Stanford Brown TW3 – Trees Don’t Grow To The Sky

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Market Wrap

Global markets had another strong rebound this week, with political developments once again at the forefront of investors’ minds. The week started off relatively subdued, as investors sat on their hands in anticipation of the US mid-term election results. American markets soared on Wednesday after results came in that the Democrats had regained the House of Representatives, with investors hoping Trump will be forced to water down his policies and work with the Democrats. US equities have historically seen above average returns when the House and Senate are controlled by different parties (aka a split congress).

US shares trended lower overnight, as the Federal Reserve left rates unchanged. Although this was widely expected, some investors were betting that the recent volatility in markets would prompt the Fed to reduce the pace of its interest rate hikes, however the Fed made no reference to market volatility in its press release.

Both bonds and stocks sold off in response to the Fed decision, continuing a unique trend whereby the correlation between US stocks and bonds has been positive. This means that the traditional investment strategy of purchasing government bonds as downside protection is unlikely to be successful, as bond prices are currently more likely to decline when shares decline and vice versa.


Whilst most Australians were watching the ponies on Tuesday afternoon, the RBA was hard at work sitting on their hands and waiting for the economy to pick up, leaving rates unchanged at record low levels for the 27th month in a row. A growing number of economists don’t expect the RBA to raise rates until 2020, and if a prolonged housing downturn and/or global economic shock puts further pressure on the Australian economy, further rate cuts may be on the cards.

*A correction to last week’s Market Wrap – CBA acquired Colonial First State (CFS) for $10b in 2000. Last week’s sale of CFS’ asset management arm for $4b only represents a segment of their total assets.

Finance 101 – The Risk Premium

Although investing isn’t governed by natural laws like we see in the natural sciences, one of the unavoidable aspects of investing is that returns are proportionate to risk. Stocks, bonds, bitcoin and everything else in between have their unique risks and rewards, which contributes to the divergence in their returns and volatility.

A business professor once quoted that “risk means more things can happen than will happen”. The higher the chance of a negative development, the higher return investors will demand to compensate them for that risk, which is known as a “risk premium”. For example, governments and corporations both issue bonds (debt) to finance their operations, however, government bonds are viewed as safer than corporate bonds. This is because the sales revenue of corporations is less stable than the tax revenue of governments, meaning an investor in corporate bonds should demand higher returns than as they run a higher risk of not being repaid.

The chart below is a simple example of the relationship between return and risk. The curved lines represent the probability of a return, the most likely scenario occurs where the curve is widest, whilst the least likely scenarios occur when the curve is narrow. This is why it’s misguided to say “shares return 8% per year”, as a range of other outcomes have a high probability of occurring.


Investment markets are not governed by concrete laws like the natural sciences because they consist of human beings, who are flawed decision makers. When times are good, investors get complacent about risk and don’t demand a large risk premium, making investments expensive. When times are bad, investors become too risk-averse and demand too high a risk premium, making investments cheap. We currently don’t view shares as offering a sufficient risk premium, and have positioned our client portfolios accordingly.

Trees Don’t Grow To The Sky

Technology stocks have been the major drivers of the current global bull market, with almost 40% of the rise in the S&P 500 since 2013 attributable to Amazon, Apple, Facebook, Microsoft, Netflix and Alphabet (Google’s parent company). These companies have gone from disrupters to the big kids in town, employing millions of people and taking in hundreds of billions in revenue. The wild growth of these companies, and the potential for further expansion, has prompted many investors to pay dear prices for their equity.

Trees don’t grow to the sky, and in September we saw signs of these large tech companies coming back to earth as a result of three developments:

  1. Sales growth slowing from previously astronomical levels
  2. Profit forecasts for future years being revised downwards
  3. As these companies expand, an increasing amount of capital on non-core business activities and the acquisition of competitors.

An important lesson for investors to remember even a quality company can be a poor investment if they pay too high a price. Investors buying tech stocks, bitcoin, or any other investment in vogue are banking that the future will be even better than what already an overoptimistic market expects, whilst even the slightest stumble will result in losses.

Mild Mid-Terms for ‘Merica

The US (or at least those inclined to vote) went to the polls on Wednesday to vote for members of the House of Representatives, one third of the Senate, 39 gubernational seats and a host of other state and local elections. For those struggling to keep up with the American electoral process, here’s a primer.

So what happened? As expected, voter sentiment swang against Trump, with the Democrats regaining control of the House of Representatives. Although the swing was large, it was smaller than the swing against Obama in 2010, and there have only been three occasions since 1910 where a US president didn’t experience a swing against them in the midterms. Despite the swing in the House, Republicans expanded their slim majority in the Senate, mostly thanks to only 9 of the 35 seats up for election being held by Republicans.


Source: The New York Times

Although many are breathing a sigh of relief in the hopes that Trump will be stymied by the Democrat’s win in the House, others are more cautious. Kevin Rudd warned that a Trump defeat would result in Trump believing he doesn’t have sufficient political capital to strike a deal with Xi Jinping, bringing the trade war to an end. Another concern is that Trump could simply implement his agenda via executive orders, which has been popularised by both Republican and Democrat presidents wishing to circumvent an uncooperative congress.

The Dark Side of Screens

Since the launch of the iPhone in 2007, there has been an ongoing debate on the costs and benefits of smartphones and tablet computers, usually portrayed as an intergenerational dispute between “dinosaur” boomers and “zombie” millennials. However, as a new generation is raised on Apple and Facebook, parents are increasingly curbing their children’s access to smartphones and tablets.

The fact that Steve Jobs wouldn’t let his kids use an iPad at home should speak volumes as to the dangers of these technologies when taken to excess. There are reports that the average US teenager spends up to nine hours each day consuming online media, with some researchers linking the rise of smart phones and social media to increased rates of teen depression and suicide.

Older generations aren’t immune from smartphone addiction either, with a recent poll from Pew Research revealing that both teens and their parents are having issues with smartphone overuse. Developmental psychologists have found that parental withdrawal and unresponsiveness from phone overuse can have deleterious effects on the social-emotional development of infants and toddlers, whilst a third of children surveyed said that their parents spend equal or less time with them than on their devices.


So what can we do to reduce our screen usage? Some apply general rules such as “no screens in the bedroom” or use apps that restrict usage. Others, including the millennial writing this article, have gone a step further by abandoning their smartphones in lieu of “dumbphones”. These technologies are not evil by design, rather, like many other vices or pleasures in life they require moderation.

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Have a great weekend!

Jonathan Hoyle, CEO & Nicholas Stotz, Investment Analyst

Stanford Brown

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