Riding the wave of uncertainty with clients’ long-term goals in mind
In recent market commentaries, we talked of a structural market correction, and of the strategic changes we expect to make to portfolios when the time comes to adopt a more defensive stance. On reflection, after a turbulent period in markets, while hindsight now tells us that repositioning at the end of September would have been more beneficial, there are several factors which influenced our decision to remain fully invested throughout October. For these reasons, we remain fully invested going into the final weeks of 2018.
In September, markets experienced a slight pull back, however the data remained relatively strong, and not indicative of the market conditions we would classify as awaiting a structural correction. The decision was made to stay invested and not alter our positioning. Heading into October, with fundamentals holding strong, and the overwhelmingly positive earnings data coming out of the US, a significant decline in markets in October was unexpected, and is still yet to be explained by more than political uncertainty over the US mid-term elections, Italian budget concerns, and the ongoing trade wars. In hindsight, we now know that portfolios would have benefitted from a more defensive stance following the September drop back, however as nothing more than the usual October volatility was forecasted, the risk was not deemed significant enough to reposition portfolios.
While in the short term, the decision not to reposition is painful, we are staying invested and riding the short term market volatility, with the expectation that momentum investing within markets will enable us to recover from the October lows. This is the generally accepted consensus with fund managers and economists, however is also likely result in high levels of volatility in the last weeks of the year. From a behavioural economics standpoint, in the short term, we are moving with the herd, with market consensus remaining fully invested and supportive of equities. Data continues to indicate that a structural correction involving a c. 20% – 30% decline in equity market valuations is on the horizon, with most economists are forecasting a slowdown in 2019, before a contraction in 2020. Based on this, we remain fully invested for now, however as we go into 2019, we will be reviewing the positioning of portfolios with a view to take a more defensive stance with the expectation of increased market volatility and slowdown in 2019.
In terms of asset allocation, all assets experienced decline over October due to the unexpected, non-structural nature of the correction, with all portfolios registering negative returns over the period. Non-equity assets lost value as yields drew higher, and equities fell in value over the month. In contrast, during a structural correction, we expect non-equity assets to increase in value due to lower bond yields, benefitting portfolios with more defensive asset allocations. Where we do believe in making strategic alterations to portfolios based on positioning in the business cycle, we do not believe in trying to time the markets, and defensively repositioning portfolios during a correction would prove futile unless the correction becomes structural. It is clear based on the movement of asset classes and the unexpected nature of the correction that this was not structural, therefore repositioning after the market turned in October would have disadvantaged portfolios, crystallising losses during a drop-back in markets. The negative hit to market indices was quick to take hold, and continued over the course of five trading days, therefore unless we were concerned about the start of a more severe correction, the most suitable course of action was to wait for stabilisation and ride the recovery afterwards. We remained in close contact with fund managers throughout this period and all remained invested and retained their asset allocation to equities. (see chart below for pace of change)
Overall Thesis
Overall, the correction in October has not altered our investment outlook. We continue see evidence of the end of the economic cycle and see a structural correction on the horizon. The data suggests that equity markets still have some headroom to provide positive returns therefore we remain fully invested for the final weeks of 2019. Despite this, we do still intend to step away from the herd as we go into 2019, in line with our long-term outlook for 2019 and 2020. Hindsight is a beautiful thing; however, we continue to monitor global economic conditions with our long-term objectives in mind, riding market volatility through noise and political instability.
For further details on the underlying economic data please refer to the attached economic data set.
FYI by structural we mean that we are going to see a significant global slowdown that will see circa 20% – 30% peak to trough wiped off global equity valuations in the short term and will predicate the end of this economic cycle and the start of a new one. When that happens, we expect non-equities to rise and bond yields will fall, and equities will fall. Also, FYI we are still fully invested in Active 9 and CAT stock and I am happy to stay invested for now as I am content that the markets will l rally to year end and the midterm has and as it always does is a cause for volatility that should be ignored.
Model Portfolios & Indices
As you will note from the index’s performance below, we have had another week of negative performance in most of the global indices, but the volatility is much lower than we experienced at the beginning of October. We have though experienced a fall in the value of sterling due to uncertainty over Brexit which has fed through and provided for a more positive feed through into the portfolios. Overall the week has been positive for the model portfolios against the backdrop which is good.
Important Information
The data above will not directly correlate to the indices as there is always a delay in pricing because the US markets close significantly later than the European markets and the Asian markets. The data set above reflects the last close and much of the days movements will not yet be reflected in the portfolios due to pricing delays. You cannot therefore directly correlate indices to the portfolios. The value of investments may fluctuate in price or value and you may get back less than the amount originally invested. Past performance is not a guarantee of future performance. Performance figures quoted include the fund manager charges but exclude other fees such as adviser, custodian, switch and/or discretionary investment management fees. Unless otherwise instructed and accrued, income is reinvested into the portfolio.
Fact of the week!
When NASA started sending up astronauts, they quickly discovered that ballpoint pens would not work at zero gravity. To combat the problem, NASA scientists spent a decade and $12 billion developing a pen that wrote at zero gravity, upside down, underwater, on almost any surface including glass and at temperatures ranging from below freezing to 300C. The Russians used a pencil.
VBW and stay safe. Will be back to the usual Wednesday next week.
Jason
