A week on from our Market update and the world of equities isn’t as doom and gloom as some would have suggested. Corrections typically happen quickly and this is what we observed last week. The fall can be attributed to some poor numbers out of the banking sector, these poor numbers were considered ” misses” by many and this led to falls of over 15% in each of the four major banks. Given that they dominate the All Ordinaries index most things followed the market lower to see the index hit a low of 5600 – this represented a 6% correction.
The timing of this correction fell perfectly into our hands and we have invested heavily for new clients into our IPS strategy. This strategy focuses on high yielding stocks and also protects the value of the investment by purchasing put options
We also had the “Have a go budget” released by the treasurer, Joe Hockey. As most of you will have read by now this was a steady budget with an aim to encourage investment in small business and to lock in votes for the election next year. Given the negative reaction to the 2014 budget we can all breathe a sigh of relief and move forward.
What we have noticed is that the stocks we have kept in our growth portfolio have outperformed the market. In focus today we will take a look at AHG- Automotive Holding Group and IPL Incitec Pivot and provide you with some insight as to how we have managed the positions.
AHG – we have been in this position for over 2 months. During that time we have received a 9c dividend and seen the stock trade in a tight range. Below the share price you can see our trailing stop which has now started moved higher as the share price moves higher. The stock has been consolidating at these levels and we have been waiting for a close above $4.32 for a move higher. This happened 2 days ago and we now believe the stock will continue its uptrend and our clients will benefit.
AHG Chart
IPL is another stock we invested in as the stock was looking to break higher. After initially getting this move the stock pulled back and reversed below our entry price. The chart below shows our where our trading stop was running. Evidently since we have exited the position we have seen a further 10% fall in the stock.
IPL Chart
This confirms our belief in the risk management that we are using.
Current Holdings
Income Protection Returns
Changing in Bond Markets
One of the big influences on the market over the past month has been a strong rally in bond rates. The US bond market is the largest & most significant driver of interest rates so this will be our focus.
Surprising moves have been seen in the yield curve between 2 and 10 year spread which has steepened significantly. What we would normally expect to see is shorter term rates increasing while the longer term rates move less, leading to a shallower yield curve. The implications of a steepening yield curve is that the market is now thinking that the Fed has waited too long before increasing interest rates. The two year yields are a function of the Fed expectations, however the 10 year notes are a function of a lot more things. Particularly inflation expectations, Supply & Demand for loanable funds and Supply & Demand for securities of that maturity. What we are seeing is that investors are starting to think about inflation again. With longer term bonds inflation expectations become critical, as a small rise in inflation could result in negative yields.
We have already seen many bonds in Europe bid up to levels where the yields are negative, so any increase in inflation expectations in Europe could see a dramatic sell off in these bond markets.
Another way to look at bond markets is considering the supply & demand for loanable funds. At the moment banks in the US have literally been choking on loanable funds, holding massive amounts of cash which has increased their reserves. Given so much supply of available funds, it is little surprise that interest rates have been so low. What we may be seeing is that now we are actually starting to see a recovery in the economy that is resulting in more demand for loanable funds. This demand for loanable funds is pushing up the interest rates as the market moves back into equilibrium.
The other factor impacting bond markets has been massive demand for long term bonds from the likes of pension funds, insurance companies, and sovereigns. If something changes leading to lower demand and we end up in a bond bear market, the resulting moves will be very disorderly. The risk in this lies with lies with those who have invested in bond funds, the largest investor being the Baby Boomers. Many of these got wiped out in the GFC in 2008 and switched to bond funds, which produced stellar returns as interest rates were dropped to today’s record low levels. This saw unprecedented funds flowing into the likes of Pimco & Vanguard Bond funds.
Duration is something that Bond investors should be acutely aware of, however I doubt that most investors have any idea of what Duration means. “Duration is a weighted average of the times that interest payments and the final return of principal are received”. As a Rule of Thumb, Duration is the percentage change in the price of a bond multiplied by the change in interest rates. For example if a bond fund has a Duration of 10 years and we see interest rates increase by 2.5% (keep in mind long term interest rates have increased 0.5% just in the last 3 weeks), then we would expect to see the value of the bond decline by 25%. The majority of retail investors would be unaware of the adverse impact that rising interest rates could have on bond funds that they consider to be very safe. Something to think about.
For more information, contact our Portfolio Managers on 1300 220 360
