ARTICLES

The portfolios were all up for the month with universally solid performances. 

Subsequent to month end, the risk-on rally has continued as election certainty has receded and central banks have provided further reassurances.  Investor optimism about vaccines remains despite worsening COVID-19 case counts worldwide.  Markets have disregarded - for now - substantial and growing problems with debt, uncertainty post the US election, and wealth inequality. 

We are less concerned in the short-term but remain very concerned about medium-term economic prospects including the risk of deflation and stagflation, geopolitical risks, ongoing challenges to true profitability, and elevated market valuations, and are hence participating very selectively in risk assets.  Nonetheless, we are identifying attractive opportunities for alpha generation which may be increasingly crucial as we move forward in a low return environment generally.  The greatest medium-term challenge for all portfolios is probably achieving returns without suffering unduly in continuing market crises; we are seeking exposures where we believe the prospects are most positive and valuations appear attractive in contrast to the market average.

We continue to look to diversify the portfolios where sensible.  We continue to believe some meaningful exposure to assets such as precious metals is essential to navigate the coming months if governments continue to provide massive stimulus while huge issues persist.  We note that economic and political risks remain very substantive globally.  Precious metals exposures have notably been the best performing assets we’ve owned in the last couple of years, and are notably a non-traditional exposure for diversified funds, while having been a core position for us.  We prefer precious metals to overpriced bonds over the medium term and believe investor portfolios may – depending upon the path forward from here - increasingly turn away from bonds given their extremely low yields and potential susceptibility to debt burdens, currency and sovereign risk 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 more protective 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. 

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.

Extraordinary monetary and fiscal stimuli continue to be implemented by central banks.  The sheer size and extent of their actions is providing meaningful impacts on market returns and, in some 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 expect these to provide valuable return and risk contributions over time, even if they are occasionally volatile.  We believe real growth will be very slow in future as the large and unsustainable debt burdens, poor government policies and market interference continue to strangle real productivity growth for much of the economy.  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, in part by being able to differentiate between assets based upon their prospects in different economic circumstances and very disparate valuations.

We could see the current deflationary market environment morph in to a stagflationary outcome over time as we eventually recover from this shock, albeit this will depend on policy actions.  This potentially bodes poorly for some interest rate sensitive assets and potentially broader market exposures across bonds, property and equities over time.  Furthermore, 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 and bubble 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), along with precious metals exposures.  We aim to remain astute and flexible and highly risk aware and are invested in liquid assets whose weightings we will adjust over time to respond to an ever changing and likely highly challenging investment climate.

SUMMARY

In the month of October, US Stocks, on average fell -2.77% whilst local shares fell approximately -1.87%. It was a tumultuous month, as we saw volatility spike to above 40 in the final few days before November (i.e. per the VIX, a key indicat
or of uncertainty sometimes referred to as the “fear index”). This is normally a rare high, however it is the third time this year it reached this level. From the mid-month US stock market peak to trough on the final day of the month, stocks fell over -8%. The markets were under pressure due to the failure of the US government to agree to much needed fiscal stimulus. Furthermore, increasing global Covid-19 numbers, and the uncertainty regarding the US election (with the potential for riots in the event of a very close result) weighed heavily against share prices.  The markets since buoyed following election day as uncertainty reduced, with market soaring higher the following week as Biden was widely acknowledged by the media to have beaten Trump and positive vaccine news was released by Pfizer and Moderna.

ECONOMIC DRIVERS

In the US: Rates unchanged, new fiscal stimulus expected post-election

• The Fed’s position on rates and the view of the economy was little changed at their first meeting following October. The minutes released in October from their previous meeting showed that Reserve officials were concerned regarding lack of continued fiscal support and would commit to low rates until inflation averaged at least over 2%. As previously reported, for example, despite a handful of positive jobless claims reports, unemployment has not significantly improved, nor is it expected to in the coming month until material changes occur with regard to Covid-19. There are still over 30 million people unemployed and not looking for work and there are many people left unable to pay bills and rent without targeted fiscal stimulus as support before year-end.
• Volatility spiked to above 40 in the last week of October (i.e. per the VIX, a key indicator of uncertainty sometimes referred to as the “fear index”). This is the third time this year it reached this level (once in March at the depth of the market crash and again in June with a surge in Covid-19 cases and escalating Trump-China rhetoric). As mentioned above, in October the higher VIX was due to uncertainty around the upcoming Presidential Election, as well the failure of additional fiscal stimulus to be passed.
• As previously reported: a staggering amount of support has been deployed by the Fed in 2020, which includes aggressive emergency cuts to rates in March as well as a slew of additional policy measures, with similar action being taken around the world in developed economies in response to COVID-19. Following regulation changes the Fed has also launched Money Market Mutual Fund Liquidity Facility (MMLF) and MLF, The Pay check Protection Program Lending Facility (PPPLF), the Commercial Paper Funding Facility (CPFF), the Primary Market Corporate Credit Facility (PMCCF) and the Secondary Market Corporate Credit Facility (SMCCF), the latter of which is a major step toward avoiding a financial contagion that spreads to the corporate bond markets.
• Regarding fiscal measures this year, the lawmakers failed to come to agreement before the election and although previous measure were substantial, more is needed before the year end. As previously reported for 2020: Trump signed four executive orders (10^th of August) that access FEMA funds to provide emergency funds for the unemployed, to defer tax payments for those earning less than 100K and to provide assistance to home owners and renters. On the 5^th of June several changes to the Paycheck Protection Program (PPP) Act came into law, which has had the effect of easing payroll demands and gives loan forgiveness further than previously set out in April. As previously reported “Phase 3.5” of COVID related fiscal stimulus was enacted on the 24^th of April to direct 484B toward funding hospitals and Covid-19 testing. Also as previously reported: a “Phase One” 8.3B spending bill was passed on the 6^th of March, which included funding for vaccine research, and assigned money to state and local governments. On the 13^th of March, Trump declared a “state of emergency” to free up 50B in spending. On the 18^th of March “Phase Two” took the form of a stimulus bill that included free virus testing, expanded unemployment benefits and healthcare funding. “Phase Three” also known as the “CARES Act” was passed on the 25^th of March, which include 2 trillion in spending and included 300B in direct payments to earners under 75K p.a., 500B in government lending to companies impacted by the crisis, 367B in small business loans, 250B in unemployment insurance, 220B in tax cuts as well as a smaller amounts to support state governments and healthcare.

In China: recovery still underway but at slightly slower pace.

• China’s PMI fell very slightly in October to 51.4 indicating that the recovery is continuing but at a slower pace. As previously reported: the manufacturing and services as indicated by PMI and non-manufacturing PMI being 51.5 and 55.9 respectively in September. Inflation (CPI ad PPI) was also down slightly in October).
• Regarding fiscal stimulus, as previously reports: In May, China announced fiscal stimulus, which was significant at US $500B (3.6T Yuan), but still less than many other countries hit by COVID. Furthermore, the issue of 1T Yuan worth of special treasury bonds was announced (a measure not seen since 2007). The special bond quote for infrastructure was also increased from 1.6T to 3.75T yuan.
• According to the IMF, further to the above, around US 360B in fiscal support measures have been announced in China which is to include social security tax relief, increased unemployment payments, production of medical equipment and to increase spending related to controlling COVID-19.
• As previously reported, the Peoples Bank of China (PBOC) reduced bank reserve requirement further following its action in March (freeing 79B). Also, to-date, as reported previously, the PBOC deployed 174B in reverse repo operations on February 3 (i.e. very short-term loans to banks so they remain stable and able to meet cash requirements. This was followed by an additional 71B on February 4. They also cut their medium term rates by 0.1% on the 16^th of Feb.

In Australia: RBA rate reduction and stimulatory Federal Government Budget

• The RBA left rates unchanged on the 6^th of October, however, they reduced from 0.25% down to 0.1% in the first week of November. Also on the 6^th of October the government released their annual budget in which a million fewer taxpayers were forecast to be resident by end of 2022. It was also assumed a vaccine would be in-hand by end of next year. A 50 billion dollar spend was outlined, for which some of the highlights included: “JobMaker” a hiring credit for employers taking on 16 to 35 year olds, higher training spend to support upskilling jobseekers, an additional 14B on infrastructure to name a few.
• Forward GDP estimates by the government are expected to be in the 4.25% range in 2021, with recovery beginning during the end of this year. As previously reported, Australia officially recorded its first recession in 28 years at the start of September, while quarterly GDP came in lower than economist estimates (est. -6% actual -7%) for the June quarter. A resurgence of Covid-19 cases in Victoria and NSW made a new peak at the start of August before trailing off since. The RBA are still supporting credit markets and expended the eligible collateral to investment grade securities.  Also as mentioned previously: the RBA cut rates twice in March, first on the 3^rd of March by 25bps down to 0.5 percent (after having left rates unchanged at 0.75% at the previous meeting). The on the 19^th of March the RBA cut by another 25bps to their current level at 0.25%. The RBA also committed to “market operations” i.e. the purchase of government bonds in the secondary market as well as additional repo operations.
• As previously reported, to-date, the fiscal response from the government targeted businesses and the newly unemployed. There are three stimulus packages to-date as well as 11.8B total in state-level packages. The first, a 17.6B package (12^th of March) that includes cash payments of $750 to welfare recipients as well as tax breaks for small businesses.  The business incentives include cash payments of between 2,000 and 25,000 to support hiring staff and paying wages. Further to this, 2.4B will be spent on health needs, including coronavirus clinics and other related expense needs as well as 1B to support the tourism sector. The second package on the 22^nd of March, was for 66B to include income support for workers (“jobseeker payments”) and small business loans. The third stimulus package on the 30^th of March of 130B to include $1,500 fortnightly payments to employers to pass on to employees to keep them in work.
• Further to the above, an additional phase of cash payments to low income households was announced in early July, which will deliver $750 cash to around 5 million Australians, which will total around 3.8 billion.