Wednesday 23 January 2019 by Elizabeth Moran Opinion

Bondcast - 22 January 2019

Back after a break, Jake and Liz discuss what they see as important – interest rates, the economy and positioning portfolios for a bear market

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We would welcome any feedback or questions, if you could please email clientservices@fiig.com.au.


Speakers

Jake Koundjakin-spaceJake Koundakjian 
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.


Liz Moran- space
Elizabeth Moran
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.

Transcript

Hello. Welcome to another edition of BondCast. My name's Elizabeth Moran.

I'm director of education and research here at FIIG. And today I have with me Jake Koundakjian. Hi Jake.

 Jake: Great to be back.

 Elizabeth: What have you been looking at over the break?

[00:00:18] Jake: Well the break it was difficult to ignore the markets. I was sitting on the beach but really looking at those share markets really get pounded and I think personally we're in a bear market and that was the first roar of the bear in late January as we're recording this.

We're seeing the markets rip back upwards. So a bit of a bear market bounce in my opinion. So certainly it got scary very quickly and I think this was the market’s realising that growth is slowing and pricing it in. But since then we've had quite a pivot. What I'd like to call the Powell pivot so the Fed in the U.S.  track back three months in October was very very hawkish and continued to be very hawkish it was talking up rates and slowing things down and things were too hot, we’ve got to slow things down, but in December Powell changed his tune along with a few other Fed governors. So the Powell pivot has changed the psychology a bit but I still think we're in a bear market from a growth perspective.

[00:01:29] Elizabeth: We've seen that in Australia too, haven't we? All of sudden economists predicting rate hikes, to now an increasing number of them predicting that the next move to the RBA cash rate will be a cut. Do you tend to agree with that as well?

Jake: Yes I think we have been a very lucky economy here for a long time. There is enough evidence in my opinion that they don't need to be hawkish. I think they're not hawkish they're just neutral but and thankfully we have some room to cut here.

The economy here is slowing down, we're seeing it through consumer sentiment, we're seeing through the housing market which is affecting consumer sentiment, and wealth effects being influenced. So you know as far as rates, I try not to get too cute and try to guess. I tend to think that rates will climb when the world thinks the glass is half full and cut when the glass is half empty. It looks to me like half empty more and more, so sideways or downwards is the direction that I'm looking at or continue to look at.

[00:02:31] Elizabeth: But does that sort of change your thoughts on what should be in your client's portfolio? Surely if you're thinking rates are going up obviously you have a greater weighting to floating rate notes to compensate for higher interest income but if you are looking longer term, flat or negative on the rates then it then starts to bring back in the longer dated fixed rate bonds.

[00:02:52] Jake: So yeah I like I think it's important in markets to know that you don't know anything!

I guess we'll touch on maybe Jack Bogle later on but you learn a lot through these market gurus you got to know that you don't know anything. And so not knowing a thing you build portfolios with the idea that if rates go up, then my floaters will outperform. If rates go down, my fixed rate bonds will outperform. And ultimately you know I want my customers to get a good high cashflow and not have your bottom line move too much. So mixing the three ways are being paid the fixed, floating and inflation linked bonds, you're making sure that your overall portfolio value hopefully moves up marginally and continues to pay you a nice cash flow.

[00:03:37] Elizabeth: So you're not too concerned in terms of changing your client’s portfolios around at this point? And they've been fairly robust going through the last few years in terms of the mix of the different assets you have there.

[00:03:52] Yes. I guess ultimately I'm looking for value and if I see that the floaters are cheaper…. My typical portfolio has north of 50 or 60 percent in fixed pay because these are going to pay you in size cashflow.

[00:04:06] I guess the typical term is maximum four years duration. So that's not extremely long. I think the index in Australia is five years so I don't think that many FIIG investors are highly interest rate sensitive. They're typically taking being paid extra return because of taking credit risks rather than interest rate risk. I like a mix of fixed, floating and inflation linked bonds.

[00:04:33] When I'm shopping I'm looking for what is good value because I don't know what interest rates will do. I'm looking for good value. One of my colleagues Tom Guest has pointed out to me recently we're just always looking for very good value and ultimately within each portfolio we have to decide what percentage to go to fixed, floating and inflation linked.

[00:04:52] Elizabeth: So what have you thought is good value in the last few weeks?

[00:04:55] Well because I'm pretty bearish of growth and that's based on rate of change data. I think that we are going to slowdown and we're seeing it through the data now. A lot of people still point at the labor market in the U.S. and to some extent here and saying things are fine, but the labor market is the absolute last, last, last thing that ever craters.

We're seeing data come through in the U.S. housing market and here and the autos and durable goods type assets. Where we're seeing quite a lot of negative details coming through in the U.S. and the Eurozone and Japan and China.  The U.S. is finally also going down. So with that in mind, I think that growth is slowing down or decelerating from where we were.  We were in a very, very good place a year ago. You had quantitative easing not as a hawkish kind of Fed or central banks. You had a tax cut coming to the U.S. which emboldened people to really spend and then you had trade wars that were going to hit.

So people were probably front loading durable good buys. So coming from that very, very good place to where we are now, where growth is decelerating, the rate of change from last year to this year is quite will be quite noticeable.

I'm starting to notice analysts starting to bring down their profit expectations but I don't think it's priced in enough. I think we've already seen peak growth and peak earnings for this cycle. So with that in mind it's quite a bearish kind of view from a growth asset perspective.

I want more investment grade and whether that's in …we’re reviewing client portfolios quite regularly. Please reach out to me or reach out to your relationship manager to do so but it's a matter of tweaking to make sure you're comfortable with the investments you have. What percentage you have allocated to higher risk versus lower risk, safer positions and maybe position size are considerations. So make sure you're comfortable with your credits and walk through them.

[00:06:57] Elizabeth: I saw all the spreads on U.S. investment grade and the high yield credit contract just last week. Both of them coming down. So obviously there's increasing demand for bonds you know, defensive assets in people's portfolios globally. Investment grade seems to have come in more than the high yield. So I think there is that emphasis out there in markets. Time to head for the hills.

[00:07:20] Jake: Well yeah it is pricing and I think with a bear market rally this could be you know timing wise, not to get too technically oriented, but timing wise we're in the midst of the earnings season in the U.S. The expectations are kind of low. There are somethings major companies can blame like the shut down of the U.S. government, for the reasons they're not making as much money.

And I guess they can continue to buy back, but 75 percent of the S&P 500 can continue their share buybacks starting February 7th I believe. So you know the bear market rallies can last for long periods you know buy the dip mentality is pretty inked onto the investor psyche. But yeah I think these should be opportunities to sell down risk and go more defensive and whether that means within your bond portfolio or outside the bond portfolio consider your overall risk allocations.

[00:08:21] Elizabeth: It's interesting you're talking about the companies buying back shares. An article I was reading just recently was talking about how companies can still issue bonds to make big special dividends or to buy back shares and the article quoted Fox Entertainment borrowing USD7 billion to help fund a special dividend related to the Disney network purchase and you think hang on..

[00:08:47] Jake: That's cringe worthy.

[00:08:54] Elizabeth: It is cringe worthy and scary but apparently huge demand for the bonds. And you know over subscribe still. So there does still seem to be that sense of euphoria a little bit in markets and things can’t go wrong. but they certainly can.

[00:09:06] Yeah absolutely. And I think you have to step back from a macro perspective and look at what's actually going on. There's short term details happening but realistically when rates rise that slows down growth. It just does slow down growth and it takes a while to filter through and even though the FOMC has maybe paused they're still applying quantitative tightening which is similar to raising rates.

So even if they don't raise rates until say June if they push it out, they're still tightening in some other ways quantitatively. Now this is important because the next recession they need tools in their toolbox to help the economy. So I think that it's important that they do that. But we'll see how this slowdown filters its way through the economies and how it affects company profits.

[00:10:02] Elizabeth: Well Jake I think we're going to have to finish up there. We've done our time very quickly this afternoon and looking forward to chatting with you more as the year goes on. Thank you very much for joining us. If ever you have any suggestions for us at BondCast please email in thanks.

[00:10:19] Thank you. 

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