JCB ACTIVE FUND IS A PORTFOLIO OF LONG ONLY AAA AND AA+ RATED EXPLICITLY GUARANTEED GOVERNMENT BONDS. SINCE INCEPTION ANNUALIZED RETURNS ARE CURRENTLY 3.41% NET OF ALL FEE’S.

• JCB SECULAR THEME – CONSOLIDATION AFTER LONG TREND WITH RBA ON HOLD AT 1.50% FOR 2017
• NARCISSISTIC RAGE – DISPROPORTIONATE RETALIATION
• US TREASURY MARKET AT EXTREME SHORT POSITIONING, ON WATCH FOR SQUEEZE
• INVESTORS WRONG FOOTED BY AUD, ASIA’S RESERVE CURRENCY

JCB secular theme – consolidation after long trend with RBA on hold at 1.50% for 2017 -

Jamieson Coote Bonds (JCB) has recently had the privilege of speaking on interest rate policy and the macro outlook at two portfolio conferences focused on 2017 financial market outcomes (please contact us if you would like a copy of these presentations including a detailed scenario analysis of fixed income total returns over 2017 under 4 differing market scenarios). JCB’s secular theme remains that after a 35-year period of declining long term interest rates, a multi-year period of consolidation is highly likely. We have observed that long-term trends rarely rotate and reverse without such a period of consolidation. Those that assume interest rates will quickly spike higher to ‘’normal’’ will be sorely disappointed as high debt burdens, declining western demographics and technological evolution around robotics and automation will maintain structural pressure containing interest rate rises. Domestically we expect the RBA to remain on hold at 1.50% in 2017, also limiting the medium-term scope to lifting Australian yields.

Narcissistic Rage – disproportionate retaliation -

After delivering our conference outlook we had a chance to hear many other thought-leaders’ investment and research perspectives. President Trump’s agenda for significant change was naturally a major focal point. A major emphasis amongst speakers was on the possibility of extreme outcomes materialising – both good and bad. So, for instance, the Trump Administration’s agenda may gain traction and generate dramatic economic activity (representing the right tail of excess positive return).

The widening of possible market outcomes – with extreme events commonly referred to as “tail risks”.

For instance, the Trump initiatives could get traction and work well (representing the right tail of excess positive return). Equally, with regard to portfolio outcomes the wider ‘’tail risks’’ (on a normal distribution curve) received strong debate with consideration of all that could work well (the right tail of excess positive return) and what could go wrong (the left tail of negative returns) in a protectionist Trumparian world.

Currently markets continue to focus on the positive right tail of higher domestic growth and inflation. Details remain non-existent around tax and infrastructure policy – so far we have only been told Trump has ‘’a plan to have a plan’’. Let’s hope the details match the current market expectations. In discussing these scenario’s both conferences also focused on the left tail risk – the unknown things that could potentially go wrong for investors in 2017. Much of this was viewed as political risk, either stemming from European politics and the continued march of populism (with elections in Holland, France and Germany) or geo-politics in a more US sponsored protectionist global environment.

One element we found fascinating was as a speech by a clinical psychiatrist, Dr Deeta Kimber, regarding Trump and his severe narcissism. Dr Kimber suggested Trump is unlikely to change (the office will not maketh the man) and went on to propose Trump suffers from acute narcissistic rage -  an uncontrollable and irrational rage akin to temporary insanity in short bursts. Recent news articles quoting Secretary of State Rex Tillerson have suggested that the United States will not allow China to land or cultivate the Spratly and Paracel Islands, a highly concerning development (among others) from a geo-political stand point. Investors should deliberate on the implications for portfolio’s given the potential for disproportionate retaliation in the years to come if that rage should manifest into action.

US Treasury market at extreme short positioning, on watch for squeeze  -

Forecasting longer dated interest rates is a very difficult task. With much discussion around the outlook for US interest rates it is important to make the following observations. US based economists, as surveyed by Bloomberg, have a poor history of forecasting longer dated interest rates.  Since September 2011, when asked ‘’where will rates be in 6 months’ time’’ responded ‘’higher’’ in 90% of forecasts, however interest rates were higher only 42% of the time. The only time they universally responded ‘’lower’’ was if Trump was elected. Whilst JCB pays great attention to forecasts, we also use additional micro inputs such as flow of funds and positioning data to help signpost possible future interest rate moves. Currently, speculative positioning in US Treasury Bond futures has reached a once in a generation short extreme as viewed by Chicago Board of Trade holding data.  Bond futures contracts are at multi decade short levels with current readings far higher than previous short positioning build ups. Over the last 25 years of data, every time this has occurred a significant short covering rally has ensued, pushing 10 year US bond yields 50 to 100 bps lower (or raising capital prices of US 10 year Bonds by 3.5% to 7%). Holding a short position in interest rates is an expensive game if the market is not consistently moving to lower prices, as the short holder is paying away carry, or the bond coupon/dividend. This is magnified by capital losses if the market starts to rally on a negative change in the news flow. This type of excessive short positioning is a great example of why any move to higher interest rates will not be a straight line and tactical opportunities for active fund managers will abound inside our secular theme of consolidation.

Investors wrong footed by AUD, Asia’s reserve currency -

Official Interest rates in Australia are unlikely to move in 2017. The Australian dollar refuses to move lower despite tremendous hits in recent times. Despite speculation of a credit downgrade the currency continues to frustrate investors with its ongoing resilience. Indeed, in the Brexit debacle of 2016, an event that would have caused the AUD to fall down the “firepole” (the pricing cycle is ‘’up the stair case down the firepole’’) we saw the AUD fall from 76 cents to only 73cents. In a different era we would have been plumbing into the 50s. Over January the AUD rallied more than 6.00% catching many long USD positions off guard. We remain constructive on the AUD as commodity prices remain strong and terms of trade continue to improve. This resilience of the currency maintains an easing bias from the RBA, who may be required to act by cutting interest rates to stoke inflation and ease currency pressure if the AUD continues to climb over the year.

FUND UPDATE FOR JANUARY

The CCJCB fund gained 4.12% in January. The fund maintains an underweight duration position with the majority of the portfolio allocated to front end bonds with a higher correlation to RBA cash rates. JCB view the long-dated bond curve as a tactical allocation post the US election and will continue to hold a core underweight duration position. JCB historically has held a lower risk weighted portfolio than the index and we believe markets will produce plenty of opportunity to generate alpha over 2017. This lower risk holding helps improve our risk adjusted returns over time. The fund benefited from the performance of Supra bond positions which are retained for both credit quality (they will remain AAA rated if Australia is downgraded to AA+) and additional spread in short dates.