Volatility, which has been dormant in markets for the past few months, has jolted to life the last few days. The US market has concurrently had its worst and most volatile day since 2015, followed by its best day since 2016 despite nothing really happening (and this bounce is likely to be replicated by the Australian market this morning).
This has mainly been attributed in the popular press from the rise in long-dated bonds. In our view, global growth has been running hot and some in the market have forgotten that this has been facilitated by large amounts of monetary (interest rate and similar) stimulus, which needs to be slowly withdrawn now that sustained economic growth has been achieved.
The removal of stimulus in a measured way is a perfectly reasonable proposition, although it has yet again caught the unprepared by surprise. Given rates are going to rise in the Atlantic economies over the coming months, we may see further jitters. We have seen similar episodes in periods of stimulus changes, such as the ‘taper tantrum’ in 2013, and it’s proven to be a buying opportunity for quality assets for the patient investor.
From a local point of view, this volatility created a sharp sell-off across many asset classes at the beginning of the week and Aussie equities haven’t been immune, although we suffered less. Areas of the market that have been running hot since September, such as small resources and the expensive high valuation names like IT, have had the worst of the selling.
However, these names don’t feature heavily in our portfolio. We are positioned defensively in companies with strong businesses, solid balance sheets and healthy cash flows/dividends. And we have recently confirmed that our monthly income distribution will be unchanged for the remaining months of the year to June, so clients can be comfortable in the knowledge they will continue to receive that.
Amid the commotion, and what we’re more interested in, is the domestic reporting season, which is kicking off. We are particularly interested in areas such as energy utilities and the large bulk resource companies with de-geared balance sheets, strong cash flow and heaving franking balances.
On the banks front, recent domestic credit data suggests that some limited earnings per share growth can continue as the banks move to strengthen their capital position. Some industrials have been looking expensive and they will need to come through with good profits to hold up in this bumpy environment.
Beware the sound of trumpets, buy to the sound of canons.
Dermot Ryan and Tom Young are Co-Portfolio Managers (Income) at AMP Capital
How earlier fears have faded.