Dear Switzer subscribers, June has seen a strong recovery in global equity markets, with the losses of May already recovered. The question becomes, what changed? Simple answer: central bank language.
There’s an old adage “don’t fight the Fed”. Nowadays, more accurately, it’s don’t fight the Fed, ECB, BOJ, BOE, PBOC and RBA all working in concert.
This month we’ve seen coordinated “jawboning” from central banks about the possibility of lower interest rates and even the potential reintroduction of QE.
Bond yields globally have plummeted, cash rate forecasts have been cut and equity markets have rallied sharply on the combination of short-covering and rotation to the higher equity yields available.
The equity markets believe there is a ‘central bank put’ and despite slowing global growth, slowing earnings growth, weak inflation, inverted yield curves and a trade war, participants have bid equities straight back up.
There is a complete contradiction between what bond markets/yield curves are implying about future growth and what equity markets are discounting. That’s the traditional view and widely broadcast by cautious commentators.
They may well be right and the equity party is premature, but what if the equity market is right in believing the bond market, in terms of interest rates and inflation, is going to remain low for another decade?
I tend to believe the equity market isn’t ignoring the bond market, it’s actually thinking about what the bond market is pricing in terms of long-term interest rates and is adding P/E to long-duration growth businesses.
I also believe the equity market is listening to central bankers and taking the view the real return on cash will be negative for the foreseeable future. Cash isn’t king at all right now, in fact it’s the clear underperforming asset class.
Thankfully, my fund deployed cash reserves in the May correction in great long duration businesses such as Apple, Tencent and Alibaba, feeling our entry prices should generate returns better than cash over the next 12 months. We also covered all short positions last month, feeling fighting central banks and an increasing M&A cycle would mean shorting would become even higher risk, particularly in single stock shorts. Those actions proved correct and we have been capturing the equity market recovery in June.
What interesting is that most investors remain cautiously positioned. It would appear that this month’s strong equity market recovery hasn’t suited everyone, with hedge fund positioning light and institutional cash levels high. That’s why this rally potentially has more to it as many professional investor are underexposed to what is currently a rising market.
However, after the sharp recovery rally, it’s not easy to identify domestic or global stocks that you would commit further money to at today’s prices. What I’m focused on is great global companies that have underperformed in the recovery rally and look good value relatively versus their long-term growth prospects. The vast bulk of those stocks remain China facing, due to continued bearish commentary and positioning towards China.
China facing equities remain laggards and wouldn’t require much “non-negative” news to spark a solid rally. When underperformance, sentiment, value and positioning collide, the chances of a strong counter rally are large. Refer to the big four Australian banks example post the Federal Election result.
Right now, I feel very similar characteristics in the China facing companies we own. Stocks such as Alibaba (BABA.US),Tencent (700HK), Ping An Insurance (2318HK), Apple (APPL.US) and even A2 Milk (A2M) are all still lagging and trading with a significant “China discount”.
My personal view is all five of the names above are offering solid medium-term investment opportunities and my fund has been adding to all those holdings in recent times.
What will release that China facing value I hear you ask?
- A ceasefire in the trade war.
- A peaking US dollar as the Fed starts cutting rates.
- Emerging market ETFs attracting inflows.
- China using money and fiscal policy stimulus.
- Short covering.
As we saw in the Big Four Australian bank example, when the catalyst comes, the price moves are very quick and very sharp. You don’t have time to react, you need to be invested before the event.
For comparison sake, below is a year-to-date chart of the ASX Bank Index (+16.2% and the HSCEI China Enterprises Index (5.37%) in HK). I’m of the view this performance gap will close in favour of HSCEI in the months ahead.
This is why I favour global equities over Australian equities. I’m now struggling to find value, or opportunities to deploy cash in Australia. In fact, we’ve been selling Australian exposure I think is now fully valued, such as Aristocrat (ALL) and Cleanaway (CWY). I have my lowest weighting to Australia in five years, due to lack of value and lack of growth. However, I still see places to put money to work globally where price to growth ratios remain in favour of medium-term capital gains.
That said, I’m not simply allocating to global equities over domestic equities because of a bearish view of the Australian dollar (AUD/USD). I tend to be of the view that the big capital gains in shorting the Aussie vs the US dollar have already been made, from 100usc to today over the last seven years. Many global fund managers based in Australia have done very well from this currency fall, in fact some have done better from currency than stock picking. Yet I tend to think the major down currency move has already happened. The chart below shows the AUD/USD cross rate at major long-term technical support levels.
If anything, I would suggest that investing globally from Australia that not solely relying on further Aussie dollar falls for capital gains in offshore portfolios is prudent at these levels.
Either way, as I said on the Switzer Report webinar last week that many of you would have heard, I believe equity markets will continue to perform strongly in 2019 as the investing world comes to grips with ultra-low cash rates and increased merger and acquisition (M&A) activity.
Markets always move to the point of most pain, and, bizarrely enough, that point of most pain is currently HIGHER due to conservative positioning of most professional fund managers. In Australia, SMSFs continue to run large cash weightings.
In reality, we are in “TINA”… “There is no alternative “ (to equities). You get no real return in cash, no real return in fixed interest, and arguably flat rental and capital growth returns in property. At the moment all roads lead to equities and that will most likely continue to be the case as central banks continue to reduce the risk free rate of return.
Australia for income, international for growth…
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.
