Learn more about which bonds are on the move with this weekly podcast. This week Elizabeth Moran, Stephen Mackie and Jake Koundakjian discuss last week's share market correction.
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Director, Fixed Income Sales
Jake grew up in Ottawa, Canada, where he rose from a teenage bank teller to a portfolio manager overseeing more than $600 million in assets for the Bank of Nova Scotia. With over twenty years in asset management he moved to Australia seven years ago with his family.
Director – Fixed Income
Stephen Mackie is based in the firm's Brisbane office, managing investments for clients, ranging from individuals to institutions.
Stephen has over 25 years' experience in global markets, including his most recent role at QIC where he was a Director - Investment Specialist in the Global Multi-Asset team. Prior to this, he has held a variety of senior roles as a trader and portfolio manager with RBC Capital Markets, Citi, Kapstream Capital and the Commonwealth Bank.
Director – Education and Research
Elizabeth has been with FIIG for ten years and for much of that time has been a corporate and bank analyst. In recent years her passion for education has seen her role shift, to author/ edit FIIG’s “The Australian Guide to Fixed Income” and an online fixed income course for Financial Advisers. She continues to edit FIIG’s weekly newsletter, “The WIRE”.
In her role as Director of Education, Elizabeth has delivered presentations at conferences across Australia. Prior to joining FIIG, Elizabeth worked as an Editor/Analyst for Rapid Ratings, writing daily press releases for Bloomberg. Elizabeth spent five years in London, three working as a credit rating analyst for NatWest Markets.
[00:00:00] Welcome to another edition of BondCast. My name is Elizabeth Moran. I'm director of education and research here at the FIIG. Today I have with me Steve Mackie and Jake Koundakjian.
Jake and Steve - Good afternoon Liz. Good to be back.
Elizabeth - Great to have you both. I thought this week we might touch on that correction last week of the stock market down about 7% from the start of the year. I'm not sure what the correction was last week it was up and down a bit quite a bit wasn't it?
[00:00:28] Jake - Well it's October. So in October you kind of give it a bit of a pass and I guess I am showing my age but I've been through a few corrections since the mid 90s in Canada. But a few other corrections I've seen basically there's three types of corrections, I wouldn’t really designate a correction at 7% move since the beginning year. Typically you'd want to see a 20% downside to call it a correction. But generally speaking you have three types of corrections that occur in share markets - technical corrections usually valuation based. So if things get too expensive like the Internet bubble compared to other things. There's also economic corrections. That's just basically cyclical - as the cycle goes on eventually it companies becomes tired. Then you have the GFC structural type correction and it’s really big and something structurally has changed. So those are the types of corrections that occurred I guess and I'm giving October a bit of a pass as the economic background still looks okay to me. So the market comes off the boil from what we had last year at this time. But I don't see the economy really pulling back aggressively.
[00:01:42] Elizabeth - It seems like just the interest rate hike the US interest rate hikes and the potential for a global trade war have upset the equilibrium of the market. So it seems from what I've read that perhaps it's that US earnings are disappointing or perhaps that growth isn't there?
[00:02:05] Steve - Yeah. I think you know if we look at say the S&P 500 it got up to about 2900. Now you can go back to the start of the year and say for example Citi were forecasting 2800. So we're pretty much through that target. Earnings have been quite good in the US. So I think the market sort of reached a point where to continue in we need continued good news. We think about asset classes. If we just think pure bonds to pure equities at the end of September, equities are on their highs and bond yields are about 3.2%. Now if I'm discounting my future earnings using a bond yield at 3.2% I need a pretty good pick up in future from equities. So, normally that equity premium is about 3 to 3.5% over bonds and it just wasn't there at the end September. So you've got billions of dollars that will rebalance on that sort of market situation which is what we saw. And it takes a while for these funds as they are slow moving, to rebalance. They have to have investment committee meeting proposals to approve the rebalance and that's probably what we've seen filter through the market.
And don't forget a lot of this move in stocks has been driven by momentum as well. I just mean ones that are going up all the time. So stocks with good momentum tend to be in hot sectors like technology and obviously they're the ones that we've seen get punished the worst. So I think you know it's normal equities are driven by numerous factors. And I think it's kind of healthy that market waxes and wanes. If you're a long term patient investor and can ride out the volatility then the returns are there for you.
[00:03:48] Jake - But with the returns in equities comes with volatility. Exactly. In my experience we’re all quite experienced in the markets. But you know I guess that the equity markets tend to be much more driven by psychological influences more so than bond markets. In my experience it's about 90% psychology and 10% fundamentals.
[00:04:08] Steve - And you know if we want to quantify that volatility, bonds for example have about 2% annualised volatility generally you know if we look at AusBond credit indices like the Bloomberg AusBond Credit Index lose you know over the past 10 years you've returned about 6.4%pa annualised on about 2% volatility. So that's not bad. You know you can sleep at night with that but equities on the other hand had annualised returns of about 7.75% over the past 10 years but you've had 12.5% volatility. So that's almost six times greater price volatility than you get with a bond portfolio. So you know as bond investors we see it as noise in the equity market we're quite comfortable that if we position our portfolios in the right sectors in the right bonds that our clients can sleep at night.
[00:05:06] Elizabeth - Well that's the whole reason you diversify isn't it?
Steve – Exactly to really drive down that volatility.
Elizabeth – To have risk and reward across the spectrum. Interesting as speaking to Lincoln from Facilitation about what's happened with bonds in the last week. He was saying liquid fixed rate bond yields actually dropped 10 to 20 basis points so the price would have risen over that past week. As a high yield example, the recent Zenith Energy bond since it began trading a couple of months ago at $100 the bond continued to rise up to about $103. But I understand some has come back on the market Jake?
[00:05:43] Jake - Yeah. Well generally speaking your investment grade bonds are a flight to quality, kind of like in the equity parlance blue chips. They are the securities that is going to be around, is going to survive. So looking at AT&T as one of the shares in the U.S. earnings came out well under expectations and so shares were down about 12% over a few sessions. Bonds were flat to up in value. So you see kind of similar things. I was looking at Nufarm as well as talking to an investor this morning about this. Nufarm shares are down about 18%. The bonds have actually risen over the last month. So you know there's certainly a disconnect. But in my experience the higher the quality of bond the more negatively correlated with the share market.
[00:06:34] Steve - That's a good point. So normally very high yield bonds have it will have a big equity component. They'll feel like they're trading like equities. Investment grade bonds will give you that protection and respond in inverted manner to what the equity markets is doing so you know like Jake was saying that the benchmark 10 year US government was at 325bps at the start of this month. You know it's sub 310bps now so you know it's rallied a good 15 to 20 basis points. And the thing with that you know a rising tide lifts all boats so good quality bonds will provide a bit of cover in these periods.
[00:07:09] I think we also have to point out though, the higher yielding a bond is, the more risk you're exposed to and the higher yielding your assets or your bond is the more correlate with the share market. So you should expect if you see a major correction, the sub investment grade or riskier bonds that are paying five, six, seven, eight, nine, 10, 12, 15 percent type returns will be much more equity like. It you are earning double digits returns for a bond you should expect some higher volatility for that investment. But that's where you know you turn to experts in the fixed income space like FIIG, just a plug us, to build out a diversified portfolio with investment grade allocations and some stuff to add a bit of spice to your life, to your returns.
[00:07:58] Steve- And you know you want to be able to sleep at night at times like this, so your bond portfolio that shouldn't be the part of your investments that are keeping you up at night. If it is then you need to give your friendly FIIG figure advisor a call and let's have a chat.
[00:08:13] Jake - Shift more of your portfolio towards investment grade.
This is gonna hurt you with a lower return but it's going to pay you come rain or shine.
[00:08:17] Elizabeth - But also it's going to preserve capital right? There's always that sort of heightened risk with the high yield that capital value my might fall.
[00:08:28] Jake - In times of fear it becomes I don't want to grow my money it's just I want to make sure the money is still around.
[00:08:34] Elizabeth - Exactly. I think that concludes another week of BondCast. Thanks very much for joining.