Summary of key points

  • The equity markets have recovered partially from the significant but not catastrophic sell-off in October. As we indicated earlier such episodes will become more frequent and severe in the unstable policy environment being driven out of Washington, which is part of what has been a noisy presidency.
  • Equity markets are still fairly priced from a longer-term point of view, with both monetary and fiscal policy still supportive of economic growth as well as financial asset prices, but momentum is becoming fragile.
  • Equity market momentum has been weakening back towards neutral. Increased caution is warranted with consideration of some reduction in equity allocation for more risk averse investors after any significant rises which will likely occur following further short run sell offs.
  • The severity and the duration of the trade dispute between the world’s two biggest economies is not yet clear, nor will it be for some time to come. From time to time optimism about a resolution builds in the equity markets but can suffer setbacks such as late in the week ending 9 November.
  • The shape of the yield curve, a good forward indicator of recessions and downturns in equity markets, has flattened but has not yet turned negative and so is not yet signaling recession or a more severe equity market downturn.
  • It is possible to see the emergence of the causes of a recession in 2020 or soon thereafter. They include:
    • A too rapid increase in interest rates in the US at the same time as fiscal stimulus is waning;
    • Too much tightening of credit availability in China;
    • Worsening disruption to global supply chains from the trade dispute between the US and China;
    • The failure to find a compromise between the European Commission and Italy on Italian fiscal and banking problems;
  • Based on the mainstream scenario of continued growth in earnings and low but rising short term interest rates and bond yields, together with a yield curve that is not yet negatively sloped (where long rates are lower than short rates) a neutral weight to Australian and International equities is still warranted at this stage.
  • Allowing for the risks to the mainstream scenario:
    • Holdings in the equity asset classes should be well diversified, with a significant weighting to more defensive funds or stocks. This will include equity funds that may from time to time hold enlarged cash balances for defensive or opportunistic purposes.
    • Be prepared to reduce equities if the US ten-year bond yield moves significantly above 3.5% p.a. or if the yield curve turns negatively sloped or if the US- China trade dispute concerns continue to worsen.

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