Charlie Aitken joins chorus warning of expensive defensives
'the simple fact is the direction of the “risk-free rate”, and the rate of change of the risk-free rate is crucial to overall equity market pricing and stock and sector selection.'
' I have been warning on long bonds and bond-like equities for 12 months. We believe long bonds and bond-like equities are real return free capital risk. '
'I believe we are going from Central Bank quantitative easing (QE) to Central Bank quantitative tightening (QT). At the same time, the US has lost all fiscal discipline under Trump and will now run huge budget deficits that require record issuance of US Treasuries. The world, led by so-called bond vigilantes, is going to charge the US a higher interest rate to fund its deficits.
After a decade of QE, Central Bank action will turn negative in 2018:
Fed balance sheet redemptions will increase, and ECB purchases will cease
At the same time, increased fiscal deficits will see “issuance” increase
The combined impact is a ~$500bn step up in supply of US Treasuries
Similarly the size of cumulative central bank balance sheets has been highly correlated to asset prices.
'If AIM is right and central bank balance sheets have peaked, and the risk-free rate is rising, then we are almost certainly past the end of the ultra-low volatility period in risk assets. You must now condition yourself for a rise in volatility. You are going to see equity index moves driven by bond market pricing. You are also going to see a rotation away from perceived defensive equities, or equities with bond-like characteristics and durations '
'I say again, just because a company operates in a defensive sector doesn’t mean its share price will prove defensive. I am of the view some of the largest potential capital losses over the next few years lie in perceived defensive sectors. As bond yields rise the price paid for defensive equities will fall, led by infrastructure, healthcare, utility, telco, supermarket and REIT sectors.'
' Defensive sector doesn’t mean defensive share price at the turning point of the interest rate cycle. This is particularly so after a decade of interest rate compression by central banks.'