Weekly Talking Point - 12 November 2018

InvestSense
Jonathan Ramsay
Jonathan Ramsay
InvestSense Director
1
Markets Back Up ... But So Are Rates. As Buffet famously said "when the tide goes out you see whop has been swimming naked. Have You Got Your Swimmers On?

    Summary

    1. Markets have recovered strongly in the past week or so. Ominously, however, interest rate expectations are tracking up and down with markets but overall still seem to be on an upwards trajectory.
    2. Just as lower interest rates were a boon for asset prices, higher rates represent a turning of the financial tide and, as Warren Buffet has pointed out, that is when we see who has been swimming naked.
    3. Quantitative easing (QE) has undoubtedly floated all boats including, we think, the trend towards passive investing via ETF’s. If this is the start of the unwind then clients need to make sure their eggs are not in the same basket of assets that benefited from these ‘unconventional policies’ seen over the last 10 years. That requires some lateral thinking as it tuns out stocks, houses and bonds were all in the same basket.

    Are Markets The Chicken Or The Egg?

    Markets have recovered much of their losses from October, which will have reassured many clients. That was probably because interest rate expectations started to ease in October (lower cost of money and borrowing will support asset prices). You could also say that long-term interest rates started to ease because markets were down (the market started seeing weakness in the global economy and equity markets which might slow the Fed’s path to higher rates). That is the nature of the late cycle, low interest rate and interest rate sensitive environment we now live in. Looking forward long-term interest rates are already starting to drift up and the results of the mid-term elections in the US will probably exert more upward pressure rather than less. The main reason is that a Democrat controlled Congress means that the path of least resistance could well be bipartisan support of greater government spending, especially on infrastructure. It may also take some political pressure off the Fed.


    That is mixed news for markets but bad news for Australian house owners. Amidst the headlines about what the ‘powers that be’ in Australia ‘must’ do to stop a potential housing rout, it is worth reflecting that both the RBA and APRA did not wish the housing market higher during the last decade. Quite the opposite. Instead, a sluggish economy, ultra low European, Japanese and US rates and an already very strong currency has kept local rates arguably too low for the local housing market. That’s the rate part, or in interest rate parlance the price impact of rates. There is also the quantity side - the reversal of QE (Quantitative Tightening or what is now being called QT) is the US Fed selling back many of the bonds that they bought during and after the GFC. That entails less Dollars in the world and essentially a reduction in US Dollar liquidity. This is putting pressure on emerging markets, especially China, and their trading partners.

    That is one reason why the highly indebted Chinese economy is showing signs of stress and it may also be why Australian rates are apparently even more sensitive to the US economy than US rates right now. More than ever we are a small price taker in a highly interconnected global financial system and in that sense Australian housing can be seen as a leveraged bet on the forces that drove lower rates. If that tied has turned then individuals might want to do some stress testing of their overall asset portfolio bearing in mind that they might have more eggs in the QE basket than they might have realised.

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