Who's up for a game of chicken?

William Buck Wealth Advisory?- December 2021 Market Review?

Published 28th January 2022

Who’s up for a game of chicken?

When I was 7 yrs old I played a game of ‘chicken’ with my friend Greg White. I rode my bike down the footpath and he stood between the concrete pilon and the shop windows – he who moved first, lost.

I was the loser in more ways than one. I ended up hitting the pilon at full speed, spent a night in hospital with a cracked kneecap while my family and friends attended my dad’s 50th birthday party.

As I discovered, losing a game of chicken is one thing, however not being at the party is what hurt the most.

The US market has had a fantastic run over the last 12 years. However, the same can’t be said for all markets. The current gains since the GFC are the S&P 500 is +620%, the ASX 200 +145% and the TSX up +130%. It just so happens that the respective Central Bank balance sheets have also risen over this time. The FED +847%, the RBA +523% and the BOC (Bank of Canada) up +633%. A large portion of these increases have come over the recent COVID period.

When you couple this massive stimulus with falling and negative interest rates (ironically designed to stave off deflation) you can see how much additional liquidity has been provided. Consequently, this has fueled high returns. I am not suggesting that the market has only risen because of QE; that would be incorrect. What I am saying is that QE and low interest rates have had a significant impact and are an historical outlier.

I believe much of the consistency, of the longest US bull market in history, is attributable to the QE programs that were released worldwide in 2008 – 2009.

So, here we are today; at the beginning of much sought after inflation, with numerous rate rises now imbedded in the bond markets. I am not 100% convinced inflation is going to be the sole killer of markets that many believe. Especially in Australia, where we have a number of factors that are still transitory in nature. Plus with the advent of domestic and global travel, a number of our inflationary drivers will dissipate – especially supply constraints and wage inflation, which as you know, is my number one data point of interest.

The liquidity that has been showered on us through QE (increasing opportunity cost of holding cash) has driven a lot of the PE expansion – especially in long duration growth stocks of which the US has a lot. This PE expansion is what will be missing going forward as liquidity and stimulus is withdrawn. The markets will be more reliant on earnings growth, which has been bolstered over the last 2 years.

What I believe will end this amazing bull run is a lack of confidence (negative sentiment) in the market surviving on its own, without the added liquidity (QE). Yes, adding inflation will complicate matters, but with the US SP500 providing another head fake to the FED Reserve, with a ~12.5% fall this month, we will soon find out how serious they are to end QE once and for all.

If we cast our minds back to October 2018, equity markets pulled back 19%, leading into Christmas on the back of concerns the US FED had risen rates too quickly. The result was an about face on interest rates in late Jan 2019 and a market that rose +30% for the remainder of the year. Go back further to 2013 and we had the Taper Tantrum. The extraordinary component of this Tantrum was that the FED only said they were thinking about tapering QE. The bond market subsequently pushed yields higher, leading to a modest pullback in equities. And lastly for those students of economics, the 1987 crash and Dot Com Bubble were supported by the “Greenspan Put”, Alan Greenspan (US FED Chair ’87-‘06) who had a happy knack of reducing interest rates after a 20%+ fall in the share market.

The market is at a critical juncture, with a lot of change hitting at the one time. This game of chicken, between the Bond & Share Market and the US FED, is a game we have seen many times before. The US FED has a history of buckling under the pressure. But with US inflation looking less transitory than once indicated, this time it may be different.

These bouts of volatility remind us to ensure we reassess our risk profile, understand the “real risk” we are taking (see Dec 2020 Publication) and adjust your asset allocation if required.

It is one thing to play a game of chicken from time to time. However, if you don’t think through your strategy methodically, your portfolio could be the one in need of surgery, and you might miss the party of a lifetime.

Nigel Credlin

Director - Wealth Advisory

?