CIO Insights: Bonds perform for portfolios in the final quarter of 2018


In 2018, many Australian investors missed a cornerstone defensive allocation that diversified risk when the rest of portfolios struggled.

According to Bloomberg, major global equity markets returned -6% to -25%, global aggregate credit -3%, global inflation-linked credit -4%, and global high yield -4%. Government bonds? US treasuries +0.9% and Australian Government bonds a healthy +5.1% return in 2018 – a perfect example of the defensive characteristics that high grade bonds provide in times of stress and heightened volatility.

Defying all precedent and using tools never before tested – the final quarter of 2018 showcases a world without Quantitative Easing and excess liquidity

JCB believes what investors are currently experiencing is historic and totally without precedent. Quantitative Easing (QE), a wonder drug for asset prices, has globally reversed to Quantitative Tightening (QT) and risk markets are taking exception to this. Having become grossly accustomed to the benefits of QE, risk markets are reacting with such vehemence, it is unpleasant to watch. The wonder drug of QE together with its somewhat depressive cousin QT have never been trialled before. Investors are collectively living this trial without a safety net not, knowing how this may end.

According to JCB there is one certainty, the technical damage inflicted on markets in the December 2018 quarter will have consequences for 2019. Post the intoxication of Trump’s ineffective tax cuts promising sustained growth, the resulting hangover is painful. As investors close the year, the entire Trump-fuelled tax cut equity rally is gone, as if it never happened. The promised growth is leaking away as housing and autos continue to decay under the burden of higher interest rates. Unfortunately, this hangover includes damage in the form of a trillion dollars of additional debt. From a technical perspective, markets have now reached material new highs and have experienced a colossal failure. Looking forward, JCB believes this doesn’t bode well.

Investors should get used to higher volatility ahead, as policy settings remain unfriendly

JCB considers 2019 will most likely be a highly volatile year and represents a year of regime change. Financial ecstasy has already flipped to anxiety so it is important for investors to be well prepared. Balanced portfolios should outperform and ‘defend and protect’ assets should ease the pain. There will likely be good opportunities inside powerful counter trend risk rallies. However, these are chances to re-position portfolios as the major theme of QT and higher rates makes for difficult times under policy settings designed to cool financial markets. Until those policy settings swing to a more favourable position (rate cuts and more QE) the theme remains negative with no or little support.

Bonds perform for portfolios with strong negative correlation to equity markets in the final quarter of 2018

JCB believes that the fourth quarter returns for fixed rate bonds has defeated any argument around asset market correlation under major stress periods. The performance of both domestic and international fixed rate bonds has been extremely powerful in contrast to many equity markets. No doubt the debate will continue, with plenty of debate from both sides. Despite all the noise, JCB rests in the knowledge that an allocation to domestic and international fixed rate bonds delivers defence and protection to investor portfolios, particularly in times of great volatility.

Reasons to be upbeat looking ahead

Whilst 2019 has its fair share of worries, there will also be excellent opportunities inside the macro environment. Domestically, JCB expects high levels of government spending ahead of the federal election, on areas such as infrastructure, which are needed to help stabilise an economy suffering from a property market correction.

Internationally, the U.S. Federal Reserve looks likely to be almost complete with their rate hiking cycle that has been well telegraphed and articulated with great transparency. Central bankers are acutely aware of the feedback loops that are created by their actions, so JCB expects this is about letting some air out of the tyres for an orderly and contained correction. Ultimately, if this asset deflation happens in an orderly way, it sets up the structures of the market in a far stronger period for the next acceleration of growth, whenever that may be.

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