We are investing through extraordinary times, with huge forces at play. To extract the market's 'signal' from the 'noise', we asked four of our partners to nominate a single chart and explain its importance.
Anthony Doyle at Fidelity summarises the predicament the RBA is in today with the chart that is keeping them up at night. Steven Glass from Pengana builds on this with an investment strategy built for such an environment.
Charlie Aitken took a 25-year view to argue for staying fully invested, and Adrian Warner backed this to explain why the obsessing with the inverted yield curve could invert your portfolio returns instead.
Read on for the only four charts that matter today.
The chart keeping the RBA up at night
Anthony Doyle, Fidelity International
Despite two interest rate cuts to a record low of 1.00%, market expectations of future inflation have collapsed in August.
The breakeven inflation rate is a market-based measure of expected inflation. It is the difference between the yield of a nominal Australian government bond and an Australian inflation-linked government bond of the same maturity (in this case, 10 years).
Worryingly for the RBA, market expectations of inflation have collapsed to only 1.12%, the lowest on record going back to 2000.
Consequently, the market expects that inflation will average 1.12% over the next 10 years, well below the RBA’s inflation target of 2-3%.
The bond market is telling the RBA that unless it continues to cut interest rates to stimulate economic growth and inflation, there is a substantial chance that it will miss meeting its key target of monetary policy.
This chart suggests that the market is losing faith that the RBA will be able to meet its inflation target, and indicates that the cash rate will likely be cut again in the near future.
The perfect environment for large-cap growth stocks
The chart below provides insight into two important factors. Firstly, the key driver of the US 10-year treasury is global PMI; if PMIs are subdued, it makes sense that the 10-year yield is low, which drives up asset prices.
Chart: The US 10-year yield has declined as one would expect (belatedly) given the global PMI
The second factor is far more nuanced and requires some explanation. Low interest rates coupled with weak economic growth is the key driver of the outperformance of large cap growth stocks.
Without the support of a strong economy, investors are seeking companies that can grow on their own. These companies are often labeled ‘disruptors’ or ‘quality’ or ‘growth’ stocks. Small caps are more economically sensitive than larger companies. During periods where corporate earnings are getting less help from the economy it makes sense to seek growth from larger companies. Therefore, insipid economic growth drives the market towards large cap growth companies.
There are always large cap growth stocks, even in the most moribund economies. All that ever changes is how much people are willing to pay for these stocks. This brings us to interest rates. Lower interest rates increase the value of future earnings relative to current earnings. Given valuations are the present value of future earnings people are prepared to pay more for growth when interest rates are low. Low interest rates have a bigger impact on the valuations of growth stocks than other types of stocks.
Combining the above factors it is clear that insipid economic growth coupled with low interest rates is the perfect environment for large cap growth stocks.
It's time in the market (not timing the market) that works
Charlie Aitken, Aitken Investment Management
While general market volatility can be uncomfortable, it is part and parcel of equity investing. The short-term spike we have experienced in August should therefore not be seen as out of the ordinary, if anything, the relatively subdued volatility markets have enjoyed year to date has been the outlier.
With that in mind, it is good to remind ourselves of the adage that it is time in the market rather than timing the market that makes a difference to long term returns.
The red line in the chart below shows long run OECD inflation from 30th June 2004 to 30 June 2019), and contrasts that the MSCI World Net Total Return index (dark blue line).
The lighter blue lines in the chart show what the index would look like if if you had missed the 5, 10, 15, 20, 30, or 50 biggest ‘up’ days over this period.
Equity is by its nature volatile but can demonstrably beat inflation and grow wealth in real terms over the very long run. Trying to trade or time the market on near-term news flow may feel psychologically better (i.e. you avoid the volatility and near-term distress it causes).
This can seriously impact your long-term returns however, as evidenced by the gap between just owning the index and missing the 5 best days (nearly 75% over the period). And if you were unlucky enough to be out of the market on more than 15 of the best days, you actually ended up eroding wealth in real terms.
Don't let the fear of an inverting yield curve invert your returns instead
Adrian Warner, Avenir Capital
Given all the noise recently about the inverted yield curve, you would think that it was the single most important issue currently confronting investors. The media headlines seem to suggest that it is time to reduce exposure to risk assets like equities as we must be on the verge of a recession. Only yesterday, I had an investor complaining that “this inverted yield curve is making me nervous!”
The chart below shows the number of articles mentioning an inverted yield curve, in the New York Times, over rolling thirty-day periods since 1976. The media interest in this measure, and therefore the interest shown by many investors, has increased exponentially over time.
It is unlikely that the importance of this measure to long term investing success has changed to the same degree over this time.
In the modern age, huge amounts of information flow enormously quickly and it can be difficult to separate the noise from the signal. All that is ‘news’ is not necessarily important.
It is for this reason that it is critical for investors to keep their focus on the long-term and to follow a disciplined and repeatable process for identifying and taking advantage of compelling long-term investment opportunities.
This way they could prevent the ever-increasing noise about the inverting yield curve from ‘inverting’ their hoped-for investment results.
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