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.