Summary of key points

  • Both short and long-term US interest rates rose by enough to trigger a significant but not catastrophic sell-off in US equities. This spread to other equity markets. It is likely to be short lived, with equity prices recovering, however, such episodes will become more frequent and severe in the unstable policy environment being driven out of Washington

  • 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, given the opaque decision-making processes of the US and Chinese governments.

  • Against this backdrop, equity markets are still fairly priced from a longer-term point of view. The largest equity market by far, that of the US, still has solid earnings growth and stock price momentum notwithstanding the recent short-term falls.

  • Both monetary and fiscal policy in most major countries are supportive of economic growth as well as financial asset prices.

  • We continue to watch the level and the shape of the yield curve closely as it has been a good forward indicator of recessions and downturns in equity markets. So far, the curve has flattened but not yet turned negative, which would be a lead indicator of recession.

  • In addition, the US ten-year Treasury bond yield has not yet reached the historically sensitive range of 3.5% to 4.0% p.a. but has fluctuated closer to it in the last month.

  • 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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