The great investor, Stanley Druckenmiller, recently said “earnings don’t move the overall market: It’s the Federal Reserve Board. Focus on central banks and focus on the movement of liquidity. Most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets.”
I’ve been doing the rounds seeing investors over the last week and every single meeting starts with “how on earth are equity markets currently doing so well, despite coronavirus?”
The answer is because the market sees the increased chance of further liquidity pumping from central banks and potentially even lower cash rates. The People’s Bank of China (PBOC) has aggressively pumped liquidity, while the Fed continues to expand its balance sheet via buying large quantities of overnight repos.
The market appears to believe the coronavirus impact is a short-term interruption, yet the response from central banks will be longer term in terms of increased liquidity/lower interest rates. It’s the old playbook from the post-GFC era: bad news is good news, as it means lower interest rates and more central bank support for longer.
Hedge funds know this playbook and have reduced short positions in the S&P500 Index ETF to the lowest level since 2007. Short covering has clearly driven some recent index strength.
While the natural contrarian in me tends to be wary of markets rallying into negative macro news, I remind myself that I have seen markets climb the wall of worry before, and it’s a phenomenon that is difficult to fight. Apple was an interesting case study this week. The company abandoned its previous guidance range, after saying sales and supply chains have been disrupted by the coronavirus outbreak. Apple shares fell just -1.83% on confirmation of guidance being abandoned, and remain +8.63% for the CY20 to date. Rightly or wrongly – and only time will tell – markets are optimistically looking through the valley to an extended period of ultra-low interest rates and balance sheet expansion from central banks.
Another theme that has popped up from meetings this week is the elevated levels of cash that SMSFs are holding. Recent ATO data revealed that the average SMSF continues to hold cash levels of 25%-29%, despite the asset class delivering negative returns in real terms. I tend to believe this is a style of post-traumatic stress syndrome response to the horrors of the GFC, which remains very clear in investors’ memories. The question that now needs to be asked is: how will cash as an asset class perform over the next decade? If the bond market is right and we are heading for another extended period of ultra-low rates, then we are going to see SMSFs slowly acknowledge that cash remains the underperforming asset class and start putting a little to work.
And if they do start lowering their cash allocation, where will it go?
One destination will be high-yield (high risk) fixed interest products. My only view here is many of these high-yield products need rigorous scrutiny. Another will be high-dividend yielding domestic equities and equity yield funds. The advantage of franking credits inside the superannuation fund structure remains attractive. The final destination will be global equities in global dollars, to diversify away from the somewhat fragile Australian dollar and banks/resources that dominate the ASX200. It’s worth reminding SMSFs about the case for Australian investors owning global equities in global dollars. Global equities represent just 2% of the average SMSF asset allocation.
Source: MSCI
The pie chart above reminds you 97.7% of developed equity market investment opportunities lie outside Australia.
The case for global equities also lies in the sectors that aren’t represented in domestic indices. Australia is massively exposed to financials, at 35% of the Australian benchmark. Due to our natural resource endowment, materials and energy represent over 22% of the benchmark. More than half of the Australian equity benchmark is deeply cyclical via commodity producers, providers of credit and providers of insurance.
If you look where Australia is underexposed, it is structural growth sectors such as Information Technology (IT) and Communication Services. Australia is massively underexposed to technology; period. I believe it makes sense for Australians to diversify away from deep cyclicals and a commodity currency. That doesn’t mean you sell Australian equities; it means there is a case for sensible diversification into global equities to gain exposure to great growth sectors and businesses not available on the ASX. Global equities in global dollars compliments Australian equity positions and provides a more balanced exposure to the future of 7.4billion people (not just 25 million). You need some exposure to large addressable markets if you want growth in your portfolio. I said for many years, Australian equities for income, global equities for growth. I still think that is true today.
I tend to feel Druckenmiller is right and that central banks pumping liquidity will support equity markets and potentially see some cash come in from the sidelines. Let’s see what comes, but I am not sure that 25% – 29% in cash and just 2% in Global equities is the correct long-term asset allocation in an SMSF.
Some food for thought…
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.