US Market Reaction – Insights

Markets completely got the US Presidential election result wrong, but ended up with good gains nonetheless. The view was that “Trump should not win, but if he does markets will tank.” As it turned out, Trump won but the market melt-down lasted only a few hours – with Trump’s less belligerent victory speech quickly soothing market fears, and enabling the Dow Jones to reach a new record high. The focus now is the extent to which “post-election Trump” will be more responsible in approach than the “pre-election Trump”.

In terms of Trump’s economic policies, markets are particularly excited about fiscal stimulus through tax cuts and increased spending on defence and infrastructure (including that wall!). This is helping construction and defence related stocks on Wall Street. Trumps’ other economic policy, reduced regulation, is also bullish for financial and health care stocks. The prospect of increased US fiscal stimulus is bullish for the USD and will add to upward pressure on bond yields. Apart from post-Trump sector rotation opportunities (as noted above), US equities overall remain challenged by still-high valuations and sluggish corporate earnings. Any possible boost to economic growth and earnings from fiscal stimulus needs to be counter-balanced with the likely added upward pressure on bond yields and inflation. Indeed, it should not be forgotten that the US economy already has a fairly tight labour market, as evident with a now clear upward trend in wages growth.

Australian Market Reaction – Insights

The “Trump trade” was also reflected in local markets, with the S&P/ASX 200 up nicely and bonds being dumped. Trump’s victory, along with China’s high PPI result, also provided another excuse for iron ore prices to rally further! Despite the recent changes and market performance nothing is likely to change the outlook for interest rates, with attention focused on the US and Trump.

All up, to the extent Trump’s victory is bullish for the US economy and the $US, it reduces at the margin the chances of a further RBA rate cut in 2017. Key market themes remain, sensitivity of local defensive yield plays (like listed property) in light of higher bonds yields, and a rotation toward financials for those still seeking yield. Resources remain bullish, but I remain skeptical of the sustainability of the recent surge in iron ore and coal prices and remain wary that “too much too soon” goods news has already been priced into the sector.

Article sourced from BetaShares economist David Bassanese published Dec 2016

Sixty percent of large cap managers failed to beat the index over the past year according to the 2016 mid-year review by Dow Jones of active versus passive investing, while over five years almost 70 per cent of managers couldn’t match the major index.

The results were better if investors had given their money to a small or mid-cap manager. Although just over 61 per cent failed to beat their benchmark index over a year there was some good news if investors allowed them more time to generate returns.

Over a five year time frame about 62 per cent of fund managers in small and mid-caps did better than the index. Small and Mid-Cap stocks have been fertile ground for investors looking for growth over the past few years with the poor performance of the four major banks and miners such as BHP Billiton and Rio Tinto dragging down the large cap index.

The worst performance, however, came from active managers of global shares, bonds and property trusts with more than 8 out of 10 funds across all three asset classes failing to do better than their relevant benchmark index.

How does this relate to your portfolio?

Australian Private Capital’s patient strategic asset allocation approach to portfolio management lowers costs through reducing trading costs, maximising the use of the 50% capital gains tax discount and where prudent, using franking credits to the investor’s advantage.  These aspects of our philosophy are designed to improve net rates of investment return over the long term.  Another benefit of this approach is the capturing of small company and value company sector returns that are better than the broader market,  when they occur.  As the table below illustrates, when specific sectors ‘have their time in the sun’, it usually happens quickly.  Therefore by applying a patient approach to portfolio management, rather than trying to ‘time markets’ or ‘pick the winners’, will tend to reward the investor over time.

 

Category	6 Months	1 Year	3 Years
S&P ASX 300 Index (Total Return)	10.43%	11.79%	6.57%
Australian Large Companies	11.79%	12.92%	7.10%
Australian Value Companies	23.49%	28.92%	8.54%
Australian Small Companies	8.73%	14.58%	6.24%

 

Reserve Bank governor Philip Lowe has predicted some of the Trump administration’s economic policies could be good for Australia and the global economy, while warning it could also turn out “very badly” if America retreats from the international order of the world.

In answers to questions following his first public address of the year, opening the A50 forum of leading international fund managers in Sydney, Dr Lowe said the RBA “was in watch and wait mode like everyone else” with the US administration. “It’s very difficult to predict how the new US administration is going to effect economic policies,” he said. “It’s quite possible that the outcomes are really good. Increased spending on infrastructure, reducing regulation, cutting corporate tax, are things that the G20 have been calling for to stimulate economic growth. “To some degree that is at the core of President Trump’s political message, if that works it could be really good for global growth.” It was these policies that Dr Lowe also urged the federal government in Australia to follow.

But he also delivered a blunt economic warning to the audience of policymakers and fund managers. “It could turn out very badly though if we do see the retreat from the open international order, the US economy would be weaker and the world economy would be weaker,” he said. “It surely can’t be the case that the way to build prosperity is to build barriers between each other.” 

In what appeared to be a swipe at developments in the United States Dr Lowe used his address to point out that Australia offered international investors “an openness and transparency not always seen elsewhere around the world”. “Australia has benefited greatly from the open international trading system,” he said. Year after year, for more than two centuries now, capital from the rest of the world has helped build our country. As investors, Australians have also benefited from being able to diversify our portfolios.”

While not commenting specifically on President Donald Trump’s migration bans that have caused turmoil in the United States and debate around the world, Dr Lowe highlighted the benefits of a dynamic migrant population to the Australian economy. “Our population has recently been growing at around 1.5 per cent a year, and around 40 per cent of us were either born overseas or have one parent born overseas,” he said. “This brings a dynamism that isn’t there in countries with stagnant and less diverse populations.”

In the address, Dr Lowe delivered an upbeat assessment of the Australian economy but implored Prime Minister Malcolm Turnbull to borrow more to spend on roads, railways and other infrastructure. Dr Lowe said while it was important for the government to rebuild its finances, that shouldn’t stop it borrowing to build the high-quality infrastructure it will need to maintain support for a growing population. “Good transport infrastructure opens up opportunities for people and opens markets. Investment in transportation infrastructure can also play an important role in addressing housing affordability,” he said. “Infrastructure investment does of course need to be paid for. The positive news here is that there is no shortage of finance for the right projects.”

His comments echo those of his predecessor Glenn Stevens, who said public investment in infrastructure could boost the economy, making the Reserve Bank’s job easier while lifting Australia’s productive capacity.

Tax cuts call

The government’s day-to-day budget would need to move closer to balance in order to give Australia headroom to deal with shocks. A “complication” was the need to make Australia’s tax system competitive. “One example of this complication is in the area of corporate tax, where there is a form of international tax competition going on in an effort to attract foreign investment,” Dr Lowe said. “Like other countries, we face the challenge of responding to this while achieving a balance between recurrent spending and fiscal revenue.”

An update of Reserve Bank forecasts released last Friday predicted economic growth of around 3 per cent in each of the next two years, boosted by a significant pick-up in liquefied natural gas exports, understood to account for around 0.5 points of growth each year, he said. The economic headwinds from the unwinding of the mining investment boom would “blow themselves out” as 90 per cent of the slide had already happened and Australia’s terms of trade had stabilised.

Housing presented a “complex picture” with investor demand strengthening and prices in Sydney and Melbourne climbing strongly, while apartment prices in other cities were falling. Although household debt was high, taken together households were “coping reasonably well”.

Article sourced from the Canberra Times via MSN Money published 10/02/2017

Every night on the TV finance news, you’ll hear about the ups and downs of household name stocks, like the big four banks, Telstra, CSL, Wesfarmers, Woolworths, BHP Billiton and Rio Tinto. But the market is more than that handful of names.

There are about 500 stocks in the All Ordinaries index, the indicator often referred to in the media as the benchmark for the Australian share market. The combined market value of all those stocks, as of August 2016, was close to $1.8 trillion.

Large cap stocks, such as the big stocks mentioned above, make up about 80-85% of the total market cap. Currently, these are roughly the largest 100 stocks by size. The remaining 15-20% of the market cap is represented by the small company stocks.

So why would you want to include these often obscure companies in your portfolio? Well, there are a couple of reasons. One is that these stocks (known as ‘small caps’) tend to behave differently to the better known larger names otherwise known as large caps.

Sometimes, large caps will be the best performers. Other times, small caps will be in favour. So owning both parts of the market means you are getting a diversification benefit. In other words, some of the volatility of being exposed to just one part of the market is reduced.

A second reason for owning small caps in a diversified portfolio is that they are expected to earn a premium over large company stocks. Research shows this small cap premium (alongside premiums from low relative price and highly profitable stocks) is persistent across time and pervasive across different markets around the world.

There are a few provisos to this finding. One is that the premiums are not there every day, every month or even every year. While we expect them to be there every day, there are periods when small caps will underperform large caps. This makes sense because if the premium was there all the time, it would be traded away.

A second caution is that within small caps, other premiums are at play. Research shows that among small stocks, those with high relative prices (sometimes known as ‘growth’ stocks) and lower profitability tend to have significantly lower expected returns than the rest. That means we need to take into account this difference in expected returns.

Finally, diversification is critical. Over shorter periods, some stocks may do exceptionally well; others exceptionally poorly. It’s difficult to identify these stocks in advance. And that’s why you need a well-diversified portfolio that can capture the performance of these stocks in a more consistent manner. Diversification also helps control implementation costs which if unmanaged can be quite high for small cap stocks.

So what’s been the long-term evidence of a small cap premium in Australia? Over nearly four decades to the end of 2015, small caps here delivered annualised returns of nearly 14%, beating large caps by around two percentage points per annum on average.¹

The tricky thing for investors is the “on average” bit. In some years, such as 1989, small caps significantly underperformed large caps. In other years, such as in 1993, small caps shot the lights out, figuratively speaking.

Indeed, over the four-decade period shown in the chart below, you can see that only in four years has the performance of small cap stocks been within 2% of that average premium. So the small cap premium (the difference between the performance of large and small cap stocks) can be volatile, which is the price you pay for earning the premium.