RBA KICKS OWN GOAL AMID GLOBAL VOLATILITY + CAPEX SHOCK

Global fixed income markets remained under heavy technical selling pressure in early May following the rapid fall in European Government Bond prices lead by the German 10 year. AUD bonds initially followed lower as all bond risk premiums where revalued in light of European sell off. The ECB have committed to a 1.2 TRILLION Euro QE program. When you are spending 1.2 TRILLION Euro’s you would hope to get what you want. In the ECB case that is stable markets with low bond yields thereby encouraging excess capital into the broader economy, whilst also lowering the cost of debt serviceability. In response to the sell-off the ECB calmed markets significantly mid-month by illustrating it would front load the pace of QE purchases. The markets immediately responded, turning what had been a technical deleveraging sell-off into a buying opportunity with much of the lost ground being regained by month end.

In Australia after April’s weak CPI data the market expected the RBA to cut rates at its May 5th meeting. In an incredible act of nativity, the RBA dropped its explicit easing bias in its accompanying statement – instead selecting a watered down implicit easing bias. In doing so the RBA kicked a significant own goal with regard to financial markets outcomes, as traders assumed the RBA easing cycle could be over. In an already difficult market the AUD currency was materially higher, bonds and equities sold off and property clearance rates screamed. Bond market’s closed 15 bps higher in yield on RBA day despite the 25 bps rate cut (only other time we have seen that is after Sept ‘11 in USA when the Bond market rallied so far on day of terror attack -flight to quality- it actually sold off the following day despite FOMC cutting rates).

Late in the month CAPEX data was outright recessionary, reminding fundamental investors that Australian glide path remains significantly challenged. We fully expect further RBA rate cut later in year (November) with a return to an ‘’explicit’’ easing bias as soon as June RBA meeting minutes.

We have argued for some time that equity markets are living on interest rate oxygen only. Interestingly, as bond yields moved 1 - 1.5% higher early in the month, equity markets were savaged as yield driven stocks collapsed, some by more than 10%. Lower bonds yields will be welcomed for now by equity investors, but be sure to mind your eye when the next crisis comes. The positive correlation will have a major breakdown in time.

FUND HIGHLIGHTS & POSITIONING

JAMIESON COOTE BONDS ACTIVE FUND GAINED 0.11% GROSS IN THE MONTH OF MAY. WITH THE WASHOUT IN EUROPEAN BONDS DRAGGING FIXED INCOME LOWER, JCBAF WAS 2.5 YEARS UNDERWEIGHT INDEX EARLY IN MAY, GENERATING SIGNIFICANT OUT-PERFORMANCE VS THE FUND MANDATE.

Given valuations had improved considerably into the RBA meeting on May 5th, JCBAF added duration for expected rate cut in line with our strategy highlighted in the April Fund update. Unfortunately due to the failure of the RBA to read market psychology, despite calling this rate cut correctly, the fund suffered as bonds prices declined after the meeting (See RBA own goal in market update)

Prior to the RBA meeting, Bond prices had been declining due to international technical factors. This change of tone from RBA added fundamental domestic pressure to the market. After being wrong footed on RBA day due to change in statement, JCBAF reduced duration again, preferring to wait for confirmation the international sell off was abating.

The news the ECB would front load QE purchases was the catalyst to lift duration again as higher duration holdings are justified at technically discounted valuations. After the release of weaker CAPEX data we quickly lifted duration again to overweight index to capture the resulting rally, running overweight positions into month end extensions where we lightened some risk and retuned to a slightly underweight index position.