Are markets moving with purpose?

SG Hiscock & Company
Hamish Tadgell
Hamish Tadgell
SG Hiscock Portfolio Manager and Head of Research
Over the past nine months, we’ve seen financial markets go down, around, and up again, following the Fed’s lead. Not surprisingly, investors now believe that the Fed is more sensitive than ever to negative action in the markets.

The Grand Old Duke of York 
He had ten thousand men,
He marched them up to the top of the hill,
And he marched them down again.
And when they were up, they were up,
And when they were down, they were down,
And when they were only half-way up,
They were neither up nor down.
                                                                                    16th Century English nursery rhyme

Frederick Augustus is widely remembered as an absurd figure mocked in the nursery rhyme ‘The Grand Old Duke of York’ for marching his army back and forth between ineffective minor actions for little result.

It could be argued that the markets’ march behind the Fed’s monetary policy directions is taking on similar absurd proportions. Investors appear to be marching asset prices up and down hill, only to end up close enough to where they started. 

As the 2019 financial year draws to a close, the ASX300 is trading 2-3% above last year’s August peak, putting it back 21% above its December lows.

So, while it’s impossible to ignore the volatility, we’ve largely been on a round trip over the past nine months, led by the Fed’s full pivot on policy from quantitative tightening to effectively wiping any rate increases from the calendar in 2019 (in fact going as far as to replace them with the potential for rate cuts). 

Coupled with a more dovish tone from central banks more generally (including the June RBA rate cut), and reversal in extreme market positioning, this has seen an extraordinary turnaround in market sentiment and repricing of assets.    

The significance of ‘Powell’s Pivot’ and the Fed’s sensitivity to financial conditions and markets should not be underestimated.  For now, we need no longer be concerned that the Fed will continue to tighten and the long-term deflation trend in place for the past 25 years will be breached. 

As Figure 1 (one of our favourite charts) shows, the US 10-year Treasury bond yield has declined around 130bp since peaking at 3.39% in early August 2018 to be back within the long run deflationary trend.  

Figure 1:  US long term bond yield critically back below 3% and within the 25-year deflationary band 

US 10-year Treasury bond yield long term (log scale)
 

Source: Bloomberg, SG Hiscock

The question in the last quarter of 2018 was whether the Fed, under the Chairmanship of Jerome Powell, when faced with a market break or unexpected economic weakness, would act independently and continue to tighten towards its stated neutral target setting of 2%, or default to lower rate policies again.  

It’s now clear that ‘the moral hazard’ (the asymmetric promise to help if times get tough but leave markets alone when times are good) is alive and well. 

From a practical perspective, investors are now assuming that the Fed remains more sensitive to negative financial markets and rising credit spreads than the risks of rising financial asset prices and extreme monetary policy. 

As we approach the next Fed meetings, increasingly it feels as though the market has the Fed in a strong hold.

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We believe in buying great companies at good prices. We are firm believers in co-investment, demonstrated by our significant investment in our own funds. Our confidence in our investment approach means we always seed new funds with our own money. We have made the decision to cap our Funds Under Management at modest levels, to ensure that the funds retain greater flexibility to generate strong investment returns across varying market conditions. In order to identify the best opportunities for our clients, we undertake a broad fundamental research program which incorporates an extensive company visitation schedule. With an experienced team of investment professionals, our approach to analysing companies is designed to ensure no stone remains unturned.

We engage with a hand-picked team of external research providers to complement our insights in the macroeconomic landscape (both locally and abroad) and general investment trends. We also have an exclusive joint advisory arrangement with one of the world’s largest commercial real estate investors; LaSalle Investment Management Securities, LLC is a subsidiary of global property giant, Jones Lang LaSalle. This provides our property team access to LaSalle’s research capabilities.

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We engage with a hand-picked team of external research providers to complement our insights in the macroeconomic landscape (both locally and abroad) and general investment trends. We also have an exclusive joint advisory arrangement with one of the world’s largest commercial real estate investors; LaSalle Investment Management Securities, LLC is a subsidiary of global property giant, Jones Lang LaSalle. This provides our property team access to LaSalle’s research capabilities.