ARTICLES

The month of August saw strong returns across the board in global equity markets, with the ASX200 gaining around +2.4%, S&P500 +2.9% and the Nikkei225 in Japan the most notable with a +3.1% rise. European equity indices and Emerging markets also lifted around +2.2%, respectively (all quoted in AUD terms).

The Aussie dollar experienced some mild volatility in August, trading down to around 0.71 vs the USD late in the month, mainly on the back of swings in the iron ore price and chatter that the RBA would postpone the tapering of its bond-buying program. Interestingly, it ended the month flat, closing around the 0.73 level after seeing strength in other commodity prices and the RBA confirming they would not change course. 

Iron ore futures fell sharply in the month, giving up around -20% from the opening month highs. Ongoing concerns around the Chinese economy slowing, industrial production target cuts and seasonal factors are all to blame for the pullback in iron ore prices. Iron ore ended the month around $152 USD/tonne after trading as high as $220 USD/tonne in July. 

The Australian second-quarter GDP numbers surprised to the upside, coming in at +0.7% (Q/Q) as growth continued to be supported by domestic spending and government fiscal policies. The restrictions in place in NSW only impacted the last few weeks of the quarter and will have more of an impact in Q3, with a large contraction expected. 

August 2021 Summary:

• The US Federal Reserve has reiterated the importance of a long-term 2% inflation target
• Major US equity bourses posted fresh all-time highs in August
• US large-cap stocks outperformed small-cap stocks
• Growth stocks outpaced Value stocks in the large-cap sector but were the opposite in the small-cap sector, with Value outperforming Growth
• Oil prices fell sharply in August, giving back over -7% in the WTI futures
• The US unemployment rate continued to fall in August and currently sits at 5.4%

US Equity Markets:

US equity indices posted fresh highs in August, snapping the trend where August is one of the worst-performing months for equity markets seasonally. The S&P500 has now gained seven straight months, which is the index's longest positive streak since early 2018. Market participants highlighted that the concerns around inflation, the spread of the Delta variant, labour market shortages and supply-chain issues were not enough to keep a lid on things. 

US Fed: 

The US Federal Reserve Chair, Jerome Powell, gave equities a boost by making some dovish comments while speaking at the Jackson Hole symposium in the last week of August. He emphasised that the FOMC remains steadfast in their commitment to support the economy for as long as needed to achieve a full recovery. Also noting that tapering on the Fed's QE program could begin by the end of the year if substantial further economic progress is seen. With the US unemployment rate sitting at 5.4%, some economists expect to see the rate dip further when the August Non-farm Payrolls data is released in a few weeks. The benchmark US10Y Treasury yield increased during the month, closing around 1.29%. Still, far from the highs seen in March this year when the benchmark yield sat around 1.70%. 

US Corporate Earnings: 

US corporate earnings jumped higher in the second quarter, simultaneously with the S&P500, Dow Jones, and Nasdaq trading to all-time highs. Over 97% of the companies within the S&P500 reported earnings growth of 88%, which was well above the consensus estimates of 63% at the start of the quarter. 89% of companies beat both earnings and sales market estimates, which was much higher than the 65% 5-year average for sales and 74% average for earnings per share in the index. Although analysts expected to see a significant upside in growth, when compared to 2020's COVID-influenced data, the surprisingly positive data has supported equity prices as analysts have revised future earnings estimates even higher.

Copper Prices:

Copper futures saw increased volatility during August, trading down close the -15% at one point during the month. The base metal managed to find some support, rallying back to close the month down only -3%. Copper has fallen close to 9% since the highs seen in May this year, mainly due to weaker economic data from China. 

Price of Oil:

WTI Crude was also hard done by, losing around -7.4% in August, which is the biggest monthly decline since October last year. Unsurprisingly, energy stocks were down in the month and were the only sector to have a negative performance with concerns around the Chinese economy, a global impact of the Delta variant, and tapering fears in the US all said to be behind the sentiment. 

The US Dollar:

The US Dollar Index (DXY) traded higher early in the month, reaching a high of 93.74 only to finish essentially flat by month-end up +0.51%. The retreat from the highs can be attributed to fears around tapering subsiding, which typically points to a stronger USD as the US economy recovers and scales back the QE program. 

Bitcoin:

Following on from some decent strength in July, Bitcoin continued to surge in August, closing the month up around +14%. Technical analysts are eyeing the $50,000 psychological level as the next price target and potential support in the cryptocurrency, which has previously been a pivotal price level. 

Looking ahead:

The timing around the US Fed's tapering intentions will be a crucial driver of market volatility in the months to come, with Fed watchers pointing to the next FOMC meeting on September 22 as a potential catalyst. Concerns remain around the continuing spread of the Delta variant and inflation around the globe as economies begin to heat up, and both these factors could weigh on markets in the months to come.

Our portfolios provided positive performances for the month, starting the new financial year in a pleasing way.

Although inflation has come through strongly economically, recently deflationary concerns have resurfaced with the delta variant.  The bond market remains unphased by inflation for now, perhaps anticipating its “transient” nature and an economic slowdown.

We remain concerned about medium-term economic prospects including the risk of stagflation, deflation without further stimulus, geopolitical risks, ongoing challenges to true profitability, and highly elevated market valuations, and are hence participating selectively in risk assets.  The greatest medium-term challenge for all portfolios is probably achieving returns without suffering unduly in the continuing market crises; we are seeking to mitigate this risk in part by avoiding the worst of the market exuberance and greater alternatives allocations than most.  We continue to see the need for strong active management to produce acceptable risk/return trade-offs. 

We continue to look to diversify the portfolios where appropriate and sensible.  We continue to believe some meaningful exposure to assets such as precious metals is essential as a hedge to navigate the coming months if governments continue to provide massive stimulus while huge geopolitical, social and economic issues persist.  We note that economic and political risks remain very elevated globally and have recently attracted broader investor attention. 

Our Cash Plus portfolio is very defensively positioned, while our Short-Term portfolio is relatively defensive, with both designed to be less volatile over shorter-term time periods than our longer duration portfolios.   

Our more medium and longer-term orientated portfolios target returns and manage risk with longer-term time periods in mind.  The Wealth Builder’s larger risk tolerance gives us most leeway to back higher risk assets on the basis of our insights and research, while still managing risk prudently over a longer-term time frame; it is in many ways a flagship portfolio for DAC and has – along with our other portfolios - proven highly competitive with both liquid retail and institutional portfolios of a similar nature.  As active management has become more productive since COVID, we have seen a positive performance gap between us and our competitors.

Dynamic Asset’s portfolios are designed to be diversified, but focus on investing where return prospects are assessed as capable of meeting the return objectives of the funds over their respective time horizons.  This diversification provides useful mitigation against risk over the appropriate time period consistent with each portfolio’s objective, while our active assessment of risk and return can target capital to where it appears most prospectively and appropriately placed.  In this way, we are much more forward-looking than a historical SAA approach which tends to be more biased to what has happened (for example, by relying upon past correlations and volatility which may be markedly different from the future).  We consider future scenarios actively and if there is a major regime shift, our approach should hence be much more capable inherently of adapting to different market conditions.  That said, the market outlook remains challenging for everyone currently, no matter what the approach.

Extraordinary monetary and fiscal stimuli have been implemented by central banks and governments, creating distortions and market interference.  The sheer size and extent of their actions are providing meaningful impacts on market returns and, in many cases, causing substantive dislocations from underlying company and economic fundamentals.  Over time, we expect these policies to be very supportive for certain portfolio positions and require dynamic management of others.  For example, and in particular, we hold meaningful weightings to ‘hard assets’ in different guises and continue to expect these to provide valuable return and risk contributions over time, even if they are occasionally volatile. 

We believe large and unsustainable debt burdens, poor government policies and market interference continue to strangle real productivity growth for much of the economy, albeit nominal growth has markedly improved.  This potentially bodes relatively poorly for traditional risk assets and index investing, upon which most traditional investment strategies and super funds are heavily dependent.  Furthermore, we think good active managers will better be able to differentiate themselves and add value over the next few years, in part by being more nimble and able to differentiate between assets based upon their prospects in different economic circumstances and very disparate valuations.

We continue to be concerned about asset prices.  We believe growth outcomes, geopolitical tensions and other risks and shocks pose further (unanticipated) risk to markets, potentially just as coronavirus has.  Indeed, it may take a market shock to end the current market rally given many investors appear to have become entirely valuation insensitive in the face of massive stimulus.  We hence think investors are best served by thinking outside the box in order to better protect and grow their capital, including potentially greater use of liquid value-adding alternatives (selectively chosen), discounted listed investment companies (selectively chosen and now more difficult to identify), along with precious metals exposures and greater weightings to real assets. 

We aim to remain astute and flexible and highly risk-aware and are invested in liquid assets whose weightings we can adjust over time to respond to an ever-changing and potentially highly challenging investment climate.

July saw a month-long rally in US equities run into some headwinds in the final week of the month. The Chinese regulatory crackdown on US listed companies began to create some trepidation for investors on those stocks and a heavy IPO issuance persevered. Robinhood's remarkable reception suggested that investors still have an appetite for the plethora of equity supply, with the stock trading up to $85/share after trading around $33/share just days earlier. 

In Australia, the ASX200 gained +1.2% in July and is up over +14.2% since the beginning of 2021. The ASX200 underperformed indices in the US (+2.5%) and Europe (+1.6%) in July, but outperformed Emerging Market (EM) indices which lost ground (-6%) in the month. The losses in EM can be largely attributed to the sell-off in Chinese and Technology stocks on the main, which reverberated locally with Technology (-7.1%), Energy (-2.7%) and Financials (-1.5%) listed on the ASX200 trading lower in the month. The Materials sector gained ground in July (+7.2%), as did Industrials (+4.4%).

July 2021 Summary:

• Headline inflation in Australia popped in the second quarter to +3.8% annually, which is the strongest in over a decade
• Large and Mega-cap growth stocks outperformed in July compared to Small and Micro-caps, which lagged
• US 10Y Treasury yields continued lower in the month, which aided growth stocks but weighed on financials
• COVID-19 cases continued to surge across the globe as the Delta variant takes hold
• Global inflation has continued to rise, which has caused the IMF to warn of possible longer-term issues
• US equities once again traded to record highs during July despite a resurgence of global COVID-19 cases 

Australian Economy:

The challenged vaccination rollout and repeated state-based lockdown measures continue to dominate headlines in Australia. The state of New South Wales is experiencing severe lockdown measures as daily COVID-19 case numbers continue to track higher. The Australian economy is expected to contract sharply in the third quarter but is likely to be short-term, as has been the case with prior lockdowns in Australia. The unemployment rate in Australia dipped to 4.9% for the last reading in June, which is below the RBA's mid-point forecasts for the year. Some analysts expect the unemployment rate to increase slightly in the months to come, largely dependent on Government support to keep workers employed during the lockdowns in certain states. Analysing the decline in total hours worked in the labour market might be a better way to view the situation, rather than the total employed figure.

The US Fed:

The US Federal Reserve has remained steadfast in its belief that emergency monetary policy measures will continue until year-end at the very least. The most recent FOMC statement reiterated that progress had been made towards the goals required before tapering will commence, although concerns around the increasing spread of the Delta variant weigh heavily on the committee member's minds.

US Corporate News:

In earnings news, the final week of July saw US heavyweights deliver quarterly earnings reports, with technology names front and centre. Alphabet shares popped higher after the search juggernaut reported strong numbers, announcing that YouTube's ad revenue almost doubled on the back of a rebound in digital ad spend. Microsoft performed well with earnings and revenue, beating market expectations. Facebook signalled its sales growth would decelerate as the Apple iOS privacy changes weigh the company's outlook, while Amazon shares fell sharply as the company missed revenue expectations and issued a soft outlook. 

Interest Rates:

Although inflation has been trending higher, US 10Y bond yields have continued to fall in July, leaving many market participants perplexed. The market could be pricing in lower future economic growth, which is already showing signs of slowing at the end of the month with Real GDP coming in at +6.5% in Q2, which was -1.9% below consensus estimates. Gold, which some consider a hedge against inflation, only saw modest gains in the month but has trended lower since after hitting all-time highs back in August 2020.  

US Housing Market:

The extreme surge seen in lumber futures has all but retraced its gains in the last two months. After Lumber futures traded to highs above $1,700 per MBF in May, they closed out the month of July around $625 MBF, down over -62% from the highs in May. Home prices have not followed suit, with an increase seen in the average home prices across the country.  The 20-city home price composite index by Case-Schiller notched new highs in July, adding +1.82% on the month, and +17.1% year over year.

Cryptocurrency:

After the bouts of volatility seen in April and May, Bitcoin has consolidated much of the selloff and is began to track sharply higher in the final week of the month, and reclaimed the key $40,000 level. Ethereum has also seen some price appreciation so far in the third quarter, trading close to the $2,500 level. According to Goldman Sachs Research, Ethereum has experienced the most network growth since 2018. The research notes that one way of valuing cryptocurrency is based on their 'underlying distributed networks', in the same way that social media companies valuations can be based on average monthly active users. Based on this methodology, Bitcoin's value has risen far higher than its network growth compared to Ethereum.

Looking Ahead: 

Equities in major US bourses remain near recent highs, but it's worth keeping an eye on the surging global COVID-19 Delta variant cases. Rising interest rates and inflation is another potential warning sign but not an immediate threat at this moment. Much has been thrown at equities to potentially dampen sentiment, though they keep tracking higher. Robust earnings, low interest rates and monetary/fiscal support to match mean that stocks should continue to find support in the short-term.

Most of our portfolios provided positive performances for the month, ending the financial year with very strong returns overall.

Although inflation has come through strongly economically, recently deflationary concerns have resurfaced with the delta variant making more of an impact. The bond market remains unphased by inflation for now, perhaps anticipating its “transient” nature and an economic slowdown due to COVID related factors.

We remain concerned about medium-term economic prospects including the risk of stagflation, deflation without further stimulus, geopolitical risks, ongoing challenges to true profitability, and highly elevated market valuations, and are hence participating selectively in risk assets. The greatest medium-term challenge for all portfolios is probably achieving returns without suffering unduly in continuing periodic market crises; we are seeking to mitigate this risk in part by avoiding the worst of the market exuberance and greater alternatives allocations than most.  We continue to see the need for strong active management to produce acceptable risk/return trade-offs. 

We continue to look to diversify the portfolios where appropriate and sensible.  We continue to believe some meaningful exposure to assets such as precious metals are essential as a hedge to navigate the coming months if governments continue to provide massive stimulus while huge geopolitical, social and economic issues persist.  We note that economic and political risks remain very elevated globally and have recently attracted broader investor attention. 

Our Cash Plus portfolio is very defensively positioned, while our Short-Term portfolio is relatively defensive, with both designed to be less volatile over shorter-term time periods than our longer duration portfolios.   

Our more medium and longer-term orientated portfolios target returns and manage risk with longer-term time periods in mind.  The Wealth Builder’s larger risk tolerance gives us most leeway to back higher risk assets based on our insights and research, while still managing risk prudently over a longer-term time frame has – along with our other portfolios - proven highly competitive with both liquid retail and institutional portfolios of a similar nature. As active management has become more productive since COVID, we have seen a positive performance gap between us and our competitors.

DAC’s portfolios are designed to be diversified but focus on investing where return prospects are assessed as capable of meeting the return objectives of the funds over their respective time horizons.  This diversification provides useful mitigation against risk over the relevant time period consistent with each portfolio’s objective, while our active assessment of risk and return can target capital to where it appears most prospectively and appropriately placed.  In this way, we are much more forward-looking than a more traditionally managed portfolio based on a more fixed Strategic Asset Allocation approach which tends to be much more biased to what has happened may be markedly different from the future.  We consider future scenarios proactively and if there is a major regime shift, our approach should hence be much more capable inherently of adapting to different market conditions. That said, the market remains challenging for everyone currently, no matter what the approach.

Extraordinary monetary and fiscal stimuli have been implemented by central banks and governments, creating distortions and market interference. The sheer size and extent of their actions provide meaningful impacts on market returns and, in many cases, causing substantive dislocations from underlying company and economic fundamentals.  Over time, we expect these policies to be very supportive for certain portfolio positions and require dynamic management of others.  For example, and in particular, we hold meaningful weightings to ‘hard assets’ in different guises and continue to expect these to provide valuable return and risk contributions over time, even if they are occasionally volatile. We believe large and unsustainable debt burdens, poor government policies and market interference continue to strangle real productivity growth for much of the economy, albeit nominal growth has markedly improved. This potentially bodes relatively poorly for traditional risk assets and index investing, upon which most traditional investment strategies and super funds are heavily dependent. Furthermore, we think good active managers will better differentiate themselves and add value over the next few years, in part by being more nimble and able to differentiate between assets based upon their prospects in different economic circumstances and very disparate valuations.

We continue to be concerned about asset prices. We believe growth outcomes, geopolitical tensions and other risks and shocks pose further (unanticipated) risk to markets, potentially just as coronavirus has. Indeed, it may take a market shock to end the current market rally given many investors appear to have become entirely valuation insensitive in the face of massive stimulus. We hence think investors are best served by thinking outside the box to better protect and grow their capital, including potentially greater use of liquid value-adding alternatives (selectively chosen), discounted listed investment companies (selectively chosen and now more difficult to identify), along with precious metals exposures and greater weightings to real assets. We aim to remain astute and flexible and highly risk-aware and are invested in liquid assets whose weightings we can adjust over time to respond to an ever-changing and potentially highly challenging investment climate.

Stock markets in the US rounded out the first half of 2021 close to or at record highs as the economy continued to pick up the pace with more people returning to work. Monetary and fiscal stimulus remaining at historic levels provided a consistent tailwind to markets, and there's little to show either will be removed any time soon.  

In Australia, the ASX200 gained +26.9% in the 12-months to June 30 2021, while the All Ords Index had its best year since 1987 in the same period. YTD, the ASX200, has gained around +11%, showing a slightly weaker second-half performance. On the final day of trading on June 30, the ASX200 index closed at 7,313 points, up slightly on the day.

The benchmark S&P500 finished the first half with a total return of above 15% after a lacklustre start in January, stringing together five straight months of gains. The Russell 2000 (+17.5%) and Russell Microcap (+28.8%) indices have outperformed broadly. The Nasdaq 100 (+13.2%) underperformed slightly in H1, after posting a record outperformance in 2020 of around +30% vs the S&P500. The Tech index came back into favour in June, as a swing back into Growth assets started to take place late in the month while the VIX index fell back to levels not seen since before the start of the pandemic.

June's FOMC meeting saw the committee surprise the market with a slightly more hawkish tone, as they indicated that the first rise of interest rates was ever so closer in late 2023, and tapering of the bond-buying program may be closer than some expected. The move triggered a change in risk appetite as Growth stocks firmed and Value lagged, while the yield on long-dated US Treasuries declined slightly. Inflation has risen sharply in recent months, and the Fed is signalling that not all price increases will be transitory, as previously mentioned. 

June 2021 Summary:

• The ASX200 gained +2.2% for the month and set the strongest 12-month return to June 30 since 06/07 with +26.9% for the 12 months
• Yields on the benchmark 10Y government bonds finished the month at 1.45% in the US (-13bps) and 1.53% AU (-11bps).
• The AUD weakened against the USD by around -3% in June, hovering around the 0.75 level.
• The jobs market in Australia continues to improve with the unemployment rate falling to 5.1%, and 115,000 new jobs added
• US equity benchmarks continued to probe record highs in June and finished H1 strongly
• The US Fed reiterated its commitment to the current policy settings despite a slightly hawkish surprise at the June FOMC meeting
• Yield spreads and rates experienced volatility after the June FOMC meeting
• The US dollar experienced its biggest monthly gain in June since late 2016
• Growth came back into favour after two consecutive quarters of underperformance vs Value

Australian Economy:

Business conditions and consumer sentiment remain historically high in Australia. The recent lift in the data, including the NAB business survey, makes a case that the impact from recent state-based lockdowns has been somewhat limited. The jobs market continues to show improvements and is on track to reach the RBA's target rate of unemployment by year-end. Employment in Australia is now back above levels since the pandemic began, and we are starting to see early signs of labour shortages, which are yet to translate into wage growth, but this might not be far away. Wage growth gained a modest +1.4% in Q1 2021.

US Equity Sector Analysis:

Interest rate-sensitive Financials declined -3% in June after a more hawkish FOMC meeting, after a four-month streak of healthy gains. For the first half of 2021, REITs (+22.4%), Financials (+25.3%) and Energy (+45.1%) were the best-performing equity sectors in H1, following on from 2020 when they were coincidentally the three worst performing sectors for the year. Utilities (+2.3%) and defensive staples (+4.8%) lagged in the first half of 2021. Tech gained ground on the late rotation back towards Growth (+13.2%) YTD. WTI has posted its fifth consecutive quarterly gain and posted a staggering (+51.2%) gain in H1. 

US Dollar:

The US Dollar Index (DXY) saw its biggest three-day gains since the beginning of the pandemic, following a more hawkish FOMC meeting in June. The index broke above key technical levels and maintained them into the quarter-end, which may signal further upside, as the US potentially leads the way to policy normalisation in 2023. The DXY Index gained +3% in June which is the biggest monthly gain since November 2016.

US Earnings Season:

The second-quarter earnings season is upon us, and to no surprise, expectations are higher than the average. More than 21% of the S&P500 companies have issued EPS guidance essentially in line with the five-year average of 20%. Of that sample, a record 65% have issued positive EPS guidance, compared to the five-year average of 36%. 18% of S&P500 names gave revenue guidance, compared to the five-year average of 14%, and of those companies, 80% gave positive revenue guidance compared to the five-year average of 51%, according to recent FactSet research.

Looking Ahead:

There are a number of mixed signals being given by markets and many possible risks to the recovery, and never a shortage of discussion about how those risks will unfold. Inflation in the US is running well above the Fed's 2% inflation average, which gives plausibility to reducing fiscal and monetary stimulus sooner rather than later. On the flipside, market inflation measures have been trending lower such as long-dated US treasuries, which peaked back in April—supporting the argument that the rising inflation we are seeing might just be transitory and could peak soon. 

US stock markets are pushing record highs, but fewer individual equity names are responsible for the gains. After the S&P500 broke out from the consolidation in May, only 4% of companies within the index made new highs, leaving many investors scratching their heads. Seasonality is also worth considering in the coming months. 

Overall the momentum in the economy is favourable and bodes well for the growth in the second half of 2021, with consumer sentiment and business surveys remaining elevated. While the second half of the year could provide more volatility to markets, the historic levels of monetary and fiscal accommodation should give good support to the economic reopening trade along with a rotation back into Value. 

The S&P500 and the Dow Jones climbed back to within striking distance of all-time highs as May drew to a close. US New Home Sales figures seemed to suggest that the surge in US home prices has caused some buyers to walk away from newly built homes. President Biden released the details of a $6T budget that is sure to get push back from Republicans as the infrastructure debate looks to drag into June. Positive late-season retail earnings reports and corporate commentary indicated consumer strength has returned to 2019 levels and even accelerated into the current quarter.  Inflation remained the overarching topic foremost in most investors' minds. The narrative didn't change, even though the Fed's preferred measure of inflation, core PCE, saw the April y/y number reach its highest level since the early 90s. 

Australia's April jobs report showed the unemployment rate falling to 5.5% as the labour market continues to improve much quicker than expected. COVID flare-ups and the expiration of the JobKeeper program may see the numbers start to slow in the coming months.  The ASX200 enjoyed a solid 2.3% gain in May, outperforming most other major global indices. Financials, Consumer Discretionary and Materials all lead the charge higher while IT and Utilities pulled back in the month. The Chinese Yuan broke out to its strongest level against the US Dollar in roughly 3-years. 

May 2021 Summary:

• The US Federal Reserve calls inflation concerns' transitory', citing an uneven global recovery and supply bottlenecks
• Major US bourses made fresh all-time highs for the month, excluding tech indices
• The ASX200 enjoyed a 2.3% gain in May on a total-return basis, outperforming the S&P500 by 1.75%
• The US 10y yield gave up ground falling to 1.58% from a high of 1.70% in May
• WTI Crude traded to new 52-week highs 
• Gold enjoyed a positive month, trading above $1,918/ounce
• Copper gained close to 5% in the month
• Iron ore futures traded up over 14.5% in May 
• The AUD gained 0.23% against the Greenback in May aided by the strength in commodities and the dovish US Fed comments
• Global COVID-19 vaccinations reached over 2 billion in May

US Economic Overview

Initial and Continuing Jobless Claims fell to the lowest levels since the COVID pandemic began, although still well above pre-pandemic levels. The market is now squarely focused on the Friday, May Jobs report, which will be released on the 4th of June. The US Employment Situation Report for April (released the 7th of May) showed disappointing Growth, with the largest miss on record compared to market expectations. 266,000 jobs were added compared with the market expectations of 1,100,000, fuelling the debate about how unemployment benefits are becoming a problem for employers as employees hesitate to return to work. The April reading (released in May) of the US core personal consumption expenditures (ex-food and energy) rose 3.1% annualised, which is one of the Fed's core inflation gauges. The +1.2% jump from last month's 1.9% reading was the largest gain on record.  Treasury yields broadly moved lower, spurred by central bankers' comments. The Reddit stocks recaptured investors' imagination led by AMC, which saw another round of dizzying gains sparking further debate over excessive risk-taking within financial markets.

US Equity Sector Analysis

Value names outshone Growth in May by over 350 basis points, continuing the trend seen so far in 2021. Since the start of 2021, Value has outperformed Growth by over 1200 basis points, mainly on the back of the economic re-opening trade theme and investors' concerns about inflation along with rising interest rates, as both tend to impact Growth stocks negatively.

US Earnings

Over 95% of the S&P500 names have now reported showing that over 85% reported a beat on EPS, and over 75% reported an upside revenue surprise. This puts Q1 on track for the highest percentage of S&P500 names to beat EPS estimates in 40 years. In summary, companies in the S&P500 reported 50.3% earnings growth and 10.8% revenue growth. Consumer Discretionary lead the way with 58%, closely followed by Energy 38%. 

Market Volatility

Volatility measured by the VIX index spiked above the 28 level during the month of May as Treasury yields ticked higher and investors' concerns around inflation peaked. The VIX, also known as the market fear gauge, closed the month off its highest levels to settle at around 17.

Copper

Copper futures spiked the previous all-time high set in February 2011, closing the month up +4.3% and over 35% YTD. Given the solid run-up to these levels, which some technicians have noted as significant long-term resistance, it is likely to see some consolidation before the next move is seen. Copper is often sighted as a leading indicator of inflation.

Energy

WTI and Brent Crude enjoyed substantial gains during the month, both up close to 5%, similar to the advancements seen in other commodity markets. Fuel prices in the US (according to AAA data) show the national average price of a gallon of fuel is just over $3.00. The highest price paid on record was just over $4.10 recorded in mid-2008 when WTI Crude was trading at over $140/barrel. 

Gold

Gold's lustre returned in May as the precious metal gained close to 8% on the month, trading back above $1,900/ounce for the first time since late 2020. Partly aided by a weaker USD and a buoyant commodity market, it should continue to stay supported in the short term.

Cryptocurrency

After trading above $59,000/coin on the 8th of May, Bitcoin gave up around -40% by month-end as various factors weighed on the virtual currency, including increasing concerns around potential government intervention and comments from Elon Musk around the environmental impact on Bitcoin mining. The Chinese government has also reportedly banned financial firms from providing cryptocurrency services.

The portfolios once again universally provided positive performances for the month. 

Inflationary pressures have picked up recently and we have seen our solid positioning in resources be well rewarded.  This is in no small way due to combined monetary and fiscal government stimulus and investor extrapolation of the same.  Despite this, the bond market remains unphased by inflation for now, perhaps anticipating its “transient” nature and an economic slowdown.

We remain concerned about medium-term economic prospects including the risk of stagflation, geopolitical risks, ongoing challenges to true profitability, and highly elevated market valuations, and are hence participating selectively in risk assets.  The greatest medium-term challenge for all portfolios is probably achieving returns without suffering unduly in continuing market crises; we are seeking to mitigate this risk in part by avoiding the worst of the market exuberance and greater alternatives allocations than most.  We continue to see the opportunities for strong active management as highly prospective.

We continue to look to diversify the portfolios where appropriate and sensible.  We continue to believe some meaningful exposure to assets such as precious metals are essential as a hedge to navigate the coming months if governments continue to provide massive stimulus while huge geopolitical, social and economic issues persist.  We note that economic and political risks remain very elevated globally, albeit they are largely being ignored for now.  We prefer precious metals to overpriced bonds over the medium term and believe investor portfolios may – depending upon the path forward from here – continue to turn away from bonds given their extremely low yields and potential susceptibility to debt, currency and sovereign crises, and rising inflationary pressures over time. 

Our Cash Plus portfolio is very defensively positioned, while our Short-Term portfolio is relatively defensive, with both designed to be less volatile over shorter-term time periods than our longer duration portfolios.   

Our more medium and longer-term orientated portfolios target returns and manage risk with longer-term time periods in mind.  The Wealth Builder’s larger risk tolerance gives us most leeway to back higher risk assets on the basis of our insights and research, while still managing risk prudently over a longer-term time frame; it is in many ways a flagship portfolio for DAC and has – along with our other portfolios - proven highly competitive with both liquid retail and institutional portfolios of a similar nature.  As active management has become more productive since COVID, we have seen the positive gap between us and competitors increase.

DAC’s portfolios are designed to be diversified but focus on investing where return prospects are assessed as capable of meeting the return objectives of the funds over their respective time horizons.  This diversification provides useful mitigation against risk over the appropriate time period consistent with each portfolio’s objective, while our active assessment of risk and return can target capital to where it appears most prospectively and appropriately placed.  In this way, we are much more forward-looking than a historical SAA approach which tends to be much more biased to what has happened (for example, by relying upon past correlations and volatility which may be markedly different from the future).  We consider future scenarios actively and if there is a major regime shift, our approach should hence be much more capable inherently of adapting to different market conditions.  That said, the market remains challenging for everyone currently, no matter what the approach.

Extraordinary monetary and fiscal stimuli continue to be implemented by central banks and governments, despite now appearing inappropriate given the strength of the economic recovery and rising inflationary pressures.  The sheer size and extent of their actions is providing meaningful impacts on market returns and, in many cases, causing substantive dislocations from underlying company and economic fundamentals.  Over time, we expect these policies to be very supportive for certain portfolio positions and require dynamic management of others.  For example, and in particular, we hold meaningful weightings to ‘hard assets’ in different guises and continue to expect these to provide valuable return and risk contributions over time, even if they are occasionally volatile.  We believe large and unsustainable debt burdens, poor government policies and market interference continue to strangle real productivity growth for much of the economy, albeit nominal growth has markedly improved.  This potentially bodes relatively poorly for traditional risk assets and index investing, upon which most traditional investment strategies and super funds are heavily dependent.  Furthermore, we think good active managers will better be able to differentiate themselves and add value over the next few years, in part by being more nimble and able to differentiate between assets based upon their prospects in different economic circumstances and very disparate valuations.

We continue to be concerned about some interest rate sensitive assets such as bonds given their substantively sub-inflation yields.  Furthermore, aside from inflation, we believe geopolitical tensions and other risks and shocks pose further (unanticipated) risk to markets, potentially just as the coronavirus has.  Indeed, it may take a market shock to end the current market rally given many investors appear to have become entirely valuation insensitive in the face of massive stimulus.  We hence think investors are best served by thinking outside the box in order to better protect and grow their capital, including potentially greater use of liquid value-adding alternatives (selectively chosen), discounted listed investment companies (selectively chosen and now more difficult to identify), along with precious metals exposures and greater weightings to real assets.  We aim to remain astute and flexible and highly risk-aware and are invested in liquid assets whose weightings we can adjust over time to respond to an ever-changing and potentially highly challenging investment climate.

The portfolios universally provided positive performances for the month. 

Inflationary pressures have picked up recently and we have seen our solid positioning in resources be well rewarded.  This is in no small way due to combined monetary and fiscal government stimulus and investor confidence in the same.

We remain concerned about medium term economic prospects including the risk of stagflation and rising inflation (the latter is now a more consensus view), geopolitical risks, ongoing challenges to true profitability, and highly elevated market valuations, and are hence participating selectively in risk assets.  The greatest medium-term challenge for all portfolios is probably achieving returns without suffering unduly in continuing market crises; we are seeking to mitigate this risk in part by avoiding the worst of the market exuberance.  That said, we continue to see the opportunities for strong active management as highly prospective.

We continue to look to diversify the portfolios where appropriate and sensible.  We continue to believe some meaningful exposure to assets such as precious metals is essential as a hedge to navigate the coming months if governments continue to provide massive stimulus while huge geopolitical, social and economic issues persist.  We note that economic and political risks remain very elevated globally, albeit they are largely being ignored for now.  We prefer precious metals to overpriced bonds over the medium term and believe investor portfolios may – depending upon the path forward from here – continue to turn away from bonds given their extremely low yields and potential susceptibility to debt, currency and sovereign crises, and rising inflationary pressures over time. 

Our Cash Plus portfolio is very defensively positioned, while our Short-Term portfolio is relatively defensive, with both designed to be less volatile over shorter-term time periods than our longer duration portfolios.   

Our more medium and longer-term orientated portfolios target returns and manage risk with longer term time periods in mind.  The Wealth Builder’s larger risk tolerance gives us most leeway to back higher risk assets on the basis of our insights and research, while still managing risk prudently over a longer-term time frame; it is in many ways a flagship portfolio for DAC and has – along with our other portfolios - proven highly competitive with both liquid retail and institutional portfolios of a similar nature.  As active management has become more productive since COVID, we have seen the positive gap between us and competitors increase.

DAC’s portfolios are designed to be diversified, but focus on investing where return prospects are assessed as capable of meeting the return objectives of the funds over their respective time horizons.  This diversification provides useful mitigation against risk over the appropriate time period consistent with each portfolio’s objective, while our active assessment of risk and return can target capital to where it appears most prospectively and appropriately placed.  In this way, we are much more forward-looking than a historical SAA approach which tends to be much more biased to what has happened (for example, by relying upon past correlations and volatility which may be markedly different from the future).  We consider future scenarios actively and if there is a major regime shift, our approach should hence be much more capable inherently of adapting to different market conditions.  That said, the market remains challenging for everyone currently, no matter what the approach.

Extraordinary monetary and fiscal stimuli continue to be implemented by central banks and governments, despite now appearing inappropriate given the strength of the economic recovery.  The sheer size and extent of their actions is providing meaningful impacts on market returns and, in many cases, causing substantive dislocations from underlying company and economic fundamentals.  Over time, we expect these policies to be very supportive for certain portfolio positions and require dynamic management of others.  For example, and in particular, we hold meaningful weightings to ‘hard assets’ in different guises, and continue to expect these to provide valuable return and risk contributions over time, even if they are occasionally volatile.  We believe large and unsustainable debt burdens, poor government policies and market interference continue to strangle real productivity growth for much of the economy, albeit nominal growth has markedly improved.  This potentially bodes relatively poorly for traditional risk assets and index investing, upon which most traditional investment strategies and super funds are heavily dependent.  Furthermore, we think good active managers will better be able to differentiate themselves and add value over the next few years, in part by being more nimble and able to differentiate between assets based upon their prospects in different economic circumstances and very disparate valuations.

We continue to be concerned about some interest rate sensitive assets such as bonds.  Furthermore, aside from inflation, we believe geopolitical tensions and other risks and shocks pose further (unanticipated) risk to markets, potentially just as the coronavirus has.  Indeed, it may take a market shock to end the current market rally given many investors appear to have become entirely valuation insensitive in the face of massive stimulus.  We hence think investors are best served by thinking outside the box in order to better protect and grow their capital, including potentially greater use of liquid value adding alternatives (selectively chosen), discounted listed investment companies (selectively chosen and now more difficult to identify), along with precious metals exposures and greater weightings to real assets.  We aim to remain astute and flexible and highly risk aware, and are invested in liquid assets whose weightings we can adjust over time to respond to an ever changing and potentially highly challenging investment climate.

US equities again pushed to record highs in April against the backdrop of an increasingly dovish Federal Reserve, improving economic data, strong earnings from big US corporates and the ever-improving vaccination rollout to combat the COVID-19 pandemic, with total US vaccinations breaking the 100 million mark during the month of April.

Once again, the Federal Reserve conveyed its intent to keep interest rates close to zero for the foreseeable future to support the economic recovery for the COVID-19 pandemic after first slashing rates over one year ago. 

The US unemployment rate remained at 6.0%, despite more than 2 million fewer Americans in the labour force compared to pre-COVID levels. The Federal Reserve expects the economy to perk up in the months ahead, with some investors worried about the fast return of inflation in the economy. 

The March CPI reading in the US came in hotter at 2.6%, which is the fastest y/y increase since August 2018. The yield on the US 10Y government bond rallied to 1.7% in March but largely consolidated in April, showing that much of the current inflation expectations are priced in already. Mega-cap growth names in the US regained their strong position in Q2 after underperforming in Q1 mainly due to the rise in yields during that time. 

April 2021 Summary:

• Small-caps lagged while Large-cap names pushed to record highs during April as yields pulled back.
• The US 10Y bond found support, with the yield consolidating from the highs seen in March.
• Economic data, corporate earnings and the ever-improving vaccine rollout boosted sentiment and pushed US equity markets to new highs.
• The ASX 200 gained 3.47% in April, though underperforming the 5.24% rise in the S&P500.
• The AU 10Y yield finished the month at 1.79% but experienced significant volatility during the month.
• The US Dollar gained ground against the Australian dollar, which gave back 1.6% during April.
• The US Dollar appreciated against most of the major currencies during the month, with the EUR 3.3% and the JPY 3.7% experiencing its brunt.
• Business and consumer sentiment in Australia moved back above pre-COVID levels as the economy continues to recover.
• The Australian housing market remained in focus, building approvals for the month up an astonishing 21.6% m/m.

US Sector Analysis

At the sector level, REITS in the US are leading the way in Q2 +8.2%, with Communications names close behind +7.9%, both of which have doubled their Q1 performance already. Consumer Discretionary names also posted good gains +7.2% as the vaccination rates climb and restrictions are peeled back across the country. Financials are now up close to +24% YTD after performing poorly in 2020 and gained +6.7% for the month of April. The Energy sector largely consolidated YTD gains during the month +1.1%, although the sector is still leading since the start of 2021. 

Interest Rates

Inflation expectations and readings have been ticking higher, as has the M2 money supply in the US, a common indicator for rising inflation. However, bond yields steadied after snowballing during the first quarter of 2021, showing that inflation expectations may be largely priced in at current levels. Closing the month at 1.63%, the US 10Y settled during the month after probing 1.75% in March. 

Commodities

Lumber prices have been surging since late 2020 as demand for new homes, and the building industry is on the rise in the US, becoming a key story in the commodity space. April Lumber futures contracts exploded higher, closing April at around $1,500 after finishing March at $1,008 per contract. The price of Gold recovered modestly during the month, after a poor start to the year, closing at $1770/oz. This has puzzled many as Gold is commonly used as a hedge against inflation but has not yet responded. 

Cryptocurrency

Bitcoin experienced large price swings during the month of April. After pushing to new highs of $63,450 per coin, it fell to below $50,000 but quickly bounced back above $57,000. Ethereum, along with many other crypto coins, saw new highs in April as the sector sees a flurry of retail and wholesale investors entering the space. The proposed VanEck Bitcoin ETF review has been delayed by the SEC. Many think the expansion of ETFs into the crypto space will provide a boost to the market and give more investors access without having to buy coins directly. 

The Months Ahead

With a backdrop of a quickly reopening economy in the US, as the COVID-19 pandemic comes under control locally, a supportive Federal Reserve and a solid earnings season behind us, markets could be headed higher before running out of pace. The old 'sell in May and go away' adage may not be appropriate in the current climate, giving the slew of bullish factors seen currently. However, market pundits will continue to watch interest rates, global COVID-19 cases and elevated valuations with caution.  

Against the backdrop of heightened volatility in March, the S&P500 (+4.6%) and the Dow Jones (+6.7%) rounded out their best month since November 2020, with both benchmarks posting new highs in the final week of the month. The Nasdaq 100 (+0.5%) consolidated recent gains as growth names felt the pressure of rising interest rates. In comparison, the Russell 1000 Value Index (+5.9%) outpaced the Russell 1000 Growth Index (+1.7%) by a massive four percentage points after gaining six percentage points in February (being the most significant outperformance since March 2001). The ASX 200 (+2.4%) gained only modestly compared to the global benchmarks, mainly due to the decline in commodity prices.

The rotation from Growth into Value and Large-cap into Small-cap continued in Q1 after beginning in October. Rounding out the quarter, the Russell 2000 (+12.8%), S&P 500 Mid-cap (+13.6%) and the Russell Micro-cap (+23.8%) were the best performers.

Looking at the US sector level during March, the often defensive Utilities (+10.6%) and Consumer Staples (+8.3%) both bounced during the month, pushing both sectors back into the green for the year. REITs (+6.5%) had another excellent month posting their fifth consecutive month in positive territory. The cyclical sectors also remained strong, led by Financials (+5.8%), Industrials (+8.8%) and Basic Materials (+7.7%). Energy (+2.7%) consolidated recent gains after a blistering start to the year. Since the beginning of 2021, Energy (+30.7%), Financials (+15.8%) and Industrials (+11.4%) are the only sectors in double-digit territory.

March 2021 Summary:

• The vaccine rollout and the fiscal stimulus plan in the US have exceeded market expectations since the start of 2021
• Volatility returned, and equities found a way to continue higher, with the SP and Dow posting new highs
• The US 10Y yield rose 83bps since the start of 2021, its largest quarterly gain since Q4 2016
• The AU 10Y yield fell (-9bps) to +1.78% during March but remained volatile with an expanded trading range
• Consumer and business sentiment moved back towards pre-pandemic levels in Australia
• The unemployment rate in Australia dropped to 5.8%, with the participation rate at all-time highs
• The Australian housing market remained in focus, posting a healthy gain m/m of +2.8% in eight capital cities
• Australian building approvals up a blistering +21.6% m/m in March aided by the HomeBuilder Scheme
• Global Value sectors outperformed Growth by around +10% in Q1, the most significant differential in over 20 years
• The USD was positive for the third consecutive month, pushing commodities modestly lower or sideways
• Corporate earnings in the S&P 500 are forecast to grow over 20% in Q1

US Landscape

US equity markets rallied in Q1 2021 mainly on the back of a larger than expected fiscal stimulus package in the US and the improving vaccine rollout. All this despite a bout of volatility into the back end of the quarter. Combined, the $900B stimulus in late 2020 and the recent fiscal package of $1.9T in March 2021 equal approximately 15% of GDP in the US. Late in March, President Biden announced the American Jobs Plan, which proposes an additional $2.25T in government spending aimed squarely at transport, power infrastructure and communication. This plan will join an additional $1T in spending on social programs, which is expected to be announced formally in April. The stimulus amounts still have to pass Congress, but the intention is unprecedented and much larger than what markets priced in at the beginning of the year. The Biden administration has proposed an increase to the corporate tax rate to fund the infrastructure plan, from 21% to 28%, which could take -9% of next year's corporate earnings according to one estimate.

Vaccine Rollout

Over 590M vaccine doses have now been administered worldwide, in what is the largest vaccine rollout in history. Estimates from Bloomberg show that over 150M doses have been administered in the US, which is more than the total number of positive cases since the pandemic began. Last week alone, there were 2.8M doses administered per day, and the Biden administration is hoping to have enough supply to vaccinate all adults in the US by May. Global case numbers are still trending higher, including in the US. The rate of immunisation is rising faster than the new case numbers, which is promising.

US Treasuries

Long-dated US treasuries surged higher during Q1, with the US 10Y yield rising 83bps which is the largest quarterly gain since Q4 2016. It started in January (+15bps) and continued during February (+34bps) and March (+34bps). Similarly, the 10Y-2Y yield curve steepened significantly, with the spread widening around 8bps in Q1 to +1.58%. Notably, this is the fastest rise since Q1 2008, which almost marked the beginning of the last financial crisis. However, the previous high occurred in the early 1980s in the early stages of a historic rally in equity markets.

The US Dollar

The US Dollar gained ground for the third month in a row (+2.6%) during March, and as was the case with long-dated treasuries, this was the best monthly performance since November 2016. Technicians have noted that the recent lows seen in January provided support near the 2018 lows, yet the 52-week trend of lower-highs remains in place for now. The DXY recently poked its head above the 40-week moving average, which has historically been pivotal for the index.

Commodities

Typically, a stronger USD provides headwinds for commodity prices. After a solid start to the year, the Bloomberg Commodity Index posted a -2.2% decline in March after five straight months in positive territory. WTI was down (-3.8%), and Copper fell (-2.5%). Precious Metals' lustre wore thin, with Gold declining (-1.5%) and has been negative in 7 of the 8 prior months.

The Months Ahead

Valuations remain above historically normal levels; the current market environment is unlike anything we have ever seen before. Substantial fiscal stimulus (pushing 25% of US GDP) and a stronger than expected vaccine rollout (>30% of the US population) is faster and more extensive than the market expected just three months prior at the beginning of the year. Similarly, forward projections and economic data continue to gain ground. Estimates for the US GDP predict a growth rate of +7%, which is the fastest pace since 1984, with the unemployment rate returning to 5% by the end of the year. Global COVID cases are still rising but not quicker than the average rate of vaccination. There are likely to be speed bumps ahead, but the reopening of the economy and the historic government spending plans are sure to support equity markets in the near term.