Australia has an availability of credit issue, not a price of money issue
Australia does not have a ‘price’ of money problem, its problem arises from a significant and one-time recalibration around the availability of credit. The days of easy money are over, no longer can loan applications make light reference to monthly expenses which go un-tested by lenders. As this recalibration occurs, think carefully about how now deflated markets could reflate. Going back to lax lending standards and poor loan due diligence isn’t a great pillar to be leaning on as the central expectation. This recalibration looks more “L” shaped for many asset markets contingent on leveraged participation than a possible “V” shape, in JCB’s eyes.
The RBA opens the door to rate cuts in the second half of 2019
Falling property prices have forced the RBA’s hand with their recent acknowledgement that the next move in rates is now ‘balanced’. This is a sizeable shift away from the previous RBA rose-coloured glasses narrative that the Australian economy remained solid and recovering towards trend, commentary JCB have long criticised as being overly optimistic, but have assumed necessary to provide reassured confidence. With property markets now falling consistently around the country the expected extrapolation into consumption and household balance sheets has seen the RBA swallow a bitter pill of reality. Many economists are now publicly calling for interest rate cuts in the second half of 2019, after the Federal election likely to occur in May. Such a move, whilst being great for the bond market, would do little to redress the major issue of credit availability.
Asset allocation has been difficult in a year of wide risk dispersion
Globally, macroeconomic data has been the weakest JCB has experienced since early 2016 when markets imploded, and yet equity markets have enjoyed a powerful new year rally on dovish Central Bank commentary and hope of continued quantitative support. Such measures can make a fool of well-constructed asset allocation thinking, as perversely bad news could be good news for risk assets again. The dispersion of possible returns seems wide under such a scenario. If credit delinquency is contained, such accommodative policies would be warmly welcomed by risk markets. However, should credit delinquency grow, such moves may not be enough (think early 2008 when U.S. Federal Reserve cut rates by 2.25%, the U.S. government had guaranteed AIG, Freddie Mac and Fannie Mae and yet risk assets continued to plunge).
As investment committees begin to think of their 2019 asset allocation, could the fixed income allocation be the easiest? The scare campaigns of global rate hikes and unknown bond supply programs are gone, mitigating the left tail of weakness in performance outcomes. JCB believes two powerful right tail outcomes potentially exist for material performance: (1) markets enter a credit crisis and bonds rally on flight to quality; or (2) markets get renewed Quantitative Easing and all assets rally including fixed income.
Searching for the ‘perfect hedge’ - the Q Super case study
The recent AFR article published on 4 March made some excellent points around the benefit of pure duration assets to provide a hedge-like counter balance for riskier asset holdings. The article explains how Q Super, Australia’s best performing Superannuation fund in 2018, took years to search for its “perfect hedge,” finally settling on the “finance 101” textbook – good old government bonds.