Markets stumble, then find their feet - for now…

The major story of the past week - or "non-story" depending on how you look at it - is that the sky has not quite fallen in (much like the member for New England) after the US market's sudden spike in volatility earlier in the month.

Inevitably there will be those who will be saying "what was that all about, it was just an over-reaction, and now there's a great buying opportunity!"

That may be, but as Hedge Clippings warned a couple of weeks ago, don't risk betting the house on it. The US market, having risen for 12 straight months, including over 5% in January, was approaching the "irrationally exuberant" stage, underpinned by low/zero/negative interest rates (depending on where in the world you are), the promise of US tax cuts and infrastructure spending, low inflation, and low wages growth, all of which are feeding into an improving economy and corporate earnings.

The canary in the mine is the 10 year bond yield at over 2.8% (and rising) vs the S&P500's 2017 yield of 2.4%, and an uptick in inflation. Perversely this is precisely what the FED has been trying to achieve. The renewed volatility (the VIX having traded around 10% for a large part of the last 6 months) was a useful warning shot across investors' bows, and luckily for them, the market seems to have stabilised - for now - rather than going into free fall.

While the economy and corporate earnings continue to improve, that won't fully insulate the market from an impending switch in asset allocation as the US10 year bond yield moves to 3% and above - which it will at some stage, and probably in the not too distant future.

Locally the damage to the Australian market was not as great, simply because in 2017 it had only risen half as much as the S&P500, but it still wasn't immune to the volatility. While it's only halfway through February, there'll be the usual wide range of fund results come the end of the month, but many absolute return funds had either short positions, or were carrying a high level of cash as at the end of January. As such their relatively low net market exposure will buffer them from the volatility, proving their worth in rocky markets.

BENNELONG KARDINIA ABSOLUTE RETURN FUND

Attached is our most recently updated Fund Review. You are also able to view the Fund's Profile.

• The Fund is long biased, research driven, active equity long/short strategy investing in listed ASX companies with over ten-year track record. 

• The Fund has significantly outperformed the ASX200 Accumulation Index since its inception in May 2006 and also has significantly lower risk KPIs. The Fund has an annualised return of 10.80% p.a. with a volatility of 6.95%, compared to the ASX200 Accumulation's return of 5.72% p.a. with a volatility of 13.53%.

• The Fund also has a strong focus on capital protection in negative markets. Portfolio Managers Mark Burgess and Kristiaan Rehder have significant market experience, while Bennelong Funds Management provide infrastructure, operational, compliance and distribution capabilities.

For further details on the Fund, please do not hesitate to contact us.

Australian Fund Monitors

ATTACHED FILESAFM Fund Review - January 2018 (pdf format)

ARCO ABSOLUTE TRUST (formerly Optimal Australia Absolute Trust)

AFM have released the most recently updated Fund Review on the ARCO Absolute Trust.

We would like to highlight the following aspects of the Fund;

• ARCO Investment Management is a specialist Australian equity investment manager and the Fund has a long/short equity strategy typically with a low but variable net market exposure comprising 40 to 65 stocks broadly selected from within the ASX200. 

• The investment team comprising George Colman, Peter Whiting, and Stephen Nicholls bring 100 years combined experience in equity markets.

• The Fund has an annualised return since inception of +8.56%. The Fund's approach to risk is shown by the Sharpe ratio of 1.44 (Index 0.30), Sortino ratio of 3.07 (Index 0.33), both of which are well above the ASX 200 Accumulation Index and has recorded over 79% positive months.

For further details on the Fund, please do not hesitate to contact us.

Australian Fund Monitors

ATTACHED FILESAFM Fund Review - January 2018 (pdf format)

Established in 2014, Cyan's CG3 Fund is managed by principals Dean Fergie and Graeme Carson. In this short video Dean and Graeme explain the philosophy behind the fund and the success of their investment strategy which involves investing in early stage or small-cap stocks on behalf of professional investors.

So, what did you expect?

In last Friday's "Hedge Clippings" (which seems much longer than just a week ago) we warned that as a result of yields on 10 year US Treasury Bonds having risen to levels not seen since April 2014, the time was approaching for a seismic shift or tipping point in asset allocations, potentially destabilising the long-running equity bull market.

Having got that call correct, (albeit vague on the definition of "the time") we then incorrectly stated that following Janet Yellen's final remarks at the Fed, that markets "pretty much took things in their stride." Come last Saturday morning - what a difference a day makes! However, we did go on to warn that bull markets rarely end in a whimper, and one shouldn't bet the house on an orderly transition. Two out of three isn't too bad!

There have been some who have been surprised at the extent of the volatility over the past week, particularly in Australia where, while tied to the US, we have a significantly different economy, and market conditions. Meanwhile Hedge Clippings' old friend and sparring partner, Peter Switzer, has today predictably included hedge funds as the culprits. Consider the following:

The yield on US bonds at 2.8% vs. represented a premium of 0.4% to the S&P500's dividend yield of 2.4%, and which had risen more than 20% over the previous 12 consecutive positive months, including more than 5.5% in January alone. Compare that with Australia where the ASX200 has a yield of 4.77%, before even considering the effect of franked dividends and CGT benefits, or that the market had risen at less than half that of the S&P500.

Volatility dropped below 10%, and equities responded with stretched valuations as even 2.4% looked attractive vs. next to nothing as an alternative. All the Central Banks were longing for was a sign of growth, and inflation to go with it.

The US (and Europe) has been force fed with a diet of QE and low/zero/negative interest rates in order to revive their economies, which were dead in the water, and pump priming the equity market boom. Meanwhile the Australian economy, in spite of a market that was a poor performer, has now put together a quarter of a century of continuous economic growth.

So now the Central Bankers have delivered the growth and the first signs on inflation, (still low by historical standards) what did investors expect? Only those with short memories should have expected an orderly transition.

Let's put some perspective into the extent of the falls. The headlines may scream at the record 1,000 point falls, but in percentage terms they're not (not yet anyway) close to the percentage falls of 1987, or those in 2008 when Lehman's hit the wall, and triggering the GFC.

And for the record, while Lehman's demise might have triggered the GFC falls, it was the activity of the previous 5-7 years that caused it. This is just a case of Déjà vu.

The US economy is steadily growing, unemployment is historically low, as is wages growth and inflation, albeit rising. Interest rates remain low and although on the up (except in Australia) only in line with a growing economy, the fundamentals of which remain sound. Equity valuations which were stretched (less so in Australia), will now be coming back into line, but provided the underlying businesses are sound, should find "fair value" once again.