary outcomes for risk depending on tax reform passing or failing before Congress goes into mid-term election mode.
North Korean Inter Continental Missile Tests – 2 years ahead of CIA schedule
North Korea. The recent Inter-Continental Ballistic Missile (ICBM) tests by North Korea have rattled defence feathers in Washington. This technological leap forward from North Korea is 2 years ahead of a suggested CIA development timetable. On this timetable the North Koreans can arm an ICBM with a nuclear warhead capable of hitting Middle America (Chicago/Denver etc) within 6 months. After the initial Mar Largo meeting between Trump and Xi Jinping of China, CIA satellites noted a significant drop in trade activity between North Korea and China. This was considered a positive development in that China could ‘’quarterback’ as a go between to defuse geo-political tensions. In last few months trade activity has returned to normal highlighting China’s unwillingness to play a ‘’middle’’ role in this increasingly difficult geo political area. This again looks like a possible source of significant volatility for markets in coming months. We have written previously at length about Trump, a president that is seemingly totally self-serving, who may require a ‘boost in the polls’ from playing the strong man leadership role. A credible nuclear threat against the US is the perfect platform to divert the publics attentions from a so far failed presidency (combined with lowest ever approval ratings) that’s only real achievement to date is appointing a Supreme Court judge whilst repeatedly tarnishing the highest office in the land.
Portfolio Update for July
After the pullback in Government Bond markets in June, valuations had improved considerably considering global and domestic data still remained patchy, inflation data remained weak, geo-political risks remained elevated and bond market seasonality turned positive. JCB funds added additional duration to portfolio’s, removing a structural defensive position which is a favoured portfolio structure whilst also removing some additional semi government and supra national exposures in favour of ACGBs in expectation of a bond market rally over July and August.
Two events over the month gave global momentum accounts and CTA speculative accounts to significantly sell bonds and test lower prices in Australian Government Bonds. Firstly the hike in interest rates by the Bank of Canada were interpreted as a precursor to higher rates from all Central Banks (clearly wrong, as crushed by RBA Lowe’s explicit comments). This was followed closely by the RBA statement discussing the 3.50% neutral rate as we have discussed above in the market review also added to immediate selling pressures. On the day the RBA minutes were released the markets recorded the largest volumes seen since 2011 in Government Bond futures. These global momentum and CTA accounts pushed hard to establish a trend to lower prices, repeatedly selling securities and futures contracts in shorted dated instruments towards the lowest valuations of the month, flattening the yield curve in the process. This proved a losing strategy for the momentum crowd as the improvement in valuations encouraged significant buying with bond valuations holding ground and closing with a slight gain over the month. JCB added significant curve exposures to monetise existing positions in the portfolio into this opportunity.
From a technical perspective the candles at the extremes of this choppy range showed extremely long wicks, highlighting the volatility towards extremes with stop loss selling/buying quickly being retraced. The market managed to withstand this heightened volume from the sellers, however, JCB portfolio’s remained on high alert for a possible move to lower prices and stood ready to hedge accordingly to protect capital should the momentum speculators gain the upper hand for a short period. This lead to the portfolio being increasingly active over the month to protect capital as required. Over the month the portfolio managed to outperform its index by 0.05% on a gross basis.
MARKET UPDATE AUGUST 2017
JCB returns +3.44% (gross) YTD 2017, following on from +2.99% in calendar 2016 and +4.94% in 2015.
Binary set-ups continue for markets into Debt Ceiling and North Korea showdown
As northern hemisphere markets return from summer breaks they are facing two major binary issues in 1) The US Government will run out of money by end of September and needs to raise its debt ceiling to continue functioning and 2) North Korea continues to antagonize the western world with weapons tests.
The potential for US Government shutdown will hang over markets in September. JCB wrote about Trump (Trump vs Congress) in our July monthly suggesting the president may hold Congress hostage on tax reform as a trade-off for passing the debt ceiling. Trump commented during August that he may fail to extend the debt ceiling unless Congress passes his border wall funding and also added he may make Hurricane Harvey emergency repair funding contingent on the debt ceiling debate. This makes September a potentially dangerous period for markets where politicians will seemingly use whatever means necessary to push their personal agendas. Trump leverage here comes from the fact he has nothing to lose – he doesn’t face reappointment till November 2020. However Congress face re-election at mid-terms into 2018.
North Korea hostilities continue to threaten markets. After being a basket case of the nuclear world for so long with failed test after failed test, all of a sudden within a year they have successfully tested long range ballistic missiles along with a supposedly miniaturised thermonuclear warheads. Conspiracy theorists must assume they have had international help which suggests a greater game is at hand in time. Make no mistake as to the lethality of a possible strike – recent nuclear tests show a detonation yield of 120 kilotons. To put that in context the bombs dropped on Hiroshima and Nagasaki had 13 and 20 kilotons. The North Korean situation remains very difficult to price. Markets are taking a diminishing return view with each geo-political spike having a diminished impact in both time and price. Such complacency seems fair until we escalate to a ‘fire and fury’ moment.
Markets temper expectations for Central Bank action in 2017
Markets tempered their expectations for the removal of highly accommodative central bank policies over the month of August. Dovish comments from US Federal Reserve members around the string of low inflation outcomes has lowered market pricing for any additional rate hikes in 2017. Probabilities based off Fed Funds futures markets now stand at only 34% for further rate hikes by the US Federal Reserve’s December meeting. This leaves egg on the face of many strategists and economic forecasters who were certain 2017 would deliver a round of rate hikes lead by optimism inspired by Trump. JCB would argue that if not for the material cheapening of the USD currency over 2017, US economic data would already be significantly weaker and ironically it has been Trump’s failures as a president that have caused the USD sell off and allowed for economic activity and US stock markets to continue forward.
Whilst further rate hikes in the US have been pushed well out we do expect the Federal Reserve to commence balance sheet normalization in September, reducing the ~$4.5 trillion US Federal Reserve balance sheet by 20 billion a month. This has been well telegraphed to the market and we do not expect any material pricing movement as a result of quantitative tightening.
In Europe ECB Chair Draghi’s failure to use the Jackson Hole meetings in August to communicate near term removal of ECB stimulus. Draghi was adamant at the last ECB meeting he will continue printing 60 billion in QE until end of Dec 2017. The expected winding down of QE has been complicated with the EUR currency strength which is adding deflationary forces to the Eurozone economy, restricting the ECB from meeting their sole policy objective of 2% inflation.
Hurricane Harvey floods Texas, disrupting Oil and Gas – another distraction for Trump
The near term impact of Hurricane Harvey is both physical (damage to buildings and infrastructure) and indirect with the damages caused by people losing their purchasing power from the loss of employment. Around 100,000 homes remain flooded whilst oil and gas production facilities remain shut which has seen US retail petrol prices hit their highest level for two years. This has a near term dampening on US economic activity, followed by a lift as the rebuilding commences. The 500,000 vehicles that were damaged or destroyed will have implications for the broader economy as well.
The requirement for disaster aid for Hurricane Harvey will potentially expedite a deal being reached on the debt limit however the urgency for an agreement will distract Trump from other pressing issues and as such the likelihood of tax reform will be kicked further down the road.
Portfolio Update for August
AUD rates markets underperformed global peers over the month of August. Despite solid rallies from US and European bond markets, Australian bonds were little changed month over month. Intra month volatility produced a trading range of 17 bps in Australian 10yr bonds allowing for JCB portfolios to lock in some duration gains before resetting that risk at lower prices.
We had expected global markets to rally, and thereby Australian Bonds to perform well tracking with high correlations and as such positioned the portfolio to hold longer dated duration. This did eventuate after Korea fired a missile over Japan but otherwise Australian rate correlations were much lower than normal over much of the month. The strength of the AUD currency has effected flow of funds for AUD rates, seeing increased participation from currency sensitive sellers cashing in on a stronger AUD.
JCB also retained a smaller allocation to semi government and supra holdings as we believe these spreads have tightened significantly and pricing doesn’t reward additional risk in spread based instruments.
JCB has reduced duration holdings and will look to invest as opportunities arises over the month of September. As September is 1 of 4 contract futures contract expiry months we are sure to see some intra month volatility ahead.
MARKET UPDATE SEPTEMBER 2017
JCB returns +3.09% (gross) YTD 2017, following on from +2.99% in calendar 2016 and +4.94% in 2015.
Market prices nearly two rate hikes for RBA in 2018 despite continued rebuttal from RBA speeches
Despite continued pushback in speeches from a number of senior RBA officials, markets have moved to price in almost 2 rate hikes for the RBA in 2018. RBA governor Lowe has been explicit regarding rate policy in recent speeches stating that the RBA will not follow other central banks into a tightening cycle whilst the domestic economy continues to have employment slack of 0.6% and below mandate inflation. Positive employment data combined with renewed expectations of an additional US Federal Reserve hike for year-end plus recent rate hikes in Canada have resulted in a cautious mood for bond markets who have moved to add optionality for RBA policy outlook in 2018.
Large firebreak now established in current pricing, to remain underweight short dated fixed rate debt is to expect a 3rd RBA hike which seems highly unlikely even under the most optimistic scenarios
In contrast to the predications of dire bond market returns as rates rise from many vested interested parties, the addition of nearly 2 RBA rate hikes into current market pricing has been entirely orderly, with the product continuing to generate solid returns in excess of RBA cash year to date. Importantly, as the market has already added the optionality of possible RBA hikes into current pricing, a large firebreak has been established for shorter dated fixed rate bonds (active managers don’t always own long dated debt) Should the RBA complete on rate hikes in 2018 this is already reflected in the price of those bonds today, much like a particular stock having been discounted for some possible or expected future event. However, if the RBA fail to raise rates then bonds are historically cheap versus the RBA cash rate and should generate strong excess returns to RBA cash. For those expecting a further pullback in yields the market would then be pricing in the optionality of a 3rd RBA rate hike. Such a scenario looks hugely optimistic versus RBA commentary that continues to remain comfortable with current monetary policy settings and acknowledges the balanced risk outlooks for the Australian economy with highly indebted consumers who are facing significant prices rises in non-discretionary utilities. The RBA Ian Harper made public comment early in October that the RBA are NOT ruling out an additional rate cut. Given nearly two hikes are priced in and the RBA are still
discussing rate cuts, valuations look compelling at current levels unless you believe the RBA could hike a 3 times.
With CNN’s fear and greed index having reached an extreme greed readings of 95 out of 100 – massive risk on - (http://money.cnn.com/data/fear-and-greed) we believe current market pricing presents a nice opportunity to add defensive exposures for balance portfolio’s at vastly improved levels.
Tax reform: Trumps legislative progress to date is essentially zero. Any actual tax reform should be severely reduced vs announcement if implemented at all.
Tax reform remains a critical theme for financial markets. Recent announcements for reform made headline statements without giving much detail – classic Trump. When Trump was elected last year, JCB wrote extensively about the difficulties Trump would face enacting legislation with the ‘’swamp.’’ To date, material legislative progress has been missing in healthcare, the wall with Mexico, immigration bans and border adjustment tax. This is despite having control of both the House and Senate. Whilst all sides of politics agree the US tax code requires reform, finding a common path forward remains extremely challenging. We hope to see progress here in coming months but JCB continues to believe what will be delivered will not meet the markets grand expectations.
Careful what you ‘’Warsh’’ for – favored US Federal Reserve Chairperson Kevin Warsh looks to break recent relationships with equity markets
Kevin Warsh is the current front runner to replace Janet Yellen as Chair of the US Federal Reserve in 2018. Just what the world needs, another multi billionaire (and family friend of Trump’s) deciding that fate for the rest of us. A Warsh Federal Reserve would be vastly different to the Fed under Bernanke and Yellen. Warsh has been publicly critical of current Fed policy (as has Trump) and believes the Fed has become a ‘slave’ to the stock market. This appointment is all speculation at this stage but investors should continue to monitor the composition of the US Federal Reserve into 2018. These announcements are a potential source of significant market volatility.
Toys R Us bond holders lose 80% of capital – bonds from 96 cents to 18 cents on the dollar - a stark reminder about risk as credit hits cycle highs
Toys R Us bond holders suffered significant losses in September as the company filed for bankruptcy. The household name of 1990’s and 2000’s is no more in an Amazonised retail world combined with a leveraged balance sheet. The classic joke of ‘’How did you go bankrupt?” applies in full here. The answer: “Slowly, and then really quickly’’ Their outstanding 2018 bond issue traded from 97 cents on the dollar to as low as 16 cents in September representing more than 80% loss of capital.
This serves as a stark reminder that credit risk is the biggest source of losses in fixed income and leveraged balance sheets need to be carefully considered and negotiated before investors lend money to corporations or governments. Thankfully the Australian Government is still the envy of the world with low debt to GDP ratios and coveted AAA ratings.
These types of investor losses remind portfolio constructors, advisors and investors to be truly defensive and not find quasi products to play this critical portfolio function. ‘’Bond like equities’’ received significant press coverage a few years back with market darlings like BHP, Telstra and Woolworths providing supposed stable dividend income streams. Sever capital losses and/or dividend cuts have resulted inflicting unnecessary damage to retiree portfolios. All the staff at JCB own growth assets and we do not diminish their critical role in portfolio’s but make sure ‘’caveat emptor’’ – buyer beware - is a consideration when choosing defensive final products – particularly when lending money (buying bonds).
Portfolio Update for September
AUD interest rate volatility ticked up for the month of September as we more than doubled the range from the moribund August period, a range of 37.5bp this month vs 15bps in August. September also included the quarterly expiry of the SFE futures contracts which historically provides some turning points in the market and this month was no exception. JCB was positioned for a selloff in interest rates around the in the early part of the month, however, we were forced to reduce the position following the hurricane’s in the US, dovish Fed comments, concerns over debt ceiling extension in the US and geopolitical events around North Korea (possible missile launch on North Korea national day) early in the month. JCB added exposure early in the month after triggering stop loss levels which was ultimately frustrating in the corresponding pullback that followed later in the month. This initially detracting from alpha generation early in the September versus the index. However, it is critical that JCB maintains a disciplined risk adjusted methodology in our process as we explore potential alpha generating opportunities within the portfolios, and when key levels are breached discipline must be followed to stay on process.
JCB added additional positioning in short dated rates into improved valuations later in the month as we continue to believe the RBA will have a very difficult time raising interest rates in the short term until additional employment slack has been removed and the inflation pulse picks up from below RBA mandated levels. We also added exposure to a new issue World Bank Supra position which we deemed cheap to fair value, which subsequently out performed 6.5 bp better versus the index and was a large contributor to alpha generation in the back part of the month.
JCB has also been running some curve steepening exposure which helped contribute the funds outperformance over the month - notwithstanding the initial necessary addition of exposure on geopolitical tension which proved a drag.
Looking ahead into Q4, JCB believes that market volatility is possible around the appointment of a new US Fed chairperson plus the composition of the Federal Reserve Board combined with the anticipated ECB tapering of its quantitative easing program. No doubt domestic and international politics and geopolitics will also continue to remain at the forefront of investors’ minds. We will continue to hold short and mid dated exposures and use our tactical overlay process to explore alpha opportunities as they present themselves.
MARKET UPDATE OCTOBER 2017
JCB returns +4.10% (gross) YTD 2017, following on from +2.99% in calendar 2016 and +4.94% in 2015.
Re affirming our secular views around inflation
Recent market discussion has turned towards the possibility of increased inflation as most western economies are at full employment (although sadly not Australia). Jamieson Coote Bonds has long held the secular view that some inflation will emerge at times, however, material inflation cannot be sustained. In a heavily indebted world, if central banks remain true to mandates and hike interest rates on a lift in inflation readings the likely result will be an income shock to the indebted, which has deflationary consequence (as seen in Canada this year). It is very important to acknowledge that inflation coming from an ultra-low levels up to just a low level is ‘’inflationary’’ with positive data velocity. However, this should not be confused with secular inflation of the 1970’s era, as many of the drivers of our current secular deflation remain. These are declining western demographics, high debt burdens (makes escape velocity difficult), robotics and automation, technology, immigration and the decline in worker unionisation.
With markets very focused on possible inflation velocity, we thought it prudent to deep dive over and above our usual periodic examination of JCB’s secular views with the Advisory Board re-examining the sustainability of positive inflation velocity if it should materialise. After vigorous debate around this topic, the Advisory Board remains generally comfortable that whilst some velocity is to be expected, it remains unlikely that it would be sustained in an economy which experienced higher funding interest rates. This is because any higher wage inflation is quickly cancelled out via income shock due to higher funding costs of servicing debt after rate hikes.
Utilities prices create ongoing income shock but not inflation
Australian consumer price inflation data failed to materialise with any velocity over the 3rd quarter, printing at 1.8% YoY, well below the RBA mandated level of 2-3%. This was despite significant rises in electricity prices at +8.9% and a further rise in tobacco at +4.1%. Inflation has now been below the official RBA target range for all but one of the last twelve quarters – showing how persistent and secular the undershoot remains – even in spite of significant utilities price pressure.
Mortgage stress soars around the country – more to come
Australian mortgage rates will likely move higher into 2018, because the cost of bank funding will almost certainly rise as the global cost of capital is lifted by the US Federal Reserve (the Fed). The Fed is widely expected to raise US interest rates in early December and follow on with further hikes into early 2018. In their October press conference, the Fed confirmed they will run down their balance sheet in an automated fashion and not respond to incoming economic data by changing the size of balance sheet run off. This is crucial because it means the only policy tool available to respond to strong economic data is further rate hikes.
Get ready for more out of cycle rate hikes for Christmas
KJCB has written extensively about why US Fed rate hikes ultimately places significant stress on Australian consumers, who have gorged on private debt as interest rates have fallen. Mortgage stress continues to build around the country with Brendan Coates from the highly regarded Grattan Institute recently being quoted in the AFR: “Even a relatively small rise in the interest rates paid by households would crimp their spending. If interest rates increase by 200 basis points, mortgage payments on a new home will be less affordable than at any time in living memory.’’
Despite mortgage stress already gaining steam around the nation, JCB expect Australian Banks to raise mortgage rates in response to higher loan book funding costs – in exactly the same way they hiked ‘out of cycle’ late last year and early in 2017 after the Fed raise rates in the US. This is a tax on consumers who have accumulated record household debt burdens and will be faced with higher funding costs from servicing their loan repayments.
Large rally in bond markets as 2018 RBA hikes challenged
With almost two rates hikes from the RBA priced into bond markets in early October and the likely prospect that consumers will face higher mortgage costs into 2018, it is little wonder that Australian bonds rallied significantly over the month. JCB contacted a number of clients and made the argument that with short dated bonds at their cheapest levels vs RBA cash in 7 years, valuations looked compelling to add exposures as a large fire break of valuation had been established. The RBA continue to re iterate they remain happy with current policy settings and with bond yields at the cheapest levels vs RBA cash in almost 7 years the market bounced significantly over the month, despite US yields finished slightly higher over the month.
Portfolio performance – on track to deliver 3 times the RBA cash rate with high liquidity
JCB portfolios performed well over October generating strong absolute returns taking performance of our master strategy north of 4.50% annualised for the year (if additional bond income due to year end is included). JCB portfolios did underperform the rally of the government index, as we held large exposures in the short dated bonds where we viewed the risk/reward as most compelling to own duration on an outright basis. JCB viewed this as prudent risk management as the market risks over the month were quite pronounced. The appointment of a new US Fed Chairperson, combined with ECB meeting, announcement of US tax reform and Australian CPI data all had potential to pressure longer dated bonds valuations. All of these market risk events passed without incident in the end and the markets enjoyed a relief rally. JCB continues to hold our current exposures in the belief that the RBA will find it extremely difficult to hike interest rates in 2018, as headline inflation will fall in Q4of 2017 due to CPI basket being reweighted by the ABS. Combined with out of cycle rate hikes which we expect from the banking system, financial conditions will likely tighten in Australia over 2018 without any need for RBA participation.
Given the markets are still priced for RBA rate hikes, we continue to view current valuations as generous at a time when Australian consumers are struggling (as viewed by weak retail sales data), burdened by the high cost of non-discretionary items in housing, education, health and utilities.
MARKET UPDATE JANUARY 2016
JCB Active Fund is up 7.20 % (gross) over 14 months since inception in December 2014, running a portfolio of long only AAA and AA+ rated Government Bonds.
Markets in 2016 have caught everyone by surprise with vicious negative sentiment and volatility. Energy markets and Chinese currency depreciation are often blamed, but I think we can add the strength of the US dollar to the list of causes. JCB has written at length over the last 6 months about the US Federal Reserve attempting to hike rates and the flow on effects that a series of hikes would unleash. We suggested that the Fed wouldn’t get very far before markets would suffer and force them to firstly pause on any further rate hikes, and then ultimately reverse course. That will be good news for equity markets when it comes, but unfortunately we are not there yet. Did we all see this movie before? This is exactly what happened to the European Central Bank in 2011 when they hiked rates. Similar to the Fed move in Dec ’15, the market initially took the ECB at its word that the economy would improve, and made room in bond markets for further hikes, before it became clearly evident that the hike was a policy error which would require reversal inside a fragile economy. US data has decayed considerably over January after last year’s rate hike, with manufacturing sector entering recession. US dollar strength, the equity sell off and widening of credit spreads (the cost of corporate borrowing) together imply financial conditions have tightened substantially. Deutsche Bank has an augmented Fed recession model which now predicts a 46 percent chance of a US recession in next 12 months. This elevated reading is consistent with the recent increase in cumulative deflation probability implied by options markets.
The US Federal Reserve statement in January removed the word ‘balanced’ when discussing the outlook for risks. This is either a slight oversight (unlikely) or something we should all be discussing at length - let’s hope it is an oversight for all our sakes. There has only been one other time they could not offer a ‘balance’ of risks and that was in the meeting of 18th March 2003, the day before President Bush declared war on Iraq, sending 250,000 soldiers into the Middle East. Every other statement in the last 15 years has held a ’balance of risks.’ Is the Fed saying the current environment is as uncertain as the 24 hours before America walked into a major war? Even in September 2008, when the Fed had a FOMC meeting two days after Lehman failed and Secretary of the Treasury Geithner had to miss the meeting because he was busy arranging a bailout of AIG, the Fed was able to offer a ‘balance of risks.’ But again, they could not offer this in January! Did the Fed just say that looking forward risk is a one sided trade? We wrote about our views of asymmetry in asset markets in 2016 last month but we didn’t expect the Fed to openly acknowledge these risks in such a way. Central Bankers are always glass half full – they have to be to build confidence. We will follow these developments with great interest on February 10th when Chair Janet Yellen speaks publicly for the first time since the January meeting and statement.
The Bank of Japan joined the negative interest rate experiment on the last day of January in a surprise to markets. They now sit alongside the European Central Bank, Switzerland, Sweden and Denmark in forcing official interest rates into negative territory to drive currency depreciation and force investors into risky assets and stimulate inflation. We live in truly amazing times when much of the developed world now openly accepts negative interest rates.
Japan is a fascinating case study for developed financial markets. This move is the latest attempt to reflate and stimulate the economy which peaked 25 years ago on a wave of credit creation. Today’s global love affair with credit started in Japan in the 1980’s. In very simplistic terms once the Japanese boom turned to bust, that credit bubble moved into South East Asia culminating in the Asian financial and Russian crisis in 1990’s, then moved to North Atlantic to manifest in US subprime. Has that credit boom/bust cycle moved onto China? That is all beyond the scope of this update but we are happy to discuss this in longer format if any readers wish to explore it further, as the implication for Australia would be profound.
Today the Nikkei remains 54% below its all-time high. Imagine the ASX at 3100 in the year 2032? Japan is a shocking example that a credit boom to bust, combined with bad policy errors and poor demographics can have a generational impact on asset returns. That is worth considering as Australia’s markets continue to transition away from a significant period of boom and we have a minority senate blocking real economic reform. This stimulus of negative rates in Japan is welcome by global markets in the short run, lifting all assets classes in unison. It also strengthens the case for an RBA rate cut later in 2016 and makes Australian Bonds cheaper on a global relative value basis.
After a fascinating and fast forward start to 2016 we will continue to monitor the evolution of US Fed policy, Chinese foreign exchange policy, energy markets and their effect on inflation (or deflation) expectations, the Eurozone migration crisis, the Greek debt crisis (Act IV in the Greek financial tragedy) and the continued rise of Donald Trump versus the decline of power hungry (but oil dependant) leaders such as Putin and co. We will also watch China’s Jinping try to manage a soft landing through transition. RBA policy all seems a somewhat bland verses that list but all of the above will lead markets soon enough.
FUND HIGHLIGHTS & POSITIONING
Jamieson Coote Bonds Active Fund gained 1.39% in January, under performing the market by 0.06%. The funds unit priced dropped by 1.05% after paying a semiannual distribution of 1% of Net Asset Value at 31st Dec 2015.
In keeping with our core capital preservation objective we positioned the portfolio cautiously over the Christmas and New Year period, lowering fund duration and setting up for maximum roll and carry over the holiday break. The speed of the bond market rally caught us (and market) on the back foot and we returned to work early, adding risk to capture the market volatility. Over the month the fund held an average duration position of 4.21 years which should have resulted in material underperformance, given the benchmark’s larger weighting at 5.80 years duration, but volatility provided some excellent opportunities to adjust duration over the month. The fund has some flattening exposure, as the lower for longer thematic continues in the face of lower energy prices, however we will look to add some steepening exposure in time if valuations improve (curve flattens), as we expect the RBA will be forced to reconsider their ‘’chill out’’ manta into a strengthening AUD currency on a trade weighted basis.
MARKET UPDATE FEBRUARY 2016
JCB Active Fund is up 8.54 % (gross) over 15 months since inception in December 2014, running a portfolio of long only AAA and AA+ rated Government Bonds.
NEGATIVE RATES SEE AUD SET TO RALLY, BANK FUNDING TO CAUSE OUT OF CYCLE RATE HIKES, RBA FORCED TO ACT
Europe, Japan, Switzerland, Sweden and Denmark are all very real and developed places. They also all have negative interest rates. This trend is both powerful and global. This is not happening in Timbuktu, this is happening in Paris, Tokyo, Zurich and Stockholm. Negative interest rates are Central Bankers new tool in fighting anaemic growth and low inflation. You should not dismiss them. They have vast consequences for market valuations and discount rate assumptions. Those who dismissed Quantitative Easing (QE) 10 years ago failed to grasp the huge implications QE would have on markets and financial asset returns to their peril.
Under negative interest rates, domestic banks are charged by their Central Banks to keep funds on deposit. The idea is to penalise banks for holding cash which could be lent into the economy to encourage investment and consumption. This results in much of these domestic bond markets trading at negative yields, depending on the bonds maturity. Investors in these regions are now forced to accept negative returns on their bond portfolios or find alternate sources of yield. Australia stands out like a shining light. AAA rated, a $700bln deep and liquid government bond market, Westminster legal system, and most importantly a Central Bank with ammunition to continue to cut rates. Here is where this becomes self-reinforcing. As international buyers purchase Australian Bonds, they need to buy AUD currency to settle the trades. This is part of the reason the AUD climbed so high after the GFC. Not only were investors importing capital to fund mining capex, but they were also buying Australia’s newly minted budget deficits at around $50 billion a year, which required purchasing AUD to settle the transactions.
This new development coincides with skyrocketing bank funding costs. Around 30% of bank funding is sourced in international markets, where spreads have widened significantly as credit markets continue to suffer, resulting in higher borrowing costs for the banks. Do you expect the bank to absorb these higher costs? The 3rd certainty of life, after death and taxes, is that banks will pass these costs onto customers to maintain margins (also be wary of highly complex bank products promising great things, think CDO’s – classic end of cycle trick). Westpac already raised business loan rates last week and we would expect mortgage books will be next for out of cycle rate hikes.
This tightening in financial conditions, along with a higher AUD, will be unwelcome with the RBA, who will be forced to cut rates in response. A rate cut will attempt to help Mum’s and Dad’s from higher mortgage rates at a time when the economy is quite fragile, although banks
will not pass this cut through in full, rather restoring their net interest margins. A rate cut also removes the yield from Australian Government Bonds (resulting in significantly higher bond prices in the process), thereby reducing the pressure on the AUD currency, allowing the economy to rebalance and resort better conditions for future growth.
Turning quickly to international events the rise of Donald Trump looks look to be gaining momentum. Markets hate uncertainty and in Trump they will get plenty. One of his first orders of business is to fire Janet Yellen as FOMC Chair. Combine this with Trump’s finger on the nuclear trigger and we could be in for quite a volatile ride!
JCB also believe the European migration crisis can be the theme of the year for markets. Desperate people will be forced out of Syria via Turkey and into Greece at a time when Greece is again running out of money and incapable of processing them in a secure manner. We unfortunately expect more flash points of terror and violence like Paris, Cologne and Calais when the weather improves and more people attempt the journey. This can divide the European left and right and strain the Eurozone project considerably. It will also have a large impact on the BREXIT referendum of June 23rd
MARKET UPDATE MARCH 2016
JCB Active Fund is up 8.18 % (gross) over 16 months since inception in December 2014, running a portfolio of long only AAA and AA+ rated Government Bonds.
CENTRAL BLACK MAGIC, POLICY DRIVEN MARKETS DON’T CARE ABOUT FUNDAMENTALS, BAD AND DOUBTFUL DEBTS
A few waves of the dovish wand from Ms Yellen and some increasingly negative interest rates in Europe and just like that markets are saved again. It is hard to deny the power of Central Bankers acting collectively. We are without doubt in a POLICY driven environment that can trump fundamentals in the short term.
Over much of 2015 we wrote about the need for a weaker USD and why Yellen would ultimately roll over and be supportive of markets, both fixed income bonds and equities. (Available on JCB website under ‘’Historical monthly markets and fund updates’’) The March FOMC press conference was extremely dovish, well beyond market expectations. Concerns over emerging markets and Chinese growth dominated and have global central bankers remaining on high alert.
As much as these favourable policy developments are healthy for risk markets, they are unhealthy for Australia via the immense pressure they place on the AUD currency. A weakening USD via Ms Yellen only adds more fuel to the currency fire. We believe the AUD will continue to rally until the RBA resume cutting interest rates (as early as May – although this may not halt its ascent much but will help slow things down). Structural demand for AUD assets remains from international investors who remains buyers of AUD to settle Australian bond purchases. Think about these global interest rate levels. Switzerland -0.75%, Sweden -0.50%, Europe -0.40%, Japan -0.10%, USA 0.375%, Canada 0.50%, UK 0.50% and Australia 2.00%. These rate differentials were the topic of last month’s update and outlook and until the RBA significantly cut rates this will continue.
Increased provisioning of Bad and Doubtful Debts in March saw much of the euphoric rally in Australian Bank equities powerfully reverse. One sell side analyst noted that bad and doubtful debt provisioning is like cockroaches, they are rarely found in isolation. Credit cycles are slow moving beasts and a turn negative in Australia is cause for real concern, given the heavily indebted nature of Australian consumers and bank loan book exposures. If we follow the international playbook here we would expect significant interest rate cuts which would be highly supportive for bond markets.
We are saddened to write about terror this month after events in Brussels after forecasting it in these pages last month. This will keep happening, the European migration crisis can still become the theme of the year as associated terrorist actions polarises opinion around the morality of accepting despite people in need. The flow of human traffic out of Syria via Turkey and into Greece comes at a time when Greece is again running out of money and incapable of processing them in a secure manner. We will have more flash points in coming months and it will dominate the European left and right and strain the Eurozone project considerably. It will also have a large impact on the BREXIT referendum of June 23rd and the US presidential election.
MARKET UPDATE APRIL 2016
JCB Active Fund is up 8.55 % (gross) over 17 months since inception in December 2014, running a portfolio of long only AAA and AA+ rated explicitly guaranteed Government Bonds.
SPECIAL RBA UPDATE - EXPECT FURTHER RATE CUTS ON WEAK INFLATION, $AUD RALLY IS OVER
Australia’s financial future changed significantly with the onset of deflation in April. The quarter on quarter print of -0.2% and year on year just 1.3% were shockingly low. The speed of decay in the inflation data forces the RBA’s hand to meet its inflation mandate of 2-3%. A failure to address this deflationary episode runs the risk of needing to cut rates much further and faster at a later date, hence our conviction the RBA will act in May and again soon after (probably August), as 50 bps rate cut (delivered in 2 x 25bps) is the path of least regret. We believe the RBA will cut to 1.50% before pausing to access the impact on inflation. This is consistent with our thinking on Australian interest rates for some time and will come as no surprise to anyone who has followed our fund.
JCB has written extensively about negative rates and their impact on driving the AUD currency higher via international bond investors coming to buy AUD assets. This currency rally from late January caught many investors off side. After the CPI data the topside of an AUD rally is now entirely negated. We expect the AUD to resume its bear trend towards 0.7260 (200 day moving average) and possibly beyond towards 0.70 cents as the RBA is forced to cut rates.
FX markets traded around 0.77 ahead of May RBA meeting. Market expectations were 50/50 on a rate cut of 25 bps, with expected pricing for RBA cash rates over the year (RBA Run ahead of May meeting: May 1.87 Jun 1.815 Jul 1.785 Aug 1.71 Sep 1.70 Oct 1.69 Nov 1.66 Dec 1.65). This suggests that FX had already priced in ~1.4 rate cuts by Dec year end, given their expectation of RBA cash at 1.65% being one full cut to 1.75% and 40% of a further 25 bps cut being another 0.10% to 1.65%. This means that in an efficient FX market, the RBA will be required to cut TWICE or more in 2016 to move the currency lower than current pricing of 0.77.
Over April risk markets continued to enjoy the policy support of central bankers. Further expectations for US Federal Reserve rate hikes remain muted, with the only a possible hike being in December (58% probability) after the Presidential elections. JCB commented over 2015 about the FOMC and how media expectations of 6 to 8 rate hikes would not materialise. Markets continue to re rate their FOMC expectations, whilst we are not forecasting material or multiple further rate hikes in the US, another small uptick of 0.25 bps is possible in the next 12 months.
Should investors ‘’Sell in May, buy bonds and go away’’? Whilst we have concerns about macro events coming up, well diversified portfolios will continue to perform in all scenarios. If you don’t have a balance of growth, income, defensives and liquidity then you could be in for a bumpy ride. Northern hemisphere summer trading periods have produced significant volatility lately, and there is plenty to worry about and monitor again this year.
Corporate earnings viewed via EBITDA continue to broadly decline, with many companies reporting that whilst beating low earnings expectations, period over period results have decayed leaving valuations stretched. However, as we noted in our last monthly, in periods of high policy intervention, episodes such as high valuations can go on for some time as policy trumps fundamentals.
Speaking of Trump, who could have thought that not only would Donald Trump win the Republican nomination, but also be a viable President as polling in a Clinton vs Trump contest now suggests. We note that whilst almost universally disliked by Australian’s (including ourselves) Trump is trending and evolving as a candidate. The speed of his transformation bares monitoring as markets and investors need to consider what that might look like come the November election. Gone is the yelling and the abuse, replaced by all-inclusive statements across minorities. Americans love re hab and re birth, can Trump be emerge as a front runner?
We will also continue to monitor act IV in the Greek financial tragedy, as the Greek Government is again running out of money and wants its bailout loans extended from its EU saviours, who are currently unwilling. We also must watch the European migration crisis (most migrants arrive in Europe via Greece who is broke) and the evolution of BREXIT debate (Britain voting to leave the EU) and possible market contagion.
Jamieson Coote Bonds Active Fund has performed at a monthly run rate of +53 bps (gross) since inception for a return of 8.55% (gross) running a portfolio of AAA and AA rated Government Bonds. The largest draw down in any month has been -62bps.
MARKET UPDATE MAY 2016
JCB ACTIVE FUND IS UP 9.83% (GROSS) OVER 18 MONTHS SINCE INCEPTION IN DECEMBER 2014, RUNNING A PORTFOLIO OF LONG ONLY AAA AND AA+ RATED, EXPLICITLY GUARANTEED GOVERNMENT BONDS.
RBA CUTS WITH MORE TO COME, FOMC SPINS 180 DEGREES PLAYING CHICKEN WITH MARKETS, RISK LURED IN LOW VOLATILITY FATAL ATTRACTION?
The RBA cut rates in May and will deliver another 25 bps cut by August, taking the cash rate to 1.50%. This has been JCB core thesis for some time, however, we would caution investors about getting overly excited about further rate cuts given the data at hand. Many market commentators who did not forecast these moves are now calling for 1.00% RBA rates by year end. This looks excessive in our opinion. Whilst RBA Governor Stevens stridently defended inflation targeting this month, calling it the ‘’best policy framework we’ve ever had,’’ a period of pause and access is warranted from the RBA after providing the economy with additional stimulus via lower rates and currency.
The AUD closed over 5% lower vs USD over the month and looks set to test the 70 cent level in coming weeks. We had expected more support in the currency around the 200 day moving average of 72.50 area, however, weaker domestic data during the month of May has kept pressure on the currency. Employment remains tepid at best (having lost more than 50,000 full time jobs in 2016 whilst creating more part time work), CAPEX data remains weak at -5.2% and company operating profits declined at -4.7%.
The release of April’s FOMC minutes in late May has recalibrated rate hiking expectations in the United States. After being as dovish (supportive of low interest rates) as possible in March, this move to hawkish commentary (supportive of higher rates) is a huge turn in a short time. The FOMC need to be careful treating the market in this way, as they risk a loss of credibility in changing the messaging so deliberately to drive market outcomes (clearly the dovish Yellen press conference of March was to lower the USD and ease financial conditions). We remain of the view that additional rate hikes in the US will be extremely gradual. The FOMC will pass in June (meeting date 15th) as macro markets have significant event risk later in the month with Bank of Japan meeting on the 16th, BREXIT 23rd, ECB TLTRO allotments 24th and Spanish general elections 26th. July is a possible month to hike, however, markets are only currently priced 50/50 at this stage with near term expectation’s being driven by a clear passage of the above global macro market risks. Markets traditionally get volatile in Northern summer trading, hence clearing this list without some hiccups seems unlikely to us.
We wrote in our April monthly that ‘’well diversified portfolios will continue to perform in all scenarios. If you don’t have a balance of growth, income, defensives and liquidity then you could be in for a bumpy ride.’’ So far there have been very few bumps along the road. As financial market volatility drops, risk levels are increased and times are good. The main narrative for the risk market bulls has remained that declining market breadth, deteriorating high yield debt and lower oil prices would not matter (noted these 3 measures have all improved over the last few months), and the bull market will rage on driven by extraordinary Central Bank policy intervention. This may very well be the case, however, the problem as we see it is the lack of corporate earnings. According to FactSet 72% of S&P 500 companies reporting so far have issued negative guidance for Q2 on top of declining earnings for Q1, and yet US equities remain very close to recent highs. Well played Ms Yellen, you certainly have the market snookered for now. However, without a base in US earnings, markets will remain susceptible to bouts of volatility. Either earnings improve to justify valuations or the attraction of performance in lower volatility could prove fatal when the winds change. But it may not. Investing in a policy driven environment is very difficult as policy can trump fundamentals for long periods. Is it better to risk the loss of opportunity or the loss of capital? As conservatives investors we have strong views on this question.
Jamieson Coote Bonds Active Fund has performed at a monthly run rate of +54.6 bps (gross) since inception for a return of 9.83% (gross) running a portfolio of AAA and AA rated Government Bonds. The largest draw down in any month has been -62bps.
MARKET UPDATE JUNE 2016
JCB Active Fund is up 11.13 % (gross) over 19 months since inception in December 2014, running a portfolio of long only AAA and AA+ rated explicitly guaranteed Government Bonds.
REMAIN ON HIGH ALERT, KEEP CALM & CARRY ON, CRISIS MANAGEMENT IN POLITICAL VACUUM
History does not repeat, but it can often rhyme. At the time of writing 6 retail UK property funds with $18 billion of assets have been frozen to investors sighting ‘’exceptional illiquidity.’’ These fund providers are all household names in the UK. Standard Life, Aviva, Aberdeen Asset Management, Henderson, Threadneedle and Canada Life now have products seized shut by market liquidity vanishing just like that.
In 2008, Bear Sterns froze two subprime funds (Bear Sterns ultimately failed) in what is often described as the prelude to the GFC, sparking contagion fears around all markets. The 2nd and 3rd round implications from BREXIT continue to playout and it is too early to know if this will morph further towards a full blown crisis,or be contained and perhaps another buying opportunity for quality assets. We believe more patience is required with this scare then previous market wobbles in August 2015 and Jan 2016.
As it stands today, the UK remains leaderless in all 3 major political parties. It is the first sovereign ever to be double downgraded from AAA to AA (usually go to AA+ first), and its GBP currency has suffered a peak to trough depreciation of 15% so far. Spare a thought for any businesses with USD debts but GBP revenues. Two weeks on from the vote we are no closer to understanding how BREXIT will work, what timeframes are required or who will lead the complex negotiations with Brussels. This situation requires heightened monitoring and will continue to dominate investor sentiment.
Unfortunately BREXIT has let the volatility genie out of the bottle. The ripples of such large moves in GBP currency markets will not remain contained. Central banks have used policy to fight poor fundamentals and dampen volatility since the GFC, however, this is different. After the one off shock of BREXIT we are now left with a number of continuing unknowns which cannot be easily dampened. In our last two monthly’s updates we have advised investors that ‘’we have concerns about macro events coming up, but well diversified portfolios will continue to perform in all scenarios. If you don’t have a balance of growth, income, defensives and liquidity then you could be in for a bumpy ride.’’ The bumps maybe just beginning. Good planning and process and asset allocation will be critical to holding investors in good stead.
Crisis management follows an obvious playbook. The better prepared and cooler the head, the better the financial outcomes. Keep calm and carry on trading perhaps? Volatility produces wonderful opportunities to both buy and sell assets, but investors must have a plan and stick to the script as these opportunities present themselves. Today’s bid can be tomorrows offer very quickly and vice versa. High quality assets may be dragged cheap making for good buying, low quality will be dragged down and may not recover. Liquidity management remains paramount, leverage, margin loans or high debt burdens need careful consideration as margin requirements can be increased or loans called at short notice.
In the aftermath of the BREXIT vote Jamieson Coote Bonds hosted a brief 30 minute conference call for investors to utilise the collective financial experience of the founders and advisory board members Saul Eslake and Mark Burgess, to discuss the opportunities and risks presented by such a shock vote. A recording of the call is still available on 1800 154 669, please use passcode 2386 78009.
Jamieson Coote Bonds Active Fund has performed at a monthly run rate of +58 bps (gross) since inception for a return of 11.13% (gross) running a portfolio of AAA and AA rated Government Bonds. The largest draw down in any month has been -62bps.
MARKET UPDATE JULY 2016
JCB Active Fund is a portfolio of long only AAA and AA+ rated explicitly guaranteed Government Bonds. Since inception annualized returns are currently 6.57% net of all fee’s.
• Hope for the best and plan for the worst
• RBA to pause for 2016, resume rate cuts in Q1, 2017
• Trumped – how high can Mexicans pole vault in Rio?
• Paul Chin joins JCB investment team
We did it your honour! Has it really been seven weeks since BREXIT? "What BREXIT"? we hear you say.
Long seasoned markets professionals really worried about BREXIT, ourselves included. Collectively between JCB management and our advisory board we have hundreds of years of markets or corporate experience, having occupied senior roles in large financial institutions and corporations over long time frames. Collectively we really worried and hosted a conference call in the days after, dusting off the crisis playbook. We had a plan to have substantial plans if required. Good investment process would be critical. We hoped for the best but planned for the worst.
To date, all that worry has all been in vein. Vacant political posts in the UK have been filled and BREXIT looks to be a very slow and drawn out process. Unless you own GBP assets (which has hurt) there has been little negative impact for Australian investors. In fact, perversely, it was a great opportunity with many asset classes rallying on immediate Central Bank support for markets.
The incredible resilience of markets this year had caught many by surprise. We have written about policy vs fundamentals previously and how ample liquidity and low interest rates can keep on keeping on, despite the financial building blocks of today's markets being untested over time. It is not growth and prosperity that is driving asset values, but immense central bank support and stimulus. The longer this goes on the more accepted and mainstream it becomes. Intuitively there seems a danger to this complacency. Tepid fundamentals matter in the end but the current global policy mix remains very supportive for all asset markets. Asset quality remains critical and will really matter when we hit the end of the policy super highway. Predicting when that day comes is futile, as it could be many years away. We are dealing with policy that has never been utilised before and learning some of the side effects as we go (middle class distress and growing wealth equality) It has an end point, but for now asset owners remain prosperous.
The RBA delivered as we expected in early August, completing our 50 bps of expected cuts in 2016. We believe a period of pause and assess will see out the year before they are drawn into cutting again an additional 50 bps in 2017 due to currency appreciation and continued weak inflation, remaining below the RBA target range of 2-3%. The RBA still retain an easing bias keeping a November cut a possibility, but the hurdle is high for a further move on current data. Many commentators have vastly re rated RBA cash rate estimations over this 2016 cutting cycle with Morgan Stanley, JP Morgan, Macquarie and NAB all now calling for 1.00% RBA rates into 2017.
Trump. So how high can Mexicans pole vault in Rio? We have written about Trump gaining momentum in a world effected by nationalism (producing BREXIT, Le Pen, Italian northern league, Pauline Hanson etc) This global wave of anti-establishment populism can carry Trump to the White House if he can stay out of his own way. It's been a torrid few weeks with criticism of fallen US Muslim soldier, abusing crying babies and refusing to address Paul Ryan and John McCain, the lifeblood of Republican Party. Markets are not taking Trump seriously at this stage. It is early to write him off but he must avoid Trumping himself. If he learns from these slips and stays tighter lipped, expect a bounce in polling numbers and nervousness from markets.
Finally we are pleased to welcome Paul Chin to the investment team at JCB. Paul joins after a 20 year asset management career with BGI San Fransisco (now Blackrock) and Vanguard in Melbourne. This takes the JCB investment team to 52 years of investment experience, of which 30
years has been in international markets.
JCB is a conservative fund manager, with capital preservation and risk adjusted returns being our core tenants. If we cannot find compelling risk adjusted opportunities to invest your money we will not allocate, preferring benign low duration short dated bonds with little risk. Our models and processes considered the moves around BREXIT to be excessive and as such we sold some longer dated bonds after strong performance, looking to re set when markets cooled. As at July's close that return to "fair" value had not been completed and we have under-performed our index over the month, albeit whilst generating strong absolute returns of 3.20% net of fee's over the last 3 months. Indexes are funny things, having portfolios at maximum risk at all points in the pricing cycle. They represent the opportunity set of a market place. We fundamentally disagree with passive index investment and aim to run the least amount of risk for our returns, a process that has delivered to date with the JCB active fund using only 80% of market index risk to outperform the index since inception. This makes our return profile stronger over time. At the time of writing we have outperformed in August as the market has cooled. We now believe the bond market to be at fair value for current monetary policy settings. We have added some spread risk to the portfolio over July looking to earn additional carry over the quieter European Summer period.
MARKET UPDATE AUGUST 2016
JCB Active Fund is a portfolio of long only AAA and AA+ rated explicitly guaranteed Government Bonds. Since inception annualized returns are currently 7.17% net of all fee’s.
• Marking time before volatility as markets return from the sun-lounger
• FOMC should hike in September but will wait until post US election December
• $AUD like a beach ball under water. Critical levels 0.7390 vs 0.7720
“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” - Mark Twain
After the BREXIT excitement of late June, markets have been very dull over the balance of the Northern Hemisphere summer. Central Banks have had our collective backs, providing more cheap money, whilst major news flow has been light. Financial market volatility has dropped 55% over the last 10 weeks – the largest 10 week decline ever! Northern Hemisphere summer is now over and people are dragging themselves back to work after an extended rest on the sun-loungers. We expect market participation to pick up, challenging the status quo of the tame July and August months. Of late, rhetoric from the Federal Reserve has turned hawkish (sympathy to a rate hike). Financial conditions in the US they are as favourable as we have seen for some time:
- Equity valuations are high;
- the USD currency index currently mid-range on the year;
- corporate credit spreads have tightened;
- bond yields are low; and,
- consumer confidence is high.
If we didn’t consider the implications of a US election in November, we would absolutely argue that the FOMC would hike rates immediately. Ordinarily, however, the FOMC doesn’t move during the presidential cycle and a rate hike would be considered damaging for markets, hurting the Clinton campaign. Yellen is a democrat, and we have seen commentators like Barney Frank add weight to the debate that the FOMC shouldn’t interfere with the election cycle by upsetting the apple cart. We believe that FOMC credibility is at stake, with a possible September hike being a very close call. The market and economic conditions are there to justify a single rate hike – does politics interfere and hope the winds don’t change come December?
A Clinton presidential victory, combined with a split Congress and Senate is NIRVANA for financial asset prices. Nothing can be achieved on the fiscal side in this scenario so the FOMC will be forced to keep rates low and provide significant liquidity over the presidential term, which will boost financial asset prices. This remains the central expectation of markets. We note recent Economist and CNN polls showing Trump and Clinton neck-and-neck. Trump has done everything wrong and the Democrats arguably everything right, and yet the polls are narrowing. That is truly scary. BREXIT has highlighted the dangers of ‘knowing for sure’ that Trump cannot win. We continue to monitor this space very closely into the November elections.
The outcome of the FOMC meeting on September 21st will drive near-term expectations for the AUD currency. Technically the currency is coiling, meaning when the narrowing range is broken, we would expect a substantial follow through. The major levels to watch are 0.7390 (this is trend line support and 200 day moving average) to the down side and 0.7720 to the top side being the trend line in place since April 2013 when AUD was $1.0500. At this stage we still believe the AUD will break higher through 0.7750 area to test 80 cents. Despite strong domestic opinion that the AUD currency remains overvalued, the currency has managed to rally 11% since its January lows, despite two RBA rate cuts, which begs the question where the currency would currently be if RBA hadn’t cut rates this year? We still maintain that AUD bonds are broadly range-bound in the short term, regardless of a single FOMC rate move. We continue to position the portfolio tactically around this opportunity set, and believe the RBA will be forced to cut rates again in early 2017 due to unwanted AUD currency strength.
JCB Active Fund returned 44 bps (gross) in August, beating the index by 10 bps. Whilst markets remain calm we have maintained a higher weighting to State Government Bonds and Supra Nationals Bonds, looking to earn additional carry income. Should volatility rise into September, we will review these allocations going forward and may reverse. We maintain an overweight to the long-end (20 year) of the Australian bond curve, hedging with some steepening in shorter dates to balance the curve risk. We would add to this position into any cheapening via a supply concession should the AOFM issue a new 25- year bond in October (as expected).
MARKET UPDATE SEPTEMBER 2016
JCB Active Fund is a portfolio of long only AAA and AA+ rated explicitly guaranteed Government Bonds. Since inception annualized returns are currently 6.60% net of all fee’s.
● Volatility arrives on cue in Sept; Deutsche Bank gives risk a scare
● Negative media count at 16 year highs for bonds, contrarian signal?
● What would total returns look like in a mirror image bond sell off? You should ‘’bear’’ that in mind.
September produced the challenge to status quo in markets we had written about in the August monthly, with increased volatility across all asset classes. Markets continue to grapple with quantitative easing policy and balance sheet expansion and contraction in the central banks of Japan, the US, Europe, and England. To see out the year we also have to contend with the US presidential election, Italian senate referendum - a possible BREXIT moment for Eurozone - and stressed European Banks, led by Deutsche Bank and Commerzbank.
All of these possible event risks would normally drive investors towards the safety and security of Government Bonds, and yet mainstream newspaper or social media feeds tend to be extremely negative towards bonds. In fact, the ‘’hawkish’’ (higher interest rates) count in global media is something that quantitative analyst Neil Tritton (and our London-based Advisory Board member) monitors, peaking at a 16 year high in September. We have seen
headlines such as ‘’short of the century’’ and ‘’end of bond bull market’’ littering media outlets. This is misleading. Bonds may well find a new post BREXIT valuation range, however, to achieve a sustainable sell off would require central banks to materially and consistently lift interest rates. Globally this looks extremely unlikely after rate cuts this year from Australia, Japan, Europe, New Zealand and Canada. The ‘’bears’’ tend to forget that the record asset prices we are all enjoying are a result of low interest rates, but the mirror image would be a brutal deleveraging which happens much faster than a re-leveraging that we have already experienced. It is hard to see how any central bank would be a material interest rate hiker into collapsing financial asset and property prices.
The other major problem for the bond ‘’bears’’ is time. If you are short or underweight bonds, unless the market sells off immediately, you are paying away ‘’carry or coupon’’, ie the interest payments made by the bond’s issuer (in our case, Australian dollar denominated Governments). That carry or coupon is all powerful over time and is the main source of return for this asset class. An August 2016 study by Bank of America/Merrill Lynch looked at bond returns in a bear market that entirely mirrors the rally of the last 30 odd years. A bloodbath you might think, with bond yields getting higher and higher over that time. Assuming an investor stayed invested throughout that period, the returns are incredible. German Government Bonds, starting at a negative observable yield, produce a total return in excess of +350%. US Treasury Government Bonds returned more than 400%. Australian Government Bonds were higher again. That discredits the long-term ‘’bear’’ narrative. This major advantage of bond ownership is that carry or income continues to grow as the market sells off. Bonds are entirely unique in this manner: as their price declines the income opportunity set of the asset class grows. When bonds rally, investors are in receipt of ‘income’ (coupon/carry) plus an unrealised capital gain. When bonds prices decline, investors are still in receipt of income, whilst also having an unrealised capital loss. This unrealised loss does not need to be crystalised. If you own a bond to maturity, you will receive income during the ownership period, plus return of principal upon maturity. The critical thing to assess, of course, is the creditworthiness of the bond-issuer - in our case AAA and AA+ rated Governments, to repay in the future.
Diverse opinion from buyers and sellers is a hallmark of financial markets. Bulls and bears set the market clearing price and the challenge is to pick the optimal time to buy and sell in all asset classes, whilst at the same time maintaining a balanced asset portfolio that spreads and reduces risk. We always suggest a balanced and diversified portfolio, in which government bonds, with income guaranteed by government and immense liquidity, are an anchor or bedrock asset class. Investor life-cycle and risk tolerance thereafter will dictate the allocation size as a percentage of the portfolio.
We still maintain that AUD bonds are broadly range-bound over the balance of 2016 as the RBA move to the sidelines into a pause and assess phase. However, given the extreme negative sentiment of the media, any ‘’shock’’ could produce a powerful rally, as underweight investor positioning would be seriously challenged. The market is priced the FOMC to raise interest rates once in December and has already discounted this scenario. We would expect Bonds to do well on any such move, similar to the powerful bond rally after the singular FOMC hike in December 2015. We continue to tactically position the portfolio around this opportunity set and will continue to manager through the volatility.
Fund update for September
JCB Active Fund returned -9 bps (gross) in August, beating the index significantly by 28 bps. Government Bonds traded in a wider range over the month, with the curve steepening aggressively on the announcement of a 30 year syndicated new issue for the Australian Government due in early October. The fund retained an underweight position early in the month which generated outperformance verses the index on the selloff. Markets also grappled with changes to the policy mechanics of the Bank of Japan’s Quantitative Easing policy, which now seeks to steepen the Japanese bond curve to improve the net interest margin for financials. Additionally, the threat of a September FOMC rate hike loomed over the market. Both of these event risks passed without major incident, and we added duration thereafter, moving towards index allocations into month end, locking in outperformance over the month versus the index.
We will look to set tactical underweights and steepening positions into the pricing of the new 30-year bond, as we believe this will be offered at a discount to fair value over the medium term and hence will look to participate in the new syndicated deal in early to mid-October.
MARKET UPDATE OCTOBER 2016
JCB Active Fund is a portfolio of long only AAA and AA+ rated explicitly guaranteed Government Bonds. Since inception annualized returns are currently 5.43% net of all fee’s.
• Assets markets get hit ahead of US election
• Inflation remains problematic for RBA, but SA floods produce temporary headline CPI pop
• Exceptional supply drags on bonds prices in October
Investment markets decayed in October, pricing in additional risk premium ahead of the US presidential election. Both equities and bonds suffered declines over the month, as investors repositioned to face the prospect of a Trump presidency. Investment markets grew increasingly confident that the FOMC would complete on a single rate hike by year end in their December meeting, assuming the market could navigate the US election and Italian Senate referendum without major hiccup. Volatility continued to increase across most markets, led by GBP Sterling currency
which suffered a ‘flash crash’ of over 6.00% early in the month.
Australian inflation remains problematic for the RBA, with Q3 data showing year over year CPI weighted mean decaying to only 1.3%. Headline inflation came in stronger at 0.7% quarter on quarter, but this was significantly affected by South Australian floods causing a 20% rise in fruit and vegetable prices. Once supply normalises in these fruit and vegetable producing regions, this headline shock will be removed, causing a future drag on the already weak domestic inflation picture. This continued decay in domestic inflation, combined with AUD currency which refuses to
fall, maintains a slight easing bias at the RBA into 2017. Notwithstanding the prospect of a rate hike from the Federal Reserve in December; the fact that it has taken the combination of still incredibly easy monetary policy in the developed world and a surge in credit growth in China to produce around average global growth suggests that the prospect of much materially higher global interest rates over the next few years remains highly remote. And given the sensitivity of the Australian dollar to differences between Australian and global interest rates, that would also suggest that an historically low RBA cash rates are likely to remain a feature of the Australian economy for some time.
Over the course of October, bond markets initially decayed, following international markets higher in yield. In the middle of the month, two specific transactions contributed substantial supply to the market over an 8-day period, in the issuance of Australia’s first ever 30-year Government Bond and an interest rate swap transaction for the sale of AusGrid electricity network in NSW. This supply was truly exceptional in both size and market risk. Initially the Government had telegraphed a desire to issue 4 billion 30yrs bonds. Upon opening the transaction, the initial order book was north of 14 billion in a matter of hours, and as such the government upsized the transaction to 7.6 bln. This alone was the largest ever duration issue in Australian Fixed Income history. Hot on the heels of this transaction was the AusGrid interest rate swap which produced around 10 bln of varying but longer dated maturities of duration supply to the market. This is exceptional because the combined duration of both transactions issued in a 8 day period eclipsed the entire duration of the Australian Government Bond market of 2007. Put another way, how much market concession would be required to re IPO the ASX equity market of 2007 in an 8-day period? This heavy issuance was a
major contributor to the pullback seen in bonds prices over the month.
Fund update for OCTOBER
The JCB active fund declined by -1.48% (gross) in October, beating the index by 0.35%. The fund remained cautiously positioned vs the market heading into the month, retaining an underweight duration exposure and curve steepening structures in anticipation of long end supply concessions. After a significant duration concession in the issuance of the new Australian 30 year bond, we lifted the portfolio’s exposure back toward benchmark, capturing outperformance in the process. The Ausgrid transaction was unexpected by the market and hence we didn’t manage to generate any
additional alpha return around this market movement, but did suffer beta decay. We continue to like building the portfolio with a heavy skew to short dated bonds that now carry at positive yields vs the RBA cash rate as we believe these offer compelling risk/reward over time.
MARKET UPDATE NOVEMBER 2016
JCB Active Fund is a portfolio of long only AAA and AA+ rated explicitly guaranteed Government Bonds. Since inception annualized returns are currently 4.26% net of all fee’s.
• Trump’s win pushes markets on expectation only, increases risks for portfolio’s
• Lifting the service cost on $240 trillion of global debt
• Whilst global markets focus on Trump, Australian domestic data collapses
• Observations of buyers and sellers of Australian Government Bonds
• Australian Banks hiking mortgage rates ‘out of cycle’ as funding costs increase
Trump’s win pushes markets on expectation only, increases risks for portfolio’s -
Positive Trump momentum has reigned supreme in markets since the US election, with themarket moving to a euphoric state factoring in expected future growth and inflation in the United States. Only time will tell if this fully materialises and what the implications will be for global trade and financial assets. As is widely known, markets move quicker than policies and in turn new infrastructure identification, planning, funding, and employment takes even longer.
From a technical perspective looking forward via a normal distribution bell shaped probability curve, the possible financial market return outcomes have widening significantly to both the up and downside.
Under a Trump led US Government we will likely get strong near term US growth, but we might also suffer broader global geo-political tension. This could have an impact on borrowing rates (as outlined further below) that can endanger global markets given their heavily indebted nature post the global financial crisis (GFC). The only constant that seems assured in 2017 is market volatility, making diversified portfolio’s critical to navigating future investment markets twists and turns.
Jamieson Coote Bonds notes that we have been here before post GFC; via similar financial market moves on the election of Obama, with the commencement of multiple QE programs and with Abenomics in Japan. These moments were suggested at the time as the catalyst for job creation, delivering sustainable growth and generating inflation. Sadly as we know, none of this has occurred. The outstanding question is - can Trump succeed where other capable leaders and programs have failed? It is of course too early to answer this question in full, but the markets have certainly priced in lofty expectations as evidenced by the ‘asset side’ of Trump’s future Presidential term, with little regard for the ‘liabilities’ side that will provided economic headwinds to Trump’s term in office.
The prevailing US commentary around lower taxes, stimulus spending and deregulation are all welcome near term, but cutting your income (via tax cuts) whilst spending more, plus allowing bankers free rein isn’t a sustainable or healthy proposition for the longer term.
Lifting the service cost on $240 trillion of global debt -
Since the GFC, global debt levels have increased dramatically from $140 trillion to over circa $240 trillion. All this new debt has essentially been created from zero interest rate policies, given the lower rate environment we find ourselves in. This debt of course requires servicing, as it must be rolled forward as it matures over differing time frames. The Trump euphoria has seen US borrowing costs climb quickly in expectation of higher growth and
inflation. This has had the impact of causing an immediate in specie tightening of financial conditions, as the cost of servicing this huge debt load has in effect increased. Combined with a stronger USD currency, the market has essentially hiked interest rates in the United States during November. These events will most likely be followed by the Federal Open Market Committee (FOMC) hiking rates on December 15th and Jamieson Coote Bonds notes a rate
hike is 100% priced in markets (as observed by the indicative US Fed Funds Futures contract forward pricing), leaving US consumers with essentially a double financial tightening for their hip pockets into 2017. This should have a short-term impact on standard US mortgage, car loans and student debt serviceability levels and will create a drag on future US economic growth levels and expect weaker incoming data to support this view and will be watching this
with keen interest in the New Year.
Whilst global markets focus on Trump, Australian domestic data collapses -
While Australian interest rates have historically risen in sympathy with US rate moves, Australian economic data has recently fallen dramatically. In sequential order over the last few weeks the Australian economy has:
• Recorded its weakest ever wage growth - important due to high correlation to inflation data which is still weak at 1.30% YoY and below the 2.00 to 3.00% RBA mandate,
• Lost 12,000 full time jobs on average each month during 2016, whilst creating part time work (structural under employment),
• Construction work completed has dropped -4.9% in Q3, its weakest reading in 15 years (key indicator as construction has helped fill the void left after the mining boom)
• Building approvals fell -24.9% in October following a decay of -6.8% in September, placing pressure on the construction pipeline into 2017.
• CAPEX intentions (as tracked by the ABS ) continues to fall posting -.00% for Q3; and
• GDP for Q3 was significantly below the weakest estimates at -0.5% posting negative quarterly growth
Without the recent Trump associated market moving headlines, we would normally be discussing when the RBA would be cutting interest rates to stem the recent poor domestic data flow. Ironically, Australian banks have however been increasing mortgage rates on fixed and variable products in response to the higher cost of funds. This is worrying as this comes at a time when Australian debt to income is at record highs, making Australian consumers
very sensitive to interest rate movements. Should the Banks continue this trend whilst the domestic data remains so weak, the RBA will be forced to react by cutting interest rates.
Observations of buyers and sellers of Australian Government Bonds -
Flows remained mixed over November period from international holders of Australian Government Bonds. Selling was noted as emerging Asian Central Banks raised cash to defend local currencies against large moves. Local managers have trimmed risk in longer dated bonds as the market re calibrates inflation expectation, but added risk in short dated
bonds in recognition of the poor domestic data. Sovereign wealth managers remain cautious on bonds currently given the speed of the move post Trump, however, there remains broad agreement that valuations have improved significantly, and once the asset class stabilises Australian rates are favoured given the weakening domestic data and high yields on offer. Australian Banks hiking mortgage rates ‘out of cycle’ as funding costs increase.
Jamieson Coote Bonds concluding remarks
After rapid market moves post the US election, opinions among asset owners and CIO’s are widely distributed. Without question, we are entering a period of higher uncertainty about US monetary policy and higher uncertainty about fiscal and structural policy. This will lead to continued higher uncertainty around the direction of the global economy with increased volatility for investment markets. The current and likely future macro-economic backdrop will likely lead to various different outcomes for investment portfolios.
The ‘expectation’ of Trump must meet ‘realisation’ into 2017 to justify the recent new valuations for growth and defensive assets will be tested at a time of record debt burdens. As investors are aware, there is a concrete relationship between the price of money for borrowers (i.e. individuals and corporate) and the financial health of markets. In this regard, Jamieson Coote Bonds is of the view that further material increases in the price of money may begin to impact over leveraged consumers and an over-indebted corporate sector, which could start to
impact risk asset valuations.
If this trend continues, markets should reach a tipping point where a broader deleveraging cycle begins, which will put a drag on global growth and in turn dent risk asset valuations. With volatility looking set to be our only constant in 2017, portfolio diversification remains as critical as ever. The likely future significant divergence between asset classes provides a compelling backdrop to incorporate cornerstone defensive allocations in portfolios. Australian Government Bonds can offer investors this true to label exposure.
Fund update for November
The JCB active fund declined by 1.69% in November, outperforming the Bloomberg AusBond Treasury (0+Yr) Index by 0.17%. The fund remained underweight duration during the month, with a preference for holding short dated bonds (which are more heavily driven by RBA policy) and was underweight positions in longer dated bonds (which are driven
primarily by inflation expectations). JCB notes the increase in short dated yields as being particularly unusual given the extremely poor domestic data flow experienced over the month. Moving forwards, as RBA rate hikes are extremely unlikely given the poor recent domestic data, combined with the tightening of financial conditions via out of cycle bank rate hikes, we will look to increase positioning in the front end of the curve on any further price cheapening.
MARKET UPDATE DECEMBER 2016
JCB Active Fund is a portfolio of long only AAA and AA+ rated explicitly guaranteed Government Bonds. Since inception annualized returns are currently 3.95% net of all fee’s.
“If I were to run, I’d run as a Republican. They’re the dumbest group of voters in the country. They believe anything on Fox News. I could lie and they’d still eat it up. I bet my numbers would be terrific”. Donald J. Trump, soon to be the 45th President of the United States of America."
The only certainty from here is volatility: well-diversified portfolios will be positioned to ride the tides -
Positive President-elect Trump momentum continued through December – equity markets have baked in lofty expectations of economic growth in the form of strong asset valuations. In reality, the incoming Administration will actually need to deliver on these promises, and Inauguration does not occur until mid-January.
JCB feels this is likely to be a bumpy process, causing gyrations and volatility over the coming months as Trump learns that running a Government is vastly different than running a business. Without question the range of possible market outcomes have widened significantly given the large political policy changes ahead and the possible ramifications. Predicting the outcomes of tough negotiations with House and Senate Republicans is difficult at the best of times, as well as any response from China and Russia to such developments. This will shape the environment into H1.
Whilst it is tempting to position portfolios in line with current momentum, we note that the market is now heavily skewed towards a successful implementation of Trump’s economic plan. In short, any gap between expectation and reality may cause an outsized market reaction. As always JCB advocates a balance portfolio approach, particularly in times of expected heightened volatility.
The US policy agenda according to Paul Ryan, Speaker House of Representatives: right-size growth expectations -
In private meetings with senior US Investment Banking executives held in NYC early January 2017, Paul Ryan listed the above agenda items in order of priority as discussed with the incoming Trump Administration. Last month JCB highlighted the often significant time lag of implementing infrastructure spending due to time delays of project identification, planning, funding and contracting the tender process. Infrastructure spending can be major plank in stimulating economies; given this is a stated low priority for the new Administration (according to Ryan), some caution is warranted in a market that is anticipating immediate and sustained growth.
What happened to the four US FOMC rate hikes expected at start of 2016? Finally, the market gets over the line with a hike in December -
At the beginning of 2016, the market had priced in four expected FOMC rate rises for the year ahead. For reference, calendar 2016 saw market participants expecting a ‘normalisation’ of US interest rate policies being disappointed. What played out in 2016 (which was much like 2015) saw twists and turns that delayed and frustrated the rate hawks. Finally, in December the US Federal Reserve managed to hike interest rates once.
Many market pundits for 2017 are again expecting a number of rate rises, with current market pricing suggesting three moves. JCB has written for some time about the difficulty of raising rates in an environment saddled by high debt. Considering the current position and conditions, we believe two hikes (rather than three) is more likely for 2017.
Some observations of buyers and sellers of Australian Government Bonds -
Financial market flows remained mixed over December from international holders of Australian Government Bonds. We noted selling tendencies early in the month as emerging market Asian
Central Banks raised cash to defend local currencies moves. Later in the month Sovereign Wealth Managers and international real money managers started to accumulate bonds after the significant cheapening. This dynamic saw bond valuations lift materially into the end of the month. Overall flows volume remained below average given the December and holiday period.
Jamieson Coote Bonds concluding remarks
Markets are entering a period of higher uncertainty about the path of US fiscal, monetary, and structural policy. Geopolitical events have the possibility to destabilise the status quo bringing volatility to investment portfolios.
The ‘expectation’ of Trump must meet ‘realisation’ in 2017. Jamieson Coote Bonds continues to believe that further material increases in the price of money may begin to impact over leveraged consumers and an over-indebted corporate sector. This will start to impact risk asset valuations.
If this trend continues, markets should reach a tipping point where a deleveraging cycle begins. This will likely put a drag on global growth and, in turn, dent risk asset valuations further. The likely future significant divergence between asset classes provides a compelling backdrop to incorporate cornerstone defensive allocations in portfolios. Australian Government Bonds can offer investors this true-to-label exposure.
Fund update for DECEMBER
The JCB Active Bond Fund declined by 0.29% in December, underperforming the Bloomberg AusBond Treasury (0+Yr) Index by 0.12%. The Fund remained underweight duration during the month, with a preference for holding short-dated bonds (which are more heavily driven by RBA policy). We positioned the Fund to be underweight in longer dated bonds (which are driven primarily by inflation expectations). JCB notes the increase in short dated yields as being particularly unusual given the extremely poor domestic data flow experienced over the Q4 period. The fund held a larger exposure to Supra bonds (World Bank etc) as we remained concerned that a cut in the Australian Government credit rating from AAA to AA+ was possible through the budget update period. Supra Bonds would remain AAA rated, and hence would materially outperform in this scenario.
MARKET UPDATE AUGUST 2015
CHINA DEVALUES YUAN AS DATA COLLAPSES, EQUITIES BEARISH DEATH CROSS, FOMC BLINKING, AUSSIE CAPEX SHOCKER (AGAIN)
Bonds are boring. So boring. Imagine how dull you’d be if you talked about bonds all day? I often wonder, as I stand alone at cocktail parties, why everyone loves real estate agents? Is it because they tell you what you want to hear? Sorry to tell you but unfortunately, August was all bad news and it looks like we have plenty more to come. August had been fairly uneventful until China dropped a financial nuclear weapon in response to horrific export trade data at -8.3% year on year with a shock devaluation of its currency against the USD on August 11th. This is HUGELY important for markets. China is now exporting deflation around the region by artificially making itself more competitive via a lower currency. Weakness in China was further confirmed with bad manufacturing data on Friday the 21st leading to the worst 4 day fall in the US equity markets in 75 years (in point terms). After a Chinese RRR rate cut in response to collapsing equity markets, US equity markets had their biggest 2 day gain. This is not usual volatility, it is a symptom of markets that have been too manipulated for too long. Most investors can handle a pull back, but losing a year or more of gains in a few trading sessions should be a large wake up call for complacent portfolios who should revisit portfolio construction and allocations across asset classes. China has poured huge amounts of liquidity and effort into stabilising their equity markets which has not worked. Are they losing control? Bonds are boring until everything else is dangerous (see attached chart vs equities). In August alone, Australian equities have lost 8.6% whilst bonds have continued to grind forward. Trend is your friend in markets and US equities are now trending lower on a long term basis.
Fears over weakening global trade, potential rate hikes from the FOMC and collapsing commodity prices have seen equities trading lower since May. They have now generated a technical ‘’death cross’’ where 50 day moving averages close lower than the 200 day moving average price, illustrating long term trend reversal. Investors should remain very cautious going forward as weak price action continues with equity rallies now being used as selling opportunities. We expect bonds to continue to perform as investors search for high quality, low risk and low volatility fixed income assets.
The new catchphrase in equity markets is ‘’I’m a long term investor’’, which has followed on from ‘’equities with bond like characteristics’’ earlier in the year. Which equites had those bond like characteristics? Woolworths, a place we shop every week, down 10% in a day. Banks down over 20% from their highs. Good stable businesses being violently repriced. Looking forward we have move to worry about.
Yield premiums ( credit spreads) on investment-grade debt have widened by 32 basis points over the past three months, according to Bank of America Merrill Lynch index data. Since 1996, there have been five occasions when credit spreads showed similar movement. Two of them preceded recessions in 2001 and 2007 when stocks went on to drop 50 percent or more. In the other three instances, the S&P 500 fell at least 16 percent while the economy continued to grow. The latest was in August 2011, when the S&P 500 was mired in a 19 percent retreat that almost ended the bull market. Assuming the U.S. economy will be able to avoid a recession this year, as predicted by economists surveyed by Bloomberg, and stocks fall by the average magnitude to reflect similar credit stress in the past, the S&P 500 would hit 1,742, a 18 percent decline from its all-time high reached in May. That level, last seen in February 2014, represents a 12 percent drop from its August close. http://www.bloomberg.com/news/articles/2015-08-31/s-p-500-rout-has-room-to-go-if-bond-spreads-have-anything-to-say
JCB has argued for some time that the FOMC shouldn’t raise rates in 2015 as the data and market construct does not allow. We wrote at length about this last month and how economists have consistently called this incorrectly. If they do hike, JCB believes it will be less than the 25 bps expected by markets (Yellen has a history of soothing market risk transfer) so we assume 12.5 or 15 bps hike if they go but ultimately, even a small move will be viewed as a policy error (same as ECB hike in 2011) as it will contribute to a deeper equity market sell off on USD strength. We still assume no move but there is a small probability they will move.
Australian data over August remained on weaker side with unemployment climbing to 6.3% and Q3 capex data again coming in weak at -4%. Whilst a lower currency is helpful in rebalancing Australia’s economy, we still face significant head hinds from lower commodity prices as evidenced by our declining terms of trade. Without any fiscal stimulus forthcoming, the RBA will ultimately continue its cutting cycle, despite what it says in public. Don’t forget the RBA wished everyone a Merry Christmas with language ‘’a period of stability is warranted’’ with reference to rates and cut immediately in February without warning. They are a 100% reactionary Central Bank which is why we maintain our long held view that they will cut again in November ’15 after Q3 inflation report.
There is an old maritime brokers saying ‘’dictum meum pactum’’ meaning ‘’my word is my bond.’’ It is boring no doubt, but sometimes you should just take the bonds and leave the words and promises to others.
FUND HIGHLIGHTS & POSITIONING
Jamieson Coote Bonds Active Fund gained 0.56% gross during August. After the rally in bonds markets in July, JCBAF lightened duration into month end and added to curve flattening exposure in sympathy with declining oil prices.
We also added some semi (state) government exposure up to 35% of portfolio to capture additional carry through the usually quiet August period. After the surprise Chinese devaluation of the Yuan we added duration and cut additional semi risk, moving back into core ACGB holdings. We initially outperformed the market in early part of the month, however the shock Chinese announcement generated a snap steepening of the curve, catching us poorly positioned, and we gave up that initial outperformance. The fund finishing the month essentially at index returns, 3 bps ahead of index gross or 3 bps below the index net of all fees. We expect significant financial market volatility going forward into Q4, hence we will run lighter risk and look to capture those opportunities as they arise rather than sitting on a large core position. We broadly expect bonds to continue to do well and risk markets to be vulnerable, but we need to watch for significant policy response from authorities which may dampen flight to quality premiums.
MARKET UPDATE JULY 2015
IN THE SEVENTH MONTH VOLATILITY RESTED, IS THE FOMC NEXT?
After the surge in global market volatility throughout June and early July, another temporary resolution in the Greek debt crisis allowed markets to refocus attention on economic fundamentals. Unfortunately for Australia, those fundamentals continue to decay as our terms of trade decline and the broader commodity complex remains challenged, leaving the Q2 Capex report towards recessionary territory. This led RBA Governor Stevens to comment that trend growth may be significantly lower at 2.75% in years ahead, than estimated in the budget forward estimates which assume 3.25% moving up to 3.50% in 2017-18. Such an outcome would leave the budget ~ $170 billion in arrears vs current projections.
The decline in bond market volatility allowed additional exposures to be added in July after bond market valuations had reached compelling levels during the decline of June, and a calmer environment allowed for significant price gains over the month of July. This was further fueled by oil price declines creating renewed deflation fears. US data was weak over the month leading the market to push back on timing and frequency of potential Federal Reserve (FOMC) rate hikes. We have long argued that the FOMC wants to raise rates but the data will not allow it in any material way. As much as FOMC Chairman Yellen continues to say rate hikes are coming soon, the market continues to push back those expectations with current pricing ascribing only a 38% chance of a September move, down from 66% earlier in the year. Economists believe Yellen, with 82% expecting a September rate hike, although they assumed similar earlier in the year calling for a June rate hike back in April. Whilst we believe the data doesn’t allow for US rate hikes, they may eventuate regardless. It is important to recognize how different this cycle has been to previous history and acknowledge that any movement in rates will be extremely slow and orderly. Many well regarded pundits have estimated that if the FOMC hike rates into poor data and weakening commodity complex, they could be cutting again in 2016. Since the GFC the global markets have enjoyed 582 rate cuts or stimulus policy interventions.
We have had some notable rate rises in the developed world including the ECB hiking in 2011 (now followed by -20bps interest rates and a 1.2 trillion QE program. 1,200,000,000,000.00). The Bank of Canada, RBNZ and the RBA also raised rates post GFC. All three are now in cutting cycles. JCB retains the long held view that the FOMC may well pass on hiking rates at all in 2015 (although we acknowledge they do want a hike). We also continue to believe the RBA will cut rates in November following the release of Q3 inflation report. Any pullback in rates will remain buying opportunities given that the general economic data flow remains soft.
FUND HIGHLIGHTS & POSITIONING
After the momentum sell off in bond markets during Q2, the fund was running its longest duration exposure since inception. We maintained our duration above 5.00 years as the month opened moving up to a high of 5.73 years early in the month as the commodity complex continued to collapse (as expected in last month’s market highlights).
The fund also benefited from weaker US data over July, changing the expected slope and speed of any FOMC rate hiking cycle. This repricing of FOMC expectations have made roll and carry paramount, as elevated forward curves have been challenged and some short positioning has been squeezed.
The market also enjoyed a strong seasonal bias for bonds as the northern summer sees issuance curtailed. European markets have negative net cash flows aided by ongoing ECB bond buying under QE at 65 billion a month. As the US curve started flattening early in month, we also closed all steepening exposure as the AUD curve displayed a technical triple top failure at 103 bps in 3s10s AUD curve. Further declines in the commodity complex and lack of any US wage inflation continue to favor long end rates and hence we maintain flattening exposure in the near term.
Over the month JCB has lowered its duration exposures to lock in absolute performance in keeping with our capital preservation mandate. This leaves the fund underperforming its index over July, however it remains significantly above the index over the YTD period.
MARKET UPDATE JUNE 2015
COMMODITIES SELL OFF AND GREECE – WHY IS IT SO IMPORTANT?
'Greece' was the word in financial markets in the month of June with declining commodities markets and Chinese stock market collapse taking a secondary seat. We expect commodities and China to gain more attention in July but Greece will dominate near term. The unexpected Greek referendum will effect asset valuations the world over. The market has always assumed an 11th hour Greek deal would be reached but in the ruling far left Syriza, they are taking a very large gamble. We think the risks are significant and vastly underpriced and a‘’Grexit’’ would add huge volatility to markets, being negative for risk assets and positive for bonds.
If Greece is allowed to write down their 325 billion Euros of debt, other heavily indebted nations will follow requesting similar relief. Austerity in these countries has been brutally painful giving rise to anti austerity left wing politics from an angry public, looking for champions to fight financial oppressors (creditors who would like to be repaid – funny old world). With elections in Portugal in September and Spain in December, Europe is rightly reluctant to offer debt relief (write downs) to Governments who shy away from the financial responsibilities of their predecessors. It sets a dangerous precedent that will find no end and would attack domestic banking systems causing financial contagion. We don't think an 11th hour deal is so simple this time round.
Greece’s ruling Syriza want debt relief, knowing ejection from the Eurozone will be dramatic and painful, but a deal with creditors on current terms continues painful austerity viewed as an equally bad alternative. The chances of an emotional accident are significantly higher than markets currently prescribe.
Greece is the first nation to come to the end of their mountainous debt highway – many others will follow. The world has immersed itself in high levels of debt with the public showing a casual indifference as politicians have run huge structural budget deficits (let the good times keep rolling – debt financed if need be). Households have also enjoyed debt financing, borrowing at a record pace. The centralized response to the GFC was to create more debt, with global debt now 50% higher in nominal terms than pre GFC levels. Economic growth has become debt financed, not organically driven. Add to this Quantitative Easing (printing paper money), and we have created extra demand out of thin air. However, all the existing and newly created debt requires servicing to make the mathematics of debt solvency and sustainability workable. Relief comes in the form of Zero Interest Rate Policies making debt extremely cheap to finance. Global asset markets have traded to record highs with 83% of global equities markets being currently supported by a Zero Interest Rate Policies, living on cheap debt oxygen.
So why is Greece important in all of this? In the short term a “Grexit’’ will add significant volatility to markets which hate uncertainty. We would expect risk markets of credit and equities being negatively affected as the Greek banking system becomes insolvent almost instantly without significant ECB support. Whilst this has captured the majority of attention over June, also note Chinese equities are down over 25% from mid-month peaks and commodities have started to resume their bear market sell off. We will follow these market themes closely in July.
FUND HIGHLIGHTS & POSITIONING
Jamieson Coote Bonds Active Fund declined 0.18% gross in the month of June. The momentum sell off in bond markets continued in June which we see as opportunity to add duration to the portfolio.
Markets focused on timing and speed of potential FOMC rate hikes in the US which we believe will not materialize until 2016. Greece also dominated headlines with market optimism remaining that an 11th hour outcome would materialize. After trading cautiously early in the month with low duration, JCBAF added duration mid-month as valuations improved and Chinese equity markets broke trend line supports opening significant potential downside. This was also aligned with commodity complexes rolling over to renewed bear market pressure which is very constructive for bond markets mid term. JCBAF held its largest average duration position since the fund’s inception at 5.03 years in June, and despite markets finishing lower on the month, we were able to significantly outperform the market sell-off by 106 bps thanks to headline volatility around the Greek situation providing excellent trading opportunities intra month.
MARKET UPDATE MAY 2015
RBA KICKS OWN GOAL AMID GLOBAL VOLATILITY + CAPEX SHOCK
Global fixed income markets remained under heavy technical selling pressure in early May following the rapid fall in European Government Bond prices lead by the German 10 year. AUD bonds initially followed lower as all bond risk premiums where revalued in light of European sell off. The ECB have committed to a 1.2 TRILLION Euro QE program. When you are spending 1.2 TRILLION Euro’s you would hope to get what you want. In the ECB case that is stable markets with low bond yields thereby encouraging excess capital into the broader economy, whilst also lowering the cost of debt serviceability. In response to the sell-off the ECB calmed markets significantly mid-month by illustrating it would front load the pace of QE purchases. The markets immediately responded, turning what had been a technical deleveraging sell-off into a buying opportunity with much of the lost ground being regained by month end.
In Australia after April’s weak CPI data the market expected the RBA to cut rates at its May 5th meeting. In an incredible act of nativity, the RBA dropped its explicit easing bias in its accompanying statement – instead selecting a watered down implicit easing bias. In doing so the RBA kicked a significant own goal with regard to financial markets outcomes, as traders assumed the RBA easing cycle could be over. In an already difficult market the AUD currency was materially higher, bonds and equities sold off and property clearance rates screamed. Bond market’s closed 15 bps higher in yield on RBA day despite the 25 bps rate cut (only other time we have seen that is after Sept ‘11 in USA when the Bond market rallied so far on day of terror attack -flight to quality- it actually sold off the following day despite FOMC cutting rates).
Late in the month CAPEX data was outright recessionary, reminding fundamental investors that Australian glide path remains significantly challenged. We fully expect further RBA rate cut later in year (November) with a return to an ‘’explicit’’ easing bias as soon as June RBA meeting minutes.
We have argued for some time that equity markets are living on interest rate oxygen only. Interestingly, as bond yields moved 1 - 1.5% higher early in the month, equity markets were savaged as yield driven stocks collapsed, some by more than 10%. Lower bonds yields will be welcomed for now by equity investors, but be sure to mind your eye when the next crisis comes. The positive correlation will have a major breakdown in time.
FUND HIGHLIGHTS & POSITIONING
Jamieson Coote Bonds Active Fund gained 0.11% gross in the month of May. With the washout in European Bonds dragging fixed income lower, JCBAF was 2.5 years underweight index early in May, generating significant out-performance vs the fund mandate.
Given valuations had improved considerably into the RBA meeting on May 5th, JCBAF added duration for expected rate cut in line with our strategy highlighted in the April Fund update. Unfortunately due to the failure of the RBA to read market psychology, despite calling this rate cut correctly, the fund suffered as bonds prices declined after the meeting (See RBA own goal in market update)
Prior to the RBA meeting, Bond prices had been declining due to international technical factors. This change of tone from RBA added fundamental domestic pressure to the market. After being wrong footed on RBA day due to change in statement, JCBAF reduced duration again, preferring to wait for confirmation the international sell off was abating.
The news the ECB would front load QE purchases was the catalyst to lift duration again as higher duration holdings are justified at technically discounted valuations. After the release of weaker CAPEX data we quickly lifted duration again to overweight index to capture the resulting rally, running overweight positions into month end extensions where we lightened some risk and retuned to a slightly underweight index position.
MARKET UPDATE APRIL 2015
RBA TO CUT IN MAY AFTER INFLATION DATA
In April global market data remained patchy. The US economy slowed as stronger USD and severe weather on east coast continues to weigh on data. US Non-farm payrolls for March missed by over 100,000 jobs and ISM surveys declined. GDP data for Q1 was an anaemic 0.2% for the quarter. Market watchers would assume softer data will curtail a data dependant Federal Reserve. The Citibank US Economic Surprise Index remains in deeply negative territory at -62 declining from a reading of zero in February, meaning incoming economic data is significantly weaker than market estimations (including the FOMC’s).
Australian economic data was mixed with better jobs numbers at +37k, but inflation data remained subdued. This should allow for the RBA to cut at the May 5th meeting to 2.00%.
With the onset of the ECBs 1.2 Trillion euro QE program in Feb 2015 (at 60bn per month) German 10yr Bund yields continued to rally from March to an all-time low of 6bps. By the middle of April several high profile investors including Bill Gross, Alan Howard and Jeffrey Gundlach commented publically that Bunds looked expensive despite the 60 billion Euro a month ECB QE buy program.
Whilst we believe German rates at negative or low levels to be of limited value, we question some of the commentary from the investors mentioned, particularly Jeffrey Gundlach who stated that ‘’shorting the German 2yr 100 times leveraged at negative yields produces positive carry.’’ Any fixed income investor knows there is no leveraged carry opportunity given German general collateral (GC) is -20 bps plus you also need to pay a running repo charge to borrow the bond for delivery, over the life of the short position, hence ruling his strategy mute. We think many of these comments were driven by opportunistic market positioning looking to exploit a European investment community that has too much one way (long only) risk and over exposures to curve flattening structures. At time of writing Bunds have sold off 32 bps to yield 38 bps, spilling into other fixed income markets into month end. This sell off is technical in nature and not fundamentally driven. It will be a buying opportunity for duration in time, ahead of European summer trading.
Domestically the Australian Government bond market was dominated by redemptions and coupon payments of ACGB and semi government bonds totalling 28 billion dollars. The market was well supported from the early to middle parts of the month with many investors reinvesting proceeds. However, with the onset of the selloff in German bonds taking other markets to higher yields, not even these significant reinvestment flows could stem the pressure to higher yields for ACGB’s closing the month 33 bps higher in yield at 2.65% despite the benign CPI data on the 22nd of April (seen by the market as no road block to another interest rate cut from the RBA)
JCB hold our long held view that the RBA will cut interest rates in May after deciding to hold rates steady in April. We expect to see more volatility in bond markets and we expect this to flow to other investment classes in the months before European summer hits full swing.
FUND HIGHLIGHTS & POSITIONING
Jamieson Coote Bonds Active Fund declined throughout April posting a loss of 0.69%
Bond prices remained very well supported at the start of April on the expectation that the RBA would cut the cash rate to 2.00% with market ascribing an 80% probability prior to the April 7th meeting.
JCB felt an April cut was premature ahead of Q1 inflation data due later in the month, as the RBA likes to see the inflation data before adjusting rate policy. We wrote about this in our March Market update, ”JCB maintains its long held view that the RBA will cut the cash rate in May to 2.00% (after seeing April 22nd Q1 CPI inflation data) with further cuts to come later in the year.’’
As a result we lowered our duration and risk into the RBA meeting which proved correct as RBA passed on a rate cut in April but maintained an easing bias, therefore setting up market for a cut in May post the CPI data. With the market being 80% priced for a rate cut ahead of April, a sell off resulted and we used this pull back to add some duration ahead of CPI data which we expected to be benign thereby allowing for a rate cut at the May RBA meeting.
MARKET UPDATE MARCH 2015
RBA PAUSES FOR NOW WHILST CORPORATES WOBBLE
Following the RBA rate cut in February and decline in commodity markets over the month of March, markets continue to expect rate cuts from the RBA in coming month with the interest rate swap market pricing for a year end terminal rate around 1.60%! JCB maintains its long held view that the RBA will cut the cash rate in May to 2.00% (after seeing April 22nd Q1 CPI inflation data) with further cuts to come later in the year.
The collapse in commodity markets (iron ore off 21% since Feb cut from $62 to $47), is causing significant issues for parts of the corporate sector and has far reaching implications for the economy and the federal budget. Fortescue Metals Group failed to refinance $2.5 billion in debt with a failed bond sale in mid-March (iron ore at $55 a tonne at the time, now at $47). Initially the company attempted to secure a syndicated bank loan, but once it was clear the company has lost the faith of its bankers, it turned to the high yield bond market in the United States. The heavily indebted miner could not secure funding at commercial rates and was forced to pull the offering altogether. Fortescue has nearly $12 billion of debt falling due in coming years. Once funding markets seize on a corporate they rarely reopen without a major restructuring. The playbook from here is ugly and often looks something like the following…. Hedge funds short sell the stock and plant a host of negative news articles in the media, ratings agencies get nervous and issue debt downgrades, further closing the funding market door. Once it is clear that a solvency issue is approaching a major restructuring, capital raising or trade sale must ensue. It is a shocking cycle that we have witnessed firsthand during the GFC working for US banks. Corporate failures will rise over the year, as mining boom turns to mining bust for indebted companies with weak cash flows and growing solvency issues.
The rapid and sustained fall in commodity markets coupled with contractionary fiscal policy, ensures the RBA will continue cutting to support currency and interest rates sensitive parts of the economy and sure up sagging confidence. There are risks associated with further rates cuts, predominantly in bubble like property markets of Sydney and Melbourne, however this is seemingly the lesser of two evils in a tricky balancing act for the RBA. This ultimately requires APRA to provide macro prudential policy restrictions, capping loan to valuation ratios in some investment markets.
Turning to offshore markets March’s mid-month meeting of the US Federal Reserve saw a marked shift in FED speak from Chair Janet Yellon who lowered the ‘’dot plot’’ or the FED’s expected glide path for US interest rates whilst also removing the key phrase ‘’patient’’ from the statement. This effectively ends the post GFC policy of forward guidance from the FED – which in turn will lift volatility of all financial markets. Data in US has been declining of late. JCB believes the FOMC will raise rates in Sept 2015, however we believe it will be a very small increment of 10 bps rather than market consensus at 25 bps.
European Quantitative Easing continues in full swing with 10 year German Government debt now yielding a whopping 16bps or 0.16%. If that doesn’t encourage an investment then maybe you should consider 2yr German Government Debt at -28bps or -0.28%. We live in truly amazing times. Australian Government Debt, AAA rated, Westminster system, slowing economy, fiscal contraction, RBA with cutting bias, continues to attract massive foreign buyers and will do so for some time yet. JCB remains very constructive on Australian Government Bonds.
FUND HIGHLIGHTS & POSITIONING
Jamieson Coote Bonds enjoyed returns throughout March of 0.89% maintaining our move towards our high single digit returns on a per annum basis.
Over the course of March the largest risk for the portfolio was mid-month FOMC meeting where we reduced duration significantly surrounding the event risk, in keeping with our risk management philosophy. Chair Yellon removed the word ‘’patience’’ but lowered the dot plot catching markets offside, which caused a significant rally in Global Bond markets. JCBAF added duration immediately as the desk was staffed for FOMC meeting.
The ongoing deterioration of commodity complex will continue to support the Australian Government Bond market although may create some widening pressure on State Government paper. The budgetary positions of both West Australia and Queensland State Governments require careful consideration as falling mining based revenues will impact budgets positions and therefore pricing for State issued bonds. Any further performance will be an opportunity to lighten all state holdings and return to Federal Government holdings.
MARKET UPDATE FEBRUARY 2015
RBA REMAINS IN PLAY
After an 18 month ‘’period of stability’’ the RBA surprised markets with a 25bp rate cut on Feb 3rd kicking off a volatile month for markets. We have argued for some time that the RBA would be required to cut rates in 2015 and fully expect further rate cuts to materialise over the course of year. The RBA rarely tweaks interest rates with a single move, making this adjustment significant as the start of a new rate cutting cycle. JCB looks for a further cut of 25 bps to 2.00% in the May meeting, after the release of Q1 inflation data which we expect to remain soft. JCB continues to retain its long held view that economic outlook for Australia remains extremely challenging with lower commodity prices and slower global growth.
Fixed income markets remained unsettled throughout February despite a month on month close move of only 2 bps in Australian Government 10yr Bonds from 2.42% to 2.44%. After the surprise RBA cut the market rallied aggressively as many domestic managers were forced into the market to cover underweight exposures. Thereafter, the stabilisation of the energy complex (oil recovered from $43.58 low to extend rally to $54.24 before settling around $50 per barrel) allowed international fixed income markets to drift lower taking Australian Government Bonds lower in sympathy. This ultimately present a buying opportunity for Australian Fixed Income.
During the month the market experienced heightened volatility around Australian political instability with a shock result in Queensland Election and spill motion against sitting Prime Minister Abbott. Queensland State Government Bonds suffered immediate losses as the planned privatisation of state owned assets looked to be shelved by the incoming Labour Palaszczuk Government, although bonds have since recovered most of those spread based losses as it seems state asset disposal remains inevitable. Prime Minister Abbott survived the spill motion although much debate continues to rage regarding the leadership of the Federal Government.
Offshore Greece was again the centre of markets attentions as the election of new populist government played hard ball with European Commission over debt restructuring and potential further bail out measures causing some flight to quality periods, although this has now been kicked further down the road with a 4 month extension. In the US, FOMC Chair Janet Yellen completed her semi-annual testimony to the House Banking Committee (Known as Humphrey Hawkins Testimony) stating that the FOMC remain on track to normalise interest rate policy assuming the incoming economic data allows. We assume a US rate hikes will commence in Q3 of 2015, albeit at a very slow pace.
Finally, last month we commented on equities market participants declaring some blue chip equities had ‘’bond like’’ returns. The hunt for yield has forced many investors to chase high quality stocks, but we were reminded with a bang during February as to why equities remain the riskiest asset class in capital chain. Woolworths (a company we shop at every day) had a slight miss on H1 numbers and the stock fell 15% in 36 hours, destroying significant investor value in the process. When equities are priced for perfection a small blip in the road can have major consequences for valuations.
FUND HIGHLIGHTS & POSITIONING
Jamieson Coote Bonds enjoyed returns throughout February of 0.40% maintaining our move towards our high single digit returns on a per annum basis.
February was volatile with bond prices closing slightly lower on the month despite a surprise RBA rate cut on the 3rd of month, causing many domestic fund managers to stop into the market, clawing back underweight exposures. The JCB Active Fund sold half its bond duration into this spike higher in prices locking in gains early in the month. The consolidation of the energy market (oil rallied from low of $43.58 to touch $54.24 before settling around $50 per barrel) removed much of the dis-inflationary force in markets and as such US Treasury Bonds led many global bond markets lower over the month. Australian Government bonds also headed lower in price in sympathy with US Treasuries, before rallying back after weak CAPAX data late in the month.
MARKET UPDATE JANUARY 2015
RBA CUTS WITH MORE TO COME
Firstly, if you are reading this we welcome you to Jamieson Coote Bonds. We will attempt to keep these monthly’s short and relevant however we urge you to call us to discuss any of the following content in greater detail. There is a huge amount going on in macro space causing currents and cross currents for all asset markets.
2015 will remain an extremely volatile year. In January alone we have witnessed and explosive month for macro markets with the surprise removal of the Swiss Franc ( CHF) peg ( vs EUR) by the Swiss National Bank combined with a 50bps rate cut taking official cash rates in Switzerland to negative 0.75%, resulting in Swiss Government Bonds trading at negative yields. This shock move generated significant volatility in FX markets with CHF appreciating 35% on the day and highlights the impact Central Bankers are having on markets in distorting the allocation of capital and removing the free markets ability to set prices.
The ECB followed suite with a massive 1.1 trillion Euro’s of Quantitative Easing (buying Government Bonds with printed money) and stated they would include sovereign bonds with negative yields in the buying program. The evolution of negative yields on government bonds is extraordinary and removes the lower boundary valuation condition at 0%. Capital prices for bonds continue to increase as bond yields fall – even when negative. Trillions of dollars of Government bonds now trade with negative yields highlighting the vicious deflationary forces at play in much of the globe. Australian 10yr Government Bonds at yields of 2.50% look extremely attractive to the global investment community in this context.
Oil, commodity and energy markets remain in key focus. Corporates have reacted to lower oil prices pulling capex and slowing production, withdrawing oil rigs at fastest pace in recent history. We feel prices will stabilise for a period as supply is beginning to be constrained.
As a result of the macro forces at play, the RBA will be compelled to act by lowering the cash rate in coming months to sure up domestic demand and force the currency lower helping stabilise the economy. JCB retains its long held view that economic outlook for Australia remains extremely challenging with lower commodity prices and slower global growth.
Recent comments from equity market participants that equities have ‘’bond like’’ characteristics are absurd. Government Bonds carry the explicit guarantee of a nation and taxes can but levied on citizens to repay these obligations. Equities are the riskiest investment one can make and returns should compensate for the larger risks associated. There is absolutely ZERO guarantee of return of monies invested in the equity space. When the economy turns and credit cycle bursts, bad and doubtful debts rise dramatically. Dividends get cut and equity valuations plummet. We have experienced these unpleasant events first hand. Working for Merrill Lynch pre GFC I received stock at $100. It traded at $1 two years later. Lower interest rates are great for asset valuations while the world remains calm but the risk build up in the system is potentially explosive and fatal when the winds change.
FUND HIGHLIGHTS & POSITIONING
Jamieson Coote Bonds enjoyed solid returns throughout January in line with our mandate of high single digit annual returns with a strict focus on capital preservation.
The month was characterised by significant intervention in markets from Central Banks with Swiss National Bank unexpectedly removing its currency peg vs Euro and ECB embarking upon a larger than expected 1.1 trillion Euros of Quantitative Easing to fight deflationary forces in the Eurozone. With oil prices also declining significantly, deflation or disinflation was the subject of much discussion in markets and collapsed yield premiums across asset classes.
JCBAF was cautious for the opening part of January, given relatively illiquid markets at the beginning of the year and large macro-economic events on the calendar with binary outcomes. Prior to the ECB policy meeting, markets generated lively debate regarding the potential commencement of a QE program, and what would be the size, timing and guarantee structure of such an initiative. After the announcement of the larger than expected bond buying program from the ECB we increased duration and exposure of the portfolio in expectation of international investor demand for globally attractive long dated Australian Government Bonds.
MARKET UPDATE SEPTEMBER 2015
FOMC BLINKS (as predicted), VW and Glencore in trouble, Aussie data shocker but cause to Turnbull-ish ?
We wrote at length about risk markets and the dangers ahead in our August monthly. September provided continued volatility, not helped by a confused US Federal Reserve (FED) who passed on hiking rates despite talking of such an occurrence all year. This did not come as a surprise to us, as the FED is market dependent, not data dependent, as they would have us believe.
The FED say they are not influenced by the stock market. However, when QE1 ended the stock market dropped 20% and the FED caved and gave us QE2. It ended and the stock market dropped 19% and they gave us Operation Twist. They talked of ending Twist and we had taper tantrum in May 2013 and so they extended it. Now as QE3 has ended markets are again falling and they have told us they want to raise rates. Markets have fallen and they didn’t raise rates. Is there a tradeable pattern of a Quantitative Easing cycle developing?
We do not expect the FED to raise rates in 2015. We absolutely acknowledge they would like to raise rates but ultimately the markets will not allow under that.
If markets were not confused enough, the troubles at VW and Glencore only heightened the sense of fear. It has been sometime since we have experienced a large corporate failure with potentially systemic consequences. Both these situations require careful attention, VW as one of Europe’s largest employers and Glencore as global commodities giant with huge involvement in commodity trading and derivatives businesses. We discussed widening credit spreads in our August monthly – these issues will only add fuel to the credit spread widening fire.
Turning to Australia the data early in September proved quite sobering, with GDP printing a mere 0.2% (would have been negative if not for defence spending) and retail sales -0.1%. With the AUD at 70 cents, Australian's should be shopping on the high street rather than online, and yet that retail sales kicker is not forth coming. Employment remained stable but doesn’t show any material signs of improving. We remain concerned that the Australian economy is operating below long run average and further stimulus will ultimately be required. We had always assumed that the FED would pass in September, thereby opening the RBA to a rate cut in November to provide that stimulus, but we are pushing back on that now.
The election of Malcolm Turnbull as Prime Minister is significant and will generate a much needed boost to confidence. We believe the RBA will now wait to see if a) Turnbull can clear the Senate in any meaningful way and b) if the lift in confidence generates increased CAPEX intentions. We remain sceptical of both but time is required to answer those questions. We are moving back our rate cut estimation to February 2016 as a result.
FUND HIGHLIGHTS & POSITIONING
Jamieson Coote Bonds Active Fund gained 0.58% gross during September.
Coming out of a hugely turbulent August we had a defined strategy into the key September US Federal Reserve meeting on Sept 17th where over 80% of economists expected a rate hike. We reduced risk, closing curve exposures and running less duration at 4 years for the first half of the month. Whilst we were confident the FOMC would pass, our call was non consensus and required investment caution. We added duration within seconds of the decision and added further duration during the dovish press conference taking the funds duration above index up to 6.1 years. The market rallied strongly in the following few days and we started lightening risk into the rally, locking in gains and returning the fund to a more balanced position into quarter end at 4.2 years duration. We continue to expect volatile markets ahead into the fourth quarter and believe lighter risk is appropriate, looking to capture opportunities as they arise. We remain sympathetic to curve flattening views given the drop in US break evens and the inability of oil to materially rally. We will use any significant steepening of the curve to add flattening exposure.
MARKET UPDATE OCTOBER 2015
JCB has written extensively over the year about the FOMC and rate hiking expectations, stating that it was unlikely the FOMC could hike. That stance was lonely in June and September, when majority views indicated a coming rate rise. Ironically, the much weaker than expected September Non-Farm Payroll report in the US has actually opened the door for a FOMC rate rise in December ‘15. Let us explain.
The FOMC has told the market it is ‘’data’’ dependant. So the market watches the data to see the FOMC’s next move. The data was weak so the market assumed the FOMC can’t hike correct? No. The FOMC actually watches
the market, so the market has rallied risk assets (equities) in anticipation of no FOMC rate hikes, but in doing has actually paved the way for the FOMC to hike rates by virtue of market strength. The logic is entirely perverse, but in
a world of Quantitative Easing induced markets it is all about ‘’ow’’ With positive flows returning to equity assets, there is now a sufficient buffer to make the long anticipated move of hiking rates. As long as equity markets remain calm into December, JCB now expects the FOMC will hike rates, albeit by less than recent usual 25 bps increments.
We also expect any such FOMC move will be accompanied by dovish language, re enforcing a slow and gradual program of rates hikes in the US with a significantly lower terminal rate expectation than current market forecasts.
Under this scenario, we see the rates complex being broadly benign to slightly higher in yield, within a tight valuation range, however the term structure will suffer from flattening pressure with short dated maturities under-performing.
Turning to Australia we have long anticipated the Q3 CPI data release would provide catalyst to return the RBA to the rate cutting table, despite their noted reluctance to provide further stimulus. After the change of leadership in
Canberra, we moved our November ‘15 rate cut call back to Feb ‘16. Weak Q3 CPI on the 28th of October (at bottom of RBA targeted band) plus rate hikes from big 4 banks have solidified the probability of a return to actively lower RBA rates. In fact, short dated markets had the probability of a November RBA cut as high as 68% post CPI data, however, we believe the RBA will wait for the New Year (Feb ’16) before responding to the significant tightening of financial conditions in Australia from higher bank mortgage rates.
FUND HIGHLIGHTS & POSITIONING
JAMIESON COOTE BONDS ACTIVE FUND GAINED 0.85% GROSS DURING OCTOBER
We continued to hold lighter positioning as we believe the market will remain volatile. New bond issuance provided the best trading opportunities of the month with large supply concessions available in the new 24yr ACGB 39’s and new 13yr TCV 28’s bond which generated the majority of our performance for the month vs a at return on the index.
Both issues came with a generous supply concession that we felt would normalize after the issuance process, hence providing excellent opportunity for the fund to harness. We had previously highlighted a preference for curve flattening exposure in the portfolio, however, over the month it became apparent that stability in oil prices, widening of US break-evens inflation rates, the begin CPI print in Australia plus mortgage rates hikes are all supportive of steepening exposure. We set steepening exposure throughout the month and will retain through the November RBA meeting.
We remain cautious on the RBA’s ability to deliver rate cuts in a short time frame into year-end, however post the CPI data we are very condent they will re instate an explicit easing bias at the November board meeting, thereby supporting the rates complex into 2016. We have moved the fund shorter in duration after a period of strong performance, reinvesting the proceeds in very short dated state government paper while we await better valuations to re invest. This adjustment has resulted in a higher month end holding of semi (state) government bonds whilst we await opportunity to buy longer duration assets.
MARKET UPDATE NOVEMBER 2015
JCB Active fund is up 5.50 % (gross) since inception in Dec ’14 running a long only AAA and AA+ rated Government
BOOM TIME EMPLOYMENT REPORT BUT CAPEX SHOCKER (AGAIN) AND THE MOST ANTICIPATED AND
POORLY REPORTED RATE HIKE IN HISTORY
Where did our first year go? We only seem to have launched yesterday and yet JCB is into its 2nd year as a trading
fund, having returned over 5.50% in our first 12 months investing in predominantly AAA (some AA+) rated Government Guaranteed bonds. This has vastly outperformed Australian equity indices and cash deposit returns over a similar investment period. So what’s is ahead for the 2nd year?
It may surprise you to know that Australian employment is booming. Literally ‘’o the charts’’ booming. According to
the Australian Bureau of Statistics (ABS), employment in November has only been surpassed by the job growth of
March 2012 and job growth of September 2004 - that really was boom time! So the 3rd best employment report in
over 10 years?
Normally, at this point as an investor, I usually check to see if I’m standing on a trap door, but alas they are the official figures. We could almost ll the MCG with all the new jobs that have apparently been created in November alone. If you are wondering what to buy for your Kris Kringle this year, then buy a calculator, in the hope that someone might pass it to the ABS, because they sure can do with some help!
The ABS have been altering the seasonally adjusted data of late and we believe this has caused significant statistical
noise to the data. Markets shoot first and ask questions later. This employment report hurt bond markets in November, recalibrating RBA expectations into year-end which also saw the AUD currency stage a meaningful rally towards 73 cents vs USD. Importantly the AUD is now back to almost unchanged levels from earlier in the year on a trade weighted basis. Most commentators discuss the currency vs USD, but over the year much of the move down from parity vs the USD was in fact USD strengthening rather than AUD weakness. This is really important as Australia doesn’t really trade much with the US anymore (aside technology, planes and medical equipment), with most of Australia’s trade partners being in Asia or Europe. Quantitative easing has seen both the JPY and EUR fall aggressively also this year, making the trade weighted basket value of AUD only mildly lower (RBA favoured measure of watching the currency).
To rebalance the economy, Australia needs a lower currency (trade weighted) and this is what will ultimately drive Mr
Stevens and Co back to the rate cutting table in 2016. They are reluctant rate cutters no doubt, but the fundamentals
win in the end and significant headwinds remain. In November CAPEX fell by 9.2% (ouch) following a fall of 4.6% in
August. These are recessionary numbers with regard to business investment. Inflation (CPI) is at low end of the RBA
target band and financial conditions are tightening via bank rate hikes on loans and a stronger AUD. Commodity and
energy markets remain in free fall. Mr Steven’s suggested we ‘’chill out’’ ahead of the holidays. Last year in December
the RBA’s official position was ‘’a period of stability (in rates) is warranted.’’ The RBA cut rates in February without any prior warning. So ‘chill out’ folks, nothing to see here on the domestic front, aside a little more economic decay……
Moving offshore the FOMC will raise short term interest rates on December 17th. This will be one of the most
anticipated and poorly reported rate hikes in history. Anticipated because every media outlet around the world is
obsessed with a Central Bank trying to hike interest rates (remember with ECB rate cut to negative 30 bps last week
we are now at 691 rate cuts or stimulus programs globally since GFC) and poorly reported because most of the media reporting on the FOMC know very little about rates markets and the EFFECT of the policy move so will focus on the hysteria of the move rather than the implications and effects.
The FOMC rate cycle will be slow and shallow, because if it is not and rate move substantially higher the $57 trillion of newly created debt since the GFC will be at serious risk of default with chaotic consequences. That would make the GFC look a dressed rehearsal for the main event. The rate cycle must be shallow because any way we work through the FLOW of funds thereafter, the results all end at the same place, which is financial market pain.
Let’s use the assumption that the FOMC hikes 100 bps over 2016. Short dated rates will rise (long dated rates are
driven by funding, inflation, GDP, supply demand etc not just FOMC). With a rise in short end USD rates, capital will
ow into USD’s to earn carry (as most of developed world has zero or negative interest rates, thereby making the USD materially stronger). Domestically, the USD becomes less competitive with a higher currency and 40% of S&P equity earnings are based oshore so earning will decay.
Most of the $57 trillion in debt issued since GFC is denominated in USD, issued by emerging market countries.
A stronger USD makes those debts grow, plus the rise in interest rates makes them harder to fund or service. As a
result, emerging markets suffer. Commodity and Energy producers are based in USD, as is the Chinese economy with a pegged currency. Neither will enjoy a materially stronger USD, and so the flows become cyclical as the US economy cools, earnings suffer, emerging markets and commodities tank, bringing us right back to where we started. Addicted to financial stimulus.
When the FOMC hike in December the move will be accompanied by dovish language, re enforcing a wait and see
approach on rates. We expect the FOMC to acknowledge a significantly lower terminal rate expectation than current
market forecasts. Under this scenario, we see the rates complex being broadly benign over time within a tight
valuation range, although large current short positioning can lead to a short covering rally in rates markets into year
end and beyond.
MARKET UPDATE DECEMBER 2015
JCB Active fund is up 5.75 % (gross) since inception in Dec ’14 running a long only AAA and AA+ rated Government
RATE HIKES ARE LIKE DRINKING MARTINI’S, CHINA’S MANAGED YUAN DEPRECIATION, ASYMMETRIC
RISK OUTCOMES AND A FEW THINGS TO WATCH IN 2016.
My old boss from New York came to stay over the holidays and asked if I could make him a martini for his afternoon drink. Along time ago, as the new kid on the Merrill Lynch bond trading floor in New York, I found out the hard way that to many martini's can be a very bad thing. One is fine, it can actually be quite pleasant at the end of the day, two maybe passable, but any more is outright dangerous. And so it is with hiking interest rates in a heavily indebted global economy. A few is possible, but any more and watch out, financial markets will be in a lot of trouble.
The US Federal Reserve (FOMC) rate hiking cycle will be slow and shallow, because the newly minted $57 trillion of global debt created since the GFC requires servicing and re issuance – both of which require low rates to avoid debt default. The rate cycle must remain shallow because if it doesn't, any way we work through the FLOW of funds thereafter, the results all end at the same place, being substantial financial market pain – and nobody wants that, least of all the FOMC who have invested $4.5 trillion dollars in various QE programs to avoid financial pain. The more likely path for rates in the near term is one or two hikes, leading to material market and data decay, followed by some kind of stimulus program, most likely an operation twist (selling short dated bonds and buying longer dated bonds to ease financial conditions).
After talking of rate hikes all year, in order to maintain credibility the FOMC needed to deliver. The December ’15 move is the first time in history the FOMC have hiked rates with two consecutive sub 50 ISM data prints (ie manufacturing contraction). GDP data was also weaker than at the launch of QE3 in Sept 2012 where the FOMC was prepared to do QE in unlimited size. We believe the economy still remains sub trend, and any rate hikes will slow economic data going forward. We expect risk markets to suffer as a result of this hike, and the bond market will be well supported. Ordinarily, long dated bonds perform very well from the commencement of the first rate hike (in 2005 long dated bonds rallied 80 bps) in expectation of lower inflation and GDP growth and tighter financial conditions ahead. This cycle will be no different, and we are very comfortable owning duration after the Dec FOMC meeting.
One of the major themes we have marketed in December during our one on one’s has been the continued managed Chinese currency depreciation. As the USD has appreciated, China’s USD peg is unwelcome in Beijing and we expect continued managed depreciation over 2016. This exports deflation across the region and has potential to upset risk markets.
2016 looks to be a year of asymmetric risk outcomes (unfortunately skewed to the downside for many financial assets). Barring significant further central bank stimulus, it is hard to foresee what would drive asset prices materially higher. However, there are a number of issues looming on the horizon that can upset the apple cart. Energy and commodity markets will continue to weigh on risk sentiment as over supplied sectors continue to decay. With large debt maturities to be rolled forward (refinanced) in the second half of 2016, continued caution seems prudent in the energy space. Other things to watch are a resurgence of Europe’s immigration crisis coming out of winter (it’s hard to walk in the snow), further issues in the Greece debt crisis (this hasn’t gone away) and a Donald Trump Republican Presidential nomination. Geopolitics is also on the list after an eventful 2015. Russia's Putin took to the Middle East bombing campaign with fury, Erdogan of Turkey shot down a Russian fighter jet, ISIS sponsored terrorism continued across the globe, and the U.S directly challenged China, sailing a frigate through the South China Sea. In China Jinping took further measures to centralise authority and Japan’s Shinzo Abe pushed ahead with reform to re militarise.
Economic prosperity has helped keep much of the globe stable. Lets hope falling oil and commodity markets coupled with difficult emerging market conditions doesn't lead us to conflict in 2016.
Jamieson Coote Bonds Active Fund gained 0.26% (gross) in December, under performing the market by 0.19%.
In keeping with our core capital preservation objective, we positioned the portfolio cautiously through early December, where we believed we would need to navigate the first FOMC rate hike in almost 10 years. With improved clarity after the FOMC, we adding positioning to the portfolio to capture roll and carry over the Christmas holiday period by increasing basis positions to maximise carry.
MARKET UPDATE DECEMBER 2014
OUTLOOK FOR MARKETS AS AT DEC 31ST 2014 - AUSTRALIAN HEADWINDS
2015 looks to be a very challenging year for Australian investors with significant increases in volatility and a lack of clear directionality (this should increase risk premiums). Domestically the economy continues to rebalance away from a mining capex and commodity boom and faces rising unemployment pressures. RBA Governor Stevens continues to remind markets that the AUD needs to fall significantly to ease and cushion this effect. Whilst the AUD has cheapened significantly vs USD over 2014 declining 8.3%, it is important to note that on a trade weighted basis the currency has only cheapened~ 3.5%.
JCB retains our long held view that the RBA will cut interest rates by a total of 50bp in H2 2015 as unemployment continues to rise and bad and doubtful debt provisions increase and drag on bank balance sheets. The banking sector will be exposed to continued routs in commodity and energy complex putting pressure on the refinancing of loans and ultimately business failures. This spells troubled times ahead for the Australian story and increases the risk of Australia’s first recession in a generation.
In 2015 JCB believes Australian equities will trade sideways at best, with the strong possibility of a negative year for the ASX 200. JCB views equity market commentators suggesting that particular stocks have bond like qualities as absurd. Telstra may be a great stock but it will be subject to macro events on equity markets just like other stocks would. Bonds are Bonds. They share no similarities to stocks whatsoever. Telstra should not rally if the ASX is off 10%. Australian Government Bonds should.
Further afield the economic story is vastly different. The US economy and USD has decoupled from many markets and remains the shining light within the global economy and as such JCBAF expect the US Federal Reserve to commence policy normalization in late 2015. Conversely Europe and Japan continue to face adverse headwinds from a lack of structural reform, ageing populations and a lingering debt burden from the GFC. We expect both Europe and Japan to provide global liquidity with Quantitative Easing programs replacing the void created by the end of US Federal Reserve QE3.
Finally some of the known unknowns that we will monitor closely over the year include. A credit crisis triggered by large scale defaults arising from the oil price collapse pressuring refinancing of energy sector debt, a surging USD causing large scale capital flight from emerging markets, Greece leaving the Euro, further economic turmoil in Russia emerging from sanctions coupled with lower oil revenue, and terrorism effecting global confidence.
Domestically we feel that the upcoming Federal Budget will soften further with the Government stuck in an increasingly difficult situation especially as the economy sours.
JCB forecasts the 10yr Australian Government Bond rate could trade as low as 1.80% over the course of the year depending on the sequencing of the above mentioned events.
Jamieson Coote Bonds Pty Ltd ABN 12 165 890 28 AFSL 459018 is the issuer of units in the Jamieson Coote Bonds Active Fund. The fund is only available to wholesale clients or sophisticated investors as defined by ASIC. Investors should consider the Information Memorandum (IM) in deciding whether to acquire or continue to hold units in the fund. The IM is available at www.JamiesonCooteBonds.com.au or by calling (03) 9653 9255. The above report is not personal advice and does not take into account individual investment objectives. Future performance is unknown and should not be based on past performance. This report contains forward looking statements, opinions and estimates which are subject to various risks and uncertainties. Forward looking statements constitute best judgment at the time of writing and are subject to immediate change in the fluid and unknown future. Actual events are likely to be materially different, positive or negative, from those reflected in forward-looking statements.
Investments in the fund are not deposits with or liabilities of Jamieson Coote Bonds Pty Ltd and are subject to investment risk. A list of possible risks are available in the funds IM and should be fully considered prior to investment.
FUND HIGHLIGHTS & POSITIONING
Jamieson Coote Bonds hosted an opening luncheon on Friday 28th November with The Hon Josh Frydenberg MP (Assistant Treasurer of Commonwealth of Australia) as guest speaker officially launching the Jamieson Coote Bonds Active Fund (JCBAF).
JCBAF embarked throughout early December on conservatively testing the funds systems and checking processes, custodian arrangements, reconciliations, automated risk and report generation etc to make sure all was in order, operating according to plan and contract. We likened this period to a pre-flight safety check. In doing this testing we completed 5 small Government Bond trades and generated positive returns of 0.76% (net of fee’s) on funds under management in line with our high single digit returns investment objectives. The fund will commence a full month of investment starting Jan 1st 2015, from which time we will commence calculations of fund returns vs benchmark.
Advisory Board & Compliance
B Comm (Hons)
Based In Melbourne
Mark brings a wealth of experience as Chair of JCB Advisory Board as the recently retired CEO of the Australian Government Future Fund, Australia’s $110+ billion dollar sovereign wealth fund. Prior to the Future Fund, Mark was CEO of Treasury Group, a listed fund of funds manager with over $17 billion in aggregate funds under management, as well as Vice Chairman and CEO of Credit Suisse Asset Management (EMEA) in London, and Global CIO with over $250bn under management.
Mark has also held a number of high profile Global CIO roles for Credit Suisse, American Express Asset Management, Colonial First State Investments, Colonial Group and Bankers Trust.
Mark holds a Bachelor of Commerce (Honours) from University of Melbourne.
B Ec (Hons)
Based in Hobart
Saul Eslake has had more than 25 years' experience as an economist in the Australian financial markets, including four years as Chief Economist (International) at National Mutual Funds Management, 14 years as Chief Economist of the ANZ Banking Group, and three years as Chief Economist (Australia & New Zealand) for Bank of America Merrill Lynch. Over the course of his career he as also been a member of numerous advisory councils, task forces and steering committees for federal and state governments of different political persuasions, and a frequent speaker and media commentator on economic issues.
Saul brings a wealth of economic experience to the Jamieson Coote Bonds Advisory Board which is vital in forming our investment strategy.
B Comm (Hons)
Lynda is an experienced company adviser and consultant and
Lynda is the Chairman of the Aged Care Financing Authority, a statutory committee established to provide independent advice to government on funding and financing issues in aged care.
In addition to her consulting roles, Lynda is also a non-executive director of Domino’s Pizza Enterprises Limited and independent director of National Electronic Health Transition Authority (NEHTA) which transitions to the Australian Digital Health Agency in July 2016.
Lynda’s career included senior roles at Telstra as Executive Director, including as Chief of Product; Commercial Director of ACP, Publishing division of (PBL) and General Manager of Alcatel Australia.
She has previously served on the Council of Bond University, Boards of Screen Queensland and TAB Queensland and on the IT&T Board of Advisors to the New South Wales Treasurer.
She holds a Bachelor of Commerce (Honours) from University of Queensland and is a Fellow of the Australian Institute of Company Directors.
Based in London
Neil is the founding Director of Arbo Research and Trading in London. Arbor is a global independent financial research firm, headquartered in Chicago, with further offices in New York, Fort Lauderdale, and Geneva, providing innovative macro-economic analysis across a broad range of global fixed-income, equity, currency and commodity markets.
Arbor Research provides clients with a set of proprietary quantitative tools to measure market momentum and evaluate the persistence of trends for macro markets.
Prior to joining Arbor in 1999, Neil was a fixed income bond trader for a number of global investment banks and has experience in a host of sovereign debt markets across the investment grade, credit and high yield complex.
Neil brings a wealth of experience and acute knowledge with global oversight to Jamieson Coote Bonds and we welcome his invaluable commentary surrounding European and US based markets to complement our own marco-economic views.
OAM, FCA, FAICD
Based In Sydney
John was the founding partner of WHK (now Crowe Howarth), Australia’s 5th largest accounting practice. After retiring in 2000, John now acts as an Independent Business Advisor and holds a number of company directorships with businesses involved in trade, primary production, property, healthcare and finance.
John’s recent appointments include Chairman of Pinpoint Pty Ltd, Asia/Pacific’s leading Marketing Services provider for 14 years until sold to MasterCard in June 2014 as well as Directorships of RHG Limited, Haddon Rig Pty Ltd and the Australian Taiwan Business Council as well as Chairman of the Baldwin Care Group of companies.
John is one of three Honorary Life Members of the Victor Chang Cardiac Research Institute and has held a board membership since 2003. He served as Chair of the Institute’s Finance Committee until retiring from this position in 2012.
John’s vast array of experience and continued contact throughout the Australian business landscape brings valuable insight on true state of the economy to Jamieson Coote Bonds.
The JCB Compliance Process
JCB management outsources a vast array of services to ensure independent and secure provision of critical investment functions. Services outsourced and crossed checked include all handling of client monies, accounting and fund audit, securities and unit pricing, asset custody, trade settlement and reconciliation. This allows JCB to focus on adding portfolio value, whilst giving investors peace of mind their assets are safe and secure with a globally recognised asset custodian, and also offers an additional level of confidence in the credibility of calculations performed by an independent third party with added checks and balances.
Investors – Prospective investors applying for the JCB Active Fund will be thoroughly screened against Anti Money Laundering and Know Your Customer legislation. This due diligence will be ongoing throughout any relationship between both parties.
Counterparties – Market Counterparties will also be selected after detailed screening with JCB having a zero tolerance for inappropriate market behaviour. Any such breach will trigger immediate contract termination and mandatory escalation to appropriate authorities.
JCB is committed to compliance in all facets of business and as such undertakes periodical independent reviews by a reputable compliance consultant.
The JCB Fund benchmarks using the Bloomberg Australia Sovereign Bond Index. We allocate bond investment using a strict and disciplined approached to seek value and opportunity. Our strategy provides an investment which delivers all the benefits of bond ownership, with the upside of an active management team ensuring maximum performance. JCB invests in bonds explicitly backed by AAA and AA rated Governments in Australian dollars.
Stability and strength:
Large central banks, sovereign wealth funds and hedge funds choose to invest in Australian Government bonds for stability and strength. JCB targets true-to-label defensive returns across all market conditions, with a strict focus on capital preservation. Our investment portfolio approach uses both domestic and global macro-economic factors, plus a number of micro factors to adjust duration and risk exposures to create added value.
Balanced portfolios have bonds:
Bonds bring balance to investments portfolios with periodic fixed cash flows (interest) and the return of principle at maturity. The surety makes bonds particularly valuable in times of economic stress or uncertainty. As we continue to face volatile market periods, bonds will generate significant capital gains along with their fixed interest payments, as investors seek the highest quality investments with guaranteed returns backed by the full faith and credit of Governments. In fact, bonds not only balance portfolios, but are a stable and high quality investment in all markets cycles.
Charles has spent 15 years in the financial services industry working for Merrill Lynch and Bank of America Merrill Lynch (BAML) as a Bond trader; trading in Tokyo, New York, London and Sydney.
Over his career, Charles has traded Bonds in US dollars, Euro’s, Pounds Sterling, Kiwi and Australian Dollars as well as run asset portfolios as large as USD$15 billion in a host of foreign currencies and derivatives.
As a US Treasury Trader in London on 11 September, 2001 and a European Government Debt Trader in London at height of Eurozone crisis, Charles has managed difficult portfolios through a host of market scenarios.
Upon returning to Australia, Charles’s most recent appointment was Co-Head of Rates Trading for Bank of America Merrill Lynch in Sydney where he was part of the bank’s Executive Management team. In this post was also a member of the Australian Financial Markets Association (AFMA) Bond Committee.
Charles holds a Bachelor of Commerce from Monash University, majoring in accounting and finance.
Angus started his career with JPMorgan and on successful completion of the JPMorgan graduate program began as a Government Bond salesman specialising in US Treasuries and European Government Bonds in London.
Angus’s clients included Global Central Banks, Large Asset Managers, Sovereign Wealth Funds and Hedge Funds. Angus relocated to Asia with ANZ where he spent five years specialising in selling Australian Government Bonds and other debt products to the region’s largest central banks and sovereign wealth funds. During this time he was located between Hong Kong and Singapore.
Angus transacted the first ever Australian Bond trades for several of the large Asian Central Banks who now dominate the market as the largest holders of Australian Government debt. Angus returned to Australia with ANZ for a short time before being hired by Westpac in Sydney to Head Global Central Bank distribution.
Angus has a Bachelor of Business from RMIT majoring in economics and finance.
Chris has over 20 years of global financial markets experience gleaned from Merrill Lynch (ML), Société Générale (SG) and The Royal Bank of Canada (RBC) across Sydney, London and Toronto. Over his career, he has forged a deep bond investment specialisation.
Chris established his Bond management base in Sydney with ML. He was subsequently promoted to a European posting, relocating with the firm to London to specialise in European and UK Bonds. Prior to returning to Australia with Jamieson Coote Bonds in 2016, Chris served in Toronto for RBC and SG, focusing in US and Canadian fixed income products. Chris’s career has exposed him to the full spectrum of financial instruments and strategies across different markets. In addition, his work with a variety of institutional clients (e.g. financial institutions, pension plans, asset managers, hedge funds and sovereign wealth funds) translates to a valuable global network and a strong sense of market flow dynamics which are features of the JCB investment process.
To augment his portfolio management experience and base, Chris earned the right to use the Chartered Market Technician (CMT) nominal – one of the few in Australia to hold this designation. With over 10 years of experience as a CMT, Chris has developed a proprietary process of technical analysis to help mitigate investment risk and add value to duration management.
Chris has a Bachelor of Economics from La Trobe University and a Graduate Diploma in Applied Finance and Investment from SIA. He is a Chartered Market Technician from the Market Technicians Association.
INVESTMENT, RESEARCH & STRATEGY
Paul has over 20 years in funds management across the US and Australasia. He has served with Colonial First State (graduate program), Advance FM (associate Executive in strategy), 7 years with Barclays Global Investors including as a portfolio manager in San Francisco and >6 years at Vanguard as senior investment strategist.
During his career, Paul has managed money across a range of strategies including asset allocation, global macro and FX hedging. He has developed investment research insights for institutional, adviser and individual investors, and led multi-asset class and factor based research initiatives. Paul is a regular speaker at domestic/international industry forums on portfolio construction and investment markets.
Paul holds a Bachelor of Commerce from Monash University, a Masters in Applied Finance & Investments from Finsia. He is a Senior Fellow of Finsia, a Councillor on the Finsia Industry Council for Funds & Asset Management, and the Finsia Regional Council - Vic/Tas.
(03) 8580 0088
Level 30/101 Collins Street,
Melbourne, VIC 3000