2019 Review

Hue Frame

Frame Funds Management

Picture this, the week before Christmas 2018. The S&P 500 has just had the worst quarter of performance since Q3 2011. October down -6.91%, November up 1.85% and December down -10.33% by the 20th. Most market participants were shuddering at the thought of what another quarter was going to look like. It was a brutal quarter, and one that investors were just happy to have survived.

Fast forward twelve months and we have quite a different story.

Year to date, we have seen significant upside in major asset classes.

*Government bond prices have risen as yields have fallen.

We will look at three catalysts for this dramatic change of events:

1. Cessation of quantitative tightening

2. Synchronised global monetary policy easing

3. Softened China US trade rhetoric

Cessation of quantitative tightening

During 2018, the United States Federal Reserve stated they would reduce their balance sheet via quantitative tightening (QT). QT is essentially the reverse of quantitative easing (QE), which is aimed at increasing money supply in order to ‘stimulate’ the economy. Hence, QT is aimed at reducing money supply in order to ‘cool’ the economy.

The US Federal Reserve is the largest holder of US government debt. As their US treasuries matured, they stopped rolling the proceeds into new US treasuries, essentially tightening the money supply within the treasury market. The image below shows this tightening of their balance sheet throughout 2019 up until September.

At the Federal Reserve’s final meeting of the year on the 20/12/2018, they continued with their policy communication that they would stay on the same path as they were on, attempting to cool the economy. The market did not like this rhetoric and dropped 4.7% over the next two days. However, on the 05/01 Jerome Powell did a complete 180-degree change in policy communication and stated they ‘wouldn’t hesitate’ to tweak their balance sheet reduction and that ‘Fed Policy is not on a pre-set path’. This change in policy communication immediately supported markets, with the S&P rallying 8.01% in January.

Synchronised global monetary policy easing

As noted above, poor equity market performance was not confined to the United States. Germany, France, Italy, China and Hong Kong were down -22.82%, -13.54%, -16.27%, -20.08% and -8.53% from 1 January 2018 to 20 December 2018, respectively. The economic data released from these economies had also deteriorated over the course of the year. This deterioration caused global central banks to adjust the tone of their policy communication from when they plan to stop their QE programmes and when they will increase interest rates, to how they will provide support to their slowing economies.

There was synchronised communication from global central banks. They all communicated that the next move for global interest rates would be lower and that there was the possibility that they would reinstate QE if economic data deteriorated further.

This change in rhetoric comforted investors. They essentially said that if global economic data deteriorated further, they would step in to provide stimulus and support.

Softened China US trade rhetoric

The US implemented the first China-specific tariffs on July 6, 2018, valued at around US$34bn. China then responded and imposed a 25% tariff on 545 goods which originate from the US, worth approximately US$34bn.

The tit for tatt between the two nations continued, both nations released additional lists of products which were under scrutiny for tariffs. This continued throughout the whole of 2018. However, as the year concluded with both the US & Chinese equity markets having experienced difficult years, lines of communication opened, and it seemed like there may be a resolution in the near term.

On the 2nd December 2018, the US and China agreed to a temporary truce and agreed to refrain from increasing tariffs or imposing new tariffs for 90 days as the two sides work towards a larger trade deal. After this truce, the US and China seemed to be actively working towards a trade deal. In January, a 3-day trade talk meeting occurred in Beijing. In February, talks occurred in Washington. China extended the suspension of additional tariffs on US autos and auto parts at the end of March. More trade talks occurred in Washington in April. In June a temporary truce was reached, days before the G20 Summit. In September, the US & China agreed to the 13th round of trade talks. In October 2019, the US announced the ‘Phase 1’ deal and delayed tariff increases on Chinese goods. In November 2019, US & Chinese negotiators talk over the phone and agree on trade points ‘in principle’.

Although there were times when communication released from both sides was contradictory, the general direction and tone was positive, which provided comfort to investors to re-enter equity markets.

In summary

2018 was an ugly year for most global equity markets as well as most countries from an economic perspective. However, the rebound in equity prices we have seen in 2019 has been dramatic considering corporate profits have declined and economic data has either deteriorated or remained flat over the year.

The recent strong performance in equity markets can be attributed to increases in liquidity and the expectation that global central banks are willing to provide support if they see conditions deteriorate. Our focus is on the risk that the US & China are unable to come to a meaningful agreement and that the accommodative monetary policy is not going to be enough to support the current global economic downturn.

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This information is prepared by Frame Funds Management Pty Ltd (ACN 608 862 442) (Frame Funds, we or us) is a Corporate Authorised Representative (CAR No. 123 9068) of Primary Securities Limited (ACN 089 812 812 635) and is intended only for "wholesale clients" within the meaning of sections 761G and 761GA of the Corporations Act 2001 (Cth). This material is not intended to constitute advertising or advice (including legal, tax or investment advice) of any kind. These materials are not to be distributed to any person who does not qualify as a wholesale client and must not be copied, reproduced, published, disclosed or passed to any other person at any time without the prior written consent of Frame Funds. Primary Securities Ltd (ACN 089 812 635 635, AFSL 224 107) is the Trustee of, and issuer of units in, the Frame Futures Fund (Fund). In deciding whether to acquire, or to continue to hold, units in the Fund please read the current Information Memorandum available from Frame Funds. Past performance of the Fund is not a reliable indicator of future performance. The value of an investment in the Fund may rise or fall. Returns are not guaranteed by any person. Total returns are calculated before tax and after ongoing management costs. In preparing this information, we have not considered your investment objectives, financial situation or personal circumstances and therefore the Fund may not be suitable for you. Neither Frame Funds, Primary Securities Ltd, nor any of their respective related parties, directors or employees, make any representation or warranty as to the accuracy, completeness, reasonableness or reliability of the information contained in this publication or accept liability or responsibility for any losses, whether direct, indirect or consequential, relating to, or arising from, the use or reliance on any part of this material. Any rates of return, forecasts or estimates contained in this publication are not guaranteed. The content of this publication is current as at the date of its publication and is subject to change at any time. It does not reflect any events or changes in circumstances occurring after the date of publication.

Hue Frame
Founder & Portfolio Manager
Frame Funds Management

Hue Frame is the founder of Frame Funds Management and Portfolio Manager for the Frame Futures Fund and Co-Portfolio of the Frame Long Short Australian Equity Fund.

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