Market Commentary – 16th May 2018
Review of 2018 so far…
We had our investment committee meeting yesterday and, in these meetings, we look at the markets, our positioning as well as market opportunities moving forward, and we are still positive on the fundamentals given the current positioning on the global economic cycle. As a summary we are forecasting markets to continue to give us positive returns throughout the remainder of 2018, subject to no shocks. Although we are definitely at the peak cycle as regards to earnings and although we still firmly believe that 2019 / 2020 are going to be very poor for equity returns as US and global GDP is set to slow as detailed in the Chart below for the US. We are therefore still balancing being defensive with remining invested and are watching and discussing daily the risks as they rise and fall. There is no doubt that I am worried but it was agree yesterday that by getting out today we are potentially leaving too much cash on the table at this juncture so we for now remain balanced. IT was a unanimous decision though that if risks as they are seen today continue to grow and earnings show a peak is upon us, we will before the end of 2018 have taken a very defensive position and put capital preservation above riding this roller coaster.
Risks are still high and the above chart forecasting a slowdown in US GDP as always means the rest of the world will catch a cold and the size of that cold can depend purely on how fast the dollar appreciates and how high the 10 year US debt yield goes which is today at 3.10%. The higher the yield the less interest their will be in equity risk being taken.
Review of the Investment Committee Meeting
Q1 of 2018 has been a mixed picture, with January following on from the trend of the global economic upswing we saw in 2017, however the story changed in February when we started to see more economic volatility in the global financial markets, increasing the risks as at this juncture. The volatility present in the markets has been purely due to the rally in the equity markets throughout 2017 and strong investors sentiment being eroded as only value investors remain in the markets. Investors are selling down their positions and locking in profits as well as buying back into the markets again as the economic data remains resilient, hence the fluctuations in the valuations.
Indicators of a period of scarce growth are seen in current valuations and the risk of stagflation increases with slowing economic growth and rising inflation. We will keep an eye on the key indicators and leading indicators, to identify this stage. At OCM we are still optimistic in the economic data and feel the markets still have some more room to grow, globally. 2018 has followed on from 2017 and the risks are increasing of an economic correction as we remain in a bull stage of the economic cycle. Political risks remain on a downside, but economic risks may be tilted to the upside, and we see only a gradual response by central bankers to the favourable economic backdrop as they have started to hike interest rates. Having said that, they are cautious on the trend and not drastically increasing interest rates. Despite the general increase since the 2007/8 financial crisis, the Fed has kept its rate steady in the latest FOMC meeting. This indicates that central bankers are weary of the future and have considered peaks in inflation. With the markets currently on edge, we have highlighted various key risks on the next slide.
With the UK, we still have fears over the overall health of the economy and the future. As sterling should start falling towards the deadline of the Brexit deal that has to be seen by October 2018 for it to be ratified by all the countries in the EU for the March 2019 exit. We are therefore with so many risks politically in the UK pessimistic about the short term direction of sterling, which we feel will benefit our portfolios and our international positions.
For anyone who wants further data to substantiate the position please review the attached Global Economic News Document.
Reminder of what volatility looks like once scarcity of returns becomes no returns for equities and risk explodes – Review of 2008
One constant we are seeing with clients is that they have forgotten what real volatility is because nervousness over a 4% decline is nothing when faced with declines of 40% plus as seen in 2008, and it is this we are terrified off, to the extent that we are always prepared to forego some growth at this stage of the cycle to be protectionist. The aim with the defensive position is that we try as hard as we can to avoid the significant declines in value and as a result the decline becomes an opportunity whereas today it is threat. Losing a few % and falling behind benchmark is normal as stated above but it only becomes a positive if the equities fall and we become aggressive at the start of the new cycle. The only reference point we have is from March 2008 to May 2009 when we had the same issues as today and went defensive initially, markets overtook us, clients queried our position, markets collapsed and we then bought in in May back into equities 2019. All in as you can see our line being OBI Active 7 was safe and stable and the world went crazy around us.
There is no guarantee that we can avoid the potential losses we see nor is there any guarantee that the losses we forecast in equity prices as earnings decrease, will transpire. We are not alone though in our thesis and that gives us comfort and although we have done it before there is also no guarantee that we will do it again to the degree that it is reflected above. In 2008 though we went defensive to protect capital as we were at the peak of the of the cycle and there was definitely a debt bubble and leverage risk was increasing exponentially. We are not anywhere near that today so although we are expecting a slowdown, no one is forecasting problems in 2019 like we had in 2008. That does not mean though that when equities are high on the basis that earnings are peaking that with such a slowdown in US GDP ahead of us that the reverse will not happen and equities will not fall 30% plus from the previous high in early Feb. As always nothing guaranteed but we are the caretaker of assets and that is a serious job and not one that is taken lightly. If any clients are happy to have capital at risk of 25% with very little upside, which is what I forecast it will be from where we will peak at by late Q3 and into Q4, then please tell me now and we will let them ride this roller coaster. If not then please absorb the charts above as this is what we are fearful of or a baby version of it anyway…………….
Model Portfolios & Indices
Over the last week we have seen most of the indices that we track increase and improve with the backing of the global economic data and political market volatility being low. Again, most of the gains have been in the US which is currently leading the way but is still way off the highs seen early Feb 2018. With the model portfolios, these positions have been up over the past week as the equity side of the models have been building most of the growth in line with the markets. We are still defensive so are not tracking the benchmarks which hold significantly more equity than we do but at this stage of the cycle it is all about getting the balance. A few months under performance to avoid volatility is not something that concerns us over the short term.
Based on the mandate of OBI, by cyclically adjusting the portfolios asset allocation, we are able to remove investments we no longer have strong conviction on and skew the proceeds into areas we do hold strong conviction by accessing the macroeconomic climate and re-gauging our asset allocation in each Investment Committee Meeting. By tactfully rotating the asset allocation, we are able to remove funds which are drawing down the portfolio performance, as not all conviction calls are guaranteed to offer their return, with conviction that we are nearing the end of the cycle, but still have some upside, therefore we are still fully invested and will de-risk our portfolios when the data suggests so.
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.
This Day in History
On this day in 1868, the Impeachment of Andrew Johnson occurred, adopting eleven articles of impeachment detailing his “high crimes and misdemeanours,” in accordance with Article Two of the United States Constitution. The House’s primary charge against Johnson was violation of the Tenure of Office Act, passed by the U.S. Congress in March 1867, over the president’s veto. Specifically, he had removed from office Edwin M. Stanton, the Secretary of War—whom the Act was largely designed to protect—and attempted to replace him with Brevet Major General Lorenzo Thomas.
As always have a wonderful week and stay safe.
Jason Stather-Lodge CFP, MCSI, APFS
CEO & Founder
Chartered & Certified Financial Planner
Chartered Wealth Manager